Captive premiums deductible.
Captive owners received some good news in late January when the U.S. Tax Court ruled in their favor in three different cases. Taken together, the opinions allow corporations with wholly owned captives to deduct premiums paid to such captives if those captives write a certain amount of third-party business. The three cases involved AMERCO, the Harper Group and Sears, Roebuck & Co. AMERCO's subsidiary, Republic Western Insurance Co., wrote 50 percent of its business with unrelated insureds. Sears, subsidiary, Allstate Insurance Co., wrote all but .25 percent of its business with unrelated entities. Rampart Insurance Co., a subsidiary of the Harper Group, wrote 30 percent in unrelated business. The Internal Revenue Service has long denied deductions for premiums paid to captives by parent corporations based on its "economic family" theory. The amount of third-party business written has never been viewed by the IRS as relevant. The three decisions outline conditions for parent companies to deduct premiums paid to wholly owned captives. First, there must be a certain amount of third-party business written by the captive. The 30 percent standard in the Harper Group case is the lowest percentage of the three cases and indicates that at least 30 percent of the premiums written by the captive must be third-party business to qualify the parent company for a deduction. Unfortunately, it is unclear from the decisions how the court would rule if the third-party business written by the captive is less than 30 percent. The court decisions also require the captive to be subject to regulation, be treated by the parent as a separate insurance company and be properly capitalized. Finally, dealings between the parent and the captive must be at arms length. The court enunciated a three-part test to determine whether "true insurance' exists when a parent pays premiums to an insurance subsidiary: there must be an insurance risk, there must be both shifting and distribution of risk and insurance must exist under the common meaning of the word. The cases are cited as follows: AMERCO v. Commissioner, No. 5100-88, 96 T.C. No. 3; The Harper Group v. Commissioner, No. 33761-85; 96 T.C. No. 4; Sears Roebuck & Co. v. Commissioner, No. 2165-89, 96 T.C. No. 5. Editor's Comments: For years, RIMS has advocated a parent corporation's right to deduct premiums paid to a wholly owned captive. These three cases are a welcome development. The IRS' "economic family" argument was dismissed by the court in these cases as it was by the U.S. Court of Appeals for the 6th Circuit in its Humana decision. RIMS, like many other opponents of this argument, believes it ignores the very essence of corporate law. It remains to be seen whether the IRS will appeal any of these decisions. RIMS sincerely hopes that these cases, along with the Humana decision, signal a new trend toward deductibility o captive premiums. -Paul S. Brown
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|Title Annotation:||deduction of insurance premiums paid to subsidiaries by parent companies|
|Date:||Mar 1, 1991|
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