Determination 1023065: IRS revoked a small property and casualty insurer's section 501(c)(15) exemption

Plain-English summary

The IRS revoked a small property and casualty insurer's exemption under IRC § 501(c)(15), effective January 1, 20XX. The examination report states that the organization did not meet the applicable gross-receipts and premium requirements, and that its Form 990 filings were incorrect for the examined years. The report also states that the organization had not elected the alternative tax regime under IRC § 831(b), so a future election would apply only to the year made and later years. The determination directs the organization to file Form 1120-PC for years in which it does not qualify for exemption.

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 501.15-00
Attn: Mandatory Review, MC 4920 DAL

1100 Commerce St.

TAX EXEMPT AND Dallas, TX 75242

GOVERNMENT ENTITIES

DIVISION Date: March 4, 2010

Release Number: 201023065
Release Date: 6/11/10

ORG Employer Identification Number:
ADDRESS Person to Contact/ID Number:
Contact Numbers:

CERTIFIED MAIL — RETURN RECEIPT REQUESTED
Dear

In a determination letter dated February 18, 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
May 26, 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 return on Form 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

DIVISION May 8, 2009

LEGEND
ORG = Organization name XX = Date Address = address

Taxpayer Identification Number:
Form:
Tax Year(s) Ended:
Person to Contact/ID Number:
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 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

Form 886-A Department of the ‘Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 12/31/20XX
LEGEND
ORG = Organization name XX = Date State = State City = City
CO-1 = 1** Company
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 beginning 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 in the State of State in 18XX. Purpose of the organization is
to provide insurance to policyholders in case of damage or loss due to fire, lightning and
smoke.

The Articles of Incorporation filed with the State of State, on April 5, 19XX, stated the
following purpose:

e conduct and operate a ORG under and pursuant to the provisions and conditions
of Chapter 17 of the Insurance Code of the State of State, said Insurance Code
being set forth and appearing in and as Chapter 111 of the State Session Laws
of 19XX, and to insure and reinsure property against loss or damage by fire or
other casualty in the manner and to the extent provided in and by said Chapter
17...

The Bylaws dated March 20, 20XX stated the following information:

e All persons holding a valid policy of insurance in this company, the same being
full force and effect, are members thereof, and such are entitled to one vote at all
meetings of the members.

e Board of Directors: not less than 5 or more than 11.Officers.

e Organization shall not insure any property outside the limits of the State counties
of City, City, City, City, City and City, except personal property temporarily
removed.

e The company shall only insure the following property against loss or damage by
fire, lightning, smoke, explosion, riot, riot attending a strike, aircraft, vehicles and
livestock by electrocution: (a) farm dwellings and buildings, including the usual
contents therein, livestock, farm machinery, and other forms of farm property; (b)
dwellings designed for occupancy by not over two families or the usual contents

Form 886-A Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -1-

\Boysun 886A Department of the ‘l'reasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended

ORG 12/31/20XX

thereof, and private garages situated in a city or town; (c) churches, schools and
community buildings or the usual contents thereof...

Application Form 1024 was filed on August 24, 19XX. In the form the organization
stated that the organization's past, present and future activities and objectives are to
insure buildings, household goods, and other personal property against loss from fire,
lightning and smoke. It also stated that organization is owned by its members and the
members are the current policyholders.

On February 18, 19XX, ORG received a determination letter granting tax exempt status
under IRC 501(c)(15). During the course of the examination, ORG provided a copy of a
letter issued by the Service, dated August 26, 19XX granting tax exempt status under
IRC 101(11) of the Code of 19XX. Section 101(11) is equivalent to IRC 501(c)(15)
today. However, no records were able to be secured from organization or from the
Service regarding this letter and any application forms that may have been filed.

During the year under examination ORG issued policies to members to cover loss or
damage due to fire, lightning and smoke. Policyholders were able to insure their
dwellings, personal property, farm buildings and equipment, livestock and grain, and
more. At the end of 20XX, there were a total of 101 policies outstanding, with a total
insurance in force of $.

ORG was involved in a reinsurance agreement with CO-1 (CO-1). A letter dated
November 11, 20XX from CO-1 with a renewal agreement for 20XX was secured. In
Schedule A, Retention and Limit: it stated the CO-1 shall not be liable for any Loss
Occurrence until the Company’s Ultimate Net Loss on any one risk any one Loss
Occurrence exceeds $ and then the CO-1 shall be liable for 100% of the amount of
Ultimate Net Loss sustained by the Company in excess of $ on any one risk any one
Loss Occurrence, but the CO-1’s liability shall not exceed 100% of $ with respect to any
one risk any one Loss Occurrence. However, the liability shall be limited to $ $ as
respects any one Loss Occurrence, irrespective of the number of risks involved. Total
premiums of $ for the year was to be paid to the CO-1 quarterly in payments of $

Form 990 was filed for the 20XX tax year. The following is a breakdown of the Gross
Receipts received by ORG for the year ending December 31, 20XX, based on the Form
990 and annual statement provided to the State Burial Association Board and the
percentage of Gross Premiums to Gross Receipts for the same year per Notice 20XX-
42.

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -2-

(Payee 886A Department of the ‘l'reasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended

ORG 12/31 /20XX

; ORG BURIAL 7 20XX

Premiums Written
_Total Premiums Written
Interest/Dividend Income

Misc. Income -
_ Total Gross Receipts

_Percentage- Gross Premium/Reinsurance Income to Gross Receipts

The amount for Premiums Written above does not include the amount of commissions
received and the premiums refunded. The Form 990 combined all these items to arrive
at the $ amount reported. Total Gross Receipts also do not include these amounts.
The commissions received are considered a reduction in reinsurance premiums paid
and the premiums refunded are considered an expense.

An election under IRC 831(b) has never been filed. As of the writing of this report,
there has never been a filing of the election, either with the filing of the Forms 990 or
separately.

ORG was not involved in any court ordered liquidation or receivership during or 20XX.

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, 2006?

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
(II) 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.

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).

Form 886-A (Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -3-

Bown S86A Department of the ‘l'reasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit

Name of Taxpayer Year/Period Ended

ORG 12/31/20XX

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).

Section 834(c)(6) of the Internal Revenue Code allows a deduction for Capital Losses
to the extent provided in subchapter P (section 1201 and following) plus losses from
capital assets sold or exchanged in order to obtain funds to meet abnormal insurance
losses and to provide for the payment of dividends and similar distributions to
policyholders.

Form 886-A Rev.4-68 Department of the Treasu - Internal Revenue Service

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

Name of Taxpayer Year/Period Ended

ORG 12/31/20XX

Based on the changes in the limitations under Internal Revenue Code (IRC) Section
501(c)(15)(A), and the operation during 2006, it was determined from the
chart above did not qualify for tax exempt status for the years beginning
January 1, 20 did have gross receipts of under $ and $

($ ) but was unable to meet either the 50% or 35% requirement (23.31%).

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) INGENERAL- Except as provided in paragraph (2), the amendments
made by this section shall apply to taxable years beginning after
December 31, 2003.

(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 April 1, 2004, 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, 2004, and
(B) on April 1, 2004, is in a receivership, liquidation, or similar
proceeding under the supervision of a State court,
the amendments made by this section shall apply to taxable years
beginning after the earlier of the date such proceeding ends or December
31, 2007.

was not involved in a court ordered liquidation or receivership during 2006.
Therefore, Section 206(e)(2) does not apply to this organization.

Therefore, for the years beginning January 1, 2006, 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 did not qualify for tax exempt status under IRC Section 501(c)(15) for the
years beginning January 1, 20 tax exempt status should be revoked for
years beginning January 1, 20 filing of the Form 990 for 2006 was
incorrect. should have filed Form 1120-PC for years beginning January 1, 20

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

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

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

Name of Taxpayer Year/Period Ended

ORG 12/31/20XX

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-
(1) 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.

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 not entitled to the relief
under 831(b), for years under examination and for any future year, until they decide to
file the election. The election has never been filed, either with the Form 990 or

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 12/31/20XX

separately. Any election filed now or in the future would only be effective for the year
the election was filed and all subsequent years. The election can not be made
retroactive.

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, 20

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 allowed to make an election under IRC
831(b). Once the election is made, it is effective for the year the election was made
and for all future years that the Form 1120-PC is required. The election can not be
made retroactive.

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-