Reinsurance fund loses exemption after insurance activity ceases

View official IRS release (PDF)

Plain-English summary

A state-created reinsurance fund had been recognized as exempt under § 501(c)(15), but no carriers participated in the program during the examined years. The fund collected investment income and assessments while issuing no policies, collecting no premiums, paying no claims, and maintaining no claim reserves. The IRS concluded that it was not operating as an insurance company because it did not issue insurance, reinsure risks, or provide risk shifting and distribution. It also failed the statutory premium-percentage tests even if treated as an insurance company, and it had not timely elected the alternative tax under § 831(b). The IRS revoked exemption from the first examined year, denied relief from retroactive revocation under § 7805(b), and required taxable returns.

Ruling snapshot

• Question: Did a dormant reinsurance fund with only investment income and assessments remain an exempt insurance company under § 501(c)(15)?
• Outcome: Revoked
• Key authorities: IRC §§ 501(c)(15), 7805(b), 816, 831, and 834; Treas. Reg. §§ 1.801-3(a)(1) and 301.9100-8

Full text (IRS public release)

UIL 501.15-00

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION May 9, 2008

Number: 201450021 Taxpayer Identification Number:

Release Date: 12/12/2014
Form:

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

Contact Numbers:

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,

Marsha A. Ramirez
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
December 31,

20XX
December 31,

20XX

ISSUES

1. Does qualify as an insurance company under Internal Revenue Code Section 501(c)(15), for the years beginning January 1, 20XX?

2. If does not qualify as an insurance company under Internal Revenue Code Section 501(c)(15), can rely on the determination letter granted by the Service allowing it to claim tax exempt status pursuant to Internal Revenue Code Section 501(c)(15)?

3. If can not rely on the determination letter granted by the Service allowing it to claim tax exempt status pursuant to Internal Revenue Code Section 501(c)(15), is it entitled to relief under Internal Revenue Code Section 7805(b)?

4. If can not rely on the determination letter granted by the Service allowing it to claim tax exempt status pursuant to under Internal Revenue Code Section 501(c)(15), what is the effective date of the revocation?

5. If can not rely on the determination letter granted by the Service allowing it to claim tax exempt status pursuant to Internal Revenue Code Section 501(c)(15), based on the facts that it does not meet the requirements of an insurance company under Internal Revenue Code Section 501(c)(15), what are the tax consequences?

6. If does qualify as an insurance company under Internal Revenue Code Section 501(c)(15), does it meet the other requirements under Internal Revenue Code Section 501(c)(15) for tax exemption?

7. If does not meet the other qualifications under Internal Revenue Code Section 501(c)(15), can rely on the determination letter granted by the Service allowing it to claim tax exempt status pursuant to Internal Revenue Code Section 501(c)(15)?

8. If does not meet the other qualifications under Internal Revenue Code Section 501(c)(15), is it entitled to file an election under IRC 831(b) and be taxed only on its investment income?

9. If can not rely on the determination letter granted by the Service allowing it to claim tax exempt status pursuant to Internal Revenue Code Section 501(c)(15), based on the facts that it does not meet the requirements of Internal Revenue Code Section 501(c)(15), what are the tax consequences for years beginning January 1, 20XX?

FACTS

( ) was formed in the State of
pursuant to Revised Statutes ( ) .
created a nonprofit entity to be known as the for (
). The purpose of is to assure the availability of appropriate health insurance
to the state residents on an affordable basis.

There are two separate and distinct reinsurance funds (1) The ; and (2) The
This organization, is the second fund that was created.

A Plan of Operations for gives the details on how the organization will operate.
The Plan states the following:

• Pursuant to the Board of Directors of the
for (Board) hereby establishes this
Plan of Operations.

Membership- an as defined in and a
as defined in .
Purpose of the Program- to reinsure for a basic or standard health benefit plan,
the level of coverage provided; and for any other plan up to the level of coverage
provided in a basic or standard health benefit plan.
Purpose- the Plan:
• Ensure the fair, reasonable and equitable administration of the program of
reinsurance

• Provide for the sharing of the gains and losses of the program of
reinsurance on an equitable basis.

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -2-

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

Explanation of Items Exhibit
Year/Period Ended

December 31,
20XX
December 31,
20XX

Name of Taxpayer

• Establish procedures for the handling and accounting for the assets of the
program of reinsurance and for the annual fiscal reporting to the
Commissioner.

• Establishing procedures for selecting an administering carrier and set forth
the powers and duties of the administering carrier.

• Establish procedures for reinsuring risks pursuant to the program of
reinsurance.

• Establishing procedures for collecting assessments to pay claims and
administrative expenses incurred or estimated to be incurred by the
program of reinsurance.

• Establishing a methodology for applying the minimum amount of claims
and the maximum liability of the reinsuring or individuals reinsuring carrier.

• Provide for any additional matters necessary to carry out and administer
the program of reinsurance.

• Board members- 0 appointed by the commissioner as well as 0 who represent
carriers that provide health insurance coverage, 0 persons who represent small
employers and eligible persons, and the Commissioner.

• Reinsure for basic or standard Health Maintenance Organization (HMO),
Preferred Provider Organization (PPO); or indemnity health benefit plan pursuant
to of offered by a carrier.

did not provide a copy of their exemption letter during the examination.
Based on the Service’s records, tax exempt status under Internal Revenue Code (IRC)
501(c)(15) was granted in March of 19XX.

The Form 990 filed by for the years ended December 31, 20XX & 20XX were
selected for examination, to determine whether the organization remains qualified under
IRC 501(c)(15). The Code section was modified starting in 20XX, adding new
limitations and requirements for qualification.

In response to the Information Document Request (IDR) issued with original letter, the
organization stated that there were no Carriers that were participating in the program at
the present time. The only income that was received was investment income.

In review of the documents received from , it was verified that the only
income received was from investment income. Only investment income was reported
on the Form 990.

Form 886-A Department of the Treasury - Internal Revenue Service

Page: -3-

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

Explanation of Items Exhibit
Year/Period Ended

December 31,
20XX
December 31,
20XX

Name of Taxpayer

Assessments were made against seven different companies that were reported as
changes to net assets or fund balances and not as income on the returns. The
assessments were made to keep the organization operational in case there was a need
for it in the future. Assessments were made to cover the administrative and
professional fees charged to the organization.

A breakdown of the two years can be seen in the chart below:

20XX 20XX
Premiums Earned $0 $0
Other Investment Income $0 $0
Total Gross Receipts $0 $0
Percentage- Gross
Premium/Reinsurance
Income to Gross Receipts 0.00% 0.00%

During both years there were no claims filed or paid. There were no participants to file
any claims. Only expenses incurred during both years included professional fees and
administrative fees. No reserves were maintained since there were no potential claims
to be filed or to be paid.

As stated above, was formed in the state of so a 953(d) election to be
considered a domestic organization for tax purpose was not filed or applicable.

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.

Form 886-A 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
December 31,
20XX
December 31,
20XX
LAW AND ANALYSIS

1. Does qualify as an insurance company under

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

As stated above, has had no participants in the program during the years under
examination. No premiums have been collected, no claims have been filed or payments
made, no reserves maintained. The only activity being conducted by is the
maintaining of investment accounts and receiving investment income from those
accounts.

Neither I.R.C. 501(c)(15) nor its corresponding regulations define an “insurance
company.” Subchapter L of the Code (I.R.C. sections 801-848), however, addresses
the taxation of insurance companies. The term “insurance company” has the same
meaning under section 501(c)(15) as it does in Subchapter L. See H. Conf. Rep. No.
99-841, 99th Cong., 2d Sess. (Vol. II) 370-71, reprinted in 1986-3 (Vol. 4) C.B. 370-71.

I.R.C. section 816 (formerly I.R.C. section 801) defines a life insurance company. As
part of this definition, I.R.C. section 816 provides, “the term ‘insurance company’ means
any company more than half of the business of which during the taxable year is the
issuing of insurance or annuity contracts or the reinsuring of risks underwritten by
insurance companies.”

Treas. Reg. section 1.801-3(a)(1) defines an insurance company as:

A company whose primary and predominant business activity during the taxable
year is the issuing of insurance or annuity contracts or the reinsuring of risks
underwritten by insurance companies. Thus, though its name, charter powers, and
subjection to State insurance laws are significant in determining the business which a
company is authorized and intends to carry on, it is the character of the business
actually done in the taxable year which determines whether a company is taxable as an
insurance company under the Internal Revenue Code.

In this case, ’s primary and predominant business activity is not the issuing of

insurance or annuity contracts or the reinsuring of risks underwritten by insurance
companies. is not involved in either of these two activities. Its sole purpose

Form 886-A 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
Year/Period Ended

December 31,
20XX
December 31,
20XX

Name of Taxpayer

right now is to collect investment income from the investment accounts and assess
companies if necessary.

Another aspect to consider in this case is that there is no insurance contract that
provides both risk shifting and risk distribution. In AMERCO & Subsidiaries, 96 T.C. 18
(1991), a case affirmed by the 9th Circuit, the Tax Court adopted a three-part test. The
three parts consist of; (1) Is the risk an insurance risk?; (2) Is there risk shifting and risk
distribution?; and (3) Is there insurance in its generally accepted sense?

Neither the Internal Revenue Code nor the Regulations specifically define the term
“insurance contract.” The courts have generally required that a transaction involve both
risk shifting (from the insured’s perspective) and risk distribution (from the insurer's
perspective) in order to be characterized as insurance. Helvering v. LeGierse, 312 U.S.
531, 539 (1941); Gulf Oil Corp. v. Commissioner, 914 F.2d 396, 411 (3rd Cir. 1990).

Risk shifting occurs when a person facing the possibility of a loss transfers some or all
of the financial consequences of the loss to the insurer. Rev. Rul. 88-72, 1988-2 C.B.
31, clarified by Rev. Rul. 89-61, 1989-1 C.B. 75. The risk transferred pursuant to an
insurance contract must be a risk of economic loss. Allied Fidelity Corp. v.
Commissioner, 66 T.C. 1068 (1976), aff'd., 572 F.2d 1190 (7th Cir. 1978), cert. denied,
439 U.S. 835 (1978).

It is exam’s position that risk distribution requires both a distribution of exposure units
and a distribution of a pool of premiums. In addressing distribution courts have focused
on one or the other, but no case has address both.

Risk distribution of exposure units refers to the operation of the statistical phenomenon
known as the “the law of large numbers.” When additional statistically independent risk
exposure units are insured, although the potential total losses increase, there is also an
increase in the predictability of average loss. This increase in the predictability of the
average loss decreases the amount of the capital that an insurance company needs per
risk unit to remain at a given solvency level. See Rev. Rul. 89-61, 1989-1 C.B. 75.

The Courts have not spent a great deal of time explaining what they mean by risk
distribution. No court has squarely held that there can be no risk distribution if there is
only one, or a few, insureds. A fair reading of the court opinions addressing the issue,
however, supports the IRS’s position. See Barnes v. United States, 801 F.2d 984, 985
(7th Cir. 1986) (“Risk distributing is the spreading of the risk of loss among the
participants in an insurance program.”). See also, Commissioner v. Treganowan, 183
F.2d 288 , 291 (2nd Cir. 1950). Such spreading is effectuated by pooling among
unrelated insureds. “ [R]isk distribution means that the party assuming the risk

Form 886-A 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
Year/Period Ended
December 31,
20XX
December 31,
20XX

Name of Taxpayer

distributes his potential liability, in part, among others.” Beech Aircraft Corp. v. United
States, 797 F.2d 920, 922 (10th Cir. 1986). Risk distribution is accomplished where the
risk is distributed among insureds other than the entity that incurred the loss. See Ross
v. Odem, 401 F.2d 464 (5th Cir. 1968).

The Sixth Circuit touched on the issue of risk distribution in Humana, Inc. v.
Commissioner, 881 F.2d 247, 257 (6th Cir. 1989), noting that there was adequate risk
distribution, “where the captive insures several separate corporations within an affiliated
group and losses can be spread among the several distinct corporate entities.” The
Ninth Circuit has also measured risk distribution by explaining, “[i]nsuring many
independent risks in return for numerous premiums serves to distribute risk. By
assuming numerous relatively small, independent risks that occur randomly over time,
the insurer smoothes out losses to match more closely its receipt of premiums.”
Clougherty Packing Co. v. Commissioner, 811 F.2d 1297, 1300 (9th Cir. 1987)

does not issue or reinsure any policies. Its only activity is collecting
investment income from their investment accounts. There is no risk shifting and risk

distribution with because has no insurance policies.
Also, to show that is not an insurance company is the lack of reserves to pay
claims, and the payment of claims themselves. has no reserves to pay any

claims. There are no participants in the program so there is no need to have reserves.

Therefore, it is of the Service’s position that does not qualify as an insurance
company under IRC 501(c)(15). To qualify for tax exempt status under IRC 501(c)(15),
an organization must be operating as an insurance company.

2. If does not qualify as an insurance company under
   Internal Revenue Code Section 501(c)(15), can
   rely on the determination letter granted by the Service allowing it to claim
   tax exempt status pursuant to Internal Revenue Code Section 501(c)(15)?

To qualify for tax exempt status under IRC 501(c)(15), an organization must be
operating as an insurance company. Since does not qualify as an
insurance company it does not qualify for tax exempt status under IRC 501(c)(15),
therefore it can not rely on the determination letter granted by the Service allowing it to

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -7-

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

Name of Taxpayer

claim tax exempt status pursuant to IRC 501(c)(15). The organization’s tax exemption
should be revoked for years beginning January 1, 20XX.

3. If can not rely on the determination letter
   granted by the Service allowing it to claim tax exempt status pursuant to
   Internal Revenue Code Section 501(c)(15), is it entitled to relief under
   Internal Revenue Code Section 7805(b)?

An organization may ordinarily rely on a favorable determination letter received from the
Internal Revenue Service. Regulations 1.501(a)-1(a)(2); Rev. Proc. 2005-4, 14.02
(cross-referencing 13.01 et seq.) 2005-4 C.B. 128. An organization may not rely on a
favorable determination letter, however, if the organization omitted or misstated a
material fact, in its application or in supporting documents. In addition, an organization
may not rely on a favorable determination if there is a material change, inconsistent with
exemption, in the organization’s character, purposes, or methods of operation after the
determination letter is issued. Regulations 601.201(n)(3)(ii); Rev. Proc. 90-27, 13.02,
1990-1 C.B. 514. Any such changes must be reported to the Service so that continuing
recognition of exempt status can be evaluated.

The Commissioner may revoke a favorable determination letter for good cause.
Regulations 1.501(a)-1(a)(2). A favorable determination letter may be revoked by
written notice to the organization to whom the determination originally was issued.
Regulations 601.201(m) (cross-referencing Reg. 601.201(I)); Rev. Proc. 90-27, 14,
1990-1 C.B. 514, 518.

If the Commissioner revokes the tax exempt status of an organization, the remaining
question is whether the revocation should be applied prospectively or retroactively.
Generally, revocation of a determination letter is prospective. Rev. Proc. 2007-4, 14.02
(cross-referencing 13.01 et seq.). Revocation of a determination letter may, however,
be retroactive if the organization omitted or misstated a material fact or operated in a
manner materially different from that originally represented. Regulations
601.201(n)(6)(i); Rev. Proc. 90-27, 14.01; Rev. Proc. 2007-4 14.02 (cross-referencing
13.01 et seq.).

In cases where the organization omitted or misstated a material fact, revocation may be
retroactive to all open years under the statute. Regulations 601.201(I)(1). In cases
where revocation is due to a material change, inconsistent with exempt status, in the
character, the purpose, or the method of operation, revocation will ordinarily take effect

Form 886-A : Department of the Treasury - Internal Revenue Service
Page: -8-

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

Name of Taxpayer

as of the date of the material change. Regulations 601.201(n)(6)(i); Rev. Proc. 90-27.
In any event, revocation will ordinarily take effect no later than the time at which the
organization received written notice that its exemption ruling or determination letter
might be revoked. Regulations 601.201(n)(6)(i).

Under certain circumstances, however, the Commissioner may, in his discretion grant
relief from retroactive revocation under I.R.C. 7805(b) of the Code. Section 7805(b)(8)
of the Internal Revenue Code provides:

APPLICATION TO RULINGS. The Secretary may prescribe the extent, if any, to
which any ruling (including any judicial decision or any administrative
determination other than by regulation) relating to the internal revenue laws, shall
be applied without retroactive effect. Section 301.7805-1(b) of the regulations
delegates authority grated by I.R.C. 7805(b) to the Commissioner (or the
Commissioner’s delegate).

To request I.R.C. 7805(b) relief, the organization must submit a statement in support of
this application of I.R.C. 7805(b), as described in Rev. Proc. 2005-4, 14.02. See also
Rev. Proc. 2005-5, 19. The organization’s statement must expressly assert that the
request is being made pursuant to I.R.C. 7805(b). The organization’s statement must
also indicate the relief requested and give reasons and arguments in support of the
relief requested. It must also be accompanied by any documents bearing on the
request. The organization’s explanation and arguments should discuss the five factors
bearing on retroactivity listed in Rev. Proc. 2005-4, 14.02(1) (cross-referencing 13.05),
as they relate to the situation at issue. These five items are, in effect, the same as the
factors provided in Regulations 601.201(I)(5) and 601.201(m), Statement of Procedural
Rules, which states:

Except in rare or unusual circumstances, the revocation or modification of a
ruling will not be applied retroactively with respect to the taxpayer to whom the
ruling was originally issued or to a taxpayer whose tax liability was directly
involved in such a ruling if:

1. there has been no misstatement or omission of material facts;

2. the facts at the time of the transaction are not materially different from the
   facts on which the [determination letter] was based;

‘3. there has been no change in applicable law;

4. the [determination letter] was originally issued for a proposed transaction;
   and

5. the taxpayer directly involved in the [determination letter] acted in good
   faith in reliance upon the [determination letter] and revoking or modifying

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -9-

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

Explanation of Items Exhibit
Year/Period Ended

December 31,
20XX
December 31,
20XX

Name of Taxpayer

the [determination letter] retroactively would be to the taxpayer's
determinant.

If relief is granted under I.R.C. 7805(b), the effective date of revocation of a
determination letter is no later than the date on which the organization first received
written notice that its exemption might be revoked. Regulations 601.201(n)(6)(i);
Virginia Education Fund v. Commissioner, 85 T.C. 743, 7522-3 (1985), aff'd 799 F.2d
903 (4th Cir. 1986). This does not preclude the effective date of revocation being earlier
than the date on which the organization first received written notice that its exemption
might be revoked. Virginia Education Fund v. Commissioner, 85 T.C. at 753.

The Supreme Court has held that the Commissioner has broad discretion under I.R.C.
7805(b) (and its predecessor) in deciding whether to revoke a ruling retroactively.
Automobile Club of Michigan v. Commissioner, 353 U.S. 180, 184 (1957). See also
Dixon v. United States, 381 U.S. 68, 74-75 (1965). The Commissioner's determination
is reviewable by the courts only for abuse of that discretion. Virginia Education Fund v.
Commissioner, 85 T.C. 743, 752 (1985).

It is the Service’s position that the activities of the organization have changed
dramatically compared to the organizing documents above. If the organization were to
seek exemption now, based on its current activities, there is a very high probability it
would not receive a determination letter from the Service granting tax exempt status
under IRC 501(c)(15). The insurance activities that were conducted when the
organization applied for exemption are no longer being conducted.

Therefore, it is appropriate for the Commissioner to NOT grant relief from retroactive
revocation of determination letter.

4. If can not rely on the determination letter
   granted by the Service allowing it to claim tax exempt status pursuant to
   under Internal Revenue Code Section 501(c)(15), what is the effective date
   of the revocation?

is not entitled to relief under I.R.C. 7805(b). The
effective date of revocation should be for years beginning January 1, 20XX. This is the
first year under examination.

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -10-

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

Name of Taxpayer

5. if can not rely on the determination letter
   granted by the Service allowing it to claim tax exempt status pursuant to
   Internal Revenue Code Section 501(c)(15), based on the facts that it does
   not meet the requirements of an insurance company under Internal
   Revenue Code Section 501(c)(15), what are the tax consequences?

Since tax exempt status should be revoked for years
beginning January 1, 20XX, would be responsible for filing Forms 1120 for years
beginning January 1, 20XX.

6. If does qualify as an insurance company
   under Internal Revenue Code Section 501(c)(15), does it meet the other
   requirements under Internal Revenue Code Section 501(c)(15) for tax

exemption?
If for some reason is considered an insurance company under IRC 501(c)(15),
then the question is whether meets the other requirements to qualify under IRC
501(c)(15).

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
(I!) 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,
(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 Department of the Treasury - Internal Revenue Service
Page: -11-

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

Explanation of Items Exhibit
Year/Period Ended

December 31,
20XX
December 31,
20XX

Name of Taxpayer

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

Form 886-A Department of the Treasury - Internal Revenue Service

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

Name of Taxpayer Year/Period Ended
December 31,

20XX
December 31,
20XX

losses and to provide for the payment of dividends and similar distributions to
policyholders.

Based on the changes in the limitations under IRC 501(c)(15)(A), and the operation of

during 20XX & 20XX, it was determined by the chart above, that did not
qualify for tax exempt status for years starting January 1, 20XX. was able to meet
the $0 gross receipts limitation (20XX- $0; 20XX- $0) however, it was not able to meet
the 50% requirement of Gross Premiums to Gross Receipts (20XX- 0.00%; 20XX-
0.00%);

As a non-stock company, (mutual), did meet the requirement of under $150,000 in
gross receipts (20XX- $0; 20XX- $0) but was unable not meet the 35% requirement of
premiums to gross receipts (20XX- 0.00%; 20XX- 0.00%).

To be qualified under IRC 501(c)(15), had to meet all requirements, either under IRC
501(c)(15)(A)(i) or (a)(ii). did not meet the requirements under either section of the
code.

Section 206(e) of the Pension Funding Act of 2004, P.L. 118-218 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, 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 during 20XX and 20XX.
Therefore, Section 206(e) does not apply to this organization.

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -13-

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

Year/Period Ended
December 31,
20XX
December 31,
20XX

Name of Taxpayer

Based on the information above, even if is considered an insurance company, they did
not meet the requirements under IRC 501(c)(15) and their tax exempt status should be
revoked.

7. If does not meet the other qualifications
   under Internal Revenue Code Section 501(c)(15), can
   rely on the determination letter granted by the Service allowing it to
   claim tax exempt status pursuant to Internal Revenue Code Section
   501(c)(15)?

To qualify for tax exempt status under IRC 501(c)(15), an organization must be
operating as an insurance company as well as meet the other requirements under this
code section. Since did not meet the other requirements, it does not qualify for
tax exempt status under IRC 501(c)(15), therefore it can not rely on the determination
letter granted by the Service allowing it to claim tax exempt status pursuant to IRC
501(c)(15). The organization’s tax exemption should be revoked for years beginning
January 1, 20XX.

8. If does not meet the other qualifications
   under Internal Revenue Code Section 501(c)(15), is it entitled to file an
   election under IRC 831(b) and be taxed only on its investment income?

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).”

Form 886-A Department of the Treasury - Internal Revenue Service
Page: -14-

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

Name of Taxpayer

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 (i) 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
IRC 831(b), for 20XX & 20XX, because it did not meet the requirements of Regs
301.9100-8(a)(2), and therefore would be required to report all income and expenses on
Form 1120-PC for each year. As of this writing, the election has never filed, either with
the filing of the Form 990 or separately. When an election is filed, it would only allow the
organization to receive relief under IRC 831(b) in the year it is filed and all future years.
The election would not be retroactive to any prior years.

Form 886-A Department of the Treasury - Internal Revenue Service

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Form 886-A Department of the Treasury - Internal Revenue Service
Explanation of Items

Schedule No. or Exhibit

Name of Taxpayer

Year/Period Ended

December 31,
20XX

December 31,
20XX

9. If can not rely on the determination letter granted by the Service allowing it to claim tax exempt status pursuant to Internal Revenue Code Section 501(c)(15), based on the facts that it does not meet the requirements of Internal Revenue Code Section 501(c)(15), what are the tax consequences for years beginning January 1, 20XX?

Since tax exempt status should be revoked for years beginning January 1, 20XX, would be responsible for filing Forms 1120-PC for years beginning January 1, 20XX.

TAXPAYER’S POSITION

Unknown at the time of this writing.

SUMMARY

It is the Service’s position, based on the above facts, law and analysis, that the tax exemption status of for the years beginning January 1, 20XX should be revoked based on not operating as an insurance company, thereby failing to meet the qualifications for exemption under IRC 501(c)(15). Forms 1120 would be required to be filed for years beginning January 1, 20XX.

If it is determined that was operating as an insurance company, the tax exempt status should still be revoked because they have not met the other requirements of IRC 501(c)(15). Then Forms 1120-PC would be required to be filed for years beginning January 1, 20XX.

Form 886-A Department of the Treasury - Internal Revenue Service
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