1. 6
TENNESSEE REPORT 2015 | WWW.CAPTIVEREVIEW.COM
TENNESSEE | MOORE INGRAM JOHNSON & STEELE
O
n February 3, 2015, the Inter-
nal Revenue Service said using
abusive tax shelters and struc-
tures to avoid paying taxes
continues to be a problem
and remains on its annual list of tax scams
known as the “Dirty Dozen” for the 2015
filing season. Below is an excerpt from the
IRS.GOV site, with the author’s comments
added in italics below.
Another abuse involving a legitimate
tax structure involves certain small or
“micro” captive insurance companies.”
Note that the IRS acknowledges that this is a
“legitimate tax structure.”
Tax law allows businesses to create “cap-
tive” insurance companies to enable
those businesses to protect against cer-
tain risks.
As long as the risks insured are real and
fortuitous, each business owner has the
legal right to acquire these policies through
their own captive.
The insured claims deductions under the
tax code for premiums paid for the insur-
ance policies while the premiums end
up with the captive insurance company
owned by same owners of the insured or
family members.
The U.S. Tax Court never agreed with the
IRS’ “Economic Family Theory”. This the-
ory, abandoned by the IRS in 2001 (Rev. Rul.
2001-31, 2001-26 I.R.B. 1348 (6/25/2001)),
argued that the same economic group
could not insure its own risks.
The captive insurance company, in turn,
can elect under a separate section of the
tax code to be taxed only on the invest-
ment income from the pool of premiums,
excluding taxable income of up to $1.2m
per year in net written premiums.
This Code Section was enacted into law as
part of The Tax Reform Act of 1986.
In the abusive structure, unscrupulous
promoters persuade closely held entities
Written by
Matthew J. Howard
Matthew J. Howard JD, LL.M. serves as senior part-
ner in the captive, tax, and estate planning depart-
ments of Moore Ingram Johnson & Steele. Matthew
specializes in the taxation of micro captives, estate
planning and tax controversies. MIJS currently man-
ages over 100 micro captives.
Matthew J. Howard of Moore Ingram Johnson & Steele, LLP, comments on the IRS
“Dirty Dozen” list of tax scams for the 2015 filing season
THE IRS’ 2015
“DIRTY DOZEN” LIST
OF TAX SCAMS

2. 7
TENNESSEE REPORT 2015 | WWW.CAPTIVEREVIEW.COM
MOORE INGRAM JOHNSON & STEELE | TENNESSEE
to participate in this scheme by assist-
ing entities to create captive insurance
companies onshore or offshore, drafting
organizational documents and preparing
initial filings to state insurance author-
ities and the IRS. The promoters assist
with creating and “selling” to the
entities often times poorly drafted
“insurance” binders and policies to
cover ordinary business risks or eso-
teric, implausible risks for exorbi-
tant “premiums”, while maintaining
their economical commercial cover-
age with traditional insurers.
Micro Captives (captives with lim-
ited premiums and elect IRC Sec
831(b) treatment) should only be
formed and managed by a team of
experienced liability, tax, account-
ing and actuarial experts. The pol-
icies should cover risks that are real
and applicable to the insured paying
the premiums. The captive policies
should be written to compliment and
supplement the insured commercial
or group captive policies and not
be contradictory or redundant thereto.
These captive policies should be annu-
ally reviewed for changes to the insured’s
business and/or commercial policies and
periodically repriced by a competent and
independent actuary.
Total amounts of annual premiums often
equal the amount of deductions business
entities need to reduce income for the
year; […]
This should never happen purposefully
nor even be considered when the compe-
tent and independent actuary is pricing the
policies.
[…] or, for a wealthy entity, total premi-
ums amount to $1.2m annually to take
full advantage of the Code provision.
In reality, premiums of exactly $1.2m should
occur as often as a lightening strike. The
captive should be used to secure needed
insurance coverages not needed premiums.
Underwriting and actuarial substantia-
tion for the insurance premiums paid are
either missing or insufficient.
This is unacceptable in all instances.
The promoters manage the entities’ cap-
tive insurance companies year after year
for hefty fees, assisting taxpayers unso-
phisticated in insurance to continue the
charade.
Everyone has a right to make an honest liv-
ing (the operative word is “honest”).
The IRS is completely justified in includ-
ing micro captives on this tax shelter list.
We have assumed management of several
captives, which we needed to rehabilitate.
The captive industry, including several DOI
Departments in the USA domiciles and USA
State Captive Associations, is doing a better
job lately in not tolerating “unscrupulous
promoters” by insisting that micro captives
be formed and managed properly.
These micro captives can serve a vital role
in augmenting the insured’s commercial or
group captive program. We have wit-
nessed a business that would be defunct
today were it not for the coverage they
filed a claim on in their captive.
It is imperative that every micro cap-
tive exemplify a real insurance company
by exhibiting, among other indices, risk
shiftingandriskdistribution. Theseprin-
ciples have been upheld by the Courts.
Rent-A-Center, Inc. v. Commissioner,
142 T.C. 1, 21 (2014); Sears, Roebuck & Co.
v. Commissioner, 96 T.C. 61, 101 (1991),
aff’dinpartandrev’dinpart,972F.2d858
(7th Cir. 1992); AMERCO, Inc. & Subs. v.
Commissioner, 96 T.C. 18, 38 (1991), aff’d,
979 F.2d 162 (9th Cir. 1992); Harper Grp. v.
Commissioner, 96 T.C. 45, 58 (1991), aff’d,
979F.2d1341(9thCir.1992)andhavebeen
echoed by the IRS in Revenue Rulings
2002-89 and 2002-90.
In closing, I hope our captive industry
continues to weed out the unscrupulous
folks and I hope the IRS takes the time and
effort to distinguish those of us forming and
managing captives properly for our clients
from the unscrupulous promoters. Nei-
ther task is difficult!
“I hope our captive
industry continues to weed
out the unscrupulous
folks and I hope the IRS
takes the time and effort
to distinguish those of us
forming and managing
captives properly for
our clients from the
unscrupulous promoters”
10. The client, in the first discussion about
captives, insists that they pay $1.2m in
insurance premiums and the promotor
responds “no problem”
9. They suggest to their client that a
captive can be formed offshore for less
capital, regardless of underwriting
8. The promoter agrees with client that
premiums paid into the captive can be
withdrawn as a loan in any amount and as
soon as the premium has been paid
7. Premium levels never change throughout
the life of the captive
6. Promoter charges fees based upon a
percentage of premiums paid
5. Promoter agrees or even encourages
the captive owner to invest most or all of
the captive money in a life insurance policy
that has little or no cash surrender value in
the first few years
4. The promotor has a menu of coverages
and pre-written policies to choose from
regardless of the insured’s business
3. The promoter tells his client that he
never really has to file a claim
2. The promoter does not have one
commercial liability insurance broker in his
contacts list
1. The promoter has never read or
subscribed to Captive Review!
TOP 10 REASONS YOU CAN RECOGNIZE
AN UNSCRUPULOUS CAPTIVE PROMOTER