Determination Letter 201712016 Released March 24, 2017 Denied Transcribed from scan

Captive insurer denied section 501(c)(15) exemption because most contracts were not insurance

Apply this to your situation

This page covers one taxpayer's ruling from 2017, which can't be cited as precedent. Ezel answers your situation under the current Code and IRS guidance, with citations.

Not precedent. Under 26 U.S.C. § 6110(k)(3), this written determination may not be used or cited as precedent. It resolved one taxpayer's situation on its specific facts, and identifying details were redacted by the IRS before release. The official IRS release (linked on this page as a PDF) is the authoritative source.

About this page: The plain-English summary and ruling snapshot below were written by Ezel based on the official IRS release. The full text is the IRS's own document.

Transcribed from a scanned original: the IRS released this determination as an image-only PDF. The full text below is a machine transcription, proofread against the scan. Check the original PDF before quoting exact language.

View official IRS release (PDF)

Plain-English summary

A foreign captive insurer claimed exemption under section 501(c)(15) for four tax years after withdrawing an earlier exemption application. It issued property and casualty contracts to affiliated businesses, participated in a quota-share risk pool, and assumed vehicle-service-contract risks through a coinsurance arrangement. The IRS concluded that only the excess directors and officers policy involved an insurance risk, while the other direct-written contracts covered business or investment risks or were too vague to establish insurance. It also found inadequate risk distribution because the captive's direct business was concentrated among a few affiliated insureds, and it questioned whether the reinsurance arrangements involved valid insurance risks. After treating only limited receipts as premiums, the IRS determined that premiums did not exceed 50 percent of gross receipts as required by section 501(c)(15). The IRS denied exemption and concluded that the unapproved section 953(d) election could not make the captive a domestic corporation because it did not qualify as an insurance company under subchapter L.

Ruling snapshot

Question: Did the captive's direct insurance and reinsurance arrangements qualify it as an insurance company exempt under IRC § 501(c)(15), with a valid IRC § 953(d) election?
Outcome: denied
Key authorities: IRC §§ 501(c)(15), 816(a), 831(c), and 953(d); Rev. Rul. 2002-89; Rev. Rul. 2002-90; Rev. Rul. 2005-40

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Appeals Office
Employer Identification Number:

Release Number: 201712016 Person to Contact:

Release Date: 3/24/2017
Date: September 26, 2016
Employee ID Number:

ORG Tel:
ADDRESS Fax:

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 section 501(c) (15) of the
Code for the tax periods above.

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 1120 or Form 1120-F for foreign corporations) and pay tax, where applicable.
For further instructions, forms, and information please visit www.irs.gov.

We will make this letter and the proposed adverse determination letter available for public inspection
under Code section 6110 after deleting certain identifying information. We have provided to you, in a
separate mailing, Notice 437, Notice of Intention to Disclose. Please review the Notice 437 and the
documents attached that show our proposed deletions. If you disagree with our proposed deletions, follow
the instructions in Notice 437.

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

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
INTERNAL REVENUE SERVICE

TAX EXEMPT AND

GOVERNMENT ENTITIES

Date: October 21, 2013

Taxpayer Identification Number:

ORG

ADDRESS Form:
990-EZ / 990

Tax Period(s) Ended:
12/31/20XX; 12/31/20XX;
12/31/20XX; 12/31/20XX

Person to Contact/ID Number:

Contact Numbers:
Telephone:
Fax:

Dear

During our examination of the returns indicated above, we determined that
your organization was not described in Internal Revenue Code section
501(c) for the tax periods listed above and therefore, it does not qualify for
exemption from federal income tax. This letter is not a determination of
your exempt status under section 501 for any periods other than the tax
periods listed above.

The attached Report of Examination, Form 886-A, summarizes the facts,
the applicable law, and the Service’s position regarding the examination of
the tax periods listed above. You have not agreed with our determination,
or signed a Form 6018-A, Consent to Proposed Action, accepting our
determination of non-exempt status for the periods stated above. You have
not agreed to file the required income tax returns. You may appeal your
case. The enclosed Publication 3498, The Examination Process, and
Publication 892, Exempt Organizations Appeal Procedures for Unagreed
Issues, explain how to appeal an Internal Revenue Service (IRS) decision.
Publication 3498 also includes information on your rights as a taxpayer and
the IRS collection process.

If you request a conference with Appeals, you must submit a written protest
within 30 days of the date of this letter. An Appeals officer will review your

case. The Appeals Office is independent of the Director, EO Examinations.
Most disputes considered by Appeals are resolved informally and promptly.

You may also request that we refer this matter to IRS Headquarters for
technical advice as explained in Publication 892. If you do not agree with
the conclusions of the technical advice memorandum, no further
administrative appeal is available to you within the IRS on the issue that
was the subject of the technical advice.

If we do not hear from you within 30 days of the date of this letter, we will
issue a Statutory Notice of Deficiency based on the adjustments shown in
the enclosed report of examination.

You have the right to contact the office of the Taxpayer Advocate.

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

Taxpayer Advocate Service

In the future, if you believe your organization qualifies for tax-exempt status,
and would like to establish its status, you may request a determination from
the IRS by filing Form 1024, Application for Recognition of Exemption under
Section 501(a), and paying the required user fee.

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

Thank you for your cooperation.

Sincerely,

Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Form 6018-A
Report of Examination
Envelope

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

ISSUES:

Whether the contracts executed by constitute contracts of insurance?
Whether the arrangement entered into by involves the requisite element of risk
distribution?
Whether more than half of the business of 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?

If is not an insurance company , does it qualify for treatment as a tax-exempt entity
under section 501(c)(15) of the Internal Revenue Code?
Is the IRC 953(d) election valid if the taxpayer is not an insurance company, and the
election was never approved by the Service?

FACTS:

(‘Taxpayer’) was formed and incorporated in on December 27, 20XX,
under the provisions of Section 9 of the Companies Act, 2000. 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 wholly owned by , a State limited liability company, located at

, as the sole shareholder, purchased 0 shares of the taxpayer's stock for $0, on
December 27, 20XX. is owned by (aka, ) (0%) and
(0%), husband and wife. Both individuals are U.S. citizens, who reside in

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 29, 20XX.
The administrative file included a copy of the Form 1024 application, Articles of Incorporation;
the IRC 953(d) election; regulatory filings and responses of Insurance Regulators; insurance
underwriting diagrams; organizational owner chart; supplemental information for the Form
1024; financial information for 20XX and subsequent years; forms of credit reinsurance
agreements entered into by the taxpayer; and a copy of the 20XX insurance policies issued by
the taxpayer. Other documents were received from , CPA, in response to Information
Document Requests issued by the examining agent to the CPA during 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, and . serves as Chief Executive Officer (CEO), President,

Form 886-A (1-1994) Catalog Number 20810W Page 1 of 57 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
12/31/20XX
12/31/20XX

Treasurer, and Assistant Secretary of ; serves as Vice President, Secretary,
and Assistant Treasurer of the taxpayer.

is also a significant owner of and owns and/or is associated with various
other business interests called “Affiliated Business Interests.”. According to the taxpayer's
Business Plan,

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 offers the best method for satisfying its needs. will be
operated primarily to accomplish this objective.

The taxpayer was created as a controlled foreign corporation. The taxpayer is not a member
of a controlled group of corporations. As a controlled foreign corporation,

President, signed an IRC 953(d) election statement on February 23, 20XX. It appears that the
election statement was filed with the IRS office on the same day.

On October 5, 20XX, the taxpayer filed Form 1024, Application for Recognition of Exemption
Under Section 501(a), seeking exemption as a small under section 501(c)(15) of the Internal
Revenue Code. The application revealed that 20XX was the initial full tax year of the taxpayer.
Prior to filing the Form 1024 application, the taxpayer had filed Form 990 for the tax year
ended December 31, 20XX, with the Ogden Service Center. , President, signed
the application on September 24, 20XX. A Form 2848, Power of Attorney, accompanied the
application authorizing , Attorney, and , Attorney, to represent the taxpayer
during the application process. The attorneys worked for a law firm in ;

The application revealed that the taxpayer employed CO-3, to serve as its resident insurance
manager in . The taxpayer agreed to pay compensation of less than $0 annually.

On November 2, 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 in December 20XX. On January 14, 20XX, the Tax Law Specialist mailed
a letter to the taxpayer's domestic address in . Acopy of the letter was mailed to
the taxpayer’s attorney, . The letter requested additional information about the
taxpayer's operations. The taxpayer's response to the letter was due by February 14, 20XX.
After requesting two 30 day extensions, the taxpayer's attorney, , submitted the
response to the request for additional information on March 15, 20XX.

Form 886-A (1-1994) Catalog Number 20810W Page 2 of 57 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
12/31/20XX
12/31/20XX

The Form 1024 application administrative file does not reflect any more action taken on the
organization’s application by the Tax Law Specialist between the period of mid March 20XX,
through mid-September 20XX. The taxpayer’s President, submitted a letter
dated September 16, 20XX, requesting that the Form 1024 application be withdrawn from
further consideration and ruling.

The Tax Law Specialist closed the Form 1024 application file without making a final
determination whether the taxpayer did or did not qualify for IRC 501(c)(15) tax-exempt status.

Thus, the taxpayer did not receive a favorable or final adverse ruling letter from TEGE, Rulings
and Agreements. In addition to not completing the exemption application process, there is no
evidence that its IRC 953(d) election statement was approved by the Internal Revenue
Service. On March 31, 20XX, the TE/GE examining agent requested the effective date of the
IRC 953(d) election from the IRS Plantation, Florida office. On April 1, 20XX, the IRS

office informed the examining agent that the Service does not have record that the IRC 953(d)
election was approved.

The taxpayer's initial tax year consisted of the period, December 27, 20XX (the date of
incorporation), through December 31, 20XX. The taxpayer did not file a return for its initial
short tax year. The initial return filed by taxpayer was a Form 990 return for 20XX. Taxpayer
also filed Form 990 returns for the 20XX, 20XX, and 20XX tax years.

The Financial Services Commission, , issued a Class ‘B: General Insurance License to
the taxpayer effective December 27, 20XX. The taxpayer did not conduct any business during
the period of December 27, 20XX, through December 31, 20XX. During the years under audit,
the taxpayer operated primarily to provide property and casualty “insurance” coverage to

, which is partially owned by , an officer and beneficial owner of

In 20XX, the taxpayer wrote thirteen (13) direct-written contracts to as follows: (1)
Special Risk —Collection Rate, (2) Excess Directors & Officers Liability, (3) Excess
Employment Practices Liability, (4) Special Risk - Expenses Reimbursement, (5) Special Risk
— Loss of Major B2B Relationships; (6) Special Risk — Loss of Services, (7) Special Risk —
Payee Audit Liability; (8) Special Risk — Representations and Warranties; (9) Special Risk —
Breach of Medical Standards, (10) Excess Pollution Liability, (11) Special Risk — Regulatory
Changes, (12) Special Risk — Punitive Wrap Liability, and (13) Special Risk — Tax Liability,
Under the terms of each policy, was listed as the Lead Insurer (0%). The taxpayer was
listed as one of three Joint Insurers. Each Joint Insurer, , ; and

assumed 0% of the risk. as Stop Loss Insurer, assumed the remaining 0% of the risk.

Each policy listed (“ ”); (“ ”): and the (“ ”); located at
, aS the Named Insureds.

Form 886-A (1-1994) Catalog Number 20810W — Page 3 of 57 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
12/31/20XX
12/31/20XX

Supplemental information submitted by taxpayer with the Form 1024 application revealed that
each of the Named Insureds is owned as follows:

0%
0%
0%

and are not related to or

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

Special Risk-Collection Rate Insurance Policy

(Policy Number: _ )
With the office practice currently billing several million dollars annually, a drop in its collection
rate of only five percentage points, where attributable to factors largely outside of 's
control, such as levels of reimbursements by health insurers, pricing of services by third party

payers including Medicare, etc) would result in a six-figure decrease in revenue.

Excess Directors & Officers Liability Insurance Policy

(Policy Number: )
Actions against the directors and officers may follow from patients, referring physicians,
leased facilities, hospitals, managed care providers, or other third parties if billing
procedures are alleged to be inappropriate.

Excess Employment Practices Liability Insurance Policy
(Policy Number: )
is at risk for employment practices liability for discrimination, harassment, wrongful
termination, or similar wrongful act. Further, in some jurisdictions, these civil rights allegations
can come from third parties such as patients.
Special Risk — Expense Reimbursement Insurance Policy
(Policy Number: )
may confront unanticipated allegation, suspension of professional licenses, or other
adverse events, significant amounts of monies could be required for public relations crisis
management to avert and offset negative publicity which could ultimately lead to a loss of
business.
Special Risk — Loss of Major Business to Business Relationship

Form 886-A (1-1994) Catalog Number 20810W Page 4 of 57 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
12/31/20XX
12/31/20XX

(Policy Number: )
is a participant in virtually all of the major managed care insurance plans in the
geographical area. CareFirst BlueCross/BlueShield of State, Medicare, and the Workers
Compensation Commission of State represent business relationships where a significant
exposure may exist.

Special Risk — Loss of Services Insurance Policy

(Policy Number: )
As a professional practice, the practice is highly dependent on the services of '
and . The business is at risk of significant income loss upon the incapacitation or
loss of services from one or more of the insureds who are large or significant billers.

Special Risk-Payee Audit Liability Insurance Policy
(Policy Number: )
is at risks for potential unexpected costs or liability resulting from an audit, by the State
Workers Compensation Commission, of its billed medical services provided for patient
treatment of a worker's compensation related injury
Excess Pollution Liability Insurance Policy

(Policy Number: )

has a significant waste exposure which is excluded from its commercial general liability

insurance coverage. It deals with “sharps” (used needles, etc.), bodily fluids, and chemical
wastes on a daily basis. Handling procedures are in place; however, historical claims,
occurring industry-wide, illustrate that improper handling is possible and represents a
significant exposure. Further, contracts out its waste disposal and cannot guarantee
the proper disposal of its waste once it leaves facilities. If these wastes are mishandled,
a pollution incident could occur resulting in significant damage, injuries, cleanup costs, and
fines.

Special Risk-Punitive Wrap Liability Insurance Policy

(Policy Number: )
The Company is at risk if a jurisdiction rules that its conventional liability coverage cannot
provide coverage for punitive or exemplary damages. The damage awards are often
significant multiples of the actual damages sought by a plaintiff.

Special Risk-Regulatory Changes Insurance Policy
(Policy Number: )
is at risk of external factors such as regulatory changes in the pain management field
specifically or in its industry as a whole, or even regulatory changes within the facilities at
which operates. could incur significant costs to come into compliance with rules
and regulations regarding pain management or ASCs. There is also the possibility that

Form 886-A (1-1994) Catalog Number 20810W Page 5 of 57 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
12/31/20XX
12/31/20XX

compliance may not be cost effective, thereby eliminating a revenue stream from the office
practice and also resulting in a potential loss of patients.

Special Risk-Representation and Warranties Insurance Policy

(Policy Number: )
Under the terms of the May 20XX Reacquisition of assets of ' assigned to rights
to , to received certain amounts from other third parties under the Closing Documents or
other agreements associated with the sale. is at risks for any amounts that are
subsequently deemed uncollectible.

Special Risk-Breach of Medical Standards Insurance Policy
(Policy Number: )
is entrusted with and manages a large volume of sensitive personal information on
patients. The volume of “incidents” and related lawsuits from the mishandling/security breach
of sensitive personal information is on the rise — especially given the increasing reliance on
electronic data processing and the growing threat of identity theft from underground and
organized information thieves. These risks represent a potential and substantial exposure to
Special Risk - Tax Liability Insurance Policy
(Policy Number: )
is also at risk if it were to suffer an adverse decision from an unexpected tax audit with
regard to its organizational structure, cash basis accounting, captive planning, billing
methodology, or any other federal tax related issue.

Each of the above contracts appeared to be written and sold by another captive company
called In each contract, is reflected as the Lead Insurer. In addition, the policy
number reflected on each contract has the designation “ ” and then lists the type of
contraction and the contract number. as Lead Insurer, assumed 0% of the stated Limits
of Insurance. is reflected as one of three Joint Insurers, each of which assumed 0% of
the stated Limited of Insurance. Together, the Lead and Joint Insurers assumed 0% of the
stated Limits of Insurance. The remaining 0% of the stated Limited of Insurance was assumed
by , as the Stop Loss Insurer. During 20XX, did not write, sale or issue any direct
written contracts to any related or unrelated parties for which it was the Lead Insurer.

Each direct written contract listed the Named Insured as ; ‘and the
located at Address, 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 6 of 57 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
12/31/20XX
12/31/20XX

Aggregate Combined
Contract Limit Premium
Special Risk-Collection Rate $ $ 0
Excess D&O Liability
Excess Employment Practices
Special Risk-Expense Reimb.
Special Risk-Loss of Major B2B
Special Risk-Loss of Services
Special Risk-Payee Audit
Excess Pollution Liability
Special Risk-Punitive Wrap
Special Risk-Regulatory Changes
Special Risk-Rep. and Warranties
Special Risk-Breach of Medical
Special Risk-Tax Liability
Totals $

CIO OOOO OCOOOeG Oooo S
sis ou ooo a

Joint Underwriting Stop Loss Endorsement

With respect of each of the 13 above referenced property and casualty contracts, the taxpayer
and (“ ”) entered into an agreement titled, “Joint Underwriting Stop Loss
Endorsement.” The taxpayer and appear to be separate independent companies.
However, it is not known whether the companies are owned and controlled by related parties.
Under the terms of the agreement, the taxpayer is listed as one of three Joint Insurers, and is
responsible for payment of part of the claims incurred by the Named Insureds under the direct
written contracts, up to certain specified thresholds. If the specified thresholds are met, then

, as the Stop Loss Insurer, becomes liable for payment of claims up to certain specified
limits. If the specified limits for payment of claims are exceeded, then the taxpayer
again becomes liable. For 20XX, the Named Insureds paid a total Combined Premium of $0
for the 13 direct written contracts. Of the total Combined Premium paid by the Named
Insureds 0% or $0 was paid to the taxpayer. Page 5, paragraph 4 of the agreement reads as
follows:

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 Insured(s). This endorsement premium of
$0 out of the total premiums of $0 is payable directly from the Insured(s)
to the Stop Loss Insurer.

Form 886-A (1-1994) Catalog Number 20810W — Page 7 of 57 _ 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
12/31/20XX
12/31/20XX

For the 13 direct written contracts and the Joint Underwriting Stop Loss Endorsement
agreement, the Named Insureds was required to pay of total premiums of $0. Of the total
premium, $0 (or 0%) was paid to , aS Stop Loss Insurer, and the balance of $0 (or 0%)
was paid directly to the taxpayer, as Joint Insurer.

Quota Share Reinsurance Agreement
The taxpayer also entered into two types of reinsurance arrangements. The first arrangement

is referred to as a “reinsurance risk pooling program.” executed a Quota Share
Reinsurance Policy (# _) with The agreement indicates that is located at
is identified as the “Reinsurer” and 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

. 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. insured a portion of the direct insurance underwritten by the pool
participants using a so-called “stop loss” endorsement. participated in over 0+
insurance policies with more than O+ insurers. blended together its direct written
insurance and then reinsured the entire book on a quota share basis with each of the pool
participants. The contract reflected a total of 0 reinsurers participating in the in 20XX.
is not identified by number in Schedule 1 of the contract. However, there are three reinsurers
listed on page 2 of Schedule 1 of the contract that assumed 0% of the quota share risk pool.
could either be Reinsurer #42, Reinsurer #43, or Reinsurer #44. It is not pertinent to
determine which of the three reinsurers represents For purposes of the case write up,
the examining agent identified as Reinsurer #43.

As Reinsurer #43 the taxpayer received a Quota Share Premium from in exchange for
the assumption of 0% of the risk pool comprised of the stop loss coverages issued during the
policy period by to all stop loss endorsement policyholders. In 20XX,

paid total reinsurance premiums of $0 to 0 participating reinsurers. Of this amount,

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 in 20XX.

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

Form 886-A (1-1994) Catalog Number 20810W Page 8 of 57 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
12/31/20XX
12/31/20XX

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 . The taxpayer
reinsured a 0% quota share of the risks from vehicle service contracts reinsured by

. The vehicle service contracts were initially written by in 20XX, assumed by

, then by from - and finally assumed by from . The taxpayer
received a pro rata share of the earned premiums received by . The taxpayer was paid
a reinsurance premium of $0 from 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 0

Other Reinsurance Assumed 0 0
Total $ 0 0.00%

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. The taxpayer received gross receipts as follows:

20XX

Program Revenue Service

Direct Written Premiums $ 0

Quota Share Reinsurance Premiums 0

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 0.00%

In 20XX, the taxpayer deposited the direct written premiums received from the Named Insured
into its investment account.

' After offsetting cost basis of $0, the incurred a net loss of $0. Only the net loss was reported as income on the return.

Form 886-A (1-1994) Catalog Number 20810W Page 9 of 57 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
12/31/20XX
12/31/20XX

Of the total premiums received by the taxpayer in 20XX, 0% of the premiums were generated
from the 0 direct written policies with the Named Insureds, ; and the : 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, and consisted primarily of
securities and cash in the account.

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 three
programs that it engaged in during the 20XX tax year: (1) direct written contracts with affiliated
business interests; (2) quota share risk pool reinsurance; (3) credit coinsurance reinsurance.
The taxpayer wrote fourteen (14) direct contracts to insure certain property and casualty of
Affiliated Business Interests. The taxpayer wrote 11 of the 13 direct contracts as was written in
20XX, with a couple of exceptions. The taxpayer dropped the Special Risk-Loss of Services
and the Special Risk-Representation and Warranties contracts in 20XX. In addition, the
taxpayer added the Special Risk-Legal Expense Reimbursement; the Special Risk-
Commercial Medical Malpractice GAP Liability; and the Excess Cyber Risk contracts in 20XX.
The contracts appear to have been written by , as Lead Insurer. The fourteen contracts
were written for the policy period of January 1, 20XX, to January 1, 20XX. None of the
fourteen direct contracts identified the names of the Insurers. The contracts either never
included this information, or the contracts were sanitized of this information before the
documents were submitted to the examining agent for review. However, the Joint Underwriting
Endorsement did reveal that the taxpayer was one of four Insurers that assumed risk under the
direct written contracts. The taxpayer assumed 0% of the stated Limits of Insurance in
exchange for 0% of the Combined Premium paid the Named Insureds. Based on the
information provided by the 20XX contracts, the other Insurers involved in the direct written
contracts were and ; appeared to be the Lead Insurer, and
and are Joint Insurers. The four captive companies assumed 0% of the stated
Limits of Insurance in exchange for 0% of the Combined Premium paid the Named Insureds.
The remaining 0% of the Combined Premium was paid to , as the Stop Loss Insurer.

In 20XX, the direct written contracts listed the same three Named Insureds: ; ;
and the . However, General Endorsement Changes were made removing the

as one of the three Named Insureds, and transferring its risk to another captive company.
Effective October 1, 20XX, through January 1, 20XX, the insurance coverages for the

was transferred from to another unknown captive company. In the response to IDR #1
for the 20XX and 20XX tax years, the taxpayer’s , CPA, provided two sets of direct

Form 886-A (1-1994) Catalog Number 20810W Page 10 of 57 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
12/31/20XX
12/31/20XX

written contracts in effective during 20XX. The CPA provided the fourteen contracts written by

, in which the taxpayer is a Joint Insurer. The CPA also provided
a copy of the 14 fourteens written by an unknown Lead Insurer. The designation of the Lead
Insurer is . In his September 27, 20XX coverletter that accompanied the response to
IDR #1 for 20XX and 20XX, the CPA stated that confidential information of third parties was
removed.

Taxpayer participated as a Joint Insurer in the following direct contracts written by with
the , and for the policy period of January 1, 20XX, through January 1,
20XX:
Aggregate
Contract Name Policy Number Limit Premium

Special Risk — Collection Rate $ 0 $ 0
Excess Directors & Officers Liability 0 0
Excess Employment Practices Liability 0 0
Special Risk — Expense Reimbursement 0 0
Expense Reimbursement — Legal Expenses 0 0
Excess Pollution Liability 0 0
Special Risk — Punitive Wrap 0 0
Special Risk — Regulatory Changes 0 0
Special Risk — Tax Liability 0 0
Expense Reimbursement — Breach of Medical 0 0
Payer Audit Liability 0 0
Special Risk — Loss of Major B2B 0 0
Special Risk - Commercial Medical Malprac. 0 0
Excess Cyber Risk 0 0

Totals 0 $ 0
The direct written premiums charged by the Lead Insurer were reduced from the 20XX
amounts because coverages were transferred to another captive. Taxpayer did not
write, sale or issue direct written contracts to the general public or unrelated third parties.
Effective October 1, 20XX, the coverages for were transferred to another unknown
captive company. insured the same property and casualty coverages with as
with , with the exception that the Excess Cyber Risk contract was replaced by a Special
Risk- Loss of Service contract. is listed as the only Named Insured under the fourteen
direct contracts written by
Under the terms of the Joint Underwriting Endorsement with , the taxpayer is listed as

one of five Insurers. The taxpayer appears to be a Joint Insurer that agreed to assume 0% of
the stated Limits of Insurance in exchange for 0% of the Combined Written Premium by

The other four Insurers assumed the remaining 0% of the stated Limits of Insurance in
exchange for 0% of the Combined Premium paid by . Together, the five Insurers

Form 886-A (1-1994) Catalog Number 20810W Page 11 of 57 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
12/31/20XX
12/31/20XX

assumed 0% of the stated Limited of Insurance in exchange for 0% of the Combined Premium
paid by . The remaining 0% of the Combine Premium was paid to as a Stop Loss
Insurer under the Joint Underwriting Endorsement. Page 1 of the Joint Underwriting
Endorsement includes the following language:

(“ ”), as the Stop Loss Insurer, is not
Subject to Quota Share Participation, and is instead subject to the
Joint Underwriting Stop Loss Endorsement to the Policy.

In 20XX, the taxpayer participated as a Joint Insurer under the following direct contracts written
by 4 for the policy period of October 1, 20XX, through January 1, 20XX:

Aggregate

Contract Name Policy Number Limit Premium
Special Risk — Collection Rate 0
Excess Directors and Officers
Excess Employment Practices
Special Risk — Expense Reimbursement
Legal Expense Reimbursement
Excess Pollution Liability
Special Risk — Punitive Wrap
Special Risk — Regulatory Changes
. Special Risk — Tax Liability

Breach of Medical Standards
Payer Audit Liability
Special Risk — Commercial Medical Mal.
Special Risk — Loss of Major B2B
Special Risk — Loss of Service

Totals $

OONAARWN>

OCOlMOoOoODOOCOOOCOCOCOCOCO0CO°0
OlMOoooooCOCoCoCoOCoO0oO0co

According to the business plan, participated as a Joint Insurer under the and
direct written contracts for the following exposures:

Special Risk-Collection Rate Insurance Policy

With the office practice currently billing several million dollars annually, a drop in its collection
rate of only five percentage points, where attributable to factors largely outside of

control, such as levels of reimbursements by health insurers, pricing of services by third party
payers including Medicare, etc.) would result in a six-figure decrease in revenue.

Excess Directors & Officers Liability Insurance Policy

Actions against the directors and officers may follow from patients, referring physicians,
leased facilities, hospitals, managed care providers, or other third parties if billing
procedures are alleged to be inappropriate.

Form 886-A (1-1994) Catalog Number 20810W Page 12 of 57 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
12/31/20XX
12/31/20XX

Excess Employment Practices Liability Insurance Policy

is at risk for employment practices liability for discrimination, harassment, wrongful
termination, or similar wrongful act. Further, in some jurisdictions, these civil rights allegations
can come from third parties such as patients.

Special Risk — Expense Reimbursement Insurance Policy

may confront unanticipated allegation, suspension of professional licenses, or other
adverse events, significant amounts of monies could be required for public relations crisis
management to avert and offset negative publicity which could ultimately lead to a loss of
business.

Special Risk — Legal Expense Reimbursement
The contract covers all litigation expenses incurred by the Company resulting from actual of
alleged civil liability.
Excess Pollution Liability Insurance Policy

has a significant waste exposure which is excluded from its commercial general liability
insurance coverage. It deals with “sharps” (used needles, etc.), bodily fluids, and chemical
wastes on a daily basis. Handling procedures are in place; however, historical claims,
occurring industry-wide, illustrate that improper handling is possible and represents a
significant exposure. Further, contracts out its waste disposal and cannot guarantee
the proper disposal of its waste once it leaves facilities. If these wastes are mishandled,
a pollution incident could occur resulting in significant damage, injuries, cleanup costs, and
fines.

Special Risk-Punitive Wrap Liability Insurance Policy

The Company is at risk if a jurisdiction rules that its conventional liability coverage cannot
provide coverage for punitive or exemplary damages. The damage awards are often
significant multiples of the actual damages sought by a plaintiff.

Special Risk-Regulatory Changes Insurance Policy

is at risk of external factors such as regulatory changes in the pain management field
specifically or in its industry as a whole, or even regulatory changes within the facilities at
which operates. could incur significant costs to come into compliance with rules
and regulations regarding pain management or ASCs. There is also the possibility that
compliance may not be cost effective, thereby eliminating a revenue stream from the office
practice and also resulting in a potential loss of patients.

Special Risk - Tax Liability Insurance Policy

Form 886-A (1-1994) Catalog Number 20810W Page 13 of 57 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
12/31/20XX
12/31/20XX

is also at risk if it were to suffer an adverse decision from an unexpected tax audit with
regard to its organizational structure, cash basis accounting, captive planning, billing
methodology, or any other federal tax related issue.

Special Risk-Breach of Medical Standards Insurance Policy

is entrusted with and manages a large volume of sensitive personal information on
patients. The volume of “incidents” and related lawsuits from the mishandling/security breach
of sensitive personal information is on the rise — especially given the increasing reliance on
electronic data processing and the growing threat of identity theft from underground and
organized information thieves. These risks represent a potential and substantial exposure to

Special Risk-Payee Audit Liability Insurance Policy

is at risks for potential unexpected costs or liability resulting from an audit, by the State
Workers Compensation Commission, of its billed medical services provided for patient
treatment of a worker's compensation related injury.

Special Risk — Loss of Major Business to Business Relationship

is a participant in virtually all of the major managed care insurance plans in the
geographical area. CareFirst BlueCross/BlueShield of State, Medicare, and the Workers
Compensation Commission of State represents business relationships where a significant
exposure may exist.

Special Risk — Loss of Services Insurance Policy

As a professional practice, the practice is highly dependent on the services of
and . The business is at risk of significant income loss upon the incapacitation or
loss of services from one or more of the insureds who are large or significant billers.

14a. Special Risk — Commercial Medical Malpractice

The contract provides commercial malpractice coverage for the insured during the 20XX
calendar year. The contract reimburses the Named Insured for any loss sustained for which a
Claim against the underlying insurance policy specified above is denied solely and exclusively
due to the exclusion, endorsement, or limitation specified above.

14b. Excess Cyber Risk

The contract protects the Named Insured from losses resulting from cyber attacks such as
computer viruses, unauthorized access through cyber presence; and degradation or loss to its
system due to cyber presence.

Form 886-A (1-1994) Catalog Number 20810W Page 14 of 57 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
12/31/20XX
12/31/20XX

JOINT UNDERWRITING ENDORSEMENT
In addition to the direct property and casualty insurance contracts, the taxpayer also executed
separate Joint Underwriting Stop Loss Endorsements, with , for the and
contracts, whereby both parties agreed to underwrite the insurance coverages described in the
14 policies with the Affiliated Business Interests.

Under the Joint Underwriting Endorsement, the taxpayer is identified as one of four
Insurers. The other three Lead Insurers were sanitized from the contract. However, the
examining agent believes the parties are ; , and . The taxpayer assumed 0%
of the stated Limits of Insurance in exchange for 0% of the Combined Premium paid the
Named Insureds.

Under the Joint Underwriting Endorsement, the taxpayer is identified as one of five
Insurers. The names of the other four Insurers were sanitized from the agreement by the
taxpayer's CPA. However, the agreement reveals that taxpayer assumed 0% of the stated
Limits of Insurance in exchange for 0% of the Combined Premium paid by , as the sole
Named Insured. The terms of the endorsements included the following language:

The Limits of Insurance shall be borne proportionately by all Quota Share

participants listed herein to a combined maximum of 0% of the Limits

of Liability stated in the Declarations.

, as the Stop Loss Insurer, is not subject to Quota Share Participation,
and is instead subject to the Joint Underwriting Stop Loss Endorsement to
the Policy.

Under the and Joint Underwriting Endorsements, the Insurers assumed 0%
of the stated Limits of Insurance in exchange for 0% of the Combined Premium by the Named
Insureds. The remaining 0% of the Combined Premium was paid by the Named Insureds

directly to
Therefore, in 20XX, the Combined Premium paid by the Named Insureds under the fourteen
and contracts was allocated to the taxpayer as follows:
14 Direct Written Contracts
Total combined premium $ 0 @ 0% $ 0
14 Direct Written Contracts

Form 886-A (1-1994) Catalog Number 20810W Page 15 of 57 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
12/31/20XX
12/31/20XX

Total combined premium $ 0 @ 0% 0

Total Direct Written Premiums Rec’d by Taxpayer in 20XX $ 0
QUOTA SHARE REINSURANCE POLICY
Taxpayer continued to participate in the reinsurance risk pooling program by executing a
Quota Share Reinsurance Policy (#QS20XX) with . The agreement indicates that
is located at ; . Taxpayer is identified as the “Reinsurer” and is the
“Reinsured.”

According to the terms , as reinsurer, is to receive a Quota Share Premium from in
exchange for the assumption of 0% of the risk pool comprised of the stop loss coverages
issued during the policy period by to all stop loss endorsement policyholders. The
policy period runs from January 1, 20XX, through January 1, 20XX.

The contract reflects a total of 53 reinsurers participating in the ; paid total
reinsurance premiums of $0 to the 53 reinsurers. Based on the amount of reinsurance
premiums reflected in Schedule 1 of the Quota Share Agreement, was determined to

be Reinsurer #35.

As Reinsurer #35, received a quota share reinsurance policy premium of $0, which was
equal to 0% of the total premium of $0.

CREDIT INSURANCE COINSURANCE CONTRACT
Taxpayer continued to participate in the Credit Coinsurance Contract with ,a
Corp, in which the taxpayer agreed to reinsure a prorate share (.0%) of “all net retained
policies in force on the effective date assumed by from an corporation
under a treaty dated June 1, 20XX, with ,a corporation that was merged into
, on January 1, 20XX.

The risks reinsured are the 20XX insurance exposures on all policies of vehicle service

contracts direct written by in force on January 1, 20XX, and subsequently issued, and
assumed by , from , under its treaty dated January 1, 20XX.
The reinsurance premiums to be paid by to the Taxpayer shall be taxpayer’s pro rata

share (0%) 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.

Form 886-A (1-1994) Catalog Number 20810W Page 16 of 57 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
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 $ 0 0%
Quota Share Reinsurance Assumed 0 0
Other Reinsurance Assumed 0 ie)
Total $ 0 0.00%

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, reinsurance risk pooling program, 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

Credit Coinsurance Reinsurance Premiums 0

Total Premiums 0 0%

Investment Income 0 0
Proceeds from sale of assets” 0 0
Other income -0- 0.00

Gross Receipts 0 0.00%

The 20XX direct written premiums were deposited to the taxpayer's
. The investment account statements revealed that the taxpayer received the direct
written premiums from the following payers:

$0 0%
0 0
iD 0
Total $0 0.00%

A list of the deposits is shown in Exhibit A that is attached to the end of this report.

Of the total premiums received by the taxpayer in 20XX, 0% of the premiums were generated
for the fourteen direct written policies with the Affiliated Business Interests, 0% of the

After offsetting cost basis of $0, the _ incurred a net gain of $0. Only the net gain was reported as income on the return.

Form 886-A (1-1994) Catalog Number 20810W Page 17 of 57 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
12/31/20XX
12/31/20XX

premiums are from the Quota Share Reinsurance Risk Pooling Program; and 0% of the
premiums from the Credit Coinsurance Reinsurance Program.

Taxpayer's primary business continued to be that of providing property and casualty coverages
for the Named Insureds, , , and . Taxpayer continued to operate as a
Joint Insurer for property and casualty coverages written for the Named Insureds by and

continued to provide property and casualty coverages to and , and
continued to provide coverages to

During 20XX, the taxpayer continued to operate as a Joint Insurer under the same 14 property
and casualty contracts written by , and the , as in the 20XX tax year. As in
20XX, taxpayer was one of four Insurers providing coverage to the Named Insureds. Although
the contracts were sanitized by taxpayer’s CPA, it appears that continued to serve as
the Lead Insurer, while ; and _ were Joint Insurers. The Lead Insurer
assumed 0% of the stated Limits of Insurance in exchange for 0% of the Combined Premium
paid by the Named Insureds. While each of the Joint Insurers assumed 0% of the stated
Limits of Insurance in exchange for 0% of the Combined Premium.

Together, the Insurers assumed 0% of the stated Limits of Insurance in exchange for 0%
of the Combined Premium paid by the Named Insureds. The remaining 0% of the Combined
Premium was paid by the Named Insureds to , as Stop Loss Insurer under the Joint
Underwriting Endorsement.

The 14 contracts written by , in 20XX, continued to list the Named Insureds as:

; and the , even though coverages were transferred to effective October
1, 20XX. did not remove as a Named Insureds from its 14 property and casualty
contracts even though it was suppose to provide coverage only to and

However, the 14 contracts written by did reflect as the sole Named Insured.
The policy period for each contract is January 1, 20XX, through January 1, 20XX.

Form 886-A (1-1994) Catalog Number 20810W Page 18 of 57 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
12/31/20XX
12/31/20XX

During 20XX, the taxpayer did not insure direct contracts with unrelated and unaffiliated
parties, or the general public. Nor did the taxpayer write any direct contracts, during the years
under audit, with related or unrelated parties where it served as Lead Insurer.

Taxpayer served as a Joint Insurer under the following contracts written by in 20XX.
Aggregate

Contract Name Policy Number Limit Premium
Special Risk — Collection Rate $ $
Excess Directors & Officers Liability
Excess Employment Practices Liability
Special Risk — Expense Reimbursement
Expense Reimbursement — Legal Expenses
Excess Pollution Liability
Special Risk — Punitive Wrap
Special Risk — Regulatory Changes
. Special Risk — Tax Liability

Expense Reimbursement — Breach of Medical
Payer Audit Liability
Special Risk — Loss of Major B2B
Special Risk - Commercial Medical Mal.
Excess Cyber Risk

Totals

£0: 00: STO): OF Fs. Corho: =

OCOloOooooocooCoCoCoCoCo°Cc°o
O10 -C'O O O'O C1O'C OO 0O'O.0o'oO

With respect to the contracts, the taxpayer was one of five Insurers that provided
property and casualty coverage to , as the sole Named Insured. Under the terms of the
contracts, the taxpayer is listed as one of five Insurers. The names of the Lead Insurer and
other Joint Insurers were sanitized by the CPA. The contracts continue to list as the
sole Named Insured.

Taxpayer agreed to assume 0% of the stated Limits of Insurance in exchange for 0% of the
Combined Premium paid by the Named Insured. Together, the five insurers agreed to insure

0% of the stated Limits of Insurance in exchange for 0% of the Combined Premium paid
by , as the sole Named Insured. The remaining 0% of the Combined Premium was paid
by to , as the Stop Loss Insurer under the Joint Underwriting Endorsement.
Taxpayer served as a Joint Insurer under the following contracts written by in 20XX.
Aggregate

Contract Name Policy Number Limit Premium

Special Risk — Collection Rate $ 0 $ 0
Excess Directors & Officers Liability 0) 0
Excess Employment Practices Liability 0 0
Special Risk — Expenses Reimbursement 0 0
Expense Reimbursement — Legal Expenses 0 0
Excess Pollution Liability 0 0

Form 886-A (1-1994) Catalog Number 20810W Page 19 of 57 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
12/31/20XX
12/31/20XX

Special Risk — Punitive Wrap
Special Risk — Regulatory Changes
Special Risk — Tax Liability
Expense Reimbursement — Breach of Med.
Payer Audit Liability
Special Risk — Loss of Major B2B
Special Risk - Commercial Medical Mal.
Special Risk — Loss of Service
Totals

oOlMloononcocoe0o0co
Ooo OO OC Oo. 0:

Lf
Aif

According to the business plan, participated as a Joint Insurer under the and
direct written contracts for the following exposures:

Special Risk-Collection Rate Insurance Policy
With the office practice currently billing several million dollars annually, a drop in its collection
rate of only five percentage points, where attributable to factors largely outside of

control, such as levels of reimbursements by health insurers, pricing of services by third party

payers including Medicare, etc) would result in a six-figure decrease in revenue.

Excess Directors & Officers Liability Insurance Policy

Excess Employment Practices Liability Insurance Policy

Special Risk — Expense Reimbursement Insurance Policy

Special Risk — Legal Expense Reimbursement
The contract covers all litigation expenses incurred by the Company resulting from actual of
alleged civil liability.
Excess Pollution Liability Insurance Policy

Form 886-A (1-1994) Catalog Number 20810W Page 20 of 57 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
12/31/20XX
12/31/20XX

occurring industry-wide, illustrate that improper handling is possible and represents a
significant exposure. Further, contracts out its waste disposal and can not guarantee
the proper disposal of its waste once it leaves facilities. If these wastes are mishandled,
a pollution incident could occur resulting in significant damage, injuries, cleanup costs, and
fines.

Special Risk-Punitive Wrap Liability Insurance Policy

Special Risk-Requlatory Changes Insurance Policy

Special Risk - Tax Liability Insurance Policy

Special Risk-Breach of Medical Standards Insurance Policy

Special Risk-Payee Audit Liability Insurance Policy

Special Risk — Loss of Major Business to Business Relationship
is a participant in virtually all of the major managed care insurance plans in the
geographical area. BlueCross/BlueShield of State, Medicare, and the Workers

Form 886-A (1-1994) Catalog Number 20810W Page 21 of 57 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
12/31/20XX
12/31/20XX

Compensation Commission of State represents business relationships where a significant
exposure may exist.

Special Risk — Loss of Services Insurance Policy

As a professional practice, the practice is highly dependent on the services of '
and . The business is at risk of significant income loss upon the incapacitation or
loss of services from one or more of the insureds who are large or significant billers.

14a. Special Risk — Commercial Medical Malpractice

14b. Excess Cyber Risk

Under the Joint Underwriting Endorsement, the taxpayer is identified as one of four
Insurers. The other three Insurers were sanitized from the contract. However, the examining
agent believes the parties are ; , and . The taxpayer assumed 0% of
the stated Limits of Insurance in exchange for 0% of the Combined Premium paid the Named
Insureds.

Under the Joint Underwriting Endorsement, the taxpayer is identified as one of five
Insurers. The names of the other four Insurers were also sanitized from the agreement by the
taxpayer’s CPA. However, the agreement reveals that taxpayer assumed 0% of the stated
Limits of Insurance in exchange for 0% of the Combined Premium paid by , as the sole
Named Insured.

The terms of the endorsements included the following language:

Form 886-A (1-1994) Catalog Number 20810W Page 22 of 57 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
12/31/20XX
12/31/20XX

The Limits of Insurance shall be borne proportionately by all Quota Share
participants listed herein to a combined maximum of 0% of the Limits
of Liability stated in the Declarations.

, as the Stop Loss Insurer, is not subject to Quota Share Participation,
and is instead subject to the Joint Underwriting Stop Loss Endorsement to
the Policy.

Therefore, in 20XX, the Combined Premium paid by the Named Insureds under the fourteen

and contracts was allocated to the taxpayer as follows:
14 Direct Written Contracts
Total combined premium $ 0 @ O% $ 0
14 Direct Written Contracts
Total combined premium $ 0 @ 0% 0)

Total Direct Written Premiums Rec’d by Taxpayer in 20XX $ 0

QUOTA SHARE REINSURANCE POLICY
Taxpayer continued to participate in the reinsurance risk pooling program by executing a
Quota Share Reinsurance Policy (# _) with . The agreement indicates that is
located at ; . Taxpayer is identified as the “Reinsurer” and is the
“Reinsured.”

According to the terms , as reinsurer, is to receive a Quota Share Premium from

in exchange for the assumption of 0% of the risk pool comprised of the stop loss coverages
issued during the policy period by to all stop loss endorsement policyholders. The
policy period runs from January 1, 20XX, through January 1, 20XX.

The policy reflects a total of 58 reinsurers participating in the . Taxpayer is identified as
Reinsurer #31 in Schedule 1 attached to the policy. In 20XX, paid premiums of $0 to

Form 886-A (1-1994) Catalog Number 20810W Page 23 of 57 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
12/31/20XX
12/31/20XX

the 0 reinsurers. is not identified by number in Schedule 1 of the contract. However,
there are three reinsurers listed on page 2 of Schedule 1 of the contract that assumed 0% of
the quota share risk pool. could either be Reinsurer #29, Reinsurer #30, or Reinsurer

31. It is not pertinent to determine which of the three reinsurers represents For

purposes of the case write up, the examining agent identified as Reinsurer #31.

As Reinsurer #31, Taxpayer received a quota share reinsurance policy premium of $0, which
was equal to 0% of the total premium of $0 paid by to the reinsurers.

CREDIT INSURANCE COINSURANCE CONTRACT
Taxpayer continued to participate in the Credit Coinsurance Contract with , a Territory
Corp, in which the taxpayer agreed to reinsure a prorate share (0%) of “all net retained policies
in force on the effective date assumed by from an corporation under a
treaty dated June 1, 20XX, with ,a corporation that was merged into
5, on January 1, 20XX.

The risks reinsured are the 20XX insurance exposures on all policies of vehicle service

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 0

Other Reinsurance Assumed 0 0
Total $ O 0.00%

Form 886-A (1-1994) Catalog Number 20810W Page 24 of 57 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
12/31/20XX
12/31/20XX

20XX

Program Revenue Service

Direct Written Premiums $ 0

Quota Share Reinsurance Premiums 0

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 0.00%

The 20XX direct written premiums were deposited to the taxpayer's
_ The investment account statements revealed that the taxpayer received the direct
written premiums from the following payers:

$ 0 0%
0 0
0 0
Total $ 0 0.00%

A list of the deposits is shown in Exhibit B that is attached to the end of this report.

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

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:

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

*Afier offsetting cost basis of $0, the incurred a net gain of $0. Only the net gain was reported on the return.

Form 886-A (1-1994) Catalog Number 20810W Page 25 of 57 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
12/31/20XX
12/31/20XX

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.

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.

Form 886-A (1-1994) Catalog Number 20810W Page 26 of 57 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
12/31/20XX
12/31/20XX

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 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
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 —

Form 886-A (1-1994) Catalog Number 20810W Page 27 of 57 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
12/31/20XX
12/31/20XX

(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

(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 TO BE TREATED AS DOMESTIC CORPORATION.

(1) IN GENERAL. — If

(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,

Form 886-A (1-1994) Catalog Number 20810W Page 28 of 57 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
12/31/20XX
12/31/20XX

(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:
Form 1024 Application

The taxpayer filed a Form 1024 application on October 5, 20XX, seeking retroactive exemption
under IRC 501(c)(15), back to December 27, 20XX, the date of incorporation. The application
was ultimately withdrawn by , President, on September 16, 20XX. The examining
agent believes that the application was withdrawn by the company on the advice on its
counsel, , and Attorney-2, who are affiliated with , in . The
examining agent believes that its counsel advised the taxpayer to withdraw the Form 1024
application because counsel anticipated EO Rulings and Agreements would deny IRC
501(c)(15) tax-exempt status to based on the position taken by Rulings and
Agreements on applications filed by other clients of

The represented many captive insurance companies that filed Form 1024 applications
seeking tax-exempt status under IRC 501(c)(15). All of the applications included basically
identical fact patterns, and organizational and operational structure. However, after EO
Rulings and Agreements received an adverse opinion from the IRS, Office of Chief Counsel,
Financial Institutions & Products Division, concluding that the applicants were not insurance
companies within the meaning of Subchapter L of the Code, because the contracts executed
by the companies lack adequate risk distribution, Rulings and Agreements began issuing
adverse denial letters to these companies. The remaining companies suddenly withdrew their
Form 1024 applications, probably anticipating that their applications would also be denied tax-
exempt status by EO Rulings and Agreements.

The examining agent believes that the withdrawals of the remaining applications, including the
application filed by taxpayer, is more than mere coincidence. In addition, the examining agent
believes the taxpayer withdrew its Form 1024 application upon advice from its counsel in order
to avoid receiving an adverse denial letter from Rulings and Agreements.

Form 886-A (1-1994) Catalog Number 20810W Page 29 of 57 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
12/31/20XX
12/31/20XX

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), affg. 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 2d, § 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
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

Form 886-A (1-1994) Catalog Number 20810W Page 30 of 57 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
12/31/20XX
12/31/20XX

(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 event* (such as a fire or accident) is at the heart of any contract of insurance. See
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.

“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

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 31 of 57 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
12/31/20XX
12/31/20XX

20XX Policies

Special Risk — Collection Rate Insurance Policy.

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.

Excess Directors & Officers Liability Insurance Policy.
Covers wrongful acts of directors and officers.

Insurance.

Excess Employment Practices Liability Insurance Policy.

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.

Special Risk — Expense Reimbursement Insurance Policy.
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

Form 886-A (1-1994) Catalog Number 20810W Page 32 of 57 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
12/31/20XX
12/31/20XX

dispute; government litigation; financial crisis; loss of intellectual property rights; unsolicited
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.

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.

Special Risk-Loss of Major Business to Business

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.

Special Risk — Loss of Services Insurance Policy.

Covers the involuntary loss of services for key employees. The covered cause of loss must be
involuntary and includes sickness, disability, death, loss of license, resignation or retirement
after 14 days. Coverage does not include any loss of services if the insured terminated the
employment of the employee. Also excluded is any claim if the insured does not attempt to
replace the employee timely. Claim costs can include costs incurred by existing employees,
costs of temporary employees, training costs, and lost net revenue.

Not insurance. The policy is not insurance in the commonly accepted sense. Although a
policy only covering death or disability of a key employee is insurance, the policy here covers
many non-insurance risks, that is investment or business risks.

Form 886-A (1-1994) Catalog Number 20810W Page 33 of 57 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
12/31/20XX
12/31/20XX

Special Risk — Payee Audit Liability

Covers amounts of unexpected audit liability insured incurs as a result from audit by the State
Workers Compensation Commission (SWCC) of insured’s billed medical services provided for
patient treatment of a workers compensation-related injury. Also covers defense expenses
insured incurs in preparing for, or participating in any SWCC audit.

Not insurance. Insureds are located in State. It is very questionable whether an audit from the
State Workers Compensation Commission is even a possibility; therefore, there would be no
risk to insure. If insureds do provide medical care in State then the policy is still probably not
insurance in the commonly accepted sense because there is no insurance risk but only
investment or business risk.

Excess Pollution Liability Insurance Policy.

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
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.

Form 886-A (1-1994) Catalog Number 20810W Page 34 of 57 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
12/31/20XX
12/31/20XX

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.

Special Risk — Punitive Wrap Liability Insurance Policy.

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.

Special Risk — Regulatory Changes Insurance Policy.

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.

Special Risk — Representation and Warranties Insurance Policy.

Not insurance. The contract is vague as to what it covers. The documents provided do not

provide enough information for us to be able to conclude that this contract is insurance in the
commonly accepted sense.

Form 886-A (1-1994) Catalog Number 20810W — Page 35 of 57 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
12/31/20XX
12/31/20XX

Special Risk — Breach of Medical Standards Insurance Policy.

Covers all fines, penalties, defense expense and costs to bring operations in compliance
resulting from an investigation or hearing of type brought by a public regulatory agency or
private medical standards board. Types of investigations covered include but are not limited to
allegations of HIPAA violations and medical standards reviews. Criminal acts not covered.
Liability coverage is excluded.

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

Special Risk — Tax Liability Insurance Policy.
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.

20XX Policies

Same as 20XX except Special Risk — Representations and Warranties policy was replaced
with:

Expense Reimbursement — Legal Expenses Insurance Policy.

Covers all litigation expenses incurred by the insured resulting for insured's actual or alleged
civil liability.

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

Special Risk — Commercial Medical Malpractice Gap Insurance Policy.

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

Form 886-A (1-1994) Catalog Number 20810W Page 36 of 57 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
12/31/20XX
12/31/20XX

the insurer of medical operations or procedures, sales or distribution of excluded products, or
the exhaustion of the primary limits.

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.

Excess Cyber Risk Package Insurance Policy.

Insuring Agreement 1 — Cyber Risk Liability covers all damages that insured becomes legally
obligated to pay and defense expenses as a result of any claim made against insured for a
Wrongful Act. Wrongful Acts may include, but are not limited to the following: defamation;
infringement of intellectual property; and failure to prevent unauthorized access to, use of,
tampering with, or introduction of malicious code into data or systems.

Insuring Agreement 2 — 1° Party Property Loss & Business Interruption covers loss of or
damages to insured’s covered property caused by, but not limited to the following: a computer
virus; a cyber attack, theft of computer system resources; and computer crimes. Insuring
Agreement 2 also covers business interruption expenses, monies surrendered or costs
incurred as a result of Cyber-Extortion, and reward money for information leading to the arrest
and conviction of individuals committing or attempting to commit illegal acts related to
coverage under the policy.

Insuring Agreement 3 — Post-Loss Systems Crisis Management covers the cost of public
relations services required to protect insured’s image and reputation following a covered loss.
Insuring Agreement 3 also covers service fees of consultants hired to identify and/or
implement ways to prevent or decrease the possibility of a further or future loss similar to the
covered loss.

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

Same as the 14 polices written in 20XX.

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

Deemed Not Deemed
Contract Insurance Insurance
Special Risk-Collection Rate No

Form 886-A (1-1994) Catalog Number 20810W Page 37 of 57 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
12/31/20XX
12/31/20XX
Excess Directors & Officers Yes
Excess Employment Practices No
Special Risk-Expense Reimbursement No
Loss of Major Business to Business No
Special Risk-Loss of Services No
Payer Audit Liability No
Excess Pollution No
Special Risk-Punitive Wrap No
Special Risk-Regulatory Changes No
Special Risk-Representations and Warranties No
Breach of Medical Standards No
Special Risk-Tax Liability No
Special Risk-Legal Expense Reimbursement No
Special Risk-Commercial Medical Malpractice GAP No
Excess Cyber Risk No

We were able to conclude only one of the direct written contracts as insurance contracts
because they included an insurance risk. Fourteen of the fifteen 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

participated in over 0 insurance policies with more than 0 insureds. 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. 43 in the 20XX reinsurance program,
Taxpayer received a Quota Share Premium of $0 from 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). In
20XX, taxpayer was identified as Reinsurer No. 35, received a Quota Share Premium of $0
from in exchange for the assumption of .0% of the risk pool. In 20XX, taxpayer was
Reinsurer No. 31. Again, taxpayer received a Quota Share Premium of $0 from in
exchange for the assuming 0% of the risk pool.

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 do include the 0
contracts written by Therefore, it is highly likely that the entire pool, which is insured by
and reinsured on a quota share basis with each of the pool participants, is primarily comprised

Form 886-A (1-1994) Catalog Number 20810W Page 38 of 57 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
12/31/20XX
12/31/20XX

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.

Insurance In Its Commonly Accepted Sense

Staff

As a foreign corporation, taxpayer contracted with , in , 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 actuarial 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 actuarial factors and
principles. In the January 31, 20XX response to IDR #1 for the 20XX and 20XX tax years, the
CPA provided a copy of letters from ; and , which was purpose to
address the method used for pricing the direct written and reinsurance contracts for the taxable
years under consideration. In addition, the CPA provided a copy of a Captive Feasibility
Study for the ., dated January 20XX. The study was prepared by . The
purpose of the study was as follows:

to evaluate the Center's desire to explore the option

of forming a small captive insurer, specifically a small

captive under IRC Section 501(c)(15), for the purpose

of writing coverages that are generally unavailable or

impractical in obtaining in the conventional insurance

marketplace.

On page 34, addressed the pricing of the various policies written by taxpayer:

The proposed insured is currently paying $0
annually for its conventional commercial property

Form 886-A (1-1994) Catalog Number 20810W Page 39 of 57 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
12/31/20XX |
12/31/20XX }

& casualty insurance program. Since its inception

in 19XX, the proposed insured has paid close to a
million dollars for these coverages. The underwriting
profit made by the various insurers has caused the
proposed insured to be concerned about pricing inequity.

The Service concluded that the letters and feasibility study do not address the method of
pricing the specific direct written and reinsurance contracts that 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 actuarial calculations and factors.

Use of Assets

Taxpayer engaged in investment activities that are typical of insurance companies. Based on
the review of the Form 990 returns, taxpayer made two loans to the Affiliated Businesses to
whom it executed the direct written contracts. Loans were made during the 20XX and 20XX
tax years. 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 = 12/3 1/20XX

Loan balance -0- $ 0 $ 0 -0-
Total Assets $ O $ 0 $ 0 $ O
Percentage 0% 0% 0% 0%

The Affiliated Businesses repaid the outstanding notes receivable balance to taxpayer during
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,

Form 886-A (1-1994) Catalog Number 20810W Page 40 of 57 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
12/31/20XX
12/31/20XX

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
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

Form 886-A (1-1994) Catalog Number 20810W Page 41 of 57 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
12/31/20XX
12/31/20XX

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 10% of the total amounts it received
during the tax year on a gross and net basis. Thus, 90% 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 5 and 15% of the insurer's total risks. The Service concluded that this
transaction constituted insurance for federal income tax purposes.

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 five and 15% 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 50% 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

Form 886-A (1-1994) Catalog Number 20810W Page 42 of 57 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
12/31/20XX
12/31/20XX

owned subsidiary accounted for 90% of the total risks borne by the subsidiary. Similarly, in
Situation 2 of Rev. Rul. 2005-40, supra, a second insurer contributing 10% 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.

The current position of the Service with respect to captive insurance arrangements is
expressed in Revenue Ruling 2005-40. In Situation 2 of the ruling, the Service concluded that
insurance did not exist because the captive arrangement with a single-insured lacked risk
distribution. However, in Situation 4, the Service concluded that the captive arrangement with
12 LLC’s did result in insurance. The main point of Revenue Ruling 2005-40, Situations 2 and
4, is the Service established a range between a single-insured and twelve-insured entities that
might or might not meet the requisite risk distribution needed to qualify as insurance. The
closer the number of insured parties in the captive arrangement approaches 12 insured, the
more likelihood adequate risk distribution exist, and the arrangement will qualify as insurance.
However, the closer the number of insured parties in the captive arrangement approaches one
insured, the more likelihood the arrangement lacks adequate risk distribution and will not
qualify as insurance.

With respect to the contracts reviewed during the tax years under audit, the Service concluded
that the contracts between the taxpayer and the ; , and , 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
an affiliated business. The affiliated businesses are partially -owned by a beneficial owner of
the taxpayer, is one of three owners each of whom owned a one-third
interest in the affiliated businesses. 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.

In addition, of the total premiums received during the year, 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 0% of the direct written premiums were paid by only
three affiliated entities. 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.

Form 886-A (1-1994) Catalog Number 20810W Page 43 of 57 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
12/31/20XX
12/31/20XX

During the tax years under audit, the taxpayer was primarily and predominantly supported by
direct written premiums that were received from three insured parties, , , and

_ The taxpayer did not receive direct written premiums from an adequate pool of insureds.
Thus, the contracts between the taxpayer and the Affiliated Business Interests lacks the
requisite risk distribution that is necessary for the contracts to be 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 only three affiliated policyholders, ;

, and _ affiliated business interests. 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 the same Affiliated
Business Interests. 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 as to whether all of the contracts qualify as insurable risks.
Assuming that all of the agreements do constitute insurable risks or that a significant majority
of the contracts qualify as insurable risks, over 0% of the total risks assumed by the taxpayer is
with affiliated businesses that are partially owned and controlled by , a beneficial
owner of the taxpayer.

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, fourteen of the fifteen 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 for those fourteen direct
written contracts are not considered insurance premiums. The amount received by taxpayer
for one of the fourteen direct written contracts was deemed to be premiums because only for
this contracts included an insurance risk. During the taxable years under consideration,
received amounts that the Service deemed to be direct written and reinsurance premiums as
follows:

Form 886-A (1-1994) Catalog Number 20810W Page 44 of 57 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
12/31/20XX
12/31/20XX

20XX
Contract Premium

Excess Directors & Officers Liability
$ Ox 0%

Amount Deemed Premiums from Direct Written Contracts $ 0
Quota Share Premiums 0
Credit Coinsurance Reinsurance 0
Total Premiums for 20XX $ 0
Gross Receipts for 20XX 0
Percentage of Premiums to Gross Receipts 0%
20XX

Contract Premium
Excess Directors & Officers Liability

$ Ox 0% $ 0

$ 0x 0% 0
Amount Deemed Premiums from Direct Written Contracts 0
Quota Share Premiums 0
Credit Coinsurance Reinsurance _ 0
Total Premiums for 20XX $ 0
Gross Receipts for 20XX $ 0
Percentage of Premiums to Gross Receipts 0%

20XX

Contract Premium
Excess Directors & Officers Liability

$ 0 x 0% $ 0

$ 0 x 0% _ 0
Amount Deemed Premiums from Direct Written Contracts $ 0
Quota Share Premiums 0
Credit Coinsurance Reinsurance _ 0
Total Premiums for 20XX $ 0
Gross Receipts for 20XX $ 0
Percentage of Premiums to Gross Receipts 0%

Form 886-A (1-1994) Catalog Number 20810W Page 45 of 57 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
12/31/20XX
12/31/20XX

20XX

Premiums received by taxpayer for each contract in 20XX was not requested during the
examination.

Only the premium received by taxpayer for the Excess Directors & Officers contract was
deemed to be actual premium income, for the tax years under examination, because the
contract involved an insurance risk. Thus, the Excess Directors & Officers contract was deem
to be a contract of insurance. The amounts received by under the remaining 14 direct
written contracts were not premiums for insurance contracts 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, then the amount paid for each contract by the Affiliated Business Interests to the
taxpayer would 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 were included as
“premium income” for purposes of the gross receipts computation shown above. Even after
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. 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. Based on our analysis of the contracts, we concluded 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

Form 886-A (1-1994) Catalog Number 20810W Page 46 of 57 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
12/31/20XX
12/31/20XX

the two other reinsurance arrangements does not change the conclusion that the contracts
with the Affiliated Business Interests lack the requisite risk distribution. Therefore, the taxpayer
does not qualify as an insurance company.

Application of Foreign Corporation Tax Provisions

The administrative file for the original Form 1024 application filed by included a copy of
the IRC 953(d) election filed by the Company on February 23, 20XX. However, the IRS has
no record that the election was approved. As of the date of this examination, it appears that
the Service still has not approved the IRC 953(d) election filed years ago. withdrew the
initial Form 1024 application on September 16, 20XX.

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

Since the Service determined that the taxpayer is not an insurance company within the
meaning of Subchapter L of the Code for the year 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.

Form 886-A (1-1994) Catalog Number 20810W Page 47 of 57 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
12/31/20XX
12/31/20XX

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 . 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 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.

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

A Preliminary Report, Form 5701, Notice of Proposed Adjustments, was mailed to the
taxpayer's CPA, CPA, on June 19, 20XX, proposing denial of tax-exempt treatment under
section 501(c)(15) of the Internal Revenue Code, for the tax years ending December 31, 20XX,
December 31, 20XX, and December 31, 20XX.

Finally, the Government contends that although the operations and financial records for the tax
year ended December 31, 20XX, were not examined by TEGE, the taxpayer would also fail to
qualify an insurance company for that year, if taxpayer operated in the same manner as that
during the years audited.

TAXPAYER’S POSITION:

A response to the Preliminary Report was received from , CPA, on August 19, 20XX.

In the response, the CPA summarized that the taxpayer disagreed with the Service's
conclusions that (1) the contracts issued by 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:

Form 886-A (1-1994) Catalog Number 20810W Page 48 of 57 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
12/31/20XX
12/31/20XX

All of the policies written by 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 are for pure insurance risks.
The Quota Share Reinsurance contracts underwritten by were contracts of

insurance because all of the risks reinsured were pure insurance risks.

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.
The Service ignored the important fact that more than 0 percent of the premiums
were attributable to unrelated insurance arrangements involving many thousands of
independent, unrelated risks of hundreds or thousands of unrelated insureds.
The Service also ignored achieving distribution by issuing 0 policies to four
insureds.
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 ignores the Tax Court
ruling in The Harper Group and Includible Subs. v Commissioner, 96, T.C. 45
(1991), aff'd979 F.2d 1342 (9th Cir. 1992), where 30% unrelated risks was
determined to be sufficient to meet the risk distribution requirement.
The CPA stated that the Service conducted no meaningful examination of risk
distribution in its audit of . 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).
The Service ignored 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.
The CPA argues the Service's analysis of risk distribution is incomplete. The
Service ignores the numerous unrelated risks that 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 57 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
12/31/20XX
12/31/20XX

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. These favorable rulings were issued to taxpayer on substantially
similar, or less favorable, facts to those of . There has been no intervening
change in law to account for the Service’s disparate tax treatment between
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).
The election under IRC Section 953(d) does not require approval by the Service.
made a valid election under IRC 953(d) to be treated as a United States
corporation for Federal tax purposes.

Government’s Response to Taxpayer’s Position:
After reviewing the response to the Preliminary Report received from , CPA, on
August 19, 20XX, the Service’s initial position is unchanged. 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 August 16, 20XX 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 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 , 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 was to assume risks of affiliated businesses partially owned and controlled
by officers of and beneficial owners of the affiliated businesses. Approximately 0% of
the risk assumed by was that of the affiliated businesses. 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 arrangement does not include an
adequate pool of related or unrelated insured for the law the large numbers to operate. The
pool consisted of a single policyholder and payer of direct written premiums. Thus,

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 57 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
12/31/20XX
12/31/20XX

Taxpayer’s Position:

On pages 2 through 4, the CPA described the terms of 17 direct contracts written by

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 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 5 of the Taxpayer’s position, the CPA cites the Harper Group & Subsidiaries v.
Commissioner, 96 T.C. 45(1991) to support his argument that qualifies as an
insurance company. The CPA sited the court’s holding, when a significant percentage (0
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 0 percent is irrelevant on the issue whether sufficient risk distribution is present
because of the significant presence of unrelated risks. The CPA made the following statement
in paragraph 1 on page 2 of the May 17, 20XX response:

In its preliminary report, the Service merely states, that due to 0 percent of
premiums being direct written premiums for coverages written to four
insureds, which in fact owned no interest in , there is a lack of
adequate risk distribution. The Service's position ignores the fact that
more than 0 percent of premiums were attributable to unrelated insurance
arrangements involving many thousands of independent, unrelated risks
of hundreds or thousands of unrelated insureds. The Service also ignores
achieving distribution by issuing 28 policies to these four 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

Form 886-A (1-1994) Catalog Number 20810W Page 51 of 57 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
12/31/20XX
12/31/20XX

ruling further emphasized that an issuer with contracts with a small number of policyholders
can be insurance if the percentage of business exceeds 50 percent of the total insurance
business conducted.

Even if the CPA claimed that insurance exists under the rationale in the Harper case, where
approximately 30% of the risk assumed by 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 two thirds 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 6, paragraph 2, of the taxpayer’s position, the CPA stated that the Service conducted
no meaningful examination of risk distribution in its audit of . 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:

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 amounts reported on the
Form 990 returns, the taxpayer assumed risks as follows:

20XX
Direct Written Premiums $ 0 0%
Quota Share Reinsurance Assumed 0 0
Other Reinsurance Assumed 0 0
Total $ 0 0.00%
20XX
Direct Written Premiums $ 0 0%
Quota Share Reinsurance Assumed 0 0
Other Reinsurance Assumed 0 0
Total $ 0 0.00%

Form 886-A (1-1994) Catalog Number 20810W Page 52 of 57 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
12/31/20XX
12/31/20XX

20XX
Direct Written Premiums $ 0 0%
Quota Share Reinsurance Assumed 0 0
Other Reinsurance Assumed 0 0
Total $ 0 0.00%
20XX
Direct Written Premiums $ 0 0%
Other Reinsurance Assumed 0 0
Pooled Reinsurance Assumed 0 0
Total $ 0 0.00%

Under this method, the Service concluded that the taxpayer’s the primary and predominant
activity conducted is 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 7, 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 Ruling Revenue 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 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
insureds does not constitute risk distribution because of the very high likelihood of the insured

Form 886-A (1-1994) Catalog Number 20810W Page 53 of 57 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
12/31/20XX
12/31/20XX

paying for any of 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 2, on page 8, 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. These favorable determination letters were issued to taxpayers on
substantially similar, or less favorable, facts to those of . There has been no
intervening change in law to account for the Service’s disparate tax treatment between

and such similarly situated taxpayers.

Government’s Position:

Each taxpayer stands alone. The audit of the activities and books and records of and
the outcome of such audit stands alone. The issues raised by the Service with respect to the
audit of are based on available facts.

Taxpayer’s Position:

In the last page, paragraph 3, the CPA stated that qualified for tax-exempt status as
an described in IRC Section 501(c)(15) during all of the years under review. As made a
valid election under IRC Section 953(d) to be treated as a domestic corporation, the Service's
conclusion that 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 office of the Service on
February 23, 20XX.

IRS records reveal that the IRC 953(d) election was not approved by the Service because the
taxpayer did not submit proof of IRC 501(c)(15) tax-exempt status. The taxpayer could not
provide proof of IRC 501(c)(15) tax-exempt status because it did not complete the Form 1024
application process. The taxpayer withdrew its Form 1024 application on September 16,
20XX, after its Counsel anticipated that the Service would issue a final adverse ruling letter
denying IRC 501(c)(15) exemption.

Form 886-A (1-1994) Catalog Number 20810W — Page 54 of 57 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
12/31/20XX
12/31/20XX

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).
Since the Service determined that the taxpayer is not an insurance company within the
meaning of Subchapter L of the Code for the year 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.

Since the IRC 953(d) election filed by has not been approved by the IRS, and the

requirements for IRC 953(d) elections were not meet, the taxpayer should be treated as a
controlled foreign corporation, and the subpart F provisions should apply.

Deposit of Direct Written Premiums
20XX

Date of Deposit | Total Deposit | Premiums
3/3/20XX | 0 | 0 | 0
4/1/20XX | 0 | 0 | 0
4/15/20XX | 0 | 0
5/5/20XX | 0 | 0 | 0 | 0 | 0
6/2/20XX | 0 | - | 0 | 0 | 0 | 0
7/2/20XX | 0 | - | 0 | 0 | 0
7/24/20XX | 0 | - | 0 | - | 0 | 0
8/4/20XX | 0 | - | 0 | 0 | 0 | 0
8/26/20XX | 0 | 0 | - | - | 0.00 | 0
8/28/20XX | 0 | - | - | - | 0 | 0
9/14/20XX | 0
10/19/20XX | 0 | 0 | - | - | 0.00 | 0
12/28/20XX | 0 | 0 | - | - | 0.00 | 0
Totals | 0 | 0 | 0 | 0 | 0 | 0

Less: Return of Premiums
8/3/20XX | (0)
9/10/20XX | (0)
12/31/20XX | (0)

Adjusted Direct Written Premiums for 20XX | 0

Deposit of Direct Written Premiums
20XX

Date of Deposit | Total Deposit | Center For Pain Mgmt | Pain Mgmt Billing | Mgmt | Pain Mgmt ASC | Premiums | Interest on Notes Rec.
1/11/20XX | 0 | - | - | - | - | -
1/6/20XX | 0 | - | - | - | - | - | 0
2/2/20XX | 0 | - | - | - | - | - | 0
3/2/20XX | 0 | - | - | - | - | - | 0
3/15/20XX | 0 | - | - | 0 | 0 | 0 | -
3/16/20XX | 0 | - | 0 | - | - | 0 | -
3/29/20XX | 0 | - | - | - | 0 | 0 | -
3/30/20XX | 0 | - | - | - | - | - | -
4/5/20XX | 0 | 0 | - | - | - | 0 | 0
4/19/20XX | 0 | 0 | - | - | - | 0 | -
4/26/20XX | 0 | - | 0 | 0 | 0 | 0
5/4/20XX | 0 | - | - | - | - | - | 0
5/10/20XX | 0 | - | - | 0 | 0 | 0
5/14/20XX | 0 | - | 0 | - | - | 0
6/3/20XX | 0 | - | 0 | 0 | 0 | 0 | 0
6/28/20XX | 0 | 0 | - | - | - | 0 | -
7/6/20XX | 0 | - | - | - | - | - | 0
7/13/20XX | 0 | - | - | 0 | 0 | 0 | -
7/14/20XX | 0 | - | 0 | - | - | 0 | -
8/3/20XX | 0 | - | 0 | 0 | 0 | 0 | 0
8/23/20XX | 0 | 0 | - | - | - | 0 | -
8/30/20XX | 0 | - | - | - | - | - | -
9/8/20XX | 0 | 0 | - | 0 | 0 | 0 | 0
9/13/20XX | 0 | - | 0 | - | - | 0 | -
10/4/20XX | 0 | - | 0 | 0 | 0 | 0 | 0
11/2/20XX | 0 | - | - | - | - | - | 0
12/6/20XX | 0 | - | - | - | - | - | 0
Totals | 0 | 0 | 0 | 0 | 0 | 0 | 0

Get today's answer for your situation

You just read what the IRS ruled for one taxpayer in 2017, and it can't be cited as precedent. Ezel checks the current Internal Revenue Code and IRS guidance and answers your specific situation, with citations.

Opens in Ezel Pro. Every answer cites the authority it relies on.

Apply this to your situation

This page covers one taxpayer's ruling from 2017, which can't be cited as precedent. Ezel answers your situation under the current Code and IRS guidance, with citations.

On this page

Document type

Determination Letter

IRS subject

Insurance Companies or Associations With Net Written Premiums of $350,000Or Less

Topics

Tax-exempt organizations

Code sections

§ 162, § 501, § 816, § 831, § 951, § 953, § 957, § 958, § 6110, § 7428

Ruling dated

September 26, 2016

Publicly released

March 24, 2017

View Official PDF