The Economic Family Cases: Conclusion

This will be the last blog posting of this year; I will resume the captive section of this blog's writing with the Humana case after the first of the year.  To all, Merry Christmas and Happy New Year.

The captive cases can be broken down into two segments: the economic family cases -- where the IRS gained trial momentum for their theories, and the Humana cases, where taxpayers began scoring victories.  As such, this is an appropriate place to stop and sum up the overall captive legal situation before moving onto Humana.

Here are the salient points moving forward.

1.) Business necessity drove the formation of early captives.  In all economic family cases, some defining business need drove the formation of the captive.  For example, the taxpayer in Ocean Drilling was engaged in a business which was new (offshore oil drilling) and extremely risky; hence they could only find third party insurance from companies such as Lloyd's of London.  The taxpayer in Beech Aircraft wanted to gain control of the insurance policy drafting process.  The taxpayers in Clougherty and Carnation wanted to lower their worker's compensation costs.  In all the cases business necessity drove the transaction.  


2.) The IRS was prepared.  The service had several years to develop their legal theory.  In addition, they could pick their cases to find facts that were most beneficial to their position -- a standard IRS tactic.  Finally, they had a stable of credible experts lined up to bolster their argument.  In short, the service presented a solid case backed by the intellectual heft of their experts.


3.) The taxpayers were not prepared.  Reading the taxpayers cases and responses is like reading an appellate brief that relies on a strict reading of the law without using the resources of an appropriately credentialed expert or any in-depth analysis of the transaction beyond a cursory reading of the facts.  In essence, all the taxpayers used the argument that the IRS' theory violated the separate corporate existence as espoused in the Moline Properties case.  That is essentially where the taxpayer's argument ended.  No case provides any reference to a taxpayer expert to counter the IRS' experts.  Essentially, the taxpayers were out-maneuvered by the service.  


4.) The IRS was most successful against the single parent structure: the one case the IRS lost  was Crawford Fitting, where the insured's captive insured multiple entities and where the captive had multiple owners.  However, all single parent cases resulted in IRS victories.

5.) The overall analysis lacked a great deal of nuance:  Captives were a new business idea during this time; courts had little to no practical knowledge of these transactions, making them incredibly dependent on the IRS' arguments, documentation and experts.  Because the taxpayers had very weak cases, the courts relied extensively on the IRS' arguments, with several of the decisions more or less tracking the IRS' central legal theories.  Lacking from the decisions was a serious discussion of actuarial sciences in the insurance process or any counter-veiling theories.  With the exception of the Crawford Fitting case, the courts' decision is essentially the IRS' legal theory, nothing more.

Next up, we'll take an in-depth look at the Humana case, where taxpayers began gaining ground.