In Uncategorized on 08/21/2017 at 16:42

As darkness overspread our land, The Great Dissenter, a/k/a The Judge Who Writes Like a Human Being, s/a/k/a The Implacable, Indefatigable, Ineluctable, Ineffable, Incontrovertible, Irrepressible, Illustrious and Irrefragable Foe of the Partitive Genitive (although perhaps in recovery), Old China Hand and Master Silt Stirrer, Judge Mark V. Holmes enlightens us and the Self-Insurance Institute of America, Inc., in Benyamin Avrahami and Orna Avrahami, 149 T. C. 7, filed 8/21/17.

You remember Ben and Orna? No? Then see my blogposts “The Front – Part Deux,” 12/18/15, and “The Fighting Lawyer,” 3/29/16.

Well, now the whole captive insurance business is up for grabs, and Judge Holmes is the man.

The Avrahamis had three jewelry stores and three shopping centers. They also had what they called an insurance company called Feedback, owned by Orna, which paid no claims, but lived up to its name by feeding back to the Avrahamis a lot of the deducted premiums the Avrahamis sent them.

Their CPA turned the Avrahamis on to the Fighting Lawyer, who set up their captive in St. Kitts. I’ve been there. It ain’t much. But the captive filed a 953(d) election to be taxed as a US C Corp, and a Section 831(b) small insurance company election.

Notwithstanding the captive, the Avrahamis insured their multiplex business with US commercial insurers, and IRS has no beef with that. The captive did tax risk, litigation risk, and other exotics.

They also dealt with a St. Kitts outfit that insured against terrorism risks. They also joined a quota share (reinsurance) deal, a favorite of Lloyds of London brokers who were stealing from their Names. Only here it was a roundy-round to move premium money back to the cedant.

The Avrahamis, ever inventive, created an entity named Belly Button, Inc., to make loans to themselves with money from Feedback. Judge Holmes says the “omphaloskeptical” St. Kitts insurance regulators gazed askance at these.

IRS elevated this scam to the “dirty dozen” list in 2015 and made them transactions of interest in 2016. See Notice 2016-66, 2016-47 I.R.B. 745; I.R.S. News Release IR-2015-19 (Feb. 3, 2015). But this is the first such case that went to trial.

The bottom line, despite the overlay of tax breaks for small mutual insurance companies, is whether risk has truly shifted, been diversified (so that “no man is undone, but rather the losse falleth lightlie upon many, and not heavilie on fewe” as the English said in 1601), and has been run like a for-profit insurance company.

Remember Rent-A-Center? See my blogpost “Leading Captivity Captive,” 11/4/16. That captive was OK.

Just not the Avrahamis’.

“But it [the captive] might also be run so that related parties pay the captive deductible insurance premiums of just under $1.2 million a year.  In turn the captive might pay out few if any claims, might make a section 831(b) election so it pays tax only on its investment income, and might quickly build up a large surplus.  Then, if the captive were to be licensed and regulated in a jurisdiction with extremely low reserve requirements and loose rules on related-party transactions, it might lend its surplus back to its affiliates.  This might generate nearly $1.2 million in tax deductions while arguably only moving money from one pocket to another.  Or perhaps the captive could be owned by a Roth IRA, which might mean it could make large dividend payments to its stockholder, creating a form of deductible, yet tax-free, retirement savings.  Or perhaps the captive could be owned by its business owner’s children or an irrevocable family trust, which might enable the avoidance of future gift and estate taxes.” 149 T. C. 7, at pp. 58-59.

There was an insufficient spread of risk on the facts, the terrorism quota share was a true roundy-round, the captive didn’t pay claims until the IRS was all over the Avrahamis, and at the end of the day, Judge Holmes finds it wasn’t a true insurance company.

“We have to find that Feedback’s operations left something to be desired.  It dealt with claims ‘on an ad hoc basis.’  It invested only in illiquid, long-term loans to related parties and failed to get regulatory approval before transferring funds to them.  And we will not overlook the fact that the Avrahami entities made no claims whatsoever against Feedback from its inception in 2007 until March 2013–two months after the IRS sent the Avrahamis documents about the audits of the returns of [Avrahamis’ entities] that suggested Feedback was a sham.  And even the claims Feedback did receive it dealt with in questionable ways.  Most of the claims were approved despite being filed late–the policies required that Feedback be notified within 30 days of the loss ‘as a condition precedent to payment of any benefit hereunder.’” 149 T. C. 7, at pp. 78-79.

And Feedback only had cash and loans to the Avrahamis’ entities. But the caselaw says that adequate capitalization in the state or country of organization is sufficient. And even though in St. Kitts to be an insurance company you only need what you need for a MegaMillions ticket (“all you need is a dollar and a dream”), that’s enough.

The policy language was not of the best (claims-made vs when-occurred), but the Avrahamis produced the Incomprehensible Actuary. Judge Holmes couldn’t figure him out, and I didn’t even try.

Finally, a loan between Feedback and Belly Button was a real loan, although barely, so no income to Orna except interest.

The Avrahamis have a partial escape from the accuracy chops, as one person they relied upon had credentials, full information, and wasn’t a promoter.

The rest of you captors, beware.

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