The U.S. Tax Court recently issued a very fact intensive ruling in Avrahami v. Commissioner, holding that the risk distribution requirements for insuring either related or unrelated entities were not met and that the arrangement was found to not constitute insurance. However, when it comes to the decision over risk distribution, there are some key takeaways for taxpayers.
First, the court did not offer its opinion on the number of related entities that would constitute proper risk distribution for a micro-captive. Second, the court indicated that it was interested in the overall number of independent risk exposure units involved, but refused to opine on the number of risks that would be sufficient to cover. Finally, while the court held that the risk distribution requirement was not met through the particular risk pool in the case, the court did not prohibit or even speak negatively about the use of risk pools more generally. As a result of this methodology, alliantNational recommends that taxpayers review how their risk distribution arrangements compare to Avrahami.
When deciding that the micro-captive arrangement did not constitute insurance, the court analyzed a variety of factors including if the company was organized, operated, and regulated as an insurance company; whether it was adequately capitalized; whether policies were valid and binding; whether premiums were reasonable and at arm’s length; and whether claims were paid. However, it should be noted that not one variable caused the court to rule against the Avrahamis. Rather, these factors were judged in their totality—and together, the arrangement didn’t add up to commonly accepted principles of insurance. This points to the fact-specific nature of the case, and that Avrahami will not necessarily serve as the end-all standard for future micro-captive insurance cases. While this decision was not favorable to the Avrahamis, there is a long way to go before the controversy around micro-captives is settled.
Going forward, it will be vital for all captives to undergo a thorough review of their program, and to implement immediate changes. alliantgroup’s full statement on the ruling can be found here. Those with questions can feel free to contact alliantgroup should they need further guidance on the impact of the court’s decision.