Recently, the Internal Revenue Service (IRS) mailed Letter 6336 to everyone that it could determine had filed (or in some cases not filed) Form 8886 relating to their participation in a micro captive transaction (the Micro Captive Soft Letter).
The IRS announced several months ago that they are increasing their compliance activity in the micro-captive area as they look for abusive arrangements by taxpayers. As the Micro Captive Soft Letter states, the IRS has deployed examination teams to specifically target such arrangements. The term “micro-captive” refers to taxpayers involved in arrangements that utilize the rules embodied in a particular part of the Internal Revenue Code, namely Section 831(b), which allows certain benefits in the tax law to smaller insurance companies. This section allows the reinsurance company the ability to only be taxed on investment income and not be taxed on insurance underwriting income.
Automobile dealers have historically participated in this space primarily via automotive finance and insurance (F&I) reinsurance companies (ARCs). The IRS has taken various positions as to the legitimacy of ARCs. In each case, the legitimacy of ARCs has been upheld by the IRS and, when litigated by the IRS, the court system.
Automobile dealers have also participated less frequently in the micro captive insurance space via enterprise risk arrangements, which are being tested in the court system and examined with more frequency by the IRS. If you have one of these arrangements utilizing the benefits of Section 831(b) for enterprise risk (e.g., garage-keepers liability, cyber risk, etc.), you should reach out to your tax advisor – even if you have not received IRS Letter 6336, it is important to understand the IRS’s activities and communications in this area.
The Micro Captive Soft Letter also contains a “Penalties of perjury statement.” The following are items from this section that will be of interest to automobile dealers:
- A reinsurance arrangement involving dealerships that currently cedes unrelated F&I risk premiums into a reinsurance company is an arrangement that utilizes the benefits of IRC Section 831(b) by the reinsurance company.
- A reinsurance company continues to utilize the benefits of IRC Section 831(b) until such time as all policies inside the reinsurance company are no longer in force either due to their lapsing due to time or being cancelled by the insured.
- As the recipient of this letter of the IRS, if you are either a dealership, a dealership shareholder or a reinsurance company shareholder, please remember to consider all of your reinsurance arrangements as you make the decision whether to sign and return the “Penalties of perjury statement” contained in the Micro Captive Soft Letter.
If you are selected for examination as a part of this increased effort by the IRS, please contact your tax advisor immediately for assistance during the examination process. DHG has an entire reinsurance team dedicated to the automotive reinsurance industry that is available should the need arise. For more information, reach out to us at email@example.com.