Page 560 - TaxAdviser_2022

TAX CLINIC

199 (4th Cir. 1989), by the Fourth Cir- that the majority of his income was
cuit, to which this case would ordinarily from his legal business, which the Tax It is recommended
be appealable, to determine whether the Court said indicated that development
taxpayer held the property “primarily for and sale of real estate was not his every- that tax professionals’
sale to customers”: day business. clients that have
1. The purpose for which the property Factors 7 and 8 weighed for the
was acquired; taxpayer and against the government, captive insurance
companies take great
2. The purpose for which the property the court held, noting evidence indicat-
was held; ing that, immediately after receiving
3. Improvements, and their extent, the lots, Musselwhite hired a real estate care to distribute risk
properly.
made to the property by the taxpayer; broker to aggressively market and
4. The frequency, number, and continu- sell them.
ity of sales; However, with the “overwhelming
5. The extent and substantiality of weight” of the remaining six factors to function as an insurance company (a
the transaction; against the taxpayer and for the gov- captive insurer) for the taxpayer. The
6. The nature and extent of the tax- ernment, the four lots were not Mus- captive insurer, in other words, functions
payer’s business; selwhite’s inventory, stock in trade, or as self-insurance for the taxpayer.
7. The extent of advertising or lack property held primarily for sale to cus- Taxpayers can use captive insurance
thereof; and tomers in the ordinary course of busi- arrangements to generate financial
8. The listing of the property for sale ness under Sec. 1221(a)(1). They were savings. From a cost perspective, the
directly or through a broker. instead capital assets, the court held. taxpayer can tailor the insurance to its
Factors 1 and 2 were considered by What could a taxpayer in similar industry or its specific business needs.
the Tax Court in tandem. The court held circumstances do differently to have the From a tax perspective, the taxpayer
that at the time of the property distribu- best chance possible of being able to can deduct the insurance premiums it
tion in 2012, the purpose for which the claim an ordinary loss for real property pays the captive insurer. Additionally,
property was acquired and held was held as inventory? A taxpayer could if the captive insurer meets certain
investment. This was evidenced at trial keep detailed records of the amount qualifications in Sec. 831(b), it can
by testimony of the taxpayer, who stated of time spent preparing properties for exempt the premiums it receives from
that the activity within the partnership sale. Another option may be to set up income tax.
was “really investment.” Additionally, an alternative entity with a different However, the IRS has recently begun
no progress was being made or even principal business activity description analyzing captive insurance companies
attempted to develop the properties for that would handle sales. All of this is to and, specifically, microcaptive transac-
eventual sale, further convincing the say that, to alter the outcome, the in- tions with increased scrutiny. Beginning
court that the property was held for puts need to be altered. The IRS looks in 2015, microcaptive transactions have
investment purposes. at taxpayers’ facts and circumstances, so, been listed on the IRS’s “Dirty Dozen”
The lack of development of the lots logically, taxpayers need to be mindful list of the worst tax scams for every year,
during the brief time Musselwhite held of the limitations of those facts and with the exception of 2020. See, gener-
them caused the court to likewise find surrounding circumstances. ally, Newkirk and Webber, “Microcaptive
that factor 3 favored the government. From Merrick Shawe, CPA, Insurance Arrangements After CIC Ser-
As for factors 4 and 5, the only Irvine, Calif. vices,” 53 The Tax Adviser 18 (September
properties that DS & EM sold were 2022).
reported as capital in nature; after the Despite the IRS’s increased scrutiny,
property distribution from DS & EM Procedure & Administration captive insurance companies can, if
to the taxpayer, the one sale of real used appropriately, offer valuable tax
property was the only real estate sales Distribution of risk in captive savings. A number of requirements
activity engaged in by the taxpayer. insurance companies must be followed to ensure proper
Factor 6 examines the broader pic- Captive insurance companies have long compliance; however, this item focuses
ture of the taxpayer’s financial activities been used by taxpayers to self-insure in solely on the requirement that captive
and sources of income. As indicated a financially effective manner. Typically, insurance companies must sufficiently
earlier, the taxpayer was a personal in- a captive insurance arrangement is cre- distribute their risks for an arrange-
jury attorney. He consistently reported ated when a taxpayer forms a new entity ment to be considered insurance for

18 November 2022 The Tax Adviser