How did the 1 May IRS Notice 2016-66 deadline go for small captives? Did they make it, in general?
It was a very hectic situation on two fronts. First, you had taxpayers who hadn’t made this kind of a disclosure before and we found them scrambling to find out what the requirements of the rules were. The penalties for failing to report are very substantial. This especially affected taxpayers who have owned a captive for a number of years because there was large amount of information required to be disclosed and that created some chaos. We didn’t hear a lot about people missing the deadline, so we think that most made it, although there is always a group that either doesn’t hear about the rules or are not advised on the rules.
On the second front, we talked to many certified public accountants, financial advisers and others who were affected by some of the disclosure requirements, and we saw a lot of chaos because the definition of material adviser was very inclusive. The penalties for failing to disclose as a material adviser are pretty substantial as well. We answered a number of questions for all different kinds of professionals such as, if they met the definition of a material adviser, clarifying where that line was drawn, and provided help around and how they represent clients going forward.
Do you think the guidelines from the IRS should have been made clearer?
I think the guidelines could have been clearer. One of the challenges is that they were very inclusive and broad in the way they were described. The other challenge we found is that there wasn’t a lot of notice. When Notice 2016-66 was announced, it happened at a fast pace and little or no time was provided for companies to comment, let alone comply.
It takes real time to mobilise, to understand what is going on and recieve commentary from practitioners. That time frankly wasn’t there. The IRS did extend the reporting deadlines from January to May but, although that provided more time and relief, it was still too short a timeline.
What were the consequences for not making the reporting deadline?
The failure to disclose could put someone at risk of a maximum penalty of $50,000 or a minimum of $10,000, depending on the type of taxpayer they are. It is a substantial penalty, particularly if you are dealing with those on the smaller end of the spectrum.
SIIA sent a letter to the US Treasury asking for Notice 2016-66 to be included on President Donald Trump’s executive order. Do you think the notice meets the criteria?
We do think the notice meets the criteria. We are still looking to see what the administration is going to do with it. Very recently, there has been IRS guidance issued did address another disclosure issue, but not captives. The guidance delayed one of the reporting requirements for investors relating to conservation easements. However, it is difficult to say at this point whether the captive industry will be successful in showing that the requirements are too broad and too resource-intensive. While the recent guidance did not address the captive situation, clearly this administration has telegraphed an interest in reducing regulation and burden, and we are going to be monitoring that situation closely.
Is the IRS likely to be the target of deregulation?
At this point we haven’t heard much. We recently held a meeting with a number of people in our offices. We also invited speakers such as Senator John Cornyn and others to discuss the tax policy in the US. At this point the focus of the tax policy debate appears to be tax rates and incentives, focusing on adjusting tax rates for individual taxpayers, flow-through and C corporations.
We have not heard a specific discussion about deregulation as it relates to the IRS, although I do think it is fair to say that this administration has made it clear it believes that regulations create undue barriers, and it has an interest in removing them. There has, however, been some discussion of restructuring the agency, so stay tuned.
What should small captives be focusing on in terms of tax planning, given this uncertainty?
Small captives should be focusing on continuing to do things the right way. A large amount of work we are doing is coming in from a compliance standpoint—the purpose of every captive should first and foremost be to function as a risk management tool, providing better coverage, terms and conditions for the related operating business and making sure the captive’s assets are protected. If you’re following that kind of general guideline of putting insurance first, rather than focusing on the other benefits of the captive, I think you are going to be in a good place.
Congress has indicated that this is a permissible vehicle for small business, and even recently increased the amount of premium that can be received tax-free by the captive under section 831(b).
On the other hand, we have seen an increase in IRS scrutiny. If you are following the right course, our recommendation would be to continue to do that. There is no reason to stop taking advantage of this insurance vehicle just because it is getting this scrutiny.
Are you hearing any concern from your clients?
Absolutely, and it does vary, but our clients want to know whether they should remain in the industry. Clients are concerned about the IRS’s recently announced campaign on captives, the inclusive of captives on the Dirty Dozen list and new changes in the Protecting Americans from Tax Hikes Act. My advice remains that if captives are following the rules, then there is less reason for concern, but clients are obviously aware anytime the IRS mentions an increase in scrutiny.
As I suggested, assuming people are following the right guidelines, this is not something they should be running away from.