Curtis K. Kadau and Lori A. Kadau, Deceased, Curtis K. Kadau, Personal Representative, T. C. Memo. 2025-81, filed 7/31/25 had a successful industrial Sub S, but needed a cash stash. Enter a couple promoters (hi, Judge Holmes) who sold them a Nevis (that’s another Island in the Sun) insurance company.

It’s the usual shaky underwriting, excessive premiums, minimally capitalized, insurance-reinsurance roundy-round. Cash goes in a circle, invested in a single premium life insurance policy that benefitted Curtis. It’s the same old story for 39 (count ’em, 39) pages of Judge Christian N. (“Speedy”) Weiler’s deconstruction of this dodge, until we get to the Section 6662(h)(6) and (i) 40% enhanced chops for undisclosed economic insubstance. Enter Section 7701(o)(i), added by the Health Care and Education Reconciliation Act of 2010. Though Section 7701(o)(i) talks of meaningful economic change other than tax, some commentators weren’t sure if this meant sham transaction as well as want of economic substance. And how do we find out if Sectio0n 7701(o)(i) applies?

In short, though the deal must move the nontax economic needle, did the Act move the commonlaw needle?

“The Act also added a new subsection (o) to section 7701 of the Code, codifying the “economic substance” doctrine. That subsection provides a conjunctive test whereby a transaction is treated as having economic substance only if (1) ‘the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position” and (2) ‘the taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into such transaction.’ I.R.C. § 7701(o)(1). The codified economic substance doctrine applies ‘[i]n the case of any transaction to which the economic substance doctrine is relevant.’ Id. And the determination of whether the economic substance doctrine ‘is relevant’ must be made in the same manner as if section 7701(o) had never been enacted. I.R.C. § 7701(o)(5)(C).

“To date, there has been minimal caselaw addressing these provisions. In none of the microcaptive insurance cases decided to date did this Court address whether the transactions lacked economic substance within the meaning of section 7701(o)(1). Nor did those opinions consider what constitutes ‘adequate disclosure’ of a microcaptive transaction under section 6662(i)(2). The Court has withheld ruling on these questions and ordered additional briefing on the ‘relevancy’ question.” T. C. Memo. 2025-81, at p. 40.

Judge Speedy Weiler does likewise.

“We will accordingly defer ruling on the applicability of the 40% penalty in this report, which will be addressed in a subsequent ruling.” Order, at p. 41.

But the 20% 6662(a)s are in; Curtis’ reasonable reliance and substantial authority arguments fail.

IRS tries to wildcard in a $131K increased deficiency to Curtis’ micro via an out-of-time amendment to the answer, earning IRS BoP on that point, which it doesn’t sustain. IRS says since the micro isn’t an insurance company, its Section 953(d) election fails so the premiums Curtis’ Sub S paid to the micro don’t get Section 831(b) shelter, thus taxable. Curtis’ trusty attorneys say it’s a nontaxable contribution to capital, and Judge Speedy Weiler buys it.

“Here, the objective reality is that [Sub S]} and [micro] entered into contracts that required [micro] to pay if it suffered losses covered by the contracts. We find those contracts are not insurance contracts and that the policies, with their unreasonable premiums, had no legitimate business purpose. Therefore, the premiums are not deductible. These conclusions, however, do not mean that the transfer of funds from [Sub S] to [micro] could not serve an otherwise legitimate business purpose such as the contribution of capital. See Rsrv. Mech. Corp. v. Commissioner, 43 F.4th at 918 (analyzing Rev. Rul. 2005-40). Respondent bears the burden here, and we find he has not otherwise established that the transfer of funds from [Sub S] to [micro] should not be classified as nontaxable contributions of capital.” T. C. Memo. 2025-81, at pp. 38-39. (Citation omitted).