The U.S. Tax Court has issued another opinion regarding microcaptive transactions in the case of Patel v. CIR, T.C. Memo. 2024-34. This is the third such opinion this year, with a previous opinion in 2020. The trend in these cases is consistent – taxpayers and captive owners are losing due to inflated premiums, lack of an arm’s length transaction, and absence of insurance in the traditional sense.
The case involves Dr. Sunil S. Patel from Abilene, Texas, who formed a captive insurance company called Magellan Insurance Company in St. Kitts in 2011. This company was used to purchase a life insurance policy from Minnesota Life Insurance Company. In 2016, a second captive called Plymouth Insurance Company was formed in Tennessee. Both captives operated under a risk pool managed by Capstone Reinsurance Company in the Turks & Caicos Islands.
The premiums paid to Magellan and Plymouth were significantly higher than premiums paid to traditional commercial insurance companies. Actuary Allen Rosenbach’s calculations for these premiums were criticized for being inflated to reach the $1.2 million limit allowed by Section 831(b) of the tax code. The court found that the premiums were not actuarially determined and did not reflect actual risks.
The risk pool managed by Capstone Reinsurance Company was found to be deficient in providing genuine risk distribution. Moreover, some individuals involved in managing the captives owned their own captives that participated in the same risk pool, raising concerns about conflicts of interest. The court also noted that the captives did not provide insurance in the commonly accepted sense.
The court ultimately ruled that the insurance transactions involving Magellan and Plymouth were not deductible for federal tax purposes as they did not meet the criteria of genuine insurance. The case highlights the common issues seen in microcaptive cases, and the outcome was unsurprising given the flaws in the structure and operation of the captives.
The use of life insurance in captives, as seen in this case, raises additional concerns about the true purpose of the captives and potential promoter penalties for those involved in selling such products. The potential inclusion of life insurance commissions in promoter penalty assessments is an issue that may be explored further in future cases.
Overall, the Patel v. CIR case adds to the growing body of U.S. Tax Court opinions on microcaptive transactions, showcasing the pitfalls and challenges faced by taxpayers and captive owners who engage in such arrangements. The case serves as a cautionary tale for those considering or currently involved in microcaptive structures and underscores the importance of compliance with tax laws and regulations.
