In Avrahami v. Commissioner, 149 TC No. 7  (Aug. 21, 2017), the Tax Court disallowed a couple’s insurance premium deductions for amounts paid to a purported captive insurance company, finding that the entity was not an insurance company.  The Tax Court also held the couple liable for taxes on unreported interest and dividends and for some accuracy-related penalties.

The Tax Court summary of the opinion is as follows:

Ps claimed deductions under I.R.C. section 162 on their 2009 and 2010 tax returns for amounts paid by their passthrough entities to captive insurance company C wholly owned by PW and to off-shore company A which reinsured a portion of its risk with C. R denied the deductions and determined that C’s elections under I.R.C. section 831(b) to be treated as a small insurance company and under I.R.C. section 953(d) to be taxed as a domestic corporation were invalid, as the amounts paid did not qualify as insurance premiums for federal income tax purposes. R also determined that amounts transferred out of C were distributions to Ps, not loans, and that Ps were liable for accuracy-related penalties under I.R.C. section 6662(a).

Held: Amounts paid to C and A are not insurance premiums for federal income tax purposes and are not deductible under I.R.C. section 162.

Held, further, C’s I.R.C. section 831(b) and section 953(d) elections are invalid for 2009 and 2010.

Held, further, the amount transferred directly from C to PW is an ordinary dividend.

Held, further, the amount transferred indirectly from C to Ps is not taxable to the extent it is a loan repayment, but the excess is either taxable interest or an ordinary dividend.

Held, further, Ps are not liable for accuracy-related penalties under I.R.C. section 6662(a) except in relation to the amounts determined to be ordinary dividends or taxable interest.

Posted by Lewis J. Saret, Co-General Editor, Wealth Strategies Journal.