The “Captive Manager” Fallacy Continues

The captive insurance community is aware of a series of IRS audits over the last decade years directed at small captives operating under Section 501(c)(15) of the Internal Revenue Code (IRC). The IRS undertook a series of audits to test compliance with the 2004 legislative changes.

Our experience with these matters dates back to 1998 and thus our Firm (The Feldman Law Firm LLP) has been able to track the trends over the years. In the small captive area, our Firm has obtained more than forty affirmative rulings from the IRS as to the tax exempt nature of captives administered by our Firm's affiliate, Capstone Associated Services, Ltd. (

Three tax court matters have been closed out so far this year alone, without any tax, interest, or penalties due. After reviewing the file provided by these Capstone-sponsored and administered captives, the Service acceded to the taxpayers' position. Additionally, more than a dozen audits have been closed out over a number of years with no change.

Many so-called "captive managers" of small captives are in fact mere clerical organizations devoid of talent to design and manage sophisticated corporate and business planning. For example, banks and property & casualty (P&C) brokers began serving as captive managers in the last decade. While on the one hand, their claimed responsibilities included all aspects of "captive management," captive managers' client contracts usually disclaim all tax, legal and accounting responsibility.

When the IRS came calling, clients were left in a lurch. Most clients had very unpleasant results, learning all too late that their trusted captive managers had no expertise in dealing with tax matters and had left tax planning and compliance matters to the client. The IRS found these audits "easy pickings." Examples of these disclaimers are available from Capstone. lois lernerCapstone and our Firm have long warned of so-called "captive managers" who lack the ability and experience resources to undertake the advertised work.

More recently, former IRS Tax Exempt Organization Director Lois Lerner conducted what now appears to be an unlawful campaign against Tea Party and other political groups operating under Section 501(c). Lerner's responsibilities included IRC captives operating under Section 501(c)(15). Our Firm has seen misdirected and wasteful IRS inquiries in these areas, improperly challenging properly-formed and otherwise tax-compliant captives.

The recent Congressional investigations of Ms. Lerner resulted in her forced resignation as part of the removal of the top three IRS officials (the Acting IRS Commissioner, along with the Commissioner of the Tax Exempt and Government Entities Division and the Director of Exempt Organizations Group, being Ms. Lerner).

Hopefully, the IRS house cleaning will halt the errant conduct of the Service which undermines confidence with our country's revenue raising activities. Except as to the above, we have seen no concerted or organized IRS effort to challenge captive insurance programs generally, at least until recently. IRS audits do occur regularly, and it is therefore critical to have relied on experienced professionals in establishing and operating the alternative risk planning program. Unless alternative risk planning is tax compliant upfront, there is little opportunity to correct it after the fact. Once the patient is deathly ill, there is little chance of revival.

Our Firm continues to handle captive insurance tax matters and advise clients on planning opportunities.

• Business Insurance Press Release: Gallagher Captive Manager Artex Discloses Its Subject to IRS Probe

- September 10, 2014 Federal Court Opinion Ordering Artex's Compliance with IRS Subpoena

- Artex Docket Report


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