IRS Dirty Dozen for 2017, Tax Shelters, and Captive Insurance: Attacking Past Problems Using a Voluntary Disclosure Strategy

by Varnum LLP
Contact

The IRS summarized its annual "Dirty Dozen" List of Tax Scams for 2017 in February. Practitioners and taxpayers should pay particular attention. The IRS is broadcasting their playbook. This list includes two principal types of tax matters: (1) scams that are intended to victimize taxpayers directly, and (2) scams in which taxpayers voluntarily – or unwittingly – agree to participate. The first set of scams includes identity theft, phone scams, and things like solicitations from fake charities. These items often result from direct attacks on taxpayers. The second set of scams typically involves a taxpayer's voluntary participation, but there often are misunderstandings and reliance questions that can be very important to the resolution of the issue. Whatever the source, each problem creates a set of issues that taxpayers, their CPA advisors, and experienced tax counsel should evaluate very carefully.

Abusive Tax Shelters – Including Captive Insurance – Make the Dirty Dozen List…Again

Key among the scams that make the "Dirty Dozen" list is the abusive tax shelter. Abusive tax shelters have been a perennial target of the IRS for decades, and the IRS annually reaffirms its commitment to uncovering and stopping complex tax avoidance/evasion schemes. 

One abusive tax shelter that repeatedly makes itself a topic for the IRS is the captive insurance structure. Captive insurance is a perfect example of a structure that can be fully defensible, fully abusive, or somewhere between the two. In many cases, captive insurance can be a legitimate business activity; however, often an ill-advised taxpayer will implement a plan that is attacked by the IRS as "abusive" because it was not properly designed. 

Captive insurance generally is a legitimate, legislatively-approved tax structure. However, the IRS often determines that an abuse has occurred with respect to certain small or "micro" captive insurance companies. Federal tax law allows businesses to create "captive" insurance companies to protect against certain risks. The insured business claims tax deductions for premiums paid for the insurance policies, and the premiums are paid to a captive insurance company that normally is owned by the same owners of the insured business. The captive insurance company, in turn, can elect to be taxed only on the investment income from the pool of premiums, excluding taxable income of up to $1.2 million per year in net premiums.

In the type of structure that is likely to be classified as abusive, promoters persuade closely-held entities to create captive insurance companies. The promoters assist with creating and "selling" "insurance" binders and policies from the captive to the business to cover either ordinary business risks, or implausible risks, and charging high premiums while maintaining market rate commercial coverage with traditional insurers.

The promoted structure often results in premiums equal to the $1.2 million annually to take full advantage of the tax code provision. Underwriting and actuarial substantiation for the insurance premiums often do not exist, and the promoters manage the captive insurance companies in exchange for significant fees.

There are myriad variations of legitimate captive structures, and taxpayers should carefully evaluate any existing or proposed captive insurance program. Like other structures that are designated to be "abusive," a captive insurance structure can result in a protracted and costly audit – and potentially a criminal investigation – if it is discovered by the IRS. 

A clear warning sign to practitioners is when their client is advised to exclude you from analysis or review of the strategy or product.

Taking a Proactive Approach to Tax Issues: Considering a Voluntary Disclosure Strategy

It is the specter of exposure, including both investigations and costly audits, that reminds us of the alternative to simply sitting back and waiting for the government to audit: a voluntary disclosure. A voluntary disclosure may be used to address past reporting, non-reporting, or mis-reporting, and may be a viable strategy for many types of missteps – both the types specifically referenced by the IRS in its "Dirty Dozen," and other items that create similar audit risks. The voluntary disclosure alternative is not an unconditional surrender, and it is not without risk, but a well thought-out, designed, and implemented voluntary disclosure can minimize costs, penalties, and the time involved in addressing problems. A thoughtfully designed voluntary disclosure strategy can offer material benefits, but it should never be implemented until after there has been comprehensive analysis conducted in an attorney-client privileged environment.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Varnum LLP | Attorney Advertising

Written by:

Varnum LLP
Contact
more
less

Varnum LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.