The Internal Revenue Service (IRS) has claimed another victory against micro captives in US Tax Court after Judge Robert Ruwe ruled in its favour in Syzygy Insurance v Commissioner of Internal Revenue.
Judge Ruwe found that the arrangement between captive insurer Syzygy, its parent company High Tank and Manufacturing, and its fronting carriers, were not insurance transactions, meaning the Syzygy’s section 831(b) election is invalid and it must recognise the premiums it received as income.
Syzygy was licensed in Delaware in 2008 and was established by John Jacob, Highland Tank chairman of the board, secretary, treasurer, and a vice president, and Michael VanLenten, Highland Tank president.
In the Tax Court decision, Judge Ruwe ruled that the captive’s fronting carriers were not bona fide insurance companies and therefore Syzygy did not distribute risk and did not accomplish sufficient risk distribution for Federal income tax purposes through the fronting carriers.
He found that the arrangement between Syzygy and its fronting carriers “looks suspiciously like a circular flow of funds” and that the fact that the captive owner sought higher premiums led the court to believe “that the contracts were not arm’s-length contracts but were aimed at increasing deductions”.
Additionally, Judge Ruwe ruled that though the captive was “organised and regulated as an insurance company”, this does not overcome its other failings and that Syzygy was not operated like an insurance company.
The owners of the captive were found to have relied on the advice of their certified public accountant in good faith and Judge Ruwe determined they are not liable for the accuracy-related penalties imposed by the IRS.
