Page 561 - TaxAdviser_2022

independent of one another to suffi-
ciently distribute the risk (id. at 181).
Taxpayers have attempted to satisfy
this criterion in myriad ways. In one
case, the court found that a taxpayer
sufficiently distributed its risk, even
though the risk was distributed pri-
marily among the taxpayer’s commonly
owned brother-sister entities, because
the risks that the insurance covered
constituted “a sufficient number of
statistically independent risks” (Rent-
A-Center, 142 T.C. 1, 20–21 (2014)).
However, in Avrahami, the taxpayer at-
tempted to distribute its risk by issuing
policies to its group of three affiliated
federal income tax purposes. This was 185 (2017)). The nine factors are entities, as well as by insuring several
an issue of interest in the recent case as follows: unrelated entities by participating in a
Reserve Mechanical Corp., a decision 1. Whether the company was created risk-distribution program (Avrahami,
originally filed by the Tax Court on for legitimate nontax reasons; at 181–82). The court in Avrahami,
June 18, 2018, and affirmed on appeal 2. Whether there was a circular flow however, found that insuring only three
May 13, 2022 (Reserve Mechanical of funds; affiliated entities was not sufficient to
Corp., T.C. Memo. 2018-86, aff ’d, 34 3. Whether the entity faced actual and distribute its risk, nor was the risk-
F.4th 881 (10th Cir. 2022)). insurable risk; distribution program a bona fide insur-
4. Whether the policies were arm’s- ance company per the nine-factor test
Criteria for determining length contracts; (id. at 197).
insurance and factors for 5. Whether the entity charged actuari- In Reserve, the taxpayer argued that
defining a bona fide insurance ally determined premiums; it achieved risk distribution by insuring
company 6. Whether comparable coverage was a sufficient number of unrelated parties
As neither the Code nor the regula- more expensive or even available; (Reserve, at 36–37). Reserve accom-
tions define insurance, courts have 7. Whether the entity was subject to plished this by engaging another entity,
looked to four nonexclusive criteria for regulatory control and met mini- PoolRe Insurance Corp., as a stop-loss
establishing a framework for deter- mum statutory requirements; insurer; by doing this, the taxpayer
mining the existence of insurance for 8. Whether it was adequately capital- argued, it effectively distributed its risk
federal income tax purposes: (1) the ar- ized; and among the other entities that PoolRe
rangement involves insurable risks; (2) 9. Whether it paid claims from a sepa- insured (id.). The court, however, re-
the arrangement shifts the risk of loss rately maintained account. jected the taxpayer’s argument because
to the insurer; (3) the insurer distrib- The distribution-of-risk criteria, it found that PoolRe was not a bona
utes the risk among its policyholders; as well as the nine-factor test, are dis- fide insurance company (id. at 45–46).
and (4) the arrangement is insurance in cussed in greater detail below. In its decision, the court reviewed six
the commonly accepted sense (Reserve, Reserve’s distribution-of-risk of the nine factors it deemed most rel-
PHOTO BY JOSÉ M G PEREIRA/GETTY IMAGES focuses solely on the “distribution of Generally, risk distribution occurs the factors considered were PoolRe’s
evant and found that PoolRe was not a
T.C. Memo. 2018-86 at *33, citing
argument
Amerco, 96 T.C. 18, 38 (1991)).
bona fide insurance company (among
As stated above, this discussion
when the captive insurer pools together
failure to obtain an insurance license
during relevant periods, the appearance
risk” criteria. On this point, the courts
a sufficiently large number of unrelated
of a circular flow of funds, and the ex-
crafted a list of nine factors to be used
risks. Prior courts have determined
to determine if the captive insurer (or
istence of a one-size-fits-all rate for its
that this criterion was satisfied if the
its reinsurer, as the case may be) was
participants) (id. at 39–46). Due to the
insurer pooled enough risks to take
indeed a bona fide insurance company
court’s finding that PoolRe was not a
advantage of the “law of large numbers”
(id., citing Avrahami, 149 T.C. 144,
November 2022 19
www.thetaxadviser.com or if the insured risks were adequately bona fide insurance company, the court