U.S. Tax Court Approves Penalties For Microcaptive Transaction In Oropeza
Published - www.Forbes.com
By Jay Adkisson
The U.S. Tax Court opinion in Oropeza v. Comm'r, T.C. Memo. 2020-111 (July 21, 2020), considered the penalties that may be assessed by the IRS in a so-called "microcaptive" tax shelter, which is a captive insurance company that made 831(b) election and participated in a risk pool to try to meet the risk distribution requirements of tax law.
The IRS audited the taxpayer's captive arrangement for tax year 2012, and the IRS revenue agent sent the taxpayer a revenue agent report that proposed a $1.07 million increase in the taxpayer's distributive share of his company's (meaning the company that purchased insurance from the microcaptive) income. The revenue agent asserted a 40% penalty based on any of a gross valuation misstatement, a non-disclosed transaction lacking economic substance or undisclosed foreign financial assets.
Eventually, the revenue agent closed the case, and his supervisor signed a Civil Penalty Approval Form which authorized a 20% penalty against the taxpayer for negligence or substantial understatement of income tax. This form did not show approval of the 40% penalty.
The revenue agent and his supervisor next sent a memo for the IRS Chief Counsel's office, which recommended that the 40% penalty be assessed against the taxpayer for a "nondisclosed noneconomic substance transaction." The IRS followed with a notice to the taxpayer that a $374,570 tax deficiency was determined and also tacked on the 40% penalty for an extra $149,828. Taxpayer then petitioned to the U.S. Tax Court, which resolved the case on the motions and cross-motions for summary judgment of the parties.
In a nutshell, the Tax Court determined that the 40% penalty was invalid because the supervisor had not signed off on that originally. Instead the taxpayer would only be liable for the 20% penalty for negligence or substantial understatement of tax.
This opinion is for those folks in the microcaptive tax shelter business who have been spreading the false rumor that "the IRS isn't seeking the 40% penalty against microcaptive owners." This opinion demonstrates that while the IRS may not sometimes be careful in how they dot their "i"s and cross their "t"s, that the IRS is indeed seeking the 40% penalty.
Here, the IRS was sloppy in how it assessed the penalty, and the taxpayer was lucky to be hit with the 20% penalty instead. But if the IRS had been less sloppy, then it would have been the 40%. Anecdotally, the 40% penalty is what the IRS is now determining to be the penalty in nearly all of these cases, at least for the captive owners who have not been offered the voluntary compliance settlement.
It is not a pretty picture, and most folks who have 831(b) captives that are involved with a risk pool should take a hard look at what they are doing before the IRS shows up, if they haven't already.
Oropeza v. Comm'r, T.C. Memo. 2020-111 (July 21, 2020), as found at