Helvering v. LeGierse

Established the principle that both risk shifting and risk distribution are requirements for a contract to be treated as insurance.

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Carnation Co. v. Commissioner

Denied a deduction for premiums paid by a parent corporation to an unrelated U.S. insurer to the extent the premiums were ceded (pursuant to a reinsurance arrangement) by the insurer to the parent’s wholly owned Bermuda captive. The court’s decision hinged on its determination that the captive wrote no unrelated risk, was inadequately capitalized and entered into an agreement under which the parent could be compelled to contribute additional capital to the captive.

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Stearns-Roger Corp. v. Commissioner

The U.S. District Court held that premium payments by a parent to its wholly-owned captive subsidiary were not deductible based on the “economic family” doctrine. The 10th Circuit Court of Appeals supported the denial, but rejected the economic family argument.

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Crawford Fitting Co. v. U.S.

The court held that insurance premiums paid to a Captive by a group of separate corporations that were owned and controlled by a group of related individuals were deductible because the shareholder/policyholders of the captive were not so economically related that their separate financial transactions had to be aggregated and treated as the transactions of a single taxpayer.

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Clougherty Packing Co. v. Commissioner

This complex Tax Court decision, disallowing captive premium deductions, touched on many controversial issues and resulted in wide differences of opinions among the 19 judges.

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Humana v. Commissioner

The 6th Circuit Court of Appeals held that the brother-sister captive arrangement constituted insurance for federal income tax purposes and, as such, premium payments attributable to the risk exposures of the captive’s brother-sister entities (but not its parent) were deductible. The Court’s decision was based on the so-called “balance sheet” approach, under which risk shifting depends on the effect of the arrangement on the policyholder’s net assets.

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Gulf Oil Corp. v. Commissioner

In Gulf Oil, the Tax Court found that the outside business (two percent) fell short of the necessary threshold for risk distribution.

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Sears, Roebuck Co. v. Commissioner

Several subsidiaries of Sears, Roebuck & Co. sell insurance. One, Allstate Insurance Co., underwrote some of the risks of the parent corporation. Two others wrote mortgage insurance, promising to pay lenders if borrowers defaulted. Because Sears and all other members of the corporate group file a consolidated tax return, disputes about the tax consequences of these transactions affect the taxes of the entire group. Because over 99 percent of the “captive’s” business was with unrelated parties, the Tax Court held that “substantial” outside business was enough to produce both “risk shifting” and “risk distribution,” and that the contracts at issue in each case (including those with the captive’s parent) therefore involved insurance. The Tax Court organized the relevant factors under three general headings. To be insurance, the contract had to involve “insurance risk”; provide for risk shifting and risk distributing; and conform to “commonly accepted notions of insurance.

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AMERCO v. Commissioner

AMERCO, Inc. and a number of its subsidiaries purchased insurance policies from Republic Western Insurance Company and deducted the premiums for income tax purposes. The insurance business from the AMERCO group constituted from between 26 percent to 48 percent of Republic’s business; the remaining insurance business was unrelated. Because Republic was a subsidiary of AMERCO, the IRS determined that the transactions did not constitute “insurance” for income tax purposes, and disallowed the deductions.

AMERCO petitioned the Tax Court for a redetermination and the Tax Court held that the arrangement between AMERCO and Republic constituted insurance for federal income tax purposes.

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Ocean Drilling & Exploration Co. v. United States

The Federal Circuit has affirmed the Claims Court’s decision in Ocean Drilling & Exploration Co., which held that payments made by the company to its wholly owned subsidiary constituted insurance premiums deductible as business expenses under section 162. The Claims Court had found that the subsidiary was a valid insurance company, and that risk shifting and risk distribution were both present – when the captive did 44 percent to 66 percent of its business with unrelated parties.

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The Harper Group v. Commissioner

Tax Court held, and the 9th Circuit Court of Appeals affirmed, that risk shifting and risk distribution were present where the captive received 29 to 32 percent of its premiums from unrelated parties. As such, the captive arrangement was found to constitute insurance for federal income tax purposes and payments made to the captive were deductible under IRC §162.

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Malone & Hyde v. Commissioner

The Sixth Circuit, reversing the Tax Court, has held that a company and its subsidiaries were not entitled to deduct amounts paid for insurance to the extent that the primary insurer made payments to the company’s wholly owned subsidiary for reinsurance and concluding that brother-sister transactions were not insurance because the taxpayer guaranteed the captive’s performance and the captive was thinly capitalized and loosely regulated.

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Kiddie Industries v. United States

Applying the balance sheet approach articulated in Humana, the Court held that premium payments made by brother-sister entities to the captive were currently deductible. In contrast, payments made by divisions of the parent corporation did not constitute insurance premiums deductible under IRC §162.

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UPS v. Commissioner

The 11th Circuit found that the Tax Court had improperly determined that a restructured program in which a shipping corporation transferred its “excess value charge” income and obligations to a Bermuda insurance company was a tax sham. The Tax Court opinion describes the economic-substance doctrine as follows:

“This economic-substance doctrine, also called the sham-transaction doctrine, provides that a transaction ceases to merit tax respect when it has no ‘economic effects other than the creation of tax benefits.’ Even if the transaction has economic effects, it must be disregarded if it has no business purpose and its motive is tax avoidance.”
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Wendy’s International v. Hamer

The Illinois Fourth District Appellate Court recently overturned a trial court ruling and determined that a captive insurance company was an insurance company for Illinois corporate income tax purposes, and was therefore not includable in the corporate Illinois combined filing. Under Illinois law, insurance companies cannot be included in a combined return with noninsurance affiliates because insurance companies are required to apportion business income using a different single-factor apportionment formula based on direct premiums written. Although a significant amount of the insurance company’s income for the tax years in question was generated from intercompany trademark royalty payments and interest, rather than from insurance premiums paid by affiliates, it was still an insurance company since the company was licensed as an insurance company under Vermont law, and the Internal Revenue Service (IRS) treated it as an insurance company under separate federal audits and did not dispute its status.

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Rent-A-Ccenter, Inc. v. Commissioner

Payments made by a corporation’s subsidiaries to another of its subsidiaries, a captive insurer, were deductible as insurance expenses. The corporation conducted its business through stores owned and operated by its subsidiaries. The other subsidiaries paid amounts determined by actuarial calculations and an allocation formula to the insurer subsidiary, which reimbursed a portion of each subsidiary’s claims. As such, premiums allocated to the sibling subs and paid via the parent are deductible. The insurer subsidiary was created for significant and legitimate nontax reasons and was not a sham.

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Securitas Holdings v. Commissioner

In a memorandum opinion, the U.S. Tax Court in Securitas v. Commissioner, T.C. Memo 2014-225 (October 29, 2014) held that payments made to a brother-sister insurance company were properly deductible as insurance premiums. This decision follows the full Tax Court’s opinion earlier this year in Rent-A-Center v. Commissioner, 142 T.C. 1 (January 14, 2014) in which the court similarly ruled that premiums paid by a parent company to a subsidiary insurance company on behalf of other wholly-owned subsidiaries were properly deductible as insurance premiums. The favorable Securitas opinion provides additional support for existing captive insurance arrangements and calls in to question the status of Revenue Rulings 2005-40 and 2002-90, including whether the IRS will continue to assert the positions in these Rulings.

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R.V.I. GUARANTY v. Commissioner

In R.V.I. Guaranty Co., Ltd. & Subsidiaries v. Commissioner, the US Tax Court held that residual value insurance contracts that protect against unexpected decline in the market value of particular assets cover an insurance risk and the contracts are insurance contracts for federal income tax purposes.

Our analysis of insurance risk, risk transfer, risk distribution, and the commonly accepted notions of insurance convinces us that the RVI policies are ‘insurance contracts’ for federal income tax purposes,” Judge Albert G. Lauber said in the court’s opinion. “Because more than half of petitioner’s business during 2006 consisted of issuing ‘insurance contracts,’ petitioner was for that year an ‘insurance company’ within the meaning of section 831(c) and was required to compute its ‘insurance company taxable income’ under section 832.
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