2025 TC Memo 81
T.C.2025Background
- Curtis K. Kadau, president and sole shareholder of Surface Engineering & Alloy Co., Inc. (an S corporation), set up a microcaptive insurance arrangement with entities Risk & Asset Protection Services, Ltd. (in Nevis) and RMC Property & Casualty Ltd. for policy years 2012–2017.
- Surface Engineering continued to maintain and deduct standard commercial insurance, but also paid substantial premiums to the captive and related entities, claiming tax deductions for these captive insurance transactions.
- The IRS disallowed these deductions, arguing the arrangement did not constitute true insurance for federal income tax purposes and assessed deficiencies and substantial accuracy-related penalties.
- Key factual disputes concerned whether the captive structure truly shifted and distributed risk, if premiums were actuarially determined and reasonable, and whether the arrangement was insurance in the commonly accepted sense.
- After trial, the Tax Court addressed multiple issues, including whether the arrangement was deductible insurance, the correct tax treatment of any payments, and penalties.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether captive arrangement constitutes insurance under tax law | Risk & Asset provided bona fide insurance, meeting all legal tests | Arrangement lacked real risk distribution and was not authentic insurance | Not insurance: arrangements failed risk distribution and were not insurance in the commonly accepted sense |
| Deductibility of payments as business expenses | Payments to captive were ordinary/necessary and thus deductible | Payments non-deductible as not insurance under Section 162 | Not deductible; not "insurance" payments |
| Tax treatment: Accumulated earnings & subpart F income | Amounts (if not deductible) should be treated as nontaxable capital contributions | Transfer should be taxed as subpart F income as not insurance business | Amounts treated as nontaxable capital contributions |
| Accuracy-related penalties | Reasonable cause/good faith reliance on professional advice, substantial authority | Taxpayer negligent, penalties justified | Penalties upheld; reasonable cause and substantial authority defenses rejected |
Key Cases Cited
- Clougherty Packing Co. v. Commissioner, 811 F.2d 1297 (9th Cir. 1987) (distinguishes between insurance and self-insurance for tax deductibility)
- Welch v. Helvering, 290 U.S. 111 (1933) (allocates burden of proof in tax deficiency actions)
- Rent-A-Center, Inc. v. Commissioner, 142 T.C. 1 (2014) (provides multi-factor test for determining whether captive insurance arrangement constitutes insurance)
- Harper Grp. v. Commissioner, 96 T.C. 45 (1991) (outlines criteria for insurance deductions to a captive; affirmed on appeal)
- AMERCO & Subs. v. Commissioner, 96 T.C. 18 (1991) (explains insurance-in-the-commonly-accepted-sense factor)
- Beech Aircraft Corp. v. United States, 797 F.2d 920 (10th Cir. 1986) (risk shifting and self-insurance distinction)
- Montana v. United States, 440 U.S. 147 (1979) (collateral estoppel/issue preclusion standard)
- Parklane Hosiery Co. v. Shore, 439 U.S. 322 (1979) (discusses rationale for issue preclusion)
- Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43 (2000), aff’d 299 F.3d 221 (3d Cir. 2002) (reasonable reliance on professional advice for penalties)