It has come to our attention that the IRS recently sent a letter (Letter 6336) to all taxpayers who filed a Form 8886 in connection with their participation in a so-called micro-captive transaction.
This letter is not an existing IRS form letter but was specifically crafted for micro-captive transactions.
There is no need to respond to the letter unless you have shut down your captive in the last few years.
It has no legal effect and is nothing new.
The IRS is attempting to induce business owners to abandon their captives.
The letter advises taxpayers that the IRS has won “several” Tax Court cases on the basis that “certain micro-captive arrangements are not eligible for claimed Federal tax benefits”.
What the letter leaves out is that these “several cases” refer to only three, of which one has been appealed. Additionally, arrangements that lost in Tax Court had issues that are no longer generally present in the industry.
The captive insurance industry is hopeful to get a fair hearing in the Appeals Court.
As long as you formed your captive for legitimate business reasons, you can and should maintain your captive.
In addition, if your captive made an election under section 831(b) of the Internal Revenue Code, you must continue to attach a Form 8886 to your tax returns.
This includes not only the captive, but the insured business and the owners of the captive and the insured business.
Furthermore, the IRS letter suggests that you consult with your independent tax advisor. This is a good idea, and something that we always recommend.
It is no secret that the IRS does not like micro-captives and that it has been threatening increased audits for several years. And, this letter may forecast increased audit activity.
However, a captive insurance company is a legitimate risk management tool.
In addition, Congress specifically provided a tax benefit for small insurance companies, both captives and non-captives.
Small and mid-sized businesses should not let the IRS scare them from implementing a legitimate risk management tool; especially at a time when the commercial market is hardening.
Do you have more questions about this letter?
Please feel free to comment below or contact us for help.