Determination 201023064: IRS revoked an errors and omissions insurance organization's section 501(c)(15) exemption

Plain-English summary

The IRS revoked an errors and omissions insurance organization's exemption under IRC § 501(c)(15), effective January 1, 20XX. The attached examination report states that the organization did not meet the applicable gross-receipts limit for the years beginning January 1, 2007. It also states that the organization had made an IRC § 831(b) election in a prior year, so the election applied to the examined year and later years, but the organization was required to file Form 1120-PC when it did not qualify for exemption. The determination was based on the organization's insurance operations and the requirements of IRC § 501(c)(15).

Ruling snapshot

• Question: Did the organization qualify for exemption under IRC § 501(c)(15), and what were the consequences if it did not?
• Outcome: Revocation
• Key authorities: IRC §§ 501(c)(15), 831, 834, and 816; Pension Funding Equity Act of 2004, § 206

Full text (IRS public release)

DEPARTMENT OF THE TREASURY

INTERNAL REVENUE SERVICE
Attn: Mandatory Review, MC 4920 DAL
1100 Commerce St.

TAX EXEMPT AND Dallas, TX 75242

GOVERNMENT ENTITIES
DIVISION

501.15-00

Date: March 3, 2010
Release Number: 201023064
Release Date: 6/11/10

LEGEND

ORG = Organization name XX = Date CPA = CPA Address = address Employer Identification Number: Person to Contact/ID Number:

ORG Contact Numbers:

ADDRESS PHONE

FAX

CERTIFIED MAIL — RETURN RECEIPT REQUESTED
Dear

in a determination letter dated November 13, 19XX, you were held to be exempt from Federal income tax under section 501(c)(15) of the Internal Revenue Code (the Code).

Based on recent information received, we have determined you have not operated in accordance with the provisions of section 501(c)(15) of the Code. Accordingly, your exemption from Federal income tax is revoked effective January 1, 20XX. This is a final adverse determination letter with regard to your status under section 501(c)(15) of the Code.

We previously provided you a report of examination explaining why we believe revocation of your exempt status is necessary. At that time, we informed you of your right to contact the Taxpayer Advocate, as well as your appeal rights. On September 3, 20XX, you signed Form 6018-A, Consent to Proposed Action, agreeing to the revocation of your exempt status under section 501(c)(15) of the Code.

You have filed taxable returns on Forms 1120-PC, U.S. Property and Casualty Insurance Company Income Tax Return, for the years ended December 31, 20XX and December 31, 20XX with us. For future periods, you are required to file Form 1120-PC with the appropriate service center indicated in the instructions for the return.

You have the right to contact the Office of the Taxpayer Advocate. Taxpayer Advocate assistance is not a substitute for established IRS procedures, such as

the formal Appeals process. The Taxpayer Advocate cannot reverse a legally correct tax determination, or extend the time fixed by law that you have to file a petition in a United States court. The Taxpayer Advocate can, however, see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling. You may call toll-free and ask for Taxpayer Advocate Assistance. If you prefer, you may contact your local Taxpayer Advocate at:

If you have any questions, please contact the person whose name and telephone number are shown at the beginning of this letter.

Sincerely,

Nanette M. Downing
Acting Director, EO Examinations

cc: CPA

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
1100 Commerce Street
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES August 14, 2009

LEGEND
ORG = Organization nan XX = Date Address = address CPA = CPA Taxpayer Identification Number: Form: Tax Year(s) Ended: ORG Person to Contact/ID Number: ADDRESS Contact Numbers: Telephone: Fax: Dear

We have enclosed a copy of our report of examination explaining why we believe an adjustment of your organization’s exempt status is necessary.

We have also enclosed Publication 892, Exempt Organization Appeal Procedures for Unagreed Issues, and Publication 3498, The Examination Process. These publications include information on your rights as a taxpayer, including administrative appeal procedures within the Internal Revenue Service.

If you request a conference with Appeals, we will forward your written statement of protest to the Appeals Office, and they will contact you. For your convenience, an envelope is enclosed. If you and Appeals do not agree on some or all of the issues after your Appeals conference, the Appeals Office will advise you of its final decision

If you elect not to request Appeals consideration but instead accept our findings, please sign and return the enclosed Form 6018-A, Consent to Proposed Adverse Action. We will then send you a final letter modifying or revoking your exempt status under I.R.C. § 501(c)(15). If we do not hear from you within 30 days from the date of this letter, we will process your case on the basis of the recommendations shown in the report of examination and send a final letter advising of our determination.

In either situation outlined in the paragraph above (execution of Form 6018-A or failure to respond within 30 days), you are required to file federal income tax returns for the tax period(s) shown above, for all years still open under the statute of limitations, and for all later years. File the federal tax return for the tax period(s) shown above with this agent within 60 days from the date of this letter, unless a request for an extension of time is granted. File returns for later tax years with the appropriate service center indicated in

the instructions for those returns.

You have the right to contact the office of the Taxpayer Advocate. Taxpayer Advocate assistance is not a substitute for established IRS procedures, such as the formal appeals process. The Taxpayer Advocate cannot reverse a legally correct tax determination, or extend the time fixed by law that you have to file a petition in a United States court. The Taxpayer Advocate can, however, see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling. You may call toll-free 1-877-777-4778 and ask for Taxpayer Advocate Assistance.

If you have any questions, please call the contact person at the telephone number shown in the heading of this letter. If you write, please provide a telephone number and the most convenient time to call if we need to contact you.

Thank you for your cooperation.

Sincerely,

Sunita Lough
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Form 6018-A

Report of Examination
Envelope

cc: CPA

Department of the Treasury - Internal Revenue Service

Form 886A .
Explanation of Items

Schedule No. or
Exhibit

Name of Taxpayer

Year/Period Ended

ORG April 30, 20XX
LEGEND
ORG = Organization name XX = Date City = city State = state
[illegible]
ISSUES

1. Does ORG qualify for tax exempt status under Internal Revenue Code (IRC)

Section 501(c)(15), for the years beginning January 1, 20XX?

2. If ORG does not qualify for tax exempt status for years ending January 1, 20XX,

what are the tax consequences?

3. If the tax exempt status is revoked, how will it affect future years?

FACTS

ORG (ORG) was formed on April 5, 19XX in the State of State. The original name of the organization is ORG. Its assumed name is ORG. Its purpose as stated in its Articles of Incorporation is to provide an errors and omissions insurance program exclusively for local chapters, agencies and life insurance representatives of the CO-5, which includes CO-1, CO-2, CO-3, CO-4 and any entity owned or controlled by any of them in a manner authorized for a purchasing group pursuant to Articles 21.54 of the

State Insurance Code.

Membership in the organization is limited to one class consisting of local chapters,

agencies and life insurance representatives of CO-5.

A dissolution clause in the Articles of Incorporation states that upon dissolution any remaining assets shall be distributed to CO-1, CO-2 and CO-4.

ORG filed Application Form 1024, Application for Recognition of Exemption Under Section 501(a), with the Internal Revenue Service, seeking exemption under Internal Revenue Code (IRC) section 501(c)(15). Its purpose as stated in the application form is to provide an errors and omissions insurance program exclusively for local chapters, agencies and life insurance representatives of the CO-5, and any entity owned by the group. This activity also includes reporting errors and omissions claims to the errors

and omissions carrier.

ORG is connected with the CO-5 consisting CO-1, CO-2, CO-3, CO-4, to provide their local chapters, agencies and representatives with errors and omissions insurance

programs.

Form 886-A (Rev.4-68)

Department of the Treasury - Internal Revenue Service

Page: -1-

Form 886-A Department of the ‘I'rcasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended

ORG April 30, 20XX

The application form also states that ORG does not own, nor is it owned by any of these companies.

On November 13, 19XX, the organization received a determination letter, granting tax exempt status under Internal Revenue Code (IRC) 501(c)(15).

In response to the Information Document Request (IDR) mailed on March 20, 20XX, the organization provided copies of two insurance policies. The information is provided below:

Name: Insurance Agents and Insurance Brokers professional Liability Errors and Omissions Insurance.

Insurance Company: CO-6, City, State

Master Policy

Policy holder: Members of the ORG. 11/1/20XX to 11/1/20XX

Limits of Liability:

e As stated in each certificate- each claim, each certificate holder

e $ annual aggregate limit for all claims for all certificate holders Deductible:

e As stated in each certificate- each claim, each certificate holder

e $ annual aggregate deductible for all claims for all certificate holders

Premium: $.plus additional premium as agreed upon for those certificate holders with limits higher than $.

Name: Insurance Agents and Insurance Brokers professional Liability Errors and Omissions Insurance.

Insurance Company: CO-6, City, State

Certificate of Insurance

Policy holder: ORG. Association Local Chapter #342. 11/1/20XX to 11/1/20XX Limits of Liability:

e Each Claim: $

e Annual Aggregate for all Claims for all Certificate Holders: $

Deductible:

e Each Claim: $

e Annual Aggregate for all Claims for all Certificate Holders: $

At the end of the calendar year 20XX there were 450 policies outstanding. A listing of the policyholders and the policies held was provided in response to the IDR issued March 20, 20XX

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service

Page: -2-

Form 886-A Department of the ‘I'reasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended

ORG April 30, 20XX

Form 990 was filed for the year ending April 30, 20XX. The following is a breakdown of the Gross Receipts received by ORG for the year ending April 30, 20XX, and the percentage of Gross Premiums to Gross Receipts for the same years per Notice 20XX- 42.

| ORG” | 4/30/20XX _
_ Premiums Written

| Total Premiums _

| Interest/Dividend Income |

Total Gross Receipts

Percentage- Gross
Premium/Reinsurance
Income to Gross Receipts %

According to the information, the organization made an election under IRC 831(b) for the tax year ended December 31, 19XX.

ORG has not been involved in any court ordered liquidation during any part of 20XX or subsequent year.

LAW AND ANALYSIS

1. Does qualify for tax exempt status under
   Internal Revenue Code (IRC) Section 501(c)(15) for the years beginning January 1,20 ?

Internal Revenue Code section 501(c)(15)(A) exempts from Federal income tax insurance companies (as defined in section 816(a)) other than life (including interinsurers and reciprocal underwriters) if-

(i) (I) the gross receipts for the taxable year do not exceed $600,000, and (Il) more than 50 percent of such gross receipts consist of premiums, or

(ii) in the case of a mutual insurance company-
(I) the gross receipts of which for the taxable year do not exceed $150,000 and, (II) more than 35 percent of such gross receipts consist of premiums.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service

Page: -3-

eran 886A Department of the Treasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit

Name of Taxpayer Year/ Period Ended

ORG April 30, 20XX

Clause (ii) shall not apply to a company if any employee of the company, or a member of the employee’s family (as defined in section 2032(A)(e)(2), is an employee of another company exempt from taxation by reason of this paragraph (or would be so exempt but for this sentence).

Sec. 206, Clarification of Exemption from Tax for Small Property and Casualty Insurance Companies, of the Pension Funding Equity Act of 2004, P.L. 108-218, amended section 501(c)(15)(A) to change the definition of small property and casualty insurance companies (insurance companies other than life insurance companies) exempt from income taxes to: (1) a company whose gross receipts for the taxable year do not exceed $600,000, and over half such gross receipts consist of premiums (currently, whose net written premiums (or, if greater, direct written premiums) for the taxable year do not exceed $350,000); or (2) a mutual insurance company (a) whose gross receipts for the taxable year do not exceed $150,000 and more than 35 percent of which consist of premiums and (b) none of whose employees (or member of the employee's family) is an employee of another company exempt from tax under section 501(c)(15). These changes were applicable after December 31, 2003.

Notice 2006-42, IRB, 2006-19 provides guidance as to the meaning of “gross receipts” for purposes of section 501(c)(15)(A) of the Internal Revenue Code. This notice advises taxpayers that the Service will include amounts received from the following sources during the taxable year in “gross receipts” for purposes of § 501(c)(15)(A):

A. Premiums (including deposits and assessments), without reduction for return premiums or premiums paid for reinsurance;

B. Items described in § 834(b) (gross investment income of a non-life insurance company); and

C. Other items that are properly included in the taxpayer’s gross income under subchapter B of chapter 1, subtitle A, of the Code.

Thus, gross receipts include both tax-free interest and the gain (but not the entire amount realized) from the sale or exchange of capital assets, because those items are described in § 834(b). Gross receipts do not, however, include amounts other than premium income or gross investment income unless those amounts are otherwise included in gross income. Accordingly, the term gross receipts does not include contributions to capital excluded from gross income under § 118, or salvage or reinsurance recovered accounted for as offsets to losses incurred under

§ 832(b)(5)(A)(i).

Section 834(b)(1)(D) of the Internal Revenue Code includes under gross receipts the gains from the sale or exchanges of capital assets to the extent provided in subchapter P (section 1201 and following, relating to capital gains and losses).

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service

Page: -4-

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended

ORG April 30, 20XX%

Section 843 of the Internal Revenue Code states that an insurance company’s annual accounting period shall be the calendar year. has been using a fiscal year ending April 30". If used a calendar year as its annual accounting period, as required, a breakdown of gross receipts and percentage of premiums to gross receipts per Notice 2006-42 would be as follows:

___ GERMANIA | 12/31/20 12/31/20 12/31/20
Premiums Written | $ £| $ $ |
—_ |
_ Total Premiums | $ $ $ |
| |
| Interest/Dividend Income $ $ $
|__ a |
Total Gross Receipts __ | S$ $ $
‘Percentage-Gross | ©
Premium/Reinsurance |
_Incometo Gross Receipts = % % %
Based on the computations above, it is determined that did not meet the
$ limitation for the years ended December 31,20 & 20

Section 206(e) of the Pension Funding Act of 2004, P.L. 108-218 provides the effective date of the new requirements for exemption under IRC 501(c)(15). It states:

EFFECTIVE DATE-

(1) IN GENERAL- Except as provided in paragraph (2), the amendments made by this section shall apply to taxable years beginning after December 31, 20

(2) TRANSITION RULE FOR COMPANIES IN RECEIVERSHIP OR
LIQUIDATION- In the case of a company or association which-- (A) for the taxable year which includes April1,20 meets the requirements of section 501(c)(15)(A) of the Internal Revenue Code of 1986, as in effect for the last taxable year beginning before January 1, 20 and (B) on April 1,20 — is in a receivership, liquidation, or similar proceeding under the supervision of a State court,

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service Page: -5-

(Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit

Name of Taxpayer Year/ Period Ended

ORG April 30, 20XX

the amendments made by this section shall apply to taxable years beginning after the earlier of the date such proceeding ends or December 31, 20

was not involved in a court ordered liquidation during 20 or subsequent

year.

Therefore, for the years beginning January 1, 2007, did not qualify for tax exempt status under IRC 501(c)(15).

2. If does not qualify for tax exempt status for

years beginning January 1,20 , what are the tax consequences?

Since GERMANIA did not qualify for tax exempt status under IRC Section 501(c)(15) for the years beginning January 1, 20 filing of the Forms 990 was incorrect. For the year beginning January 1, 20 should have filed Forms 1120-PC.

IRC 831 discusses tax on insurance companies other than life insurance companies.

IRC 831(a) states as a general rule, “Taxes computed as provided in section 11 shall be imposed for each taxable year on the taxable income of every insurance company other than a life insurance company.”

IRC 831(b) provides an alternative tax for certain small companies. It states in IRC 831(b)(1) that, in general, “In lieu of the tax otherwise applicable under subsection (a), there is hereby imposed for each taxable year on the income of every insurance company to which this subsection applies a tax computed by multiplying the taxable investment income of such company for such taxable year by the rates provided in section 11(b).”

IRC 831(b)(2) discusses the companies to which this subsection applies.

(A) In general. This subsection shall apply to every insurance company other than life (including interinsurers and reciprocal underwriters) if- (i) the net written premiums (or, if greater, direct written premiums) for the taxable year do not exceed $1,200,000, and (ii) such company elects the application of this subsection for such taxable year. The election under clause (ii) shall apply to the taxable year for which made and for all subsequent taxable years for which the requirements of clause (1) are met. Such election, once made, may be revoked only with the consent of the Secretary.

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service Page: -6-

Form 886-A Department of the Treasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit

Name of Taxpayer Year/ Period Ended

ORG April 30, 20XX

Regulations (Regs.) 301.9100-8(a)(2) discusses the time for making elections. Under (i) it states in general that except as otherwise provided in this section, the elections described in paragraph (a)(1) of this section, must be made by the later of-

(A) The due date (taking into account any extensions of time to file obtained by the taxpayer) of the tax return for the first taxable year for which the election is effective, or

(B) January 22, 1990 (in which case the election generally must be made by amended return)

Regs. 301.9100-8(a)(1) mentioned above includes IRC 831(b)(2)(A).

Regs. 301.9100-8(a)(3) describes the manner of making elections. It states, “ Except otherwise provided in this section, the elections described in paragraph (a)(1) of this section must be made by attaching a statement to the tax return for the first taxable year for which the election is to be effective.”

Based on the Code and Regulation sections above, is entitled to the relief under 831(b), for the year under examination and for any future year, since it has already filed the election in a prior year. The election is for the year filed and for every year in the future where the organization files a Form 1120/1120-PC. is required to follow the election and can not terminate it themselves.

3. If the tax exempt status is revoked, how will it affect future years?

The tax exempt status should be revoked for the years beginning January 1, 2007. Form 1120-PC is required for each year and all future years where does not qualify for exemption. If meets the requirements under IRC 501(c)(15) in future years, it may be allowed to file the Form 990 for each year they qualify, as a self-declared entity. Otherwise, Form 1120-PC would be required. Any year in the future that the Form 1120-PC is required, is required to attach a copy of the election under IRC 831(b) to its tax return.

TAXPAYER’S POSITION

Unknown at the time of this writing
SUMMARY

It is the Governments position, based on the above facts, law and analysis, that the tax exemption status of ORG for the years beginning January 1, 20XX, should be revoked based on not meeting the qualifications for exemption under IRC 501(c)(15). Form 1120-PC would be required to be filed for any year where ORG does not qualify for exemption under IRC 501(c)(15).

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service Page: -7-