IRS revokes exemption for a small property and casualty insurance company

Plain-English summary

The IRS revoked an insurance company's exemption under IRC section 501(c)(15) after determining that its gross receipts exceeded the applicable limitation. The examination report said the organization had improperly excluded return premiums when calculating gross receipts, contrary to the Code and Notice 2006-42. The organization was instructed to file Form 1120-PC returns for years in which it did not qualify for exemption, and the report stated that a future election under section 831(b) could not be made retroactively. The ruling package also described the organization's appeal and Taxpayer Advocate rights.

Ruling snapshot

• Question: Did the insurance company continue to qualify for exemption under IRC section 501(c)(15)?
• Outcome: Revocation
• Key authorities: IRC §§ 11, 501, 816, 831, 832, 834, and 9100; Treas. Reg. § 301.9100-8; Notice 2006-42

Full text (IRS public release)

Internal Revenue Service Department of the Treasury

Person to Contact:
Employee ID Number:

Release Number: 201133016 .
Release Date: 8/19/2011 Tel: ( ) -
Date: May 24, 2011 Refer Reply to:
UIL: 501.15-00
In Re:
A
E Form Required to be Filed:
Tax Period(s) Ended:
December 31,
LEGEND
Certified Mail
Dear

This is a Final Adverse Determination as to your exempt status under section 501(c)(15) of the
Internal Revenue Code. We are revoking your organization’s exemption from income tax under

section 501(c)(15), effective January 1, 20°
Our adverse determination was made for the following reasons:

Your organization fails to meet the requirements for exemption under IRC section 501(c)(15). As

a result of a recent audit of your organization’s exempt status, it was determined that in the 20:
tax year, your organization exceeded the $ gross receipts limitation pursuant to section

501(c)(15)(A).

An insurance company (as defined in section 816(a)), other than a life insurance company, is
exempt from income tax under section 501(a), if its gross receipts for the taxable year do not
exceed $600,000 and more than 50 percent of those gross receipts consist of premiums. Section

501(c)(15)(A)(i).
In your 2C Form 990, you improperly excluded return premiums from the calculation of gross
receipts, which is not consistent with either the Code or Notice 2006-42.

You are required to file converted Forms 1120-PC, U.S. Property and Casualty Insurance
Company Income Tax Return, for any years which you are not qualified for exemption under

section 501(c)(15) and are still open under the statute of limitations. Forms 1120-PC for the
years ending December 31,20 and December 31, 20 should be filed with the Internal
Revenue Service TEGE: EO; 1100 Commerce St.; MC 4920 DAL: Mandatory Review; Dallas,
TX 75242-1027. Forms 1120-PC for tax periods beginning on and after January 1,20 _ for tax
years in which you do not qualify for exemption under section 501(c)(15) should be filed with

the Cincinnati Service Center, Cincinnati, OH, 45999-0012.

You have the right to contact the office of the Taxpayer Advocate. However, you should first
contact the person whose name and telephone number are shown above since this person can
access your tax information and can help you get answers. You can cal] 1-877-777-4778 and ask
for Taxpayer Advocate assistance. Or you can call the Taxpayer Advocate for the IRS office that
issued this letter. See the enclosed Notice 1214, Helpful Contacts for Your ‘Notice of
Deficiency” for Taxpayer Advocate telephone numbers and addresses.

Taxpayer Advocate assistance cannot be used as a substitute for established IRS procedures,
formal appeals processes, etc. The Taxpayer Advocate is not able to reverse legal or technically
correct tax determinations, nor extend the time fixed by law that you have to file a petition in the
United States Tax 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.

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

Sincerely yours,

Douglas H. Schulman
Commissioner
By

Sincerely,

Appeals Team Manager

ce:

IS

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

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TAX EXEMPT AND
GOVERNMENT ENTITIES April 22, 2010
DIVISION

Taxpayer Identification Number:

ORG Form:
ADDRESS 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 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,

Narette Downing

Nanette M. Downing
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Form 6018-A

Report of Examination
Envelope

Departmem of the Treasury - Intemal Revenue Service Schedule No. or

.Form 886A ° 3
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN December 31,
20KX

LEGEND
ORG = Organization name XX - Date State - state CO-1 = 1st 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 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 March 18, 19XX, in the State of State, under State Statutes
Chapter 87A. ORG was created to operate as a township mutual insurance company.
ORG operates in approximately 182 townships within 11 counties in the state. ORG
provides is fire and wind insurance to its policyholders.

The Amended Certificate of Incorporation, dated March 20XX, states that it will operate
as a mutual insurance company in various townships in various counties of the State of
i Membership of the organization consists of its policyholders. Board

members consist of 5-7 members.

The Bylaws restate the purpose of the organization as well as members and the
number of board members.

ORG provided copies of letters, one dating October 19. granting exemption under IRC
101(11) of the Internal Revenue Code which is equivalent to section 501(c)(15) of the
Internal Revenue Code of 1986. Another letter dated November 19 Stating that

exemption was granted in19 ~ under IRC 501(c)(15).

At the end of the calendar year 20XX there were policies outstanding. Policies
covered insurance on dwellings, personal property, farms, barns, sheds, other
structures and liability. A portion of the insurance for the year was reinsured with CO-1
of State (CO-1). A portion of the premiums collected by ORG are paid to CO-1 for the

reinsurance. CO-1 will reimburse ORG for any losses it is liable for.

Form 990 was filed for the year ending December 31 20XX. The following is a
breakdown of the Gross Receipts received by ORG for the year ending December 31,

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

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN December 31,
20XX

20XX, and the percentage of Gross Premiums to Gross Receipts for the same years
per Notice 20XX-42.

| aa]

|
Premiums Written |
Total Premiums |
| Investment Income |
| Capital Gains
| Total Gross Receipts
Percentage- Gross
Premium/Reinsurance
Income to Gross Receipts

ORG has never made an election under IRC 831(b) for any tax year.

LAW AND ANALYSIS

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

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-
(1) the gross receipts of which for the taxable year do not exceed $150,000

and,
(Il) 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).
Sec. 206, Clarification of Exemption from Tax for Small Property and Casualty

Insurance Companies, of the Pension Funding Equity Act of 20XX, P.L. 108-218,
amended section 501(c)(15)(A) to change the definition of small property and casualty

Form 886- Acrev.468) Department of the Treasury - Internal Revenue Service
Page: -2-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN December 31,
20XX

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, 20XX.

Notice 20XX-42, IRB, 20XX-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 990 was filed for the year ending December 31 20XX. The following is a
breakdown of the Gross Receipts received by ORG for the year ending December 31,
20XX, and the percentage of Gross Premiums to Gross Receipts for the same years

per Notice 20XX-42.

Department of the Treasury - Intemal Revenue Service

Form 886-A (Rev. 4-68)
Page: -3-

Form 886A Department of the Treasury - Imemal Revenue Service Schedule No. or
| Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN December 31,
20XX

20XX

Premiums Written |
Total Premiums |
|
|

| Investment Income

| Capital Gains

| Total Gross Receipts
Percentage- Gross
Premium/Reinsurance
Income to Gross Receipts
Premiums Written above was taken from the Trial Balance. The amount reported on
Form 990 and in their statements ($), was direct premiums minus returned premiums
($-$). As stated in Notice 20XX-42, the calculation for premiums does not include any

premiums returned.

ee ee

The amount reported for Capital Gains above does not include any losses incurred for
the year per Notice 20XX-42. The Form 990 showed Net Capital Gains which took into

consideration a loss of $

Based on the computations above, it is determined that ORG exceeded the $

limitation for the year ended December 31, 20XX.

Therefore, for the years beginning January 1, 20XX, ORG did not qualify for tax exempt
Status under IRC 501(c)(15).

2. If ORG does not qualify for tax exempt status for years beginning January
   1, 20XX, what are the tax consequences?

Since ORG did not qualify for tax exempt status under IRC Section 501(c)(15) for the
years beginning January 1, 20XX, ORG’s filing of the Forms 990 was incorrect. For the
year beginning January 1, 20XX, ORG should have filed Form 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.”

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

Form 886A Department of the Treasury- Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN December 31,
20KX

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 $ 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

amended return)

generally must be made by

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, ORG is not entitled to the relief
under 831(b), for the year under examination and for any future year, until it makes the
election. The election is for the year filed and for every year in the future where the
organization files a Form 1120/1120-PC. The election can not be made retroactive.

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

Form 886- Acrev.468) Department of the Treasury - Internal Revenue Service
Page: -5-

Form 886A Department of the Treasury - Imemal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG EIN December 31,
20XX

The tax exempt status should be revoked for the years beginning January 1, 20XX.
Form 1120-PC is required for each year and all future years where ORG does not
qualify for exemption. If ORG 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, ORG is allowed to make the election under IRC
831(b). The election will be required to be attached to the organizations tax return
yearly and can not be revoked by the organization at any time.

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.+68) Department of the Treasury - Internal Revenue Service
Page: -6-