Baldwin Haspel Burke & Mayer LLC

BHBM Tax Law Alert 9/12/2017


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BHBM Seminar for CPAs

We will be hosting our 34th Annual Seminar for Certified Public Accountants on the following dates. To access the registration brochure, click here: 2017 CPA Seminar Brochure.

Northshore Seminar – October 18, 2017
Program 1pm-4:45pm, Reception 4:45pm
Clarion Inn & Suites
501 N. Hwy 190
Covington, LA 70433

Metairie Seminar – November 8, 2017
Program 1pm-4:45pm, Reception 4:45pm
Sheraton Metairie
4 Galleria Boulevard
Metairie, LA 70001


IRS Grants Penalty Relief to Partnerships that File Returns Under Old Filing Deadline

The IRS recently announced (in Notice 2017-47) that it will grant partnerships automatic relief from penalties for failing to timely file their tax returns for the first tax year that began after December 31, 2015.

The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015 moved the filing deadline for partnership returns to one month earlier than they were due under prior law.  In particular, for calendar-year partnerships, partnership returns became due March 15th (rather than April 15th) for tax years beginning after December 31, 2015. For fiscal-year partnerships, the due date became the 15th day of the third month (rather than the fourth month) following the close of the partnership’s fiscal year.  Partnerships that fail to meet the new deadlines are subject to penalties.

To obtain relief, the partnership must have filed the required forms (i.e., Form(s) 1065, 1065-B, 8804, 8805, etc.) with the IRS and furnished copies (or Schedules K-1) to its partners by the required due date (including extensions) in place under prior law.

It is worth noting that relief under Notice 2017-47 will not be treated as a first-time abatement under the IRS’s administrative penalty waiver program.  Accordingly, taxpayers should be able to use the first-time abatement waiver if the IRS assesses a failure-to-file or failure-to-pay penalty for some other reason for the current or future tax years, provided they otherwise qualify for first-time penalty abatement relief.

Conversion of Non-grantor Trust to Grantor Trust Is Not a Taxable Transfer

In PLR 201730018 the IRS ruled that the conversion of a non-grantor charitable lead annuity trust (“CLAT“) to a grantor CLAT is not a taxable transfer of property, is not an act of self-sealing, and does not qualify the grantor for a charitable income tax deduction. The grantor desired to convert the non-grantor CLAT to a grantor CLAT by amending the trust agreement to give the grantor’s sibling, who was not a trustee, a power of substitution thereby triggering IRC § 675(4).

Neither Rev. Rul. 77-402, which examines the income tax consequences of a lapse of a grantor trust status, nor Rev. Rul. 85-13, which establishes the income tax consequences of a conversion from a non-grantor trust to a grantor trust, provide that the conversion from a non-grantor trust to a grantor trust results in a transfer of property for income tax purposes. Based on this lack of authority, the IRS concluded that the conversion to a grantor trust is not a taxable transfer of property.

Under IRC § 4947(a)(2), a CLAT is subject to the self-dealing rules of IRC § 4941, which prohibit certain transactions between a CLAT and a disqualified person. While certain family members of a grantor are considered disqualified persons, a grantor’s siblings are not. Here, because the power of substitution was granted to the grantor’s sibling, the IRS ruled that the grant of such power is not self-dealing. However, the IRS did not express an opinion on the exercise of such power.

IRC § 170(a) requires a transfer of property for a grantor to qualify for a charitable income tax deduction. Since the conversion to a grantor trust is not a transfer of property for income tax purposes, the IRS ruled that the grantor is not entitled to a charitable income tax deduction.

Based on the foregoing, if a grantor wants the accelerated up-front charitable income tax deduction associated with a CLAT, the grantor should initially create a grantor CLAT as the IRS likely will not permit the deduction if instead the CLAT is later converted to a grantor CLAT.

Micro-Captive Arrangement Was Not Considered “Insurance” so Insurance Premiums Were Not a Deductible Business Expense

In a recent Tax Court decision (Avrahami v. Commissioner of Internal Revenue), the taxpayers were disallowed deductions with respect to a captive insurance arrangement.[1] The Tax Court held that the taxpayers’ arrangement did not constitute insurance because the captive insurer lacked risk distribution and did not embody insurance in the commonly accepted sense. As a result, the deduction for payment of insurance premiums and other potential tax benefits were disallowed.

Generally, non-life insurance companies are taxed on both investment and underwriting income. However, under IRC § 831(b), “small” non-life insurance companies with written premiums that are less than the specified statutory amount may elect to be taxed at regular corporate rates on investment income only.

A captive insurance arrangement generally refers to the attempt by a taxpayer to secure the traditional benefits of insurance coverage, including tax benefits, while placing its insurance business with a corporate entity owned by or related to the taxpayer. An attempt to combine the concept of a captive insurance company with the tax advantages for “small” insurance companies is referred to as using “micro-captives”. In determining whether an arrangement involving a captive insurance company actually constitutes insurance, the Tax Court has found that the arrangement must involve risk shifting, risk distribution, and meet commonly accepted notions of insurance.

In Avrahami, Benyamin and Orna Avrahami owned three shopping centers and three jewelry stores.In 2007, the Avrahamis and their attorney formed a captive insurance company in St. Kitts named Feedback Insurance Company, Ltd. (“Feedback“). Mrs. Avrahami was its sole shareholder as well as treasurer and bookkeeper of Feedback.

In 2009 and 2010 (the years at issue), Feedback sold policies to entities owned by the Avrahamis and to reinsure terrorism policies through one of their risk distribution programs. More specifically, Feedback reinsured terrorism policies through Pan American, an insurer incorporated in St. Kitts in 2009. The Avrahamis’ attorney hired an actuary to price the various Feedback policies for the Avrahamis’ entities, which included, among other things, coverage for certain legal expenses, business risk indemnity, loss of business income, and losses caused by fraudulent or dishonest acts committed by employees. There was also a tax indemnity policy that supposedly covered all additional taxes, interest, and penalties that one of the entities might become obligated to pay as a result of an “adverse resolution” of a position taken on its tax return (with exclusions for fraud, etc.). Each year the actuary was given “target premiums” from the attorney with the total amount of premiums that the attorney had in mind for the Avrahamis.

During the years at issue, the Avrahamis deducted $1.1 million and $1.3 million in insurance expenses for their businesses even though the Avrahamis’ entities continued to buy insurance from third-party commercial carriers and made no changes in coverage. In comparison, the Avrahamis deducted only $150,000 of insurance expenses in 2006. In addition, no claims were filed against Feedback under any of its direct policies and no events took place that would even trigger a claim under the terrorism reinsurance. As a result, Feedback and Pan American accumulated a surplus, which was used to transfer funds directly to Mrs. Avrahami and to an entity owned by the Avrahamis’ children.

Tax returns from the years at issue show that Feedback elected to be treated and taxed as a small insurance company under IRC § 831(b). Feedback’s tax returns reported $2.4 million is assets in 2009 and $3.9 million in assets in 2010. However, because of the IRC § 831(d) election, Feedback only paid income tax on its investment income and not the premiums received from the related parties. The IRS issued a notice of deficiency questioning whether Feedback was a valid insurance company and claiming that the premiums received should be taxed as income.

The Tax Court held that the micro-captive arrangement did not constitute insurance because Feedback lacked risk distribution and did not embody insurance in the “commonly accepted sense.” Specifically, the Court stated that the arrangement lacked risk distribution because Feedback only insured three of the Avrahamis’ entities which did not adequately distribute risk. In addition, the Court held that the arrangement did not embody insurance in the “commonly accepted sense” because Feedback dealt with claims on an “ad hoc basis”, made investment decisions that “only an unthinking investment company would make”, and charged unreasonable premiums.

Further, the Court concluded that Pan American was not a “bona fide” insurance company. The Court found that no reasonable business would have ever bought terrorism insurance from Pan American because they charged unreasonable premiums with unreasonable terms and the primary purpose of the arrangement was the circular flow of funds.

[1] 149 TC No. 7 (2017).



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