IRS Eases Restrictions On Premiums Paid to Captives.

More companies may deduct the premiums they pay to their captive insurance companies as a result of a recent Internal Revenue Service ruling on related-party risks.

In its decision, the IRS said it would no longer invoke the "economic family" concept. That concept, set forth in two previous tax court decisions, Humana Inc. vs. Commissioner and Cloupherty Packing Co. vs. Commissioner, concluded that a transaction between a parent company and a subsidiary wasn't insurance. A captive insurance company is a form of self-insurance in which a corporation or association organizes an insurance subsidiary to insure itself or its members. Captives serve the insurance needs of the parent organization without the uncertainties of commercial insurance availability and cost.

In the IRS ruling, it was noted that "no court, in addressing a captive insurance transaction, has fully accepted the economic family theory." But it said the IRS may continue to challenge certain captive insurance transactions.

Among the deciding factors of whether to challenge those transactions will be the parent company's guarantee of the captive's performance, thin capitalization and loose regulation.

The ruling "confirms what we have been experiencing on exams for the past several years," said Mark E. Anderson, a partner with KPMG LLP, where he is risk-financing leader in the Stratecon practice.

"Unofficially, the IRS had abandoned it, but many times field agents that were not aware of the informal policy could tie up taxpayers a long time in dealing with justification of what they have done in a captive," he said.