Captive insurer lost section 501(c)(15) exemption

Plain-English summary

A foreign captive insurer had previously received recognition as a tax-exempt small insurance company under section 501(c)(15). After examining four tax years, the IRS concluded that most direct-written contracts covered business or investment risks rather than insurance risks and that the arrangement did not adequately distribute risk. The IRS also found that the organization's primary and predominant activity was not insurance and that its purported insurance and reinsurance transactions lacked economic substance. It therefore revoked the exemption for the examined years. Because the organization did not qualify as an insurance company under subchapter L, its section 953(d) election to be treated as a domestic corporation was invalid, and the report said the controlled foreign corporation rules applied.

Ruling snapshot

• Question: Did the captive's contracts and risk pool make it an insurance company eligible for section 501(c)(15) exemption and a section 953(d) election?
• Outcome: Exemption revoked and section 953(d) election treated as invalid
• Key authorities: IRC §§ 501(c)(15), 816, 831, and 953(d); Rev. Ruls. 2002-89, 2002-90, 2005-40, and 2007-47

Full text (IRS public release)

Department of the Treasury

Internal Revenue Service

Appeals Office
Employer Identification Number:
Release Number: 201645019 Person to Contact:
Release Date: 11/4/2016
Date: August 10, 2016
Employee ID Number:
Tel:
ORG
ADDRESS
Tax Period(s) Ended:
December 31, 20XX
December 31, 20XX
December 31, 20XX
Certified Mail December 31, 20XX
UIL: 0501.15-00
Dear

This is a final determination that you do not qualify for exemption from Federal income tax under Internal
Revenue Code (the “Code”) section 501(a) as an organization described in Code section 501(c)(15) for
the tax periods above. Your determination letter dated October 15, 20XX is revoked.

Our adverse determination as to your exempt status was made for the following reason(s):

You are not an insurance company within the meaning of subchapter L of the Internal Revenue Code
because your primary and predominant activity is not insurance. The purported insurance and/or
reinsurance transactions lack economic substance.

Organizations that are not exempt under section 501 generally are required to file federal income tax
returns (Form 1120, Form 1041 or Form 1120-F for foreign corporations) and pay tax, where applicable.
For further instructions, forms, and information please visit www.irs.gov.

If you decide to contest this determination, you may file an action for declaratory judgment under the
provisions of section 7428 of the Code in one of the following three venues: 1) United States Tax Court,
2) the United States Court of Federal Claims, or 3) the United States District Court for the District of
Columbia. A petition or complaint in one of these three courts must be filed within 90 days from the date
this determination letter was mailed to you. Please contact the clerk of the appropriate court for rules and
the appropriate forms for filing petitions for declaratory judgment by referring to the enclosed Publication

892. You may write to the courts at the following addresses:

United States Tax Court
400 Second Street, N.W.
Washington, D.C. 20217

U.S. Court of Federal Claims
717 Madison Place, N.W.
Washington, D.C. 20439

U.S. District Court for the District of Columbia
333 Constitution Ave., N.W.
Washington, D.C. 20001

Processing of income tax returns and assessments of any taxes due will not be delayed if you file a
petition for declaratory judgment under section 7428 of the Internal Revenue Code.

You may also be eligible for help from the Taxpayer Advocate Service (TAS). TAS is an independent
organization within the IRS that can help protect your taxpayer rights. TAS can offer you help if your tax
problem is causing a hardship, or you've tried but haven't been able to resolve your problem with the IRS.
If you qualify for TAS assistance, which is always free, TAS will do everything possible to help you. Visit
www.taxpayeradvocate.irs.gov or call 1-877-777-4778.

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

Sincerely Yours,

Appeals Team Manager

Enclosure: Publication 892

cc:

Department of the Treasury Date:

Internal Revenue Service March 14, 2014
IRS Tax Exempt and Government Entities Division Taxpayer identification number:
Form:

Tax year(s) ended:

ORG 12/31/20XX; 12/31/20XX;
ADDRESS 12/31/20XX; 12/31/20XX
Person to contact / ID number:

Contact numbers:
Telephone:
Fax:

Manager's name / ID number:

Manager's contact number:

Response due date:

Certified Mail - Return Receipt Requested

Dear

Why you are receiving this letter
Enclosed is a copy of our report of examination explaining why revocation of your organization's tax-exempt

status is necessary.

What you need to do if you agree
If you agree with our findings, please sign the enclosed Form 6018-A, Consent to Proposed Action, and return

it to the contact at the address listed above. We'll send you a final letter revoking your exempt status.

If we don't hear from you
If we don’t hear from you within 30 calendar days from the date of this letter, we’ll process your case based on

the recommendations shown in the report of examination and this letter will become final.

Effects of revocation
In the event of revocation, you'll be required to file federal income tax returns for the tax year(s) shown above.

File these returns with the contact at the address listed above within 30 calendar 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.

What you need to do if you disagree with our findings
If you disagree with our position, you may request a meeting or telephone conference with the supervisor of the

contact identified in the heading of this letter. You also may file a protest with the IRS Appeals office by
submitting a written request to the contact person at the address listed above within 30 calendar days from the
date of this letter. The Appeals office is independent of the Exempt Organizations division and resolves most

disputes informally.

Letter 3610-R (10-2012)
Catalog Number 59432G


For your protest to be valid, it must contain certain specific information, including a statement of the facts, the
applicable law and arguments in support of your position. For specific information needed for a valid protest,
please refer to page one of the enclosed Publication 892, How to Appeal an IRS Decision on Tax-Exempt Status,
and page six of the enclosed Publication 3498, The Examination Process. Publication 3498 also includes
information on your rights as a taxpayer and the IRS collection process. Please note that Fast Track Mediation
referred to in Publication 3498 generally doesn’t apply after we issue this letter.

If you and Appeals don’t agree on some or all of the issues after your Appeals conference, or if you don’t
request an Appeals conference, you may file suit in United States Tax Court, the United States Court of Federal

Claims, or United States District Court after satisfying procedural and jurisdictional requirements.

You may also request that we refer this matter for technical advice as explained in Publication 892. Please
contact the person identified in the heading of this letter if you’re considering requesting technical advice. If we
send a determination letter to you based on a technical advice memorandum issued by the Exempt
Organizations Rulings and Agreements office, then no further IRS administrative appeal will be available to

you.

Contacting the Taxpayer Advocate Office is a taxpayer right

You have the right to contact the office of the Taxpayer Advocate Service (TAS). TAS is your voice at the
IRS. This service helps taxpayers whose problems with the IRS are causing financial difficulties; who
have tried but haven’t been able to resolve their problems with the IRS; and those who believe an IRS
system or procedure is not working as it should. If you believe you are eligible for TAS assistance, you
can call the toll-free number 1-877-777-4778 or TTY/TDD 1-800-829-4059. For more information, go to

www.irs.gov/advocate. If you prefer, you may contact your local Taxpayer Advocate at:

Internal Revenue Service
Office of the Taxpayer Advocate

For additional information
If you have any questions, please call the contact 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,

Director, EO Examinations

Enclosures:

Report of Examination
Form 6018-A
Publication 892
Publication 3498

Letter 3610-R (10-2012)
Catalog Number 59432G

Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX
ISSUE:

1. Whether the contracts executed by ORG constitute contracts of insurance?

2. Whether the arrangement entered into by ORG involves the requisite element of risk
distribution?

3. Whether more than half of the business of ORG during each of the taxable years under
consideration is the issuing of insurance or annuity contracts or the reinsuring of risks
underwritten by insurance companies?

4. If ORG is not an insurance company, should its tax-exempt status under section 501(c)(15)
of the Internal Revenue Code be revoked, effective January 1, 20XX?

5. Is the IRC 953(d) election valid if the taxpayer is not an insurance company?

6. Is ORG entitled to relief under IRC 7805(b)?

FACTS:

ORG (“Taxpayer”) was formed and incorporated in Island, Territory on December 19, 20XX,
under the provisions of the International Business Companies Act, Cap. 291. The taxpayer
was formed to provide certain property and casualty insurance type services. The taxpayer is
formed as a foreign captive insurance taxpayer. The taxpayer is authorized to issue 0
common shares with a $0 par value. The taxpayer actually issued 0 shares in consideration of
$0 capital contribution.

The taxpayer is a single parent captive. Taxpayer is wholly owned by Trust, an irrevocable
trust formed in City, County, State, on September 1, 20XX, by Indv-1, grantor. Indv-1 is the
brother of Indv-2. Trust is located at Address, City, State Zip code. This is also the principal
address of Indv-2 and Indv-3.

Indv-2, and wife, Indv-3 served as the initial trustees of Trust. Indv-2 is the 100% sole
beneficiary of the trust. Over the years, the Board of Trustees was expanded to included Indv-
4 and Indv-5, son and daughter of Dr. Indv-2 and Indv-3. However, Indv-3 and Indv-5 resigned
as trustees in October 20XX. Currently, the trust is governed by Indv-2, and his son, Indv-4,
and Indv-2, is still the sole beneficiary.

The TEGE examining agent obtained a copy of taxpayer's Form 1024 application
administrative file from Rulings and Agreements in Washington D. C., on October 1, 20XX.
The administrative file included a copy of the Form 1024 application, Articles of Incorporation;
the IRC 953(d) election; regulatory filings; application for insurance business license and
responses of Insurance Regulators; insurance underwriting diagrams; organizational owner
chart; supplemental information for the Form 1024; a copy of Trust Agreement; financial
information for 20XX and subsequent years; forms of credit reinsurance agreements entered

Form 886-A (1-1994) Catalog Number 20810W Page 1 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

into by the taxpayer; and a copy of the 20XX insurance policies issued by the taxpayer. Other
documents were received from CPA, CPA, in response to Information Document Requests
issued by the examining agent to the CPA during the course of the current audit.

According to the Articles of Incorporation, the taxpayer is to be governed by a board of
directors composed of one to seven directors. The board is actually composed of two
directors, Indv-2 and Indv-3. Indv-2 served as Director, Chief Executive Officer (CEO),
President, Treasurer, and Assistant Secretary. Indv-3 served as Vice President, Secretary,
and Assistant Treasurer of the taxpayer.

Taxpayer filed an application for an insurance business license with Territory Financial
Services Department, on November 20, 20XX. The application included a copy of the
taxpayer’s business plan. According to the business plan, Indv-2 and Indv-3, are also owners
of CO-1 a City based marketer of specialty dermatologic creams that are sold to major drug
Store chains, such as Eckerd, Rite Aid, Walgreens, etc, and through the home shopping
television channels. The Family also own interests in other City based businesses. The
Family's ownership in CO-1 and other business interests was referred to as “Affiliated
Business Interests.”

The Affiliated Business Interests desired to insure certain of their property
and casualty exposures, and are unwilling, or in some cases, unable to do
so through the conventional insurance marketplace. The Affiliated
Business Interests looked at alternative methods of arranging such
insurance coverage and have found that providing such coverage through
a captive insurance company offers the best method for satisfying its
needs. ORG was formed to operate primarily to accomplish this objective.

The taxpayer was initially formed and created as a controlled foreign corporation. The
taxpayer is not a member of a controlled group of corporations. As a controlled foreign
corporation, Indv-2 Family, President, filed an IRC 953(d) election with the IRS on February
23, 20XX. The election was approved by the IRS, with an effective date of December 22,
20XX.

On March 15, 20XX, the IRS, Rulings and Agreements, in Cincinnati, received Form 1024,
Application for Recognition of Exemption Under Section 501(a), filed by taxpayer seeking
exemption as a small insurance company under section 501(c)(15) of the Internal Revenue
Code. The application revealed that taxpayer was incorporated on December 22, 20XX.
Thus, the taxpayer's initial tax year was comprised of the short year, December 22, 20XX
through December 31, 20XX. The first full year of operations was 20XX. Taxpayer filed its
initial Form 990 return for the tax year ended December 31, 20XX. Indv-2 Family, President,
signed the Form 1024 application on February 29, 20XX. A Form 2848, Power of Attorney,

Form 886-A (1-1994) Catalog Number 20810W Page 2 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A

(Rev. January 1994) EXPLANATIONS OF ITEMS
Name of taxpayer Tax Identification Number
ORG

Year/Period ended
12/31/20XX
12/31/20XX
12/31/20XX
12/31/20XX

accompanied the application authorizing Attorney, Attorney, to represent the taxpayer during

the application process. The attorney worked for a law firm in City, State.

In Part ll of the Form 1024 application, taxpayer described its past, present and planned

operations as follows:

(1) Underwriting select lines of property and casualty insurance
coverages for business entities that are related but independently
operated. Insurance risks underwritten may include, by the way of
example, directors and officers liability, employment practices liability,
expense reimbursement, intellectual asset property, tax liability, and other
lines of property and casualty exposure. The percentage of organizational
time devoted to this type of activity is estimated to be 0%-0%.

(2) Issuing reinsurance coverage for select lines of property and
casualty insurance risks, i.e. serving as underwriting on certain kinds of
property and casualty insurance coverages directly issued by other
insurance companies, or participating in an insurance pooling
arrangement with third parties. The percentage of organizational time
devoted to this type of activity is estimated to be 0%-0%.

As a supporting activity to the above two primary activities, the
organization will invest the monetary assets of the organization including
those which are required to be held as insurance reserves to support
underwriting expenses and losses. All the activities of the organization
have as their purpose the carrying on of an insurance business (other than
life insurance). The nature of the investments will be traditional insurance
activities (see Item 2, below) which include from time to time, asset-
backed loans (corporate lending) of affiliates’ receivables or other assets
in a commercially reasonably manner and as authorized by the insurance
regulators.

The above described activities were all initiated in December 20XX.

The above described activities will be conducted in the Territory through a
designed, regulated and licensed insurance manager, which present time
is CO-2. CO-2 is one of the larger captive managers in the Territory and is
a subsidiary of an international financial services firm. CO-2 senior
executives have decades of relevant insurance experience.

The largest source of financial support for the organization is income from
traditional insurance underwriting activities. The only other source of

Form 886-A (1-1994) Catalog Number 20810W Page 3 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS
(Rev. January 1994)
Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX
ORG 12/31/20XX
12/31/20XX

financial support for the organization is income from investing the
organization’s insurance reserves (e.g. investments in stocks, bonds,
corporate lending, receivable factoring, and other investments) and related
risk management activities.

On April 21, 20XX, the Form 1024 application was referred to Rulings and Agreements in
Washington, D.C., for consideration and ruling. The application was assigned to a Tax Law
Specialist for review on April 20XX. On April 24, 20XX, the Tax Law Specialist mailed a letter
to the taxpayer's representative, Attorney, Attorney, located in City, State. The letter
requested additional information about the taxpayer’s operations. The taxpayer’s response to
the letter was originally due by May 31, 20XX. However, taxpayer’s representative requested
three 30 day extensions, the last extending the due date to September 30, 20XX. During the
interim period, the Form 1024 application was transferred to a new Tax Law Specialist. On
September 13, 20XX, the new TLS mailed a letter to taxpayer’s Registered Agent in the
Territory providing notification about the application transfer and to confirm the September 30,
20XX due date to the Service’s request for additional information about the taxpayer's
operations.

The TLS received the additional information requested from the taxpayer’s representative,
Attorney, Attorney, on September 25, 20XX. On October 8, 20XX, after reviewing all
information exchanged between the parties, the Tax Law Specialist recommended approved of
the application for tax-exempt status under section 501(c)(15) of the Internal Revenue Code.
The TLS summarized the basis for approving the application as follows:

ORG was incorporated in the Territory on December 22, 20XX. ORG
underwrites property and casualty insurance coverage for business
entities that are related but independently operated. Insurance risks
underwritten are listed in ORG’s Form 1024, page 2.

Specifically, ORG writes insurance for CO-1, Indv-2 Family, M.D., P.A.,
and the Family Limited Partnership, none of which are owned by ORG. A
Diagram of Organizational Structure and a Diagram of Insurance
Underwriting Activities is shown in Exhibit D in the application case file.

ORG states that its net written premiums are not expected to exceed $0
for any year. ORG has made an election to be treated as a domestic
insurance corporation under section 953(d) of the Code.

Section 501(c)(15) of the Code provides that insurance companies or
associations other than life (including interinsurer and reciprocal
underwritten) are exempt from taxation under section 501 (a) if net written

Form 886-A (1-1994) Catalog Number 20810W Page 4 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

premium (or, if greater, direct written premiums) for the taxable year must
not exceed $0.

Taxpayer was granted tax-exempt status under IRC § 501(c)(15) on October 15, 20XX. The
ruling was effective retroactively back to the date of incorporation, December 22, 20XX. The
letter was signed by Robert C. Harper, Jr., Manager Exempt Organization, Technical Group 3.
The ruling letter included the following language:

You were incorporated under the laws of the Territory. You have made an
election under section 953(d) of the Code to be treated as a domestic
insurance company for all purposes of the Internal Revenue Code. You
are an insurance company other than life.

Based on the information supplied, and assuming your operations will be
as stated in your application for recognition of exemption, we have
determined you are exempt from United States income tax under section
501(a) of the Code, as an organization described in section 501(c)(15)
commencing on December 22, 20XX, and for tax years when your net
written premiums (or, if greater, your direct written premiums) do not
exceed the $0 limit prescribed by section 501(c)(15).

The Governor of the Territory of the Territory issued the first insurance license to taxpayer on
December 22, 20XX, in accordance with the provisions of Section 17 of The Insurance of
1994. During the period of December 22, 20XX, and December 31, 20XX, taxpayer operated
as a Territory corporation. Taxpayer filed Form 990 returns as an IRC 501(c)(15) small
insurance company. TEGE, Exempt Organizations Division, San Francisco Post of Duty,
initiated an examination of the taxpayer's 20XX Form 990 return in September 20XX.

In 20XX, the taxpayer wrote 17 direct written contracts to the Affiliated Business Interests as
follows: (1) Special Risk — Collection Rate, (2) Special Risk ~ Expense Reimbursement, (3)
Special Risk - Commercial Property GAP, (4) Special Risk — Punitive Wrap Liability, (5)
Special Risk — Product Recall, (6) Special Risk - Commercial General Liability GAP, (7)
Special Risk — Loss of Major Business to Business Relationship, (8) Special Risk — Medical
Malpractice GAP, (9) Special Risk — Regulator Changes, (10) Special Risk — Regulatory
Changes 2, (11) Special Risk — Tax Liability, (12) Special Risk — Tax Liability 2, (13) Excess
Directors & Officers Liability Insurance, (14) Excess Employment Practices Liability Insurance,
(15) Excess Intellectual Property Package Policy, (16) Excess Intellectual Property Package
Policy 2, and (17) Excess Pollution Liability. The terms of each policy stated that the Named
Insurers are ORG, as Lead Insurer, and CO-6, as a joint insurer. ORG is responsible for
insuring 0% of the risks incurred under the policies and CO-6 is responsible for 0% of the risk
under the policies. The contracts reviewed during the audit were sanitized by the CPA,

Form 886-A (1-1994) Catalog Number 20810W Page 5 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

(Rev, January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

removing the names of the other Joint Insurers that assumed the remaining 0% of the direct
risks.

Each of the direct written contracts issued by the taxpayer during the 20XX tax year is
described below:

1. Special Risk — Collection Rate Insurance Policy (#RATE-081) provides the Insured
against uncollectible premiums during the policy period based on the prior year’s experience
rate.

2. Special Risk —- Expenses Reimbursement Insurance Policy (#EXPREIM-081) covers
public relations expenses to mitigate adverse publicity to CO-1, and Indv-2 Family, M.D., P.A.
under certain circumstances, including: actual or imminent incidents where the insureds
potential liability amount is in excess of $0; product recalls; layoffs and labor disputes;
government or regulatory litigation; bankruptcy or other major financial crisis; loss of
intellectual property rights; unsolicited takeover bids; terrorism; or any other adverse incident
expected to reduce the insureds annual gross revenue by at least 0%. The policy also covers
all expenses for CO-1 and Indv-2 Family, M.D., P.A.s defenses to actual or alleged civil
liability.

3. Special Risk - Commercial Property Gap Insurance Policy (#PROP-GP-081) provides
reimbursement for claims which are denied by CO-12, under Commercial Package Policy
Number 70657, for the calendar year 20XX, which includes “exclusion/endorsement buy back”
or “differences in conditions” coverage caused by earthquakes, flood, or froze, from an
underlying commercial property policy.

4. Special Risk — Punitive Wrap Liability Insurance Policy (#PWRP-081) provides that
ORG will pay claims filed by the Affiliated Businesses, resulting from the failure of an insurer to
cover punitive or exemplary damages, judgments, or awards, related to the other 16 policies.

5. Special Risk — Product Recall Insurance Policy (#RECALL-081) provides for the
indemnification of the Affiliated Businesses for expenses involved in the recall of “all products
manufactured and/or sold by the Affiliated Businesses during 20XX.

6. Special Risk- Commercial General Liability Policy (#GP-081) provides reimbursement
for claims which are denied by CO-12, under General Liability Policy Number 70657, effective
January 1, 20XX, through January 1, 20XX, which includes “exclusion/endorsement buy back”
or “differences in conditions” coverage from an underlying commercial property, commercial
general liability or other commercial insurance policy.

Form 886-A (1-1994) Catalog Number 20810W Page 6 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

7. Special Risk — Loss of Major Business to Business Relationship Insurance Policy
(#B2B-081) provides for the indemnification of CO-1 and Indv-2 Family M.D., P.A. for any
business interruption loss of up to 12 months suffered as a result of losing the services.
Business interruption includes the impact of lost revenue and the extra expenses involved in
finding a replacement business to business relationship.

8. Special Risk — Medical Malpractice Gap Policy (#MAL-081) provides reimbursement for
claims which are denied by the Medical Malpractice Insurance Policy; State Medical Liability
Trust (“”) Policy, covering calendar year 20XX, which includes “exclusion/endorsement buy
back” or “differences in conditions” coverage from an underlying commercial property,
commercial general liability or other commercial insurance policy.

9. Special Risk — Regulatory Changes Insurance Policy (#REG-081) covers actual
compliance expenses and business interruptions suffered as a result of any regulatory change
having an adverse impact on the normal on-going business operations of the Affiliated
Businesses. The policy does not cover adverse regulatory changes resulting from substantial
noncompliance with regulations or guidelines or those changes initiated in direct response to
negligent acts, omissions, or errors by the Affiliated Businesses.

10. Special Risk — Regulatory Changes Insurance Policy (#REG-082) covers actual

compliance expenses and business interruptions suffered as a result of any regulatory change
having an adverse impact on the normal on-going business operations of the Affiliated
Businesses. The policy does not cover adverse regulatory changes resulting from substantial
noncompliance with regulations or guidelines or those changes initiated in direct response to
negligent acts, omissions, or errors by the Affiliated Businesses.

11. Special Risk — Tax Liability insurance Policy (#TAX-081) provides the Affiliated
Businesses with indemnification up to 0% of the amount of additional tax liability each may
incur on its 20XX federal income tax return. No coverage is provided for additions to tax, civil
penalties, or criminal penalties for delinquent returns or criminal or fraudulent acts.

12. Special Risk — Tax Liability Insurance Policy (#TAX-082) provides the Affiliated
Businesses with indemnification up to 0% of the amount of additional tax liability each may
incur on its 20XX federal income tax return. No coverage is provided for additions to tax, civil
penalties, or criminal penalties for delinquent returns or criminal or fraudulent acts.

13. Excess Directors & Officers Liability Insurance Policy (#D&O-081) provides
indemnification subject to certain limitations to the Affiliated Businesses for their
indemnification of its officers and directors for wrongful acts, including any error, misstatement,
misleading statement, act, omission, neglect, or breach of duty committed, attempted, or
allegedly committed or attempted by an officer or director of the Affiliated Businesses. The

Form 886-A (1-1994) Catalog Number 20810W Page 7 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XKX

ORG 12/31/20XX
12/31/20XX

policy also covers similar acts in relation to mergers and acquisitions. Moreover, the policy
includes liability for pollution. The policy also provides direct and executive liability coverage
for similar acts to the Affiliated Business officers and directors.

14. Excess Employment Practices Liability Insurance Policy (#EPL-081) provides for the
indemnification of the Affiliated Businesses against all costs and expenses incurred as a result
of claims filed by employees for wrongful termination, dismissal, discharge, sexual
harassment, unlawful employment discrimination and employment related invasion of privacy
and defamation.

15. Excess Intellectual Property Package Policy (#IPP-081) provides indemnification
subject to certain limitations to PAE and PAP for all damages legally obligated to pay for
litigation expenses, mitigation expenses, investigation expenses, costs to replace, restore, or
re-create intellectual property, additional damages and rewards resulting from wrongful acts
committed during the policy period. Wrongful acts include infringement of copyright,
plagiarism, invasion or interference of right of privacy or publicity; libel; slander; piracy or unfair
competition; breach of contract; patent infringement; and malicious prosecution with regard to
intellectual property.

16. Excess Intellectual Property Package Policy (#IPP-082) provides indemnification

subject to certain limitations to PAE and PAP for all damages legally obligated to pay for
litigation expenses, mitigation expenses, investigation expenses, costs to replace, restore, or
re-create intellectual property, additional damages and rewards resulting from wrongful acts
committed during the policy period. Wrongful acts include infringement of copyright,
plagiarism, invasion or interference of right of privacy or publicity; libel; slander; piracy or unfair
competition; breach of contract; patent infringement; and malicious prosecution with regard to
intellectual property.

17. Excess Pollution Liability Insurance Policy (7POLL-081) provides for the
indemnification of the Affiliated Businesses against clean up cost and diminution of property
value due to any pre-existing and new on-site pollution and environmental contamination.

Each direct written contract listed the Named Insured as CO-1; CO-1.; Indv-2 Family, M.D., P.
A.; the Family Limited Partnership; CO-3; CO-4, and CO-5. The address of the Named
Insureds is listed in the contracts as: Address, City, State Zip code. The policy period for each
contract was from January 1, 20XX to January 1, 20XX.

The contracts also listed the aggregate limit of insurance and the premium paid by the total
Combined Premium paid by the Named Insured as follows:

Form 886-A (1-1994) Catalog Number 20810W Page 8 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX

12/31/20XX

Aggregate Total Combined ORG

Contracts Limit Premium Premiums

1. Special Risk — Collection Rate $ 0 $ 0 $ 0
2. Special Risk — Expense Reimbursement 0 0 0
3. Special Risk - Commercial Property GAP 0 0 0
4. Special Risk ~ Punitive Wrap Liability 0 0 0
5. Special Risk — Product Recall 0 0 0
6. Special Risk - Commercial General Liability GAP 0 0 0
7. Special Risk — Loss of Major B2B Relationship 0 0 0
8. Special Risk — Medical Malpractice GAP 0 0 0
9. Special Risk — Regulatory Changes 0 0 0
10. Special Risk — Regulatory Changes 0 0 0
11. Special Risk — Tax Liability 0 0 0
12. Special Risk — Tax Liability 0 0 0
13. Excess Directors & Officers 0 0 0
14. Excess Employment Practices 0 0 0
15. Excess Intellectual Property Package Policy 0 0 0
16. Excess Intellectual Property Package Policy 0 0 0
17. Excess Pollution Liability 0) 0 0
Total $ 0 $ 0 $ 0
Direct Written Premiums, per Form 990 0

Difference $ 60

According to the contracts, the policy period runs from January 1, 20XX, to January 1, 20XX.
A more detailed description of the policies is reflected on the attached Excel spreadsheet.

The terms of each policy state that the Named Insurers are ORG, as Lead Insurer, and CO-6
as joint insurer. ORG is responsible for insuring 0% of the risks incurred under the policies
and CO-6 is responsible for 0% of the risk under the policies. The names of the remaining
Joint Insurers were removed from the contracts by the taxpayer’s CPA. The aggregate limits
for the policies range from $0 to $0, with most of the policies having an aggregate limit of $0.
Combined aggregate limit is $0. According to the terms of the contracts reviewed, ORG was
to receive 0% of the combined total premiums of $0 (or $0) from the 17 direct written policies in
20XX. The organization reported Program Service Revenue totaling $0 for 20XX. The 20XX
Form 990-EZ return does not itemize the sources of revenue included in the program revenue
amount.

Joint Underwriting Stop Loss Endorsement
In addition to the 17 direct property and casualty insurance policies, ORG also executed a
Joint Underwriting Stop Loss Endorsement, with CO-6 Insurance Corp, whereby both parties
agreed to underwrite the insurance coverages described in the 17 policies with the Affiliated
Business Interests. ORG is identified as the “Lead Insurer.” The terms of the endorsement
reads as follows:

Form 886-A (1-1994) Catalog Number 20810W Page 9 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

In exchange for the direct payment of a portion of the total policy
premiums specified in the policy declarations and as further discussed
below, the Insurers agree to jointly underwrite the policies specified above
according to the Attachment Points, Participation Levels, and additional
conditions specified herein.

The Stop Loss Insurer (“CO-6”) shall have no liability for payment of any

claims until two tests are met: (i)the total of all claims reported by the

Insured(s) against the above policies must exceed 100% of the Combined
Direct Written Premiums for all of the policies specified above; AND THEN

(ii) one of the Attachment Points specified below must be reached for the

policies specified above.

The agreement specifies five levels of Attachment Points that make the
Stop Loss Insurer liable for claims.

Once a first Attachment Point is reached, the Stop Loss Insurer (CO-6) will
be responsible for paying claims in accordance with its Participation Level
detailed in paragraph 3. If another Attachment Point is subsequently
reached, the subsequent Attachment Points shall be ignored and the Stop
Loss Insurer's participation will be dictated by the terms of the first
Attachment Point reached.

On Page 5, paragraph 4, states that the premium rate for this Joint
Underwriting Stop Loss Endorsement is 0% of the combined gross direct
written premiums for the specified policies due directly from the Insureds.
This endorsement premium of $0, out of the total premiums of $0, is
payable directly from the Insureds to the Stop Loss Insurer.

Based on the terms, it appears that Stop Loss Endorsement Policy serves to supplement the
terms of the 17 direct written policies. Under the terms of 17 direct written contracts and the
Joint Underwriting Stop Loss Endorsement agreement, the Named Insureds were required to
pay of total premiums of $0. Of the total premium, $0 (or 0%) was paid directly to CO-6, as
Stop Loss Insurer, and the balance of $0 (or 0%) was paid directly to the taxpayer, as Joint
Insurer.

In 20XX, taxpayer also entered into two reinsurance arrangements.

Form 886-A (1-1994) Catalog Number 20810W Page 10 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

Quota Share Reinsurance Agreement
The first arrangement is referred to as a “reinsurance risk pooling program.” ORG Ins. Corp
executed a Quota Share Reinsurance Policy (#QS20XX) with CO-6 The agreement indicates
that CO-6 Insurance Corp is located at Address, Island, Territory. ORG is identified as the
“Reinsurer” and CO-6 Insurance Corp is the “Reinsured.” The policy runs from January 1,
20XX, to January 1, 20XX.

Under this arrangement, the taxpayer participated in a “reinsurance risk pool” with several
other unrelated insurance companies (“pool participants”). The risk pool was operated by CO-
6 Each pool participant had one or more affiliated operating entities for which it underwrites
insurance coverage, generally casualty type coverage such as credit life and credit disability.
CO-6 insured a portion of the direct insurance underwritten by the pool participants using a so-
called “stop loss” endorsement. CO-6 participated in over 0+ insurance policies with more
than 0+ insurers. CO-6 blended together its direct written insurance and then reinsured the
entire book on a quota share basis with each of the pool participants. Schedule 1 attached to
the policy revealed that ORG is one of many reinsurers that participated in the program and
who contracted to reinsure their respective quota shares of CQ-6’s risk pool. According to
Schedule 1, a total of 44 reinsurers are identified. CO-6 paid total premiums of $0 to the 44
Reinsurers participating in the program. ORG is REINSURER #13.

As Reinsurer #13 the taxpayer received a Quota Share Premium from CO-6 in exchange for
the assumption of 0% of the risk pool comprised of the stop loss coverages issued during the
policy period by CO-6 Insurance Company to all stop loss endorsement policyholders. In
20XX, CO-6 Insurance Corporation paid total reinsurance premiums of $0 to 44 participating
reinsurers. Of this amount, CO-6 Insurance Corporation paid a quota share reinsurance
premium of $0, which was equal to 0% risk pool assumed by taxpayer (0% of the $0 total
premiums). According to the general ledger, the taxpayer received reinsurance premiums of
$0 from CO-6 Insurance Corp in 20XX.

The taxpayer relied on the services of CO-7 and CO-8 to establish the premium rating
methodology for the direct written contracts and the Quota Share Reinsurance Agreement.

Credit Coinsurance Reinsurance Agreement
Under the terms of the second arrangement, which is referred to as the Credit Coinsurance
Reinsurance Program, the taxpayer assumed reinsurance contracts from CO-6 The taxpayer
reinsured a 0% quota share of the risks from vehicle service contracts reinsured by CO-6
Insurance Corporation. The vehicle service contracts were initially written by CO-9 in 20XX,
assumed by CO-10, then by CO-11 from CO-10; and finally assumed by CO-6 from CO-11
The taxpayer received a pro rata share of the earned premiums received by CO-6. The
taxpayer was paid a reinsurance premium of $0 from CO-6 in 20XX.

Form 886-A (1-1994) Catalog Number 20810W Page 11 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

Under the terms of the contracts reviewed for 20XX, the taxpayer assumed risk exposures as
follows:

Direct Written Premiums
Quota Share Reinsurance Assumed
Other Reinsurance Assumed

Total

For the tax year ended December 31, 20XX, the taxpayer reported gross receipts of $0 and
total revenue of $0. Revenue was derived primarily from premiums received from the direct
written, reinsurance risk pooling program, and the credit coinsurance reinsurance program.
The difference between gross receipts and total revenue is only the net loss from the sale of
assets was reported on the Form 990 return. Gross receipts were not accurately reported on
the return. The taxpayer's gross receipts for 20XX were as follows:
20XX
Program Revenue Service
Direct Written Premiums
Quota Share Reinsurance Premiums
Credit Coinsurance Reinsurance Premiums
Total Premiums
Investment Income
Proceeds from sale of assets’
Other income
Gross Receipts

The direct written premium income was received from Indv-2 Family, M.D., P.A., and CO-1,
which are owned by Indv-2, one of the beneficial owners of ORG Insurance Company, and
from the Family Limited Partnership. The bank statements for the Wells Fargo checking
account shows a deposit of $0 posted to the account on December 26, 20XX. The books and
records did not reveal the source of the deposit. In his April 2, 20XX response to IDR #5, CPA,
CPA, identified the sources of the direct written premium deposit as follows.

CO-1 $
Indv-2 Family, M.D., P.A.
Family Family Limited Partnership

olooo

$

Of the total premiums received by the taxpayer in 20XX, 0% of the premiums were generated
from the seventeen direct written policies with the Named Insureds, although only three of the

" After offsetting cost basis of $0, the org incurred a net loss of ($0). The net loss was reported on the return.

Form 886-A (1-1994) Catalog Number 20810W Page 12 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

Named Insureds actually paid the direct written premium; 0% of the premiums are from the
Quota Share Reinsurance Risk Pooling Program; and 0% of the premiums from the Credit
Coinsurance Reinsurance Program.

As of December 31, 20XX, the taxpayer’s assets totaled $0, which consisted primarily of cash
in temporary savings ($0) and notes and loans receivable balances due from Affiliated
Business Interests ($0).

20XX Tax Year
The taxpayer filed Form 990, Return of Organization Exempt From Income Tax, for the tax
year ended December 31, 20XX, claiming to be tax-exempt under IRC 501(c)(15). During the
year, the taxpayer continued to operate as a captive company that insured certain property
and casualty risks of affiliated business interests. However, the taxpayer participated in two of
the three programs that it engaged in during the 20XX tax year: (1) direct written contracts with
affiliated business interests, and (2) the credit coinsurance reinsurance programs. Taxpayer
did not participate in the quota share risk pool reinsurance program in 20XX.

In addition, the direct insurance business was smaller than in 20XX. The taxpayer wrote only
eight (8) of the 17 direct contracts, as written in 20XX, to insure certain property and casualty
of Affiliated Business Interests. The taxpayer wrote the following 8 contracts in 20XX: Special
Risk — Collection Rate; Special Risk - Commercial General Liability Gap; Excess Intellectual
Property Package; Special Risk - Commercial Medical Malpractice Gap; Special Risk —
Commercial Property Gap; Special Risk — Regulatory Changes; Special Risk — Tax Liability;
and Special Risk — Punitive Wrap ORG is listed as the sole Lead Insurer. CO-6 is listed the
sole Stop Loss Insurer. The contracts did not list of percentage of risk assumed by the Lead
and Stop Loss Insurers.

The contracts listed CO-1; CO-1.; Indv-2 Family, M.D., P. A.; Family Limited Partnership; CO-
3, CO-5.; and CO-4, as the Named Insureds. The eight contracts were written for the policy
period of January 1, 20XX, to January 1, 20XX.

The contracts did not list of percentage of risk assumed by the Lead and Stop Loss Insurers.
However, taxpayer, as lead insurer, received 100% of the premium paid by the Named
Insurers. The Named Insureds did not pay any portion of the direct written premiums to CO-6
Nor did the taxpayer disburse any portion of the direct written premiums received from the
Named Insureds to CO-6 Thus, it appears that the taxpayer 100% of the risk under the terms
of the direct written contracts.

Taxpayer is the sole Lead Insurer in the following direct contracts it wrote to insure certain
property and casualty risks of CO-1; CO-1.; Indv-2 Family, M.D., P. A.; Family Limited

Form 886-A (1-1994) Catalog Number 20810W Page 13 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

Partnership; CO-3, CO-5.; and CO-4, for the policy period of January 1, 20XX, through
January 1, 20XX:

Aggregate Total Combined ORG
Contracts Limit Premium Premiums
. Special Risk — Collection Rate $ $ 0 $
. Special Risk - Commercial Property GAP
. Special Risk — Punitive Wrap Liability
Special Risk — Commercial General Liability GAP
Special Risk — Medical Malpractice GAP
. Special Risk — Regulatory Changes
Special Risk — Tax Liability
Excess Intellectual Property Package Policy
Total $
Direct Written Premiums, per Form 990
Difference $  -0-
In 20XX, taxpayer did not execute a Joint Underwriting Stop Loss Endorsement with CO-6
Insurance Corporation. Each of the direct written contracts issued by the taxpayer during the

tax year is described below:

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1. Special Risk — Collection Rate Insurance Policy (RATE-091) provides the Insured against
uncollectible premiums during the policy period based on the prior year’s experience rate.

2. Special Risk — Commercial Property Gap Insurance Policy (GP-091) provides
reimbursement for claims which are denied by CO-12, under Commercial Package Policy
Number 70657, for the calendar year 20XX, which includes “exclusion/endorsement buy back”
or “differences in conditions” coverage caused by earthquakes, flood, or froze, from an
underlying commercial property policy.

3. Special Risk — Punitive Wrap Liability Insurance Policy (PWRP-091) provides that ORG will
pay claims filed by the Affiliated Businesses, resulting from the failure of an insurer to cover
punitive or exemplary damages, judgments, or awards, related to the other policies.

4. Special Risk- Commercial General Liability GP-091) provides reimbursement for claims
which are denied by CO-12, under General Liability Policy Number 70657, effective January 1,
20XX, through January 1, 20XX, which includes “exclusion/endorsement buy back” or
“differences in conditions” coverage from an underlying commercial property, commercial
general liability or other commercial insurance policy.

5. Special Risk — Medical Malpractice Gap Coverage (GP-091) provides reimbursement for
claims which are denied by the Medical Malpractice Insurance Policy; State Medical Liability
Trust (“”) Policy, covering calendar year 20XX, which includes

Form 886-A (1-1994) Catalog Number 20810W Page 14 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

“exclusion/endorsement buy back” or “differences in conditions” coverage from an underlying
commercial property, commercial general liability or other commercial insurance policy.

6. Special Risk — Regulatory Changes Insurance Policy (REG-091) covers actual compliance
expenses and business interruptions suffered as a result of any regulatory change having an
adverse impact on the normal on-going business operations of the Affiliated Businesses. The
policy does not cover adverse regulatory changes resulting from substantial noncompliance
with regulations or guidelines or those changes initiated in direct response to negligent acts,
omissions, or errors by the Affiliated Businesses.

7. Special Risk — Tax Liability Insurance Policy TAX-091) provides the Affiliated Businesses
with indemnification up to 0% of the amount of additional tax liability each may incur on its
2007 federal income tax return. No coverage is provided for additions to tax, civil penalties, or
criminal penalties for delinquent returns or criminal or fraudulent acts.

8. Excess Intellectual Property Package Policy (IPP-091) provides indemnification subject to
certain limitations to PAE and PAP for all damages legally obligated to pay for litigation
expenses, mitigation expenses, investigation expenses, costs to replace, restore, or re-create
intellectual property, additional damages and rewards resulting from wrongful acts committed
during the policy period. Wrongful acts include infringement of copyright, plagiarism, invasion
or interference of right of privacy or publicity; libel; slander; piracy or unfair competition; breach
of contract; patent infringement; and malicious prosecution with regard to intellectual property.

JOINT UNDERWRITING ENDORSEMENT
ORG did not execute a Joint Underwriting Stop Loss Endorsement in 20XX. Taxpayer
retained 100 percent of the 20XX direct written premiums received from the Named Insureds.

QUOTA SHARE REINSURANCE POLICY
ORG did not execute a Quota Share Reinsurance contract in 20XX. Taxpayer did not receive
quota share reinsurance premiums during 20XX.

CREDIT INSURANCE COINSURANCE CONTRACT
ORG executed Credit Insurance Coinsurance Contract with CO-6, a Territory Corp, in which
ORG agrees to reinsure a prorate share (0%) of “all net retained policies in force on the
effective date assumed by CO-6 from CO-11, an Anguilla corporation under a treaty dated
June 1, 20XX with CO-11, a Island corporation that was merged into CO-11 on January 1,
20XX.

Form 886-A (1-1994) Catalog Number 20810W Page 15 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

The risks reinsured are the 20XX insurance exposures on all policies of vehicle service
contracts direct written by CO-9 in force on January 1, 20XX, and subsequently issued, and
assumed by CO-11, from CO-10( ) Ltd., under its treaty dated January 1, 20XX.

The reinsurance premiums to be paid by CO-6 Insurance Company to ORG shall be ORG’s
pro rata share of the earned premiums during the accounting period under each reinsured
policy. Earned premiums are the gross premiums charged the insureds plus the unearned
premiums at the beginning of the Accounting Period less the unearned premiums at the end of
the Accounting Period. Taxpayer received $0 in reinsurance premiums under this contract in
20XX.

Under the terms of the contracts reviewed for 20XX, the taxpayer assumed risk exposures as
follows:

Direct Written Premiums $ 0 0%

Quota Share Reinsurance Assumed 0.00 -0-

Other Reinsurance Assumed 0 0
Total $ 0 0%

For the tax year ended December 31, 20XX, the taxpayer reported gross receipts of $0 and
total revenue of $0. Gross receipts were derived primarily from premiums received from the
direct written and the credit coinsurance reinsurance program. The taxpayer received gross
receipts as follows:

20XX

Program Revenue Service

Direct Written Premiums $ 0

Quota Share Reinsurance Premiums 0.00

Credit Coinsurance Reinsurance Premiums 0

Total Premiums $ 0 0%

Investment Income 0 0
Proceeds from sale of assets” 0 0
Other income 0 0

Gross Receipts $ 0 100.00%

Taxpayer retained 100 percent of the 20XX direct written premiums received from the Named
Insureds. The direct written premiums were deposited to a Wells Fargo Bank account (#14).
In response to Question 8, IDR #1 for 20XX, the CPA provided a schedule reflecting deposits
of direct written premiums to this account

After offsetting cost basis of $0, the org incurred a net loss of ($0). The net loss was reported on the return.

Form 886-A (1-1994) Catalog Number 20810W Page 16 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit -

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX
Date of Deposit Amount of Deposit
12/30/20XX $ 0
07/06/20XX 0
12/22/20XX __0
Total $ 0

The deposits were verified with the bank statements from the Wells Fargo Bank account (#14).

Taxpayer did not provide records showing the amount of direct written premium paid by each
of the Named Insureds listed in the contracts. Thus, the examining agent was unable to
determine whether the direct written premiums were paid to the taxpayer by one or all of the
Named Insureds.

Of the total premiums received by the taxpayer in 20XX, 0% of the premiums were generated
from the eight direct written policies with the Affiliated Business Interests, 0.00% of the
premiums are from the Quota Share Reinsurance Risk Pooling Program; and 0% of the
premiums from the Credit Coinsurance Reinsurance Program.

As of December 31, 20XX, the taxpayer’s assets totaled $0, which consisted primarily of cash
in temporary savings ($0) and notes and loans receivable balances due from Affiliated
Business Interests ($0).

20XX Tax Year
The taxpayer filed Form 990, Return of Organization Exempt From Income Tax, for the tax
year ended December 31, 20XX, claiming to be tax-exempt under IRC 501(c)(15). During the
year, the taxpayer continued to operate as a captive company that insured certain property
and casualty risks of affiliated business interests. The taxpayer participated in the same two
programs that it engaged in during the 20XX tax year: (1) direct written contracts with affiliated
business interests, and (2) credit coinsurance reinsurance. As in 20XX, the taxpayer did not
engage in the quota share reinsurance program during 20XX.

Taxpayer's primary business continued to be that of providing property and casualty coverages
for the Named Insureds, CO-1; CO-1.; Indv-2 Family, M.D., P. A.; Family Limited Partnership;
CO-3, CO-5.; and CO-4

During 20XX, the taxpayer continued to operate as the sole Lead Insurer under the same 8
property and casualty contracts written to the Named Insureds, as in the 20XX tax year.

Form 886-A (1-1994) Catalog Number 20810W Page 17 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

The taxpayer wrote the following 8 contracts in 20XX: Special Risk — Collection Rate; Special
Risk — Commercial General Liability Gap; Excess Intellectual Property Package; Special Risk —
Commercial Medical Malpractice Gap; Special Risk — Commercial Property Gap; Special Risk
— Regulatory Changes; Special Risk — Tax Liability; and Special Risk — Punitive Wrap ORG is
listed as the sole Lead Insurer. CO-6 is listed the sole Stop Loss Insurer. The contracts did
not list of percentage of risk assumed by the Lead and Stop Loss Insurers.

Taxpayer is the sole Lead Insurer in the following direct contracts it wrote to insure certain
property and casualty risks of CO-1; CO-1.; Indv-2 Family, M.D., P. A.; Family Limited
Partnership, CO-3, CO-5.; and CO-4, for the policy period of January 1, 20XX, through
January 1, 20XX:

Aggregate Total Combined ORG
Contracts Limit Premium Premiums
. Special Risk — Collection Rate $ $ 0 $
. Special Risk - Commercial Property GAP
. Special Risk — Punitive Wrap Liability
Special Risk - Commercial General Liability GAP
Special Risk — Medical Malpractice GAP
Special Risk — Regulatory Changes
Special Risk — Tax Liability
Excess Intellectual Property Package Policy
Total $
Direct Written Premiums, per Form 990
Difference $ -

BPNOAUTRWwW-A
MmD0D0D0000

lolleRookokokok)

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leoiojl(etekowekogokono)

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7

In 20XX, taxpayer did not execute a Joint Underwriting Stop Loss Endorsement with CO-6
Insurance Corporation. Taxpayer retained 100 percent of the 20XX direct written premiums
received from the Named Insureds. Each of the direct written contracts issued by the taxpayer
during the tax year is described below:

1. Special Risk — Collection Rate Insurance Policy (RATE-101) provides the Insured against
uncollectible premiums during the policy period based on the prior year’s experience rate.

2. Special Risk — Commercial Property Gap Insurance Policy (GP-101) provides
reimbursement for claims which are denied by CO-12, under Commercial Package Policy
Number 70657, for the calendar year 20XX, which includes “exclusion/endorsement buy back”
or “differences in conditions” coverage caused by earthquakes, flood, or froze, from an
underlying commercial property policy.

Form 886-A (1-1994) Catalog Number 20810W Page 18 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

3. Special Risk — Punitive Wrap Liability Insurance Policy ( PWRP-101) provides that ORG will
pay claims filed by the Affiliated Businesses, resulting from the failure of an insurer to cover
punitive or exemplary damages, judgments, or awards, related to the other policies.

4. Special Risk- Commercial General Liability GAP ( GP-101) provides reimbursement for
claims which are denied by CO-12, under General Liability Policy Number 70657, effective
January 1, 20XX, through January 1, 20XX, which includes “exclusion/endorsement buy back”
or “differences in conditions” coverage from an underlying commercial property, commercial
general liability or other commercial insurance policy.

5. Special Risk — Medical Malpractice Gap Coverage (GP-101) provides reimbursement for

claims which are denied by the Medical Malpractice Insurance Policy; State Medical Liability

Trust (“”) Policy, covering calendar year 20XX, which includes

“exclusion/endorsement buy back” or “differences in conditions” coverage from an underlying
commercial property, commercial general liability or other commercial insurance policy.

6. Special Risk — Regulatory Changes Insurance Policy (REG-101) covers actual compliance
expenses and business interruptions suffered as a result of any regulatory change having an
adverse impact on the normal on-going business operations of the Affiliated Businesses. The
policy does not cover adverse regulatory changes resulting from substantial noncompliance
with regulations or guidelines or those changes initiated in direct response to negligent acts,
omissions, or errors by the Affiliated Businesses.

7. Special Risk — Tax Liability Insurance Policy (TAX-101) provides the Affiliated Businesses
with indemnification up to 0% of the amount of additional tax liability each may incur on its
20XX federal income tax return. No coverage is provided for additions to tax, civil penalties, or
criminal penalties for delinquent returns or criminal or fraudulent acts.

8. Excess Intellectual Property Package Policy (IPP-101) provides indemnification subject to
certain limitations to PAE and PAP for all damages legally obligated to pay for litigation
expenses, mitigation expenses, investigation expenses, costs to replace, restore, or re-create
intellectual property, additional damages and rewards resulting from wrongful acts committed
during the policy period. Wrongful acts include infringement of copyright, plagiarism, invasion
or interference of right of privacy or publicity; libel; slander; piracy or unfair competition; breach
of contract; patent infringement; and malicious prosecution with regard to intellectual property.

JOINT UNDERWRITING ENDORSEMENT
ORG did not execute a Joint Underwriting Stop Loss Endorsement in 20XX. Taxpayer
retained 100 percent of the 20XX direct written premiums received from the Named Insureds.

Form 886-A (1-1994) Catalog Number 20810W Page 19 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

QUOTA SHARE REINSURANCE POLICY
ORG did not execute a Quota Share Reinsurance contract in 20XX. Taxpayer did not receive
quota share reinsurance premiums during 20XX.

CREDIT INSURANCE COINSURANCE CONTRACT
ORG executed Credit Insurance Coinsurance Contract with CO-6, a Territory Corp, in which
ORG agrees to reinsure a prorate share 0%) of “all net retained policies in force on the
effective date assumed by CO-6 Insurance Company from CO-11, a Territory corporation
under a treaty dated June 1, 20XX with CO-11, an Island corporation that was merged into
CO-11 on January 1, 20XX.

The risks reinsured are the 20XX insurance exposures on all policies of vehicle service
contracts direct written by CO-9 in force on January 1, 20XX, and subsequently issued, and
assumed by CO-11, from CO-10 () Ltd., under its treaty dated January 1, 20XX.

The reinsurance premiums to be paid by CO-6 Insurance Company to ORG shall be ORG’s
pro rata share of the earned premiums during the accounting period under each reinsured
policy. Earned premiums are the gross premiums charged the insureds plus the unearned
premiums at the beginning of the Accounting Period less the unearned premiums at the end of
the Accounting Period. Taxpayer received $0 in reinsurance premiums under this contract in
20XX.

Under the terms of the contracts reviewed for 20XX, the taxpayer assumed risk exposures as
follows:

Direct Written Premiums $ 0 0%

Quota Share Reinsurance Assumed 0.00 -0-

Other Reinsurance Assumed 0 0
Total $ 0 100.00%

For the tax year ended December 31, 20XX, the taxpayer reported gross receipts of $0 and
total revenue of $0. Gross receipts were derived primarily from premiums received from the
direct written and the credit coinsurance reinsurance program. The taxpayer received gross
receipts as follows:

Program Revenue Service
Direct Written Premiums $ 0

Form 886-A (1-1994) Catalog Number 20810W Page 20 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

Quota Share Reinsurance Premiums 0.00
Credit Coinsurance Reinsurance Premiums 0
Total Premiums $ 0 0%
Investment Income 0 0
Proceeds from sale of assets® 0 0
Other income 0 0
Gross Receipts $ 0 100.00%

Taxpayer retained 100 percent of the 20XX direct written premiums received from the Named
Insureds. The direct written premiums were deposited to a Wells Fargo Bank account (#14). In
response to Question 8, IDR #1 for 20XX, the CPA provided a schedule reflecting deposits of
direct written premiums to this account

Date of Deposit Amount of Deposit
12/22/20XX $ 0
12/29/20XX 0
12/29/20XX 0
12/31/20XX __0

Total $ 0

The deposits were verified with the bank statements from the Wells Fargo Bank account (#14).

Taxpayer did not provide records showing the amount of direct written premium paid by each
of the Named Insureds listed in the contracts. Thus, the examining agent was unable to

determine whether the direct written premiums were paid to the taxpayer by one or all of the
Named Insureds.

Of the total premiums received by the taxpayer in 20XX, 0% of the premiums were generated
from the eight direct written policies with the Affiliated Business Interests, 0.00% of the
premiums are from the Quota Share Reinsurance Risk Pooling Program; and 0% of the
premiums from the Credit Coinsurance Reinsurance Program.

As of December 31, 20XX, the taxpayer's assets totaled $0, which consisted primarily of cash
in temporary savings ($0) and notes and loans receivable balances due from Affiliated
Business Interests ($0).

20XX

*After offsetting cost basis of $0, the org incurred a net loss of ($0). The net loss was reported on the return.

Form 886-A (1-1994) Catalog Number 20810W Page 21 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

Taxpayer filed Form 990 for the tax year ended December 31, 20XX. The books and records,
including policies and contracts, were not examined by the examining agent as part of this
audit.

Taxpayer reported gross receipts of $0 and total revenue of $0 for the year. Revenue was
derived primarily from direct written premiums and quota share and credit coinsurance
reinsurance premiums. The taxpayer received gross receipts as follows:

20XX

Program Revenue Service

Direct Written Premiums $ 0O

Quota Share Reinsurance Premiums 0

Credit Coinsurance Reinsurance Premiums _0

Total Premiums $ 0O 0%

Investment Income 0 0
Proceeds from sale of assets* ) 0
Other income 0 0

Gross Receipts $ 0 100.00%

Under the terms of the contracts reviewed for 20XX, the taxpayer assumed risk exposures as
follows:

Direct Written Premiums $ 0 0%
Quota Share Reinsurance 0 0
Other Reinsurance Assumed 0 0

Total $ 0 100.00%

As of December 31, 20XX, the taxpayer’s assets totaled $0, which consisted primarily of cash
in temporary savings ($0) and notes and loans receivable balances due from Affiliated
Business Interests ($0).

LAW:

Section 501(c)(15) of the Internal Revenue Code provides insurance companies other than life
(including inter-insurers and reciprocal underwriters) can qualify for tax-exempt status if:

1. The gross receipts for the taxable year do not exceed $600,000, and more than 50% of
such gross receipts consist of premiums, or

“After offsetting cost basis of $0, the org incurred a net loss of ($0). The net loss was reported on the return.

Form 886-A (1-1994) Catalog Number 20810W Page 22 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

2. In the case of a mutual insurance company, the gross receipts of which for the taxable

year do not exceed $150,000, and more than 35% of such gross receipts consist of premiums.

Section 816(a) of the Code provides that 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.

Section 831(c) defines the term “insurance company” for purposes of section 831, as having

the same meaning as the terms is given under section 816(a). Section 816(a) provides that

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 reinsuring of risks
underwritten by insurance companies.

Pursuant to:

Helvering v. LeGierse, 312 U.S. 531 (1941), the United States Supreme Court in defining the
term “insurance contract” held that in order for a contract to amount to an insurance contract, it
must shift and distribute a risk of loss and that risk must be an “insurance” risk.

AMERCO, Inc. v. Commissioner, 979 F.2d 162, 164-65 (9th Cir. 1992), aff'g. 96 T.C. 18 (1991),
“risk-shifting” means one party shifts his risk of loss to another, and “risk-distributing” means
that the party assuming the risk distributes his potential liability, in part, among others. An
arrangement without the elements of risk-shifting and risk-distributing lacks the fundamentals
inherent in a true contract of insurance.

Allied Fidelity Corp. v. Commissioner, 572 F. 2d 1190, 1193 (7th Cir. 1978), the common
definition for insurance is an agreement to protect the insured against a direct or indirect
economic loss arising from a defined contingency whereby the insurer undertakes no present
duty of performance but stands ready to assume the financial burden of any covered loss.

Commissioner v. Treganowan, 183 F.2d 288, 290-91 (2d Cir. 1950), the risk must contemplate
the fortuitous occurrence of a stated contingency.

Beech Aircraft Corp. v. United States, 797 F.2d 920, 922 (10th Cir. 1986), historically and
commonly insurance involves risk —shifting and risk distributing. “Risk-shifting” means one
party shifts his risk of loss to another, and “risk-distributing” means that the party assuming the
risk distributes his potential liability, in part, among others. An arrangement without the
elements of risk-shifting and risk-distributing lacks the fundamentals inherent in a true contract
of insurance.

Ocean Drilling & Exploration Co. v. United States, 988 F.2d 1135, 1153 (Fed. Cir. 1993), for
insurance purposes, “risk-shifting” means one party shifts his risk of loss to another, and “risk-
distributing” means that the party assuming the risk distributes his potential liability, in part,
among others.

Form 886-A (1-1994) Catalog Number 20810W Page 23 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

Clougherty Packing Co. v. Commissioner, 811 F.2d 1297, 1300 (9th Cir. 1987), a true
insurance agreement must remove the risk of loss from the insured party.

Humana, Inc. v. Commissioner, 881 F.2d 247, 257 (6th Cir. 1989), risk distribution involves
shifting to a group of individuals the identified risk of the insured. The focus is broader and
looks more to the insurer as to whether the risk insured against can be distributed over a larger
group rather than the relationship between the insurer and any single insured.

Revenue Ruling 89-96, 1989-2 C.B. 114, an insurance agreement or contract must involve the
requisite risk shifting necessary for insurance.

Revenue Ruling 2002-89, 2002-2 C.B. 984, it is not insurance where a parent company formed
a subsidiary insurance company and 90% of the subsidiary’s earned premium was paid by the
parent company. The Rev. Rul. further held that such arrangement between a parent and a
subsidiary would constitute insurance if less than 50% of the premium earned by the
subsidiary is from the parent company.

Revenue Ruling 60-275, 1960-2 C.B. 43, risk shifting not present where subscribers, all
subject to the same flood risk, agreed to coverage under a reciprocal flood insurance
exchange.

Revenue Ruling 2002-90, 2002 C.B. 985, a wholly owned subsidiary that insured 12
subsidiaries of its parent constitute insurance for federal income tax purposes.

Revenue Ruling 2005-40, 2005-40 I.R.B. 4, an arrangement that purported to be an insurance
contract but lacked the requisite risk distribution was characterized as a deposit arrangement,
a loan, a contribution to capital, an indemnity arrangement that was not an insurance contract.

Revenue Ruling 2007-47, 2007-30 I.R.B. 127, an arrangement that provides for the
reimbursement of inevitable future costs does not involve the requisite insurance risk.

Foreign Corporation Tax Provisions

IRC SEC. 951. AMOUNTS INCLUDED IN GROSS INCOME OF UNITED STATES
SHAREHOLDERS.
951(a) AMOUNTS INCLUDED. —

(1) IN GENERAL. —If a foreign corporation is a controlled foreign corporation for an
uninterrupted period of 30 days or more during any taxable year, every person who is a United
States shareholder (as defined in subsection (b)) of such corporation and who owns (within the
meaning of section 958(a)) stock in such corporation on the last day, in such year, on which

Form 886-A (1-1994) Catalog Number 20810W Page 24 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

such corporation is a controlled foreign corporation shall include in his gross income, for his
taxable year in which or with which such taxable year of the corporation ends —

(A) the sum of —

(i) his pro rata share (determined under paragraph (2)) of the corporation's
subpart F income for such year,

(ii) his pro rata share (determined under section 955(a)(3) as in effect before
the enactment of the Tax Reduction Act of 1975) of the corporation's previously
excluded subpart F income withdrawn from investment in less developed countries
for such year, and

(iii) his pro rata share (determined under section 955(a)(3)) of the
corporation's previously excluded subpart F income withdrawn from foreign base
company shipping operations for such year; and

IRC SEC. 953. INSURANCE INCOME.
953(a) INSURANCE INCOME. —

(1) IN GENERAL. —For purposes of section 952(a)(1), the term “insurance income” means
any income which —
(A) is attributable to the issuing (or reinsuring) of an insurance or annuity contract,
and

(B) would (subject to the modifications provided by subsection (b)) be taxed under
subchapter L of this chapter if such income were the income of a domestic

insurance company.
(2) EXCEPTION. —Such term shall not include any exempt insurance income (as defined in
subsection (e)).
IRC SEC. 953. INSURANCE INCOME.

953(d) ELECTION BY FOREIGN INSURANCE COMPANY TO BE TREATED AS DOMESTIC CORPORATION.
(1) IN GENERAL. — If

Form 886-A (1-1994) Catalog Number 20810W Page 25 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

(A) a foreign corporation is a controlled foreign corporation (as defined in section
957(a) by substituting “25 percent or more” for “more than 50 percent” and by using the
definition of United States shareholder under 953(c)(1)(A)),

(B) such foreign corporation would qualify under part I or II of subchapter L for the
taxable year if it were a domestic corporation,

(C) such foreign corporation meets such requirements as the Secretary shall
prescribe to ensure that the taxes imposed by this chapter on such foreign corporation are
paid, and

(D) such foreign corporation makes an election to have this paragraph apply and
waives all benefits to such corporation granted by the United States under any treaty, for
purposes of this title, such corporation shall be treated as a domestic corporation.

GOVERNMENT’S POSITION:
Qualification as Insurance Company

Neither the Internal Revenue Code nor the Income Tax Regulations define the terms
“insurance” or “insurance contract.” The standard for evaluating whether an arrangement
constitutes insurance for federal tax purposes has evolved over the years and is, at best, a
nonexclusive facts and circumstances analysis. Sears, Roebuck and Co. v. Commissioner,
972 F.2d 858, 861-64 (7th Cir. 1992). The most frequently cited opinion on the definition of
insurance is Helvering v. LeGierse, 312 U.S. 531 (1941), in which the Court describes
“insurance” as an arrangement involving risk-shifting and risk-distributing of an actual
“insurance risk” at the time the transaction was executed. Cases analyzing “captive insurance”
arrangements have described the concept of “insurance” for federal income tax purposes as
containing three elements: (1) involvement of an insurance risk; (2) shifting and distributing of
that risk; and (3) insurance in its commonly accepted sense. See e.g., AMERCO, Inc. v.
Commissioner, 979 F.2d 162, 164-65 (9th Cir. 1992), aff'g. 96 T.C. 18 (1991). The test,
however, is not a rigid three-prong test.

There is also no single definition of insurance for non-tax purposes. “[T]he subject has no
useful, or fixed definition. There is neither a universally accepted definition or concept of
‘insurance’ nor a [sic] exclusive concept or definition that can be persuasively applied in
insurance lawyering.” 1 APPLEMAN ON INSURANCE 24, § 1.3 (2005). While “it seems
appropriate that any concept and meaning of insurance be sufficiently broad and flexible to
meet the varying and innovative transactions which humankind perpetually produces,” care
must be used to describe insurance because “overbroad definitions are not useful and may

Form 886-A (1-1994) Catalog Number 20810W Page 26 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

cause many commercial relationships erroneously to constitute insurance.” Id. Moreover, a
state’s determination of whether a product is insurance for state law purposes does not control
whether the product is insurance for federal tax law. See AMERCO, 96 T.C. 18, 41 (1991).
There is no need for parity between a state law definition and federal definition as the objective
for state purposes is company solvency. Solvency is not a concern for determining whether an
arrangement qualifies as insurance for federal income tax purposes.

Not all contracts that transfer risk are insurance policies even where the primary purpose of the
contract is to transfer risk. For example, a contract that protects against the failure to achieve
a desired investment return protects against investment risk, not insurance risk. LeGierse, 312
U.S. at 542 (the risk must not be merely an investment risk); Securities and Exchange
Commission v. United Benefit Life Insurance Co., 387 U.S. 202, 211 (1967) (the transfer of an
investment risk cannot by itself create insurance). See also, Rev. Rul. 89-96, 1989-2 C.B. 114
(risks transferred were in the nature of investment risk, not insurance risk); Rev. Rul. 68-27,
1968-1 C.B. 315 (although an element of risk existed, it was predominantly a normal business
risk of an organization engaged in furnishing medical services on a fixed price basis rather
than an insurance risk) and Rev. Rul. 2007-47, 2007-2 C.B. 127 (the arrangement lacked the
requisite insurance risk to constitute insurance because the arrangement lacked fortuity and
the risk at issue was akin to the timing and investment risks of Rev. Rul. 89-96).

The line between investment risk and insurance risk, however, is pliable.

[t]he finance and insurance industries have much in common. The
different tools these industries provide their customers for managing
financial insurable risks rely on the same two fundamental concepts: risk
pooling and risk transfer. Further, the valuation techniques in both
financial and insurance markets are formally the same: the fair values of
a security and an insurance policy are the discounted expected values of
the cash flows they provide their owners. Scholars and practitioners
recognize these commonalities. Not surprisingly the markets have
converged recently; for example, some insurance companies offer
mutual funds and life insurance tied to stock portfolios, and some banks
sell annuities.

FINANCIAL ECONOMICS WITH APPLICATIONS TO INVESTMENTS,
INSURANCE AND PENSIONS 1 (Harry H. Panier, ed., 2001).

Insurance risk requires a fortuitous event or hazard and not a mere timing or investment risk.
A fortuitous event⁵ (such as a fire or accident) is at the heart of any contract of insurance. See

⁵ A happening that, because it occurs only by chance or accident, the parties could not reasonably have foreseen. Black's
Law Dictionary, 725 (9th ed. 2009). See also, First Restatement of Contracts § 291, cmt. a (1932); American Law

Form 886-A (1-1994) Catalog Number 20810W Page 27 of 56 publish. no.irs.gov © Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

Commissioner v. Treganowan, 183 F.2d 288, 290-91 (2d Cir. 1950) (the risk must contemplate
the fortuitous occurrence of a stated contingency not an expected event).

Lack of Insurance Risk
The Service analyzed the risk of the contracts to determine whether the contracts qualify as
contracts of insurance, annuity contracts or reinsurance contracts: In deciding whether the
contracts qualify as insurance contracts for federal tax purposes, we have considered all of the
facts and circumstances associated with the parties in the context of the captive arrangement.
When deciding that a specific contract is not insurance because it does not have an insurance
risk but deals with a business or investment risk, we have considered such things as the
ordinary activities of a business enterprise, the typical activities and obligations of running of a
business, whether an action that might be covered by a policy is in the control of the insured
within a business context, whether the economic risk involved is a market risk that is part of the
business environment, whether the insured is required by a law or regulation to pay for the
covered claim, and whether the action is question is willful or inevitable.

20XX Policies

1. Special Risk — Collection Rate Insurance Policy.

(RATE-081)
Policy indemnifies for a portion of the differential between the Net Collection Percentage (NCP)
during the covered period and the NCP during a baseline period. The NCP is calculated by
dividing the actual collections amount during a specified period into the gross billings amount
for that same period.

Not Insurance. The Policy is not insurance in the commonly accepted sense. There is no
insurance risk but only investment or business risk.

2. Special Risk — Expense Reimbursement Insurance Policy.

(EIM-081)
Coverage Form A deals with crisis management public relations expenses. This covers all
public relations expenses to mitigate the insured's adverse publicity generated from an actual
or imminent: liability incident that could exceed $0; product recall; employee layoff or labor
dispute; government litigation; financial crisis; loss of intellectual property rights; unsolicited

Institute, Restatement (Second) Contracts § 379, cmt. a (1981). See Generally, Jeffery W. Stempel, Stempel on
Insurance Contracts, § 1.06A[4] (2007 Supp.) ("[I]n the past 20 years, a "modern" view of fortuity as a matter of law has
emerged in United States courts, one that largely embraces the notions of fortuity held by the American Law Institute
when it adopted the Restatement of Contracts, first in 1932 and again in the Second Restatement published in 1981."

Form 886-A (1-1994) Catalog Number 20810W Page 28 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

takeover bid; security incident; or any incident expected to reduce annual gross revenue by at
least 0%.

Coverage Form B deals with uninsured defense. This covers all defense expense for actual
or alleged civil liability where there is no insurer to provide such coverage or where such
coverage has been exhausted under an existing insurance contract.

Not insurance as to Coverage A. Coverage Form A is not insurance in the commonly
accepted sense. There is no insurance risk but only investment or business risk.

Not insurance as to Coverage Form B. We could not conclude that Coverage Form B is
insurance in the commonly accepted sense. It is vague as to what liability/contract underlies
the need for defense expenses.

3. Special Risk - Commercial Property GAP Liability Insurance Policy

(GP-081)
This policy provides “exclusion/endorsement buy back” or “differences in conditions” coverage
for a Coverage Trigger from “Commercial Real Estate Package Policy, CO-13 policy pending
that provide coverage during year 20XX.

Not Insurance. Terms of the contract are too vague.

4. Special Risk — Punitive Wrap Liability Insurance Policy.

(PWRP-081)
Covers claims for punitive or exemplary damages upon the failure of the insurer under policies
listed that are issued to the insured to cover punitive or exemplary damages, judgments, or
awards solely due to the enforcement of any law or judicial ruling that precludes the insuring of
punitive or similar damages and that but for such law or ruling would otherwise be covered,
and for which an insured is legally obligated to pay.

Not Insurance. The policy is not insurance in the commonly accepted sense. There is no
insurance risk but only investment or business risk.

5. Special Risk—Product Recall Insurance Policy
(RECALL-081)

Not Insurance.
The policy is not insurance in the commonly accepted sense. There is no insurance risk but
only investment or business risk.

Form 886-A (1-1994) Catalog Number 20810W Page 29 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

6. Special Risk - Commercial General Liability GAP

(GP-081)
This policy provides coverage for certain claims which are denied by Employers Fire Insurance
Company, under General Liability Policy Number 77-00, effective August 31, 20XX through
August 31, 20XX, as follows: (1) Knowing Violation of Rights of Others exclusion for Personal
and Advertising Injury; (2) Limitations of Coverage to Designated Events; and (3) Abuse or
Molestation Exclusion.

Not Insurance. The terms of the contract are too vague.

7. Special Risk-Loss of Major Business to Business

(B2B-081)
Covers any business interruption loss of up to 12 months suffered as a result of losing the
services of a Major Business-to-Business Relationship (any business relationship that
contributes 10% or more to revenue). Business interruption losses include the impact of lost
revenue and the extra expenses involved in finding a replacement Business-to-Business
Relationship. The policy will not cover the voluntary loss of a Major Business-to-Business
Relationship where the insured initiates the termination of the agreement; the loss of a Major
Business-to-Business Relationship that insured did not attempt or intent to replace; or the loss
of a Major Business-to-

Business Relationship due to insured’s substantial non-compliance with the terms and
conditions of its contractual agreement with the customer.

Not Insurance. The policy is not insurance in the commonly accepted sense. There is no
insurance risk but only business risk.

8. Special Risk - Commercial Medical Malpractice Gap Insurance Policy.

(GP-081)
Covers claims that have been denied by the listed insurance company, which issued the
underlying medical malpractice insurance policy, due to a breach of warranty, failure to notify
the insurer of medical operations or procedures, sales or distribution of excluded products, or
the exhaustion of the primary limits.

Not Insurance. It is vague as to what it covers.

9. Special Risk — Regulatory Changes Insurance Policy (#081)
(REG-081)

Form 886-A (1-1994) Catalog Number 20810W Page 30 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XKX

Covers actual compliance expenses and any business interruption loss of up to 12 months as
a result of any regulatory change that has an adverse impact on insured's normal on-going
business operations. Regulatory changes include governmental, administrative agency, or
legislative changes, changes to environmental, zoning, transportation, or safety laws or
regulations, changes to import/export laws, regulatory changes due to foreign political risk
including the collapse of a foreign economy, and any regulatory change due to the insured's
reorganization, such as changing from a corporation to a limited partnership. The policy
excludes any claim for an adverse regulatory change due to the insured's substantial non-
compliance with regulations or other guidelines.

Not insurance. The policy is not insurance in the commonly accepted sense. There is no
insurance risk but only investment or business risk.

We could not conclude that this contract is insurance in the commonly accepted sense. The
contract is vague as to what it covers.

10. Special Risk — Regulatory Changes Insurance Policy (#082)

(REG-082)
Covers actual compliance expenses and any business interruption loss of up to 12 months as
a result of any regulatory change that has an adverse impact on insured's normal on-going
business operations. Regulatory changes include governmental, administrative agency, or
legislative changes, changes to environmental, zoning, transportation, or safety laws or
regulations, changes to import/export laws, regulatory changes due to foreign political risk
including the collapse of a foreign economy, and any regulatory change due to the insured's
reorganization, such as changing from a corporation to a limited partnership. The policy
excludes any claim for an adverse regulatory change due to the insured's substantial non-
compliance with regulations or other guidelines.

Not insurance. The policy is not insurance in the commonly accepted sense. There is no
insurance risk but only investment or business risk.

We could not conclude that this contract is insurance in the commonly accepted sense. The
contract is vague as to what it covers.

11. Special Risk — Tax Liability Insurance Policy (#081)

(TAX-081)
Covers any additional tax liability up to $0 subject to a deductible equal to 0% of the actual
filed IRS tax liability provided return prepared and signed by CPA. Policy also covers defense

Form 886-A (1-1994) Catalog Number 20810W Page 31 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) . EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

expenses incurred in determining the final tax liability. Several IRS penalties are excluded
from coverage.

Not insurance. The policy is not insurance in the commonly accepted sense. Although a policy
only covering defense expenses is insurance, this policy also covers non-insurance risks that
are investment or business risks.

12. Special Risk — Tax Liability Insurance Policy (#082)

(TAX-082)
Covers any additional tax liability up to $0 subject to a deductible equal to 0% of the actual
filed IRS tax liability provided return prepared and signed by CPA. Policy also covers defense
expenses incurred in determining the final tax liability. Several IRS penalties are excluded
from coverage.

Not Insurance. Although a policy only covering defense expenses is insurance, this policy also
covers non-insurance risks that are investment or business risks.

13. Excess Directors & Officers Liability Insurance Policy.
(D&O-081)
Covers wrongful acts of directors and officers.

Insurance.

14, Excess Employment Practices Liability Insurance Policy.

(EPL-081)
Covers 11 categories of wrongful acts including wrongful termination, refusal to hire or
promote, sexual harassment, unlawful discrimination based on age, gender, etc., invasion of
privacy, failure to create employment policies or procedures, retaliatory treatment, violation of
civil rights, violation of Family and Medical Leave Act, breach of employment contract, failure
to provide safe work environment, violations listed herein against a non-employee. There is
excluded from coverage claims related to employee's entitlements under various listed non-
specific laws, rules or regulations. Also excluded are claims under various listed laws such as
the Occupational Safety and Health Act. These exclusions shall not apply to claim for any
actual or alleged retaliatory, discriminatory, or other employment practices-related treatment.

Not Insurance. Policy is not insurance in its commonly accepted sense. There is no insurance
risk but only investment or business risk.

15. Excess Intellectual Property Package Policy (#081)

(IPP-081)

Form 886-A (1-1994) Catalog Number 20810W Page 32 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

Insuring Agreement 1 “Liability to Third Parties”: Covers wrongful acts (listed above)
committed by third parties against insured's intellectual property. It pays for litigation
expenses, mitigation expense to mitigate the extent of the claim, costs to replace, restore, or
re-create the covered intellectual property, and finally additional damages to the insured's
business operations such as business interruption, loss of clients or market share, or public
relation damage control efforts. The policy excludes loss due to insured's cyber presence.

Not Insurance. Insuring Agreement 1 is not insurance in the commonly accepted sense.
There is no insurance risk but only investment or business risks. It is not clear what intellectual
property the insured possesses.

16. Excess Intellectual Property Package Policy (#082)

(IPP-082)
Insuring Agreement 2 “Loss to Your Intellectual Property”: Covers damages, defense
expenses, and compliance redesign expense for listed wrongful acts: infringement of
copyright, trademark etc., plagiarism or unauthorized use of ideas characters, plots etc.:
invasion of privacy or publicity; libel, slander, or product disparagement; piracy or unfair
competition, misappropriation of advertising ideas etc.; breach of contract resulting from the
alleged submission of material used by insured; patent infringement; malicious prosecution
with regard to intellectual property. Compliance redesign expense covers expense to recall
and/or redesign the insured's intellectual property to comply with a judgment or settlement.
The policy excludes any intentional act by a director, officer or employee.

Not Insurance. Insuring Agreement 2 is not insurance in the commonly accepted sense.
There is no insurance risk but only investment or business risks. It is not clear what intellectual
property the insured possesses.

17. Excess Pollution Liability Insurance Policy.

(POLL-081)
Insuring Agreement 1 and 2 cover clean-up costs and diminution in value costs resulting from
pre-existing or new on-site pollution conditions. Coverage is conditioned on an affirmative
obligation to report on site pollution conditions to a governmental agency so as to be in
compliance with environmental laws. Various laws covering solid waste disposal, super funds,
clean air, clean water, and toxic substances are listed in a non-exclusive list provided the
insured has or may have a legal obligation to incur clean up costs for pollution conditions or
pollution release. Clean up costs cover the expenses of investigation or removal of, or
rendering non-hazardous pollution conditions to the extent required by environmental laws.
Diminution in value means the difference in the fair market value of the property when the

Form 886-A (1-1994) Catalog Number 20810W Page 33 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

remedial action plan is approved and the fair market value of the property had there been no
on site pollution conditions.

Insuring Agreements 3 to 12 provide for third party claims for on site or off site clean up and
diminution in value costs for pre-existing or new on site or off site pollution conditions, as well
as bodily and property damage, as well as non-owned locations.

Insuring Agreement 13 covers pollution release from transported cargo carried by covered
autos. No covered auto is identified in the declarations.

Insuring Agreement 14 covers third party claims from transporting of a product or waste.

Insuring Agreement 15 covers actual loss resulting from the interruption of the business
operations caused solely and directly by on site pollution conditions. Actual loss means the
net income the insured would have earned had there been no interruption. Coverage also
includes loss of rental value, which generally means the anticipated rental income from tenant
occupancy of insured property.

Not Insurance. The policy is not insurance in the commonly accepted sense. There is no
insurance risk but only investment or business risk.

20XX Policies

ORG was a Joint Insurer under 8 direct contracts written by an unnamed Lead Insurer. The
contracts written in 20XX were also written in 20XX. The 20XX contracts were as follows:

1. Special Risk — Collection Rate Insurance Policy

(RATE-091)
Policy indemnifies for a portion of the differential between the Net Collection Percentage (NCP)
during the covered period and the NCP during a baseline period. The NCP is calculated by
dividing the actual collections amount during a specified period into the gross billings amount
for that same period.

Not Insurance. The Policy is not insurance in the commonly accepted sense. There is no

insurance risk but only investment or business risk.

2. Special Risk —- Commercial General Liability GAP
(GP-091)

Form 886-A (1-1994) Catalog Number 20810W Page 34 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

Policy provides reimbursement for claims which are denied by CO-12, under General Liability
Policy Number 70657, effective January 1, 20XX, through January 1, 20XX, which includes
“exclusion/endorsement buy back” or “differences in conditions” coverage from an underlying
commercial property, commercial general liability or other commercial insurance policy.

Not Insurance. The terms of the contract are too vague.

3. Excess Intellectual Property Package Policy

(IPP-091)
Insuring Agreement 1: Covers damages, defense expenses, and compliance redesign
expense for listed wrongful acts: infringement of copyright, trademark etc.; plagiarism or
unauthorized use of ideas characters, plots etc.; invasion of privacy or publicity; libel, slander,
or product disparagement; piracy or unfair competition, misappropriation of advertising ideas
etc.; breach of contract resulting from the alleged submission of material used by insured;
patent infringement; malicious prosecution with regard to intellectual property. Compliance
redesign expense covers expense to recall and/or redesign the insured's intellectual property
to comply with a judgment or settlement. The policy excludes any intentional act by a director,
officer or employee.

Insuring Agreement 2: Covers wrongful acts (listed above) committed by third parties against
insured's intellectual property. It pays for litigation expenses, mitigation expense to mitigate
the extent of the claim, costs to replace, restore, or re-create the covered intellectual property,
and finally additional damages to the insured's business operations such as business
interruption, loss of clients or market share, or public relation damage control efforts. The
policy excludes loss due to insured's cyber presence.

Not Insurance. Insuring Agreement 1 is not insurance in the commonly accepted sense.
There is no insurance risk but only investment or business risks. It is not clear what intellectual
property the insured possesses.

Insuring Agreement 2 is not insurance in the commonly accepted sense. There is no
insurance risk but only investment or business risks.

4. Special Risk - Commercial Medical Malpractice Gap Insurance Policy.

(GP-091)
Covers claims that have been denied by the listed insurance company, which issued the
underlying medical malpractice insurance policy, due to a breach of warranty, failure to notify
the insurer of medical operations or procedures, sales or distribution of excluded products, or
the exhaustion of the primary limits.

Form 886-A (1-1994) Catalog Number 20810W Page 35 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

Not Insurance. We could not conclude that this contract is insurance in the commonly
accepted sense. The contract is vague as to what it covers.

5. Special Risk - Commercial Property GAP

(GP-091)
This policy provides “exclusion/endorsement buy back” or “differences in conditions” coverage
for a Coverage Trigger from “Commercial Real Estate Package Policy, CO-13 policy pending
that provide coverage during calendar year 20XX.

Not Insurance. Terms of the contract are too vague.

6. Special Risk — Regulatory Changes Insurance Policy.

(REG-091)
Covers actual compliance expenses and any business interruption loss of up to 12 months as
a result of any regulatory change that has an adverse impact on insured's normal on-going
business operations. Regulatory changes include governmental, administrative agency, or
legislative changes, changes to environmental, zoning, transportation, or safety laws or
regulations, changes to import/export laws, regulatory changes due to foreign political risk
including the collapse of a foreign economy, and any regulatory change due to the insured's
reorganization, such as changing from a corporation to a limited partnership. The policy
excludes any claim for an adverse regulatory change due to the insured's substantial non-
compliance with regulations or other guidelines.

Not Insurance. The policy is not insurance in the commonly accepted sense. There is no
insurance risk but only investment or business risk.

We could not conclude that this contract is insurance in the commonly accepted sense. The
contract is vague as to what it covers.

7. Special Risk — Tax Liability Insurance Policy.

(TAX-091)
Covers any additional tax liability up to $0 subject to a deductible equal to 0% of the actual
filed IRS tax liability provided return prepared and signed by CPA. Policy also covers defense
expenses incurred in determining the final tax liability. Several IRS penalties are excluded
from coverage.
Not Insurance. The policy is not insurance in the commonly accepted sense. There is no
insurance risk but only investment or business risk.

Form 886-A (1-1994) Catalog Number 20810W Page 36 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

8. Special Risk — Punitive Wrap Liability Insurance Policy.

(PWRP-091)
Covers claims for punitive or exemplary damages upon the failure of the insurer under policies
listed that are issued to the insured to cover punitive or exemplary damages, judgments, or
awards solely due to the enforcement of any law or judicial ruling that precludes the insuring of
punitive or similar damages and that but for such law or ruling would otherwise be covered,
and for which an insured is legally obligated to pay.

Not Insurance. The policy is not insurance in the commonly accepted sense. There is no
insurance risk but only investment or business risk.

20XX Policies

Wrote the same 8 polices written in 20XX. None of the direct written policies written
during 20XX were deemed to be contracts of insurance.

Our review of the direct written contracts executed during the tax years under consideration is
summarized as follows:

Deemed Not Deemed
Contract Insurance Insurance

01. Special Risk-Collection Rate No
02. Special Risk-Expense Reimbursement No
03. Special Risk - Commercial Property GAP No
04. Special Risk-Punitive Wrap No
05. Special Risk — Product Recall No
06. Special Risk —- Commercial General Liability GAP No
07. Loss of Major Business to Business No
08. Special Risk-Commercial Medical Malpractice GAP No
09. Special Risk-Regulatory Changes (081) No
10. Special Risk-Regulatory Changes (082) No
11. Special Risk-Tax Liability (081) No
12. Special Risk-Tax Liability (082) No
13. Excess Directors & Officers Yes

14. Excess Employment Practices No
15. Excess Intellectual Property Package (081) No
16. Excess Intellectual Property Package (082) No

Form 886-A (1-1994) Catalog Number 20810W Page 37 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

17. Excess Pollution No

We were able to conclude only one of the direct written contracts as insurance contracts
because they included an insurance risk. Sixteen of the Seventeen direct written contracts
were deemed not to include an insurance risk and was either a business or investment risk, or
we were unable to clearly identify an insurance risk.

Other Insurance Policies

Quota Share Reinsurance Program.

CO-6 participated in over 0+ insurance policies with more than 200 insureds. CO-6 blended
together is direct written insurance and then reinsured the entire book on a quota share basis
with each of the pool participants. As Reinsurer No. 13 in the 20XX reinsurance program,
Taxpayer received a Quota Share Premium of $0 from CO-6 in exchange for the assumption
of 0% of the risk pool comprised of the stop loss coverages issued to all the stop loss
endorsement policyholders (see also the Joint Underwriting Stop Loss Endorsement). ORG
was not a party to the Quota Share Reinsurance Agreement during the 20XX and 20XX. ORG
did not receive a Quota Share Reinsurance premium during 20XX and 20XX. ORG received a
Quota Share Reinsurance premium of $0 in 20XX.

We do not have any understanding of the risks insured by Taxpayer. We do not know whether
the policies "reinsured" are similar to the several policies that we have concluded above are
not insurance. However, the direct written contracts insured by CO-6 do include the 17
contracts written by ORG. Therefore, it is highly likely that the entire pool, which is insured by
CO-6 and reinsured on a quota share basis with each of the pool participants, is primarily
comprised of direct written contracts that the Service would deem not be insurance in the
commonly accepted sense. Thus all or a portion of the premiums received by taxpayer, during
the taxable years under consideration, would not be for reinsuring insurance risks.

Credit Coinsurance Reinsurance Program.

The policy reinsures risks on vehicle service contracts. Again, we do not know what risks are
being insured and reinsured.

Form 886-A (1-1994) Catalog Number 20810W Page 38 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

Insurance In Its Commonly Accepted Sense

Staff

As a foreign corporation, taxpayer contracted with CO-2 Trust Limited and CO-2 Insurance
Management Company, in Island, Territory, to serve as its Residential Insurance Manager.
Taxpayer did not hire or employ staff to conduct an insurance business. During the tax years
under consideration, taxpayer did not incur salaries and wages expenses or any other payroll
costs.

Pricing of Contracts

The Service also has concern about whether the premiums charged for the contracts were
reasonable. A premium for an insurance contract is based on actual CO-10 calculations and
factors. Even if an insurance contract is deem to be “insurance” for federal tax purposes, the
premium paid pursuant to that contract must be determined based on actual CO-10 factors
and principles. In the August 23, 20XX response to IDR #1 for the 20XX and 20XX tax years,
the CPA provided a copy of letters from CO-14; CO-7; and CO-8, which was purpose to
address the method used for pricing the direct written and reinsurance contracts for the taxable
years under consideration. However, the Service concluded that the letters did not address
the method of pricing the specific direct written and reinsurance contracts that ORG was a
party to during 20XX, 20XX, and 20XX. Thus, the Service concluded that the premiums
received by taxpayer were not reasonable because they were not based on actual CO-10
calculations and factors.

Use of Assets

Taxpayer engaged in investment activities that are not typical of insurance companies. Based
on the review of the Form 990 returns, taxpayer had four note receivable loan balances due
from the Affiliated Businesses to whom it executed the direct written contracts. Loans
exceeding $0 million dollars were made to CO-1, and loans exceeding $0 were made to a trust
called Trust-2, in which the beneficiaries are Jeval affiliates. The amount of the outstanding
loan receivable balances represented the total percentage of assets as follows:

12/31/20XX 12/31/20XX 12/31/20XX 12/31/20XX
Loan balance $0 $ 0 $ O $ 0
Total Assets $0 $ 0 $ O $ 0
Percentage 0% 0% 0% 0%

The loans due to taxpayer from the Affiliated Businesses were still outstanding as of December
31, 20XX.

Form 886-A (1-1994) Catalog Number 20810W Page 39 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX
Risk Shifting

Risk shifting occurs if a person facing the possibility of an economic loss transfers some or all

of the financial consequences of the potential loss to the insurer, such that a loss by the
insured does not affect the insured because the loss is offset by a payment from the insurer.

See Rev. Rul. 60-275 (risk shifting not present where subscribers, all subject to the same flood

risk, agreed to coverage under a reciprocal flood insurance exchange).

Risk Distribution
Risk distribution incorporates the statistical phenomenon known as the law of large numbers.
The concept of risk distribution “emphasizes the pooling aspect of insurance: that it is the
nature of an insurance contract to be part of a larger collection of coverages, combined to
distribute risks between insureds.” AMERCO and Subsidiaries v. Commissioner, 96 T.C. 18,
41 (1991), aff'd, 979 F.2d 162 (9th Cir. 1992). In Treganowan, 183 F.2d at 291, the court
quoting Note, The New York Stock Exchange Gratuity Fund: Insurance That Isn't Insurance,
59 Yale L.J. 780, 784 (1950), explained that “by diffusing the risks through a mass of separate
risk shifting contracts, the insurer casts his lot with the law of averages. The process of risk
distribution, therefore, is the very essence of insurance.” Also see Beech Aircraft Corp. v
United States, 797 F.2d 920, 922 (10th Cir. 1986), (risk distribution “means that the party
assuming the risk distributes his potential liability, in part, among others”); Ocean Drilling &
Exploration Co. v. United States, 988 F.2d 1135, 1135 (Fed. Cir. 1993) (“risk distribution
involves spreading the risk of loss among policyholders’).

Distributing risk allows the insurer to reduce the possibility that a single costly claim will exceed
the amount taken in as premiums and set aside for the payment of such a claim. By assuming
numerous relatively small, independent risks that occur over time, the insurer smoothes out
losses to match more closely its receipts of premiums. Clougherty Packing Co. v.
Commissioner, 811 F.2d 1297, 1300 (9th Cir. 1987). Risk distribution necessarily entails a
pooling of premiums, so that a potential insured is not in significant part paying for its own
risks. See Humana, Inc. v. Commissioner, 881 F.2d 247, 257 (6th Cir. 1989).

"In Situation 1 of Rev. Rul. 2002-89, S, a wholly owned subsidiary of P, a domestic parent
corporation, entered into an annual arrangement with P whereby S provided coverage for P’s
professional liability risks. The liability coverage S provided to P accounted for 90% of the total
risks borne by S. Under the facts of Situation 1, the Service concluded that insurance did not
exist for federal income tax purposes. On the other hand, in Situation 2 of Rev. Rul. 2002-89,
the premiums that S received from the arrangement with P constituted less than 50% of total
premiums received by S for the year. Under the facts of Situation 2, the Service reasoned that
the premiums and risks of P were pooled with those of unrelated insureds and thus the

Form 886-A (1-1994) Catalog Number 20810W Page 40 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

requisite risk shifting and risk distribution were present. Accordingly, under Situation 2, the
arrangement between P and S constituted insurance for federal income tax purposes.

In Rev. Rul. 2002-90, S, a wholly owned insurance subsidiary of P, directly insured the
professional liability risks of 12 operating subsidiaries of its parent. S was adequately
capitalized and there were no related guarantees of any kind in favor of S. Most importantly, S
and the insured operating subsidiaries conducted themselves in a manner consistent with the
standards applicable to an insurance arrangement between unrelated parties. Together, the
12 operating subsidiaries had a significant volume of independent, homogeneous risks. Under
the facts presented, the ruling concludes the arrangement between S and each of the 12
operating subsidiaries of the parent of S constitute insurance for federal income tax purposes.

Situation 1 of Rev. Rul. 2005-40, describes a scenario where a domestic corporation operated
a large fleet of automotive vehicles in its courier transport business covering a large portion of
the United States. This represented a significant volume of independent, homogeneous risks.
For valid non-tax business purposes, the transport company entered into an insurance
arrangement with an unrelated domestic corporation, whereby in exchange for an agreed
amount of “premiums,” the domestic carrier “insured” the transport company against the risk of
loss arising out of the operation of its fleet in the conduct of its courier business. The unrelated
carrier received arm’s length premiums, was adequately capitalized, received no guarantees
from the courier transport company and was not involved in any loans of funds back to the
transport company. The transport company was the carrier's only “insured.” While the
requisite risk-shifting was seemingly present, the risks assumed by the carrier were not
distributed among other insured’s or policyholders. Therefore, the arrangement between the
carrier and the transport company did not constitute insurance for federal income tax
purposes.

The facts in Situation 2 of Rev. Ruling 2005-40 mirror the facts of Situation 1 except that in
addition to its arrangement with the transport company, the carrier entered into a second
arrangement with another unrelated domestic company. In the second arrangement, the
carrier agreed that in exchange for “premiums,” it would “insure” the second company against
its risk of loss associated with the operation of its own transport fleet. The amount that the
carrier received from the second agreement constituted 0% of the total amounts it received
during the tax year on a gross and net basis. Thus, 0% of the carrier’s business remained with
one insured. The revenue ruling concluded that the first arrangement still lacked the requisite
risk distribution to constitute insurance even though the scenario involved multiple insureds.

In Situation 4 of Rev. Rul. 2005-40, 12 LLC’s elected classification as associations, each
contributing between 0 and 0% of the insurer's total risks. The Service concluded that this
transaction constituted insurance for federal income tax purposes.

Form 886-A (1-1994) Catalog Number 20810W Page 41 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

The principal concern with regard to your activities is whether there is sufficient risk
distribution. As discussed above, the idea of risk distribution involves some mathematical
concepts. For example, risk distribution is said to incorporate the statistical phenomenon
known as the “law of large numbers” whereby distributing risks allows the insurer to reduce the
possibility that a single costly claim will exceed the amount taken in as premiums. The
concept hinges on the assumption of “numerous relatively small” and “independent risks” that
“occur randomly over time.” Clougherty Packing Co., 811 F.2d 1297 at 1300.

As discussed, the Service in Rev. Rul. 2002-90, concluded that insurance existed where 12
insureds each contributed between zero and 0% to the insured’s total risks. Similarly, in
Situation 4 of Rev. Rul. 2005-40, the Service concluded that insurance existed where 12 LLCs,
electing classification as associations, each contributed between five and 15% of the insurer’s
total risks. Moreover, in Situation 2 of Rev. Rul. 2002-89, supra, the Service concluded that
insurance existed where a wholly owned subsidiary insured its parent, but the arrangement
represented less than 0% of the insurer's total risk for the year.

In the instance case, the facts therein are analogous to the analysis under Situation1 of Rev.
Rul. 2002-89, supra, the liability coverage provided to the parent corporation by its wholly
owned subsidiary accounted for 0% of the total risks borne by the subsidiary. Similarly, in
Situation 2 of Rev. Rul. 2005-40, supra, a second insurer contributing 0% of the insured’s risks
was added to the single-insured scenario of Situation1. The Service concluded in both of the
above scenarios that insurance did not exist because there lacked a sufficient number of
insureds. The small number of insureds produced an insufficient pool of premiums to
distribute any insurance risk.

With respect to the contracts reviewed during the tax years under audit, the Service concluded
that the contracts between the taxpayer and CO-1 and Affiliated Businesses, the Named
Insureds, do not constitute contracts of insurance because the risk transferred is a business or
investment risk and not an insurance risk; and the contracts lack the essential element of risk
distribution. Most of the risk insured by the taxpayer is under the direct written contracts with
affiliated businesses. The affiliated businesses are indirectly owned by Indv-2, through his
ownership and control of Trust, which is the 100% sole shareowner of ORG. Of total risk
insured by the taxpayer, approximately 0% percent of the risk assumed during the years under
audit is that of the affiliated business. Rev. Rul. 2005-40 cited several court decisions that
have recognized that risk distribution necessarily entails a pooling of premiums, so that a
potential insured is not in significant part paying for its own risks. In this case, the large
concentration of insurance risks in three insureds does not constitute risk distribution because
of the very high likelihood of the insureds paying for any of its claims with its own premiums.
Such an arrangement is not insurance but a form of self-insurance.

Form 886-A (1-1994) Catalog Number 20810W Page 42 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XKX
12/31/20XX

In addition, of the total premiums received during the 20XX, 20XX, and 20XX tax years, 0%
percent of the premiums were derived from the direct written contracts that insure the risk of
the affiliated business. Approximately 0% of all premiums and 100% of the direct written
premiums were paid by only three of the seven affiliated entities. Furthermore, documents
reviewed during the audit revealed that three of the affiliated entities paid direct written
premiums to the taxpayer in 20XX only. ORG did not write, issue or sell direct written
contracts to non-affiliated business interests. Nor did the taxpayer sell direct written contracts
to the general public.

During the tax years under audit, the taxpayer was primarily and predominantly supported by
direct written premiums that were received from only three of the Named Insureds, CO-1, Indv-
2 Family, M.D., P.A., and the Family Limited Partnership, although the contracts lists seven
Named Insureds. The remaining four Named Insureds did not pay separate direct written
premiums to the taxpayer during the years under consideration. The taxpayer did not receive
direct written premiums from an adequate pool of insureds. Thus, the direct written contracts
between the taxpayer and the Affiliated Business Interests lack the requisite risk distribution
that is necessary for the contracts to be deemed contracts of insurance, as described in
Subchapter L of the Internal Revenue Code.

The Service concluded that the primary and predominant activity of the taxpayer is to assume
risk from contracts that are solely concentrated in seven affiliated businesses: CO-1, Ltd: CO-
1.; Indv-2 Family, M.D., P.A., Family Limited Partnership; CO-3; CO-5; and CO-4 Again,
although the direct written contracts list seven Named Insureds, the direct written premiums
are only paid to taxpayer by CO-1 , Indv-2 Family, M.D., P.A., and the Family Limited
Partnership. Because the risk is too heavily concentrated in the Affiliated Business Interests,
it is clear that any losses paid by the taxpayer would be those of the Affiliated Business
Interests and not from an unrelated third party. In addition, since the Affiliated Business
Interests paid the majority of premiums received by the taxpayer during the years under audit,
the Service concluded that losses incurred by the Affiliated Business Interests were paid only
from the premiums paid to the taxpayer by three of the seven Named Insureds. In other
words, the arrangement between the taxpayer and the Affiliated Business Interests represents
a form of self-insurance, and no court has held that self-insurance is insurance for federal tax
purposes.

The Service's other concern is that over 0% of the total risks assumed by the taxpayer is with
affiliated businesses that are indirectly controlled by Indv-2, beneficial owner of the taxpayer.

Because ORG did not qualify as an insurance company for federal income tax purposes, it
failed to meet the requirements of section 501(c)(15) of the Code. Thus, the taxpayer did not
qualify for recognition of exemption under section 501(a) of the Code as an organization

Form 886-A (1-1994) Catalog Number 20810W Page 43 of 56 publish. no.irs.gov © Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

described in section 501(c)(15) of the Internal Revenue Code. Thus, revocation of the
taxpayer's tax-exempt status under IRC 501(c)(15) is proposed, effective January 1, 20XX.

Gross Receipts Test
Section 501(c)(15) of the Internal Revenue Code provides exemptions for insurance
companies, other than life insurance companies (including inter-insurers and reciprocal
underwriters), if the gross receipts for the taxable year do not exceed $600,000, and more than
50% of such gross receipts consist of premiums.

Based the Service's analysis of the contracts for 20XX, sixteen of the seventeen direct written
contracts were deemed not to be insurance (or we could definitively determine whether the
contract included an insurance risk). Therefore, the amounts received by ORG for those
sixteen direct written contracts are not considered insurance premiums. The amount received
by taxpayer for only one of the seventeen direct written contracts was deemed to be a
premium because only for this single contract included an insurance risk. For 20XX and 20XX,
none of the eight direct written contracts were deemed to include an insurance risk. Therefore,
none of the amounts received by ORG, during 20XX and 20XX, for the direct written contracts
were deemed to be premiums from insurance contracts. None of the amounts received for the
direct written contracts were included as gross receipts for purposes of the gross receipts
computation described in Notice 20XX-42. ORG received amounts that the Service deemed to
be direct written and reinsurance premiums as follows:

20XX
Contract Premium
Direct Written Contracts:
Excess Directors & Officers Liability
$0 x 0% $0
Amount Deemed Premiums from Direct Written Contracts $0
Quota Share Premiums
Credit Coinsurance Reinsurance
Total Premiums for 20XX
Gross Receipts for 20XX
Percentage of Premiums to Gross Receipts

Le

RA
OPO

%

20XX
Contract Premium
Direct Written Contracts:

No DW Premiums Received $ 0.00
Amount Deemed Premiums from Direct Written Contracts $ 0.00

Form 886-A (1-1994) Catalog Number 20810W Page 44 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

Quota Share Premiums 0.00

Credit Coinsurance Reinsurance _0

Total Premiums for 20XX . $ )

Gross Receipts for 20XX $ 0
Percentage of Premiums to Gross Receipts 0%

20XX
Contract Premium
Direct Written Contracts:

No DW Premiums Received $ 0.00

Amount Deemed Premiums from Direct Written Contracts $ 0.00

Quota Share Premiums 0.00

Credit Coinsurance Reinsurance 0

Total Premiums for 20XX $ 0

Gross Receipts for 20XX $ 0
Percentage of Premiums to Gross Receipts 0%

20XX
Premiums received by taxpayer for each contract in 20XX were not requested during the audit.

The amounts received by ORG under the remaining contracts were not for insurance in the
commonly accepted sense. The terms of the contracts did not include insurance risk but
covered investment or business risks. The remaining contracts lacked the requisite insurance
risk to constitute insurance because the contracts lacked fortuity, and the risk at issue is akin
to the timing and investment risks of Rev. Rul. 89-96.

An arrangement that provides for the reimbursement of believed-to-be inevitable future costs
does not involve the requisite insurance risk for purposes of determining whether the assuming
entity may account for the arrangement as an “insurance contract” for purposes of Subchapter
L of the Internal Revenue Code. For the contracts that are deemed not to qualify as insurable
risks, the amount paid for each contract, by CO-15; CO-16; and the CO-17 to the TP, do not
qualify as an insurance premium.

In addition, although we question whether the Quota Share contracts are actually valid
reinsurance contracts, and whether the amounts received by taxpayer under the contracts are
valid reinsurance premiums, the amounts received by taxpayer from CO-6 were included as
“premium income” for purposes of the gross receipts computation shown above. Even after

Form 886-A (1-1994) Catalog Number 20810W Page 45 of 56 publish. no.irs.gov © Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

given the taxpayer the benefit of the doubt, the taxpayer still failed the gross receipts for the
years under audit.

During the tax years under consideration, the premium income received by taxpayer did not
exceed 50% of its gross receipts. Gross receipts were computed under Notice 20XX-42.°
Although gross receipts are less than the $600,000 limitation, the amount deemed to be
premiums, for each taxable year, is not more than 50% of gross receipts. Therefore, we
conclude that the taxpayer did not meet the 50% gross receipts test described in IRC
501(c)(15) and Notice 20XX-42 for any tax year under audit.

As described in Situation 1 of Rev. Rul. 2002-89, supra, and Situation 2 of Rev. Rul. 2005-40,
supra, there exists an inadequate premium pooling base for insurance to exist. The addition of
the two other reinsurance arrangements does not change the conclusion that the contracts
with the Affiliated Businesses lack the requisite risk distribution. Therefore, the taxpayer does
not qualify as an insurance company.

ORG does not meet the new gross receipts test imposed by Notice 2006-42. For tax years
ended December 31, 20XX, through December 31, 20XX, gross receipts did not exceed the
$600,000 limitation. However, premium income was not greater than 50% of the gross
receipts generated for each year.

Application of Foreign Corporation Tax Provisions

The administrative file for the original Form 1024 application filed by ORG included a copy of
the IRC 953(d) election. The election was signed by Indv-2 Family, CEO and President of
ORG, on February 28, 20XX. The election was approved by IRS, National Office,
commencing on December 22, 20XX. A copy of the approval IRC 953(d) election was
attached to the Form 990 returns filed for the 20XX through 20XX tax years.

IRC 953(a)(1) defines insurance income to mean income which is attributable to the issuing or
reinsuring of an insurance or annuity contract, and would be taxed under subchapter L if such
income were the income of a domestic insurance company. Therefore, any premium income
received by a CFC could qualify

IRC 953(d) allows foreign insurance company to elect to be treated as a domestic company for
tax purposes if it meets certain requirements. One such requirement is that the foreign
company must be a company that would qualify under part I or II of subchapter L for the
taxable year if it were a domestic corporation. See IRC 953(d)(1)(B).

® Under Notice 2006-42, only gains from the sale of capital assets are included in gross receipts.

Form 886-A (1-1994) Catalog Number 20810W Page 46 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

Since the Service determined that the taxpayer is not an insurance company within the
meaning of Subchapter L of the Code for the years under audit, it fails to meet the
requirements for the election under IRC 953(d) to be treated as a domestic corporation.

In addition, because the company does not meet the requirements to make the IRC 953(d)
election, and thus, is not a domestic corporation, the company should be treated as a
“controlled foreign corporation,” and the provisions of Subpart F of the Internal Revenue Code
(sections 951-965) should apply. However, the Company did not generate any passive
sources of income such as dividends, interest, royalties, rents or annuities, during the tax year
under audit.

The subpart F provisions apply to foreign corporations that qualify as controlled foreign
corporations (“CFCs”). IRC 957 defines a CFC as a foreign corporation with regard to which
more than 50% of the total combined voting power of all classes of stock entitled to vote or the
total value of the stock is owned by U.S. shareholders. A U.S. shareholder, in turn, is defined
under IRC 951(d) as a U.S. person who owns 10% or more of the total combined voting power
of all classes of stock entitled to vote of the foreign corporation. Therefore, a corporation with
regard to which more than 50% of the vote or value is owned by U.S. persons who individually
own 10% or more or the vote will qualify as a CFC under IRC 957.

IRC 953(a)(1) defines insurance income to mean income which is attributable to the issuing or
reinsuring of an insurance or annuity contract, and would be taxed under subchapter L if such
income were the income of a domestic insurance company. Therefore, any premium income
received by a CFC could qualify as insurance income for purposes of IRC 953 even though the
CFC fails to qualify as an insurance company under subchapter L.

IRC 953(a)(2) of the Code excepts “exempt insurance income (as defined in subsection (e)”
from the definition of insurance income. However, to qualify as exempt insurance income,
such income must be derived by a qualifying insurance company. A qualifying insurance
company is defined as a company that “is engaged in an insurance business and would be
subject to tax under subchapter L if it were a domestic corporation.

IRC 953(e)(3)(C) states that income derived from U.S. sources does not qualify for exemption.

If a CFC does not qualify as an insurance company under subchapter L, it will not meet the
definition of a qualifying insurance company for purposes of IRC 953(e). Thus, none of its
insurance income will be exempt insurance income.

Effective Date of Revocation
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. 2014-4, 14.01 (cross-

Form 886-A (1-1994) Catalog Number 20810W Page 47 of 56. publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

referencing 13.01 et seq.) 2014-1 C.B. 514. 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 ona
favorable determination [*43] 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.

Taxpayer filed Form 1024 with the Service on March 15, 20XX, seeking exemption under IRC
501(c)(15).

Taxpayer received a favorable ruling letter from the Service on October 15, 20XX, granting
IRC 501(c)(15) tax-exempt status. Exemption was effective retroactively back to the
taxpayer's date of incorporation - December 22, 20XX.

Based on the current examination, the Service proposed revocation of taxpayer’s tax-exempt
status under section 501(c)(15) of the Internal Revenue Code, effective January 1, 20XX. The
revocation covers the tax years ended December 31, 20XX, through December 31, 20XX.

Revocation was effective as of the first day of the initial tax year under examination, when the
Service determined that the taxpayer no longer met the requirements as a small insurance
company under IRC 501(c)(15). As of January 1, 20XX, the Service determined that the
taxpayer's primary and predominant activity was no longer insurance, and that it also failed to
meet the gross receipts tests described in Notice 20XX-42 and IRC 501(c)(15)(A)(i).

TAXPAYER’S POSITION:

A response to the Preliminary Report was received from CPA, CPA, on March 10, 20XX. In
the response, the CPA summarized that the taxpayer disagreed with the Service’s conclusions
that (1) the contracts issued by ORG lack insurance risks to constitute insurance contracts; (2)
the contracts lack the requisite risk distribution; and (3) the Service ignored more than 30 years
of well-established tax law, as well as the Service’s hundreds of rulings..,

The CPA argued the following points:

1. All of the policies written by ORG insure against risk of loss due to fortuitous events;
and there is no presence of business or investment risk coverage in any of the

policies. All coverages written by ORG are for pure insurance risks.

2. The Quota Share Reinsurance contracts underwritten by ORG were contracts of
insurance because all of the risks reinsured were pure insurance risks.

Form 886-A (1-1994) Catalog Number 20810W Page 48 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

3. By raising the “lack of insurance risk” issue, the Service demonstrates a clear lack
of knowledge of customary insurance products as well as the insurance industry in
general.

4. The CPA indicated that “in analyzing captive insurance arrangements for the
presence of risk distribution, courts have looked at the level of unrelated risk as a
metric for the presence of risk distribution.” The Service ignored the important fact
that when taking into account all the insurance policies and reinsurance contracts,
all of the premiums were attributable to many thousands of independent, unrelated
risks of hundreds or thousands of unrelated insureds.

5. The Service also ignored achieving distribution by issuing 28 policies to four
insureds.

6. The Service ignores the Tax Court ruling in The Harper Group and Includible Subs.
v Commissioner, 96 T.C. 45 (1991), aff'd 979 F.2d 1342 (9th Cir. 1992), where 30%
unrelated risks was determined to be sufficient to meet the risk distribution
requirement.

7. The CPA stated that the Service conducted no meaningful examination of risk
distribution in its audit of ORG. Rather, the Service simply claims that the direct
written contracts lack the requisite risk distribution. The nature of insurance is the
number of underlying risk exposures present, not an artificial entity count or an
artificial count of the number of policies written. The Taxpayer cites AMERCO, Inc.
v. Commissioner, No. 91-70732, slip op. 13187 (9th Cir. Nov. 5, 1992).

8. Based on the Harper case, which held that 29% unrelated business is sufficient,
and the recent Tax Court decision in Rent-A-Center, it is clear that the insurance
and reinsurance contracts issued by ORG did not lack the requisite risk distribution.
Rent-a-Center, Inc. & Affiliated Subsidiaries v. Commissioner, 142 T.C. 1 (2014).

9. The Service ignored Revenue Ruling 20XX-31, in which the Service conceded that
it would no longer assert the economic family theory due to its rejection by the
courts.

10. The CPA argues the Service's analysis of risk distribution is incomplete. The
Service ignores the numerous unrelated risks that ORG insures. Courts have
recognized that risk distribution can occur even with a single insured. The taxpayer
cited, Malone & Hyde v. Commissioner.

Form 886-A (1-1994) Catalog Number 20810W Page 49 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XKX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

11. CPA argues the Service’s current position is directly contrary to the position it has
taken in hundreds of prior Section 501(c)(15) tax-exempt determination letters that it
has issued, including the tax-exempt determination letter issued to ORG. . There
has been no intervening change in law to account for the Service’s disparate tax
treatment between ORG and such similarly situated taxpayers. Accordingly, the
Service has violated its own procedures and mandate to provide a uniform
application of existing tax law (Rev. Proc. 2012-9).

12. ORG qualified for tax-exempt status as an insurance company described in IRC
Section 501(c)(15) during all of the years under review. As ORG made a valid
election under IRC Section 953(d) to be treated as a domestic corporation, the
Service’s conclusion that ORG is a controlled foreign corporation is incorrect.

Government’s Response to Taxpayer’s Position:
After reviewing the response to the Preliminary Report received from CPA, CPA, on March 10,
20XX, the Service’s initial position is unchanged. ORG’s primary and predominant business in
tax years 20XX, 20XX, 20XX, and 20XX, was not insurance because the contracts issued by
the company lacked insurance risks and the requisite risk distribution.

Taxpayer’s Position:

In the second paragraph of the response to the agent’s preliminary report, the CPA stated that
the audit conclusion reached by the Service is based upon a number of unsupported and
factually incorrect positions, including that ORG’s insurance operations lacked the requisite
insurance risk to constitute insurance and lacked the requisite risk distribution.

Government’s Response:

The conclusion reached by the Service was based on an examination of the direct written and
reinsurance contracts executed by ORG, and books and records for the 20XX, 20XX, and
20XX tax years. Based on the review of the contracts, the Service concluded that the primary
activity of ORG was to assume risks of affiliated businesses partially owned and controlled by
officers of ORG and beneficial owners of the affiliated businesses. Approximately 0% of the
risk assumed by ORG was that of the affiliated businesses. ORG did not assume risk of or
receive direct written premiums from non-affiliated businesses or unrelated general public
under the terms of the direct written contracts. The Service concluded that the direct written
contracts lack the requisite risk distribution because the arrangement did not include an
adequate pool of related or unrelated insureds for the law the large numbers to operate. The
pool consisted of a single policyholder and payer of direct written premiums. Thus, ORG’s
primary and predominant activity is not insurance as described in Subchapter L of the Internal
Revenue Code.

Form 886-A (1-1994) Catalog Number 20810W Page 50 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XKX

Taxpayer's Position:

On pages 2 and 3, the CPA described the terms of 13 direct contracts written by ORG during
the tax years in question. The CPA claims that the contracts are insurance in the commonly
accepted sense; the risk covered are insurance risks; and the contracts do not lack risk
distribution.

Government’s Position:

The government’s position with respect to the status of the direct written contracts remains
unchanged. The Service contends of only the Excess Directors & Officers Liability Insurance
Policy covers insurance risks and thus, is a valid contract of insurance. The remaining 16
direct written contracts are not contracts of insurance in the commonly accepted sense
because the contract covers business or investment risks, and not an insurance risk.

Taxpayer’s Position:

On Page 4 of the Taxpayer’s position, the CPA cites the Harper Group & Subsidiaries v.
Commissioner, 96 T.C. 45(1991) to support his argument that ORG qualifies as an insurance
company. The CPA cited the court’s holding, when a significant percentage (29 percent) of an
insurance company’s income is received from a relatively large number of unrelated insureds,
the requirement of risk distribution is satisfied. The source of the remaining 71 percent is
irrelevant on the issue whether sufficient risk distribution is present because of the significant
presence of unrelated risks.

On page 4, paragraph 2, of the response, the CPA made the following statement:
In its preliminary report, the Service merely states, that due to 70 percent
of premiums being direct written premiums for coverages written to four
insureds, which in fact owned no interest in ORG, there is a lack of
adequate risk distribution. The Service’s position ignores the fact that
when taking into account all the insurance policies and reinsurance
contracts, all of the premiums were attributable to many thousands or
independent, unrelated risks of hundreds or thousands of unrelated
insureds.

Government’s Response:

The Service disagrees with the CPA’s assertion that the determining factor of whether the
requisite risk distribution is present is identifying the percentage of business with unrelated
insureds. Instead, the current Service’s position on captive insurance arrangements is
expressed in Revenue Ruling 2005-40, which emphasizes the number of policyholders and
percentage of business with the related or affiliated insureds as the determining factor of
whether risk distribution is present. The Rev. Rul. emphasizes that an arrangement where an
issuer received premiums from a single policyholder lacks the requisite risk distribution. The
ruling further emphasized that an issuer with contracts with a small number of policyholders

Form 886-A (1-1994) Catalog Number 20810W Page 51 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

can be insurance if the percentage of business exceeds 50 percent of the total insurance
business conducted.

Even the CPA claim that insurance exists under the rationale in the Harper case, where
approximately 30% of the risk assumed by ORG was from unrelated or unaffiliated insureds,
the Service believes that this conclusion would be based on a misunderstanding of the Harper
Case. In the Harper Case, 67% to 71% of the total premiums received for the years at issue
were not related to a single policyholder. Rather, the 67% to 71% were the total percentages
received from all related policyholders, including brother-sister corporations (a total of 13
entities). The court’s analysis in Harper Group must be read in its entirety and all the facts and
circumstances must be considered, i.e. that there are 13 entities making up the nearly zero risk
concentration in all the years at issue.

The Service's interpretation of the Harper Group is consistent with the conclusions reached by
the Service in Situation 2 of Revenue Ruling 2002-89 and Situation 4 of Revenue Ruling 2005-
40.

Taxpayer’s Position:
On page 5, paragraph 2, of the response, the CPA stated that the Service conducted no

meaningful examination of risk distribution in its audit of ORG. Rather, the Service simply
claims that the direct written contracts lack the requisite risk distribution. The nature of
insurance is the number of underlying risk exposures present, not an artificial entity count or an
artificial count of the number of policies written.

Government’s Response:

In the March 23, 20XX response to Information Document Request #5, Question, the CPA
indicated that the proper method for determining the amount of risk being assumed by the
company is to compare the premiums received on the various contracts. Using the CPA’s
method, the taxpayer assumed risks as follows:

20XX
Direct Written Premiums $ O 0%
Quota Share Reinsurance Assumed 0 0
Other Reinsurance Assumed 0 0
Total $ O 100.00%
20XX
Direct Written Premiums $ O 0%

Form 886-A (1-1994) Catalog Number 20810W Page 52 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX
Quota Share Reinsurance Assumed 0.00 -0-
Other Reinsurance Assumed 0 0
Total $ 0 100.00%
20XX
Direct Written Premiums $ 0 0%
Quota Share Reinsurance Assumed 0.00 -0-
Other Reinsurance Assumed 0 0
Total $ 0 100.00%
20XX
Direct Written Premiums $ 0 0%
Quota Share Reinsurance 0 0
Other Reinsurance Assumed 0 0
Total $ 0 100.00%

Under this method, the Service concluded that the taxpayer’s the primary and predominant
activity conducted was assuming risk under the direct written contracts with the affiliated
business interests, because the activity accounted for more than 0 percent of the business
(and premiums) during the years under audit.

Taxpayer’s Position:

On page 6 of the response, the CPA stated that based on the recent Tax Court decision in
Rent-A-Center, Inc. & Affiliated Subsidiaries v. Commissioner, 142 T.C. 1 (2014), it is clear
that the insurance and reinsurance contracts issued by ORG did not lack requisite risk
distribution.

Government’s Response:

The opinion and dissent in this court case emphasized the following points:

• In 2002, the IRS likewise abandoned its position that there is a per se rule
against the deductibility of brother-sister "premiums," concluding that the

Form 886-A (1-1994) Catalog Number 20810W Page 53 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A EXPLANATIONS OF ITEMS

(Rev. January 1994)

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

characterization of such payments as "insurance premiums" should be
governed, not by a per se rule, but by the facts and circumstances of the
particular case. Rev. Rul. 2002-90, 2002-2 C.B. 985; accord Rev. Rul
20XX-31, 20XX-1 C.B. at 1348 ("The Service may continue to challenge
certain captive insurance transactions based on the facts and
circumstances of each case.").

• Respondent's position in the instant cases is consistent with the ruling
position the IRS has maintained for the past 12 years--namely, that
characterization of intragroup payments as "insurance premiums" should
be determined on the basis of the facts and circumstances of the
particular case.

Revenue Ruling 2005-40 describe facts and circumstances in which payments received by
captives under “parent-subsidiary” and “brother-sister” arrangements would and would not
qualify as an IRC 162 deduction for federal income tax purposes. Rev. Rul. 2005-40 cited
several court decisions that have recognized that risk distribution necessarily entails a pooling
of premiums, so that a potential insured is not in significant part paying for its own risks. In this
case, the large concentration of insurance risks in three insureds does not constitute risk
distribution because of the very high likelihood of the insureds paying for any of its claims with
its own premiums. Such an arrangement is not insurance but a form of self-insurance.

Taxpayer’s Position:

On page 6, paragraph 4, the CPA stated that in reaching its incorrect conclusion in the
preliminary report, the Service appears to ignore Revenue Ruling 2001-31, in which the
Service conceded that it would no longer assert the economic family theory due to its rejection
by the courts.

Government’s Response:

The current Service position is expressed in Revenue Ruling 2005-40, I.R.B. 2005-27 (June
17, 2005), which provides IRS issued guidance emphasizing that the requirement of risk
distribution must be met. The ruling demonstrated that this risk distribution requirement cannot
be satisfied if the issuer of the contract enters into such a contract with only one policyholder. If
the contract fails to constitute insurance, then the premiums paid are not deductible business
expenses under Code Sec. 162 and the issuing company is not an insurance company for
federal tax purposes. Rev. Rul. 2005-40 cited several court decisions that have recognized
that risk distribution necessarily entails a pooling of premiums, so that a potential insured is not
in significant part paying for its own risks. In this case, the large concentration of insurance
risks in three premium paying insureds does not constitute risk distribution because of the very

Form 886-A (1-1994) Catalog Number 20810W Page 54 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

high likelihood of the insureds paying for its claims with its own premiums. Such an
arrangement is not insurance but a form of self-insurance.

However, when the arrangements between the companies do constitute insurance for federal
income tax purposes and assuming these arrangements represented more than 50 percent of
the insuring company's business, the company will be an insurance company within the
meaning of IRC Sections 816 and 831, and the premium payments may be deductible under
Code Sec. 162, assuming the requirements for deduction are otherwise satisfied.

Taxpayer’s Position:

In paragraph 4, on page 7, the CPA stated that Service’s current position is directly contrary to
the position it has taken in hundreds of prior Section 501(c)(15) tax-exempt determination
letters that it has issued, including the tax-exempt determination letter issued to ORG. There
has been no intervening change in law to account for the Service’s disparate tax treatment
between ORG and such similarly situated taxpayers.

Government’s Position:

The Service did issue a favorable ruling letter dated October 15, 20XX, granting IRC
501(c)(15) tax-exempt status to ORG. ORG relied on this favorable determination for seven
years prior to the initial tax year under audit (20XX through 20XX). The Service is not
precluded from revoking the ruling letter if the taxpayer did not meet the requirements for IRC
501(c)(15) tax-exempt status. Each taxpayer stands alone. The audit of the activities and
books and records of ORG, and the outcome of such audit, stands alone.

Taxpayer’s Position:

In the last page, paragraph 2, the CPA stated that ORG qualified for tax-exempt status as an
insurance company described in IRC Section 501(c)(15) during all of the years under review.
As ORG made a valid election under IRC Section 953(d) to be treated as a domestic
corporation, the Service’s conclusion that ORG is a controlled foreign corporation is incorrect.

Government’s Response:
According to the Form 1024, Application for Recognition of Tax-Exempt Status, administrative
file, the taxpayer filed its IRC 953(d) election with the Service on February 28, 20XX.

IRS records reveal that the IRC 953(d) election was approved by the Service and commenced
on December 22, 20XX

IRC 953(d) allows foreign insurance company to elect to be treated as a domestic company for
tax purposes if it meets certain requirements. One such requirement is that the foreign
company must be a company that would qualify as an insurance company, under part I or II of
subchapter L, for the taxable year if it were a domestic corporation. See IRC 953(d)(1)(B).

Form 886-A (1-1994) Catalog Number 20810W Page 55 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended
12/31/20XX
12/31/20XX

ORG 12/31/20XX
12/31/20XX

Since the Service determined that the taxpayer is not an insurance company within the
meaning of Subchapter L of the Code for the years under audit, it fails to meet the
requirements for the election under IRC 953(d) to be treated as a domestic corporation.

In addition, because the taxpayer does not meet the requirements to make the IRC 953(d)
election, and thus, is not a domestic corporation, the taxpayer should be treated as a
“controlled foreign corporation,” and the provisions of Subpart F of the Internal Revenue Code
(sections 951-965) should apply.

CONCLUSION:

Because you do not qualify as an insurance company for federal income tax purposes, you fail
to meet the requirements of section 501(c)(15) of the Code. Thus, you do not qualify for
recognition of exemption under section 501(a) of the Code as an organization described in
section 501(c)(15) of the Internal Revenue Code. Thus, the exempt status should be revoked,
effective January 1, 20XX. The revocation covers the tax years ended December 31, 20XX
through December 31, 20XX.

Since the taxpayer does not qualify as an insurance company, the IRC 953(d) election filed by
ORG is not valid.

Form 886-A (1-1994) Catalog Number 20810W Page 56 of 56 publish. no.irs.gov Department of the Treasury-Internal Revenue Service