by Brian Mahany
It didn’t take long. On July 18th we wrote about the new IRS audit push on captive insurance companies. Unless very carefully crafted, the IRS considers most to be abusive tax shelters. This means big penalties if you misuse one to avoid taxes. Unfortunately, the captive insurance market has attracted its fair share of Internet and scam promoters.
Yesterday I argued with a caller who insisted the plan he was considering was not a scam. (I know, why call a tax lawyer unless you have some deep seated doubt.) When I suggested obtaining a private letter ruling from the IRS the caller declared that the promoter was “right.” Evidently the promoter had warned him about any attorney who made such a suggestion. In a perverse twist of logic, the scam artists are now warning their victims about seeking help from legitimate tax professionals.
I suspect that I am not the first lawyer or CPA who has heard this line.
Captive insurance companies, if constructed correctly, have many tax advantages. Businesses with captives can deduct 100% of their premiums, have their money grow tax free and later get it at a lower capital gains tax rate. To qualify as a captive, however, your premium dollars have to be at risk. That and your captive must insure a certain amount of third party risk.
Many slick promoters have been setting up offshore risk “pools” with the thought of hiding the true nature of the risk from the IRS. Participants are promised that they can get all or most of their money back and with very little tax exposure.
It all sounds great until the business receives an audit notice in the mail. Unfortunately, when the IRS audits the pool it is the company, and not the promoter, who is on the hook for substantial taxes, interest and penalties.
In an effort to dupe business owners and better market their product, illegitimate promoters frequently resort to a number of tricks including
- Phony or forged IRS private letter rulings, or
- Recycled rulings that pertain a different product than what the promoter is selling, and
- Warnings to potential clients to not seek a private letter ruling.
It is the latter trick that surprised me yesterday. The caller I spoke to told me that he was warned that seeking a private letter ruling was tantamount to inviting an audit.
Private letter rulings don’t bring audits. Having one, however, can certainly protect you if you are audited. Since 2006, the cost for such a ruling has increased dramatically – a $6000 fee to the IRS plus attorney’s fees. If you are planning on sheltering millions in pretax profits, however, its worth every penny.
In today’s age of desktop publishing, it is easy to quickly churn out slick brochures, website and even forged IRS documents that suggest that these captive insurance companies and risk pools are legitimate. Be careful of who you deal with and never be afraid to seek an independent third party to review the plan. Better yet, for real peace of mind consider a private letter ruling from the IRS.
If you have questions about captive insurance companies, captive management companies or other potential abusive tax shelters, give us a call. We have experience in a wide variety of tax shelter cases including captives, 412 plans, 419 plans and the like. We are equally comfortable negotiating a resolution for you with the IRS or fighting for you in U.S. Tax Court if settlement is not an option.
Mahany & Ertl – America’s Tax Lawyers. Offices in Milwaukee, Wisconsin; Detroit, Michigan; Portland, Maine; Minneapolis, Minnesota and coming soon, San Francisco, California (tax only). IRS tax services available nationwide.
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