Coronavirus shows IRS was wrong about microcaptives

The coronavirus pandemic has shown how the Internal Revenue Service (IRS) and the Tax Court used “misguided logic” in its decision in the Reserve Mechanical Corp case, according to Capstone Associated Services.

In the high-profile 2018 verdict, the court found that Anguilla-domiciled Reserve did not meet the criteria to be considered an insurance company for federal tax purposes, and at the end of February an opening brief was filed for an appeal on the case.

Capstone has put out a statement on coronavirus, saying that the pandemic exclusions that many companies have discovered exist in their insurance show the value of microcaptives.

“The fallout from the Covid-19 pandemic highlights the role of captives as a risk mitigation tool,” Capstone said.

“This contrasts with the fallacy of the Reserve decision and the IRS’s universal rejection of statutory-based captive insurance arrangements formed under various longstanding Internal Revenue Code provisions.”

Capstone gave examples of captives that have been investigated by the IRS, such as manufacturing facility that was told it did not need pollution liability insurance.

“Under this same misguided logic, business interruption insurance providing for coverage of losses in the face of a government-imposed shutdown would be similarly dismissed,” Capstone wrote. “Four weeks ago, the IRS’s retort would have been that this is ‘unimaginable’ and not a ‘real risk’.

“To the IRS, ‘shelter in place’ orders denying a business at the same time both its staff and customer-base, are not realistic ‘fortuitous risks.'”

Capstone argued that while many businesses, including “restaurants, hotels, service companies, etc” may end up becoming bankrupt because of the current pandemic, if captives were more common these organisations could have been covered by insurance and not end up in this situation.

“Many of the risks faced by these businesses would have been covered under a well-designed captive insurance program, all given the lack of availability of these coverages from commercial carriers,” the organisation said.

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