The Treasury Department recently released a Chief Counsel Advice memorandum, CCA 202134016 addressing what constitutes a false or fraudulent statement for purposes of assessing the section 6700 penalty against a promoter of a micro-captive insurance transaction.
The CCA defines a typical micro-captive insurance transaction as one where a taxpayer attempts to reduce its taxable income, as well as that of related persons, by using contracts that the parties treat as insurance and a related company that the parties treat as a captive insurance company. Each entity that the parties treat as an insured entity under the contracts can then claim deductions for premiums paid for the insurance coverage. The captive insurance company elects to be taxed only on investment income under section 831(b) and can exclude the insurance premiums received under the contracts from its taxable income.
The CCA addresses a situation where an LLC is engaged in the promotion of these micro-captive insurance transactions. In this promotion situation, the promoter distributes documents to investors and potential investors containing statements regarding the allowability of deductions for the insurance premiums under section 162, the excludability of premium income under section 831(b) and other federal tax benefits such as the ability to elect treatment as a domestic entity under section 953(d).
Section 6700 imposes a penalty on a person who promotes abusive tax shelters. Specifically, section 6700(a)(2)(A) assesses the penalty on any person who makes a statement with respect to the allowability of any deduction or credit, the excludability of any income or the securing of any other tax benefit which the person knows is false or fraudulent. In determining what is false or fraudulent for purposes of an abusive micro-captive transaction, the CCA examines multiple court cases. The CCA finds that a statement can be either written or oral. Furthermore, the CCA determines that there are two types of statements that fall within section 6700(a)(2)(A)—statements directly addressing the availability of tax benefits and statements concerning factual matters that are relevant to the availability of the tax benefits. Case law also elucidates that false statements under section 6700 include representations that a plan qualifies for special tax treatment when it actually does not comply. The memo further explains that statements are false when assertions are not qualified and customers are not notified that following such advice could subject them to IRS scrutiny. Under the case law cited in the CCA, where a promoter has knowledge of the risks of a tax shelter, it must clearly and unambiguously inform its agents, prospective clients and current clients of that risk.
The CCA ultimately defined the meaning of statement when analyzing whether there is a false or fraudulent statement as to any matter material to the exclusion of income under section 831(b) or tax deduction under section 162 for premiums paid by the insured. The CCA determined that the term statement (in the context of micro-captive transactions), includes “opinions, promotional materials, reports, tax savings projections or other statements (or materials relied upon in making such statements).”
Promoters of abusive micro-captive insurance transaction and investors in those transactions should be aware of the extensive definition the CCA gives to the term statement. Taxpayers who believe they have made or furnished, or caused someone to make or furnish a statement subject to the section 6700 penalty should contact their tax advisor.