Section 6700 reaches false micro-captive claims, ongoing fees, and individual promoters

Plain-English summary

A promoter marketed a turnkey micro-captive insurance program as eligible for insurance deductions and the Section 831(b) income exclusion. The IRS advised that Section 6700 covers both direct claims about tax benefits and factual statements material to whether those benefits are available, including advice and recommendations. Unqualified claims can be false when clients are not clearly warned that the position may draw IRS scrutiny. When false or fraudulent statements are involved, the penalty is 50 percent of gross income from facilitating and organizing the entire promotion, including ongoing management and maintenance fees received after a captive is formed. Members, officers, employees, and other individual organizers or sellers may also be penalized separately if they made or caused material false statements they knew or had reason to know were false. Each individual's liability requires a facts-and-circumstances review of involvement, sophistication, reliance on professionals, and familiarity with tax matters.

Ruling snapshot

• Question: What statements trigger Section 6700, what income enters the penalty base, and can individuals affiliated with the promoter also be penalized?
• Outcome: Advice given: both tax-benefit and material factual misstatements qualify, the base includes income from the entire promotion, and responsible individuals may be penalized.
• Key authorities: IRC § 6700; IRC §§ 162 and 831(b); United States v. Campbell; Davison v. Commissioner; Tarpey v. United States

Full text (IRS public release)

Office of Chief Counsel
Internal Revenue Service
memorandum
Number: 202125009
Release Date: 6/25/2021
CC:PA:02:MFRANKLIN
POSTU-130868-18

UILC: 6700.00-00

date: March 12, 2021

to: Maria T. Stabile
Supervisory General Attorney
AC Area 1, Manhattan 2 (Large Business and International)

from: Meghan M. Howard
Senior Technician Reviewer
Branch 1 (Procedure and Administration)

subject: False Statements and Penalty Computation Under Section 6700, Promoting Abusive
Tax Shelters

This Chief Counsel Advice responds to your email dated December 17, 2020. In
accordance with I.R.C. 6110(k)(3), Chief Counsel Advice may not be used or cited as
precedent.

LEGEND

X = -------------

Year 1 = -------

ISSUES

1. What constitutes a false or fraudulent statement for purposes of assessing a
   section 6700 penalty against a promoter?

2. Does the section 6700 penalty calculation include a promoter’s gross income
   derived from the tax shelter promotion after the formation of the tax shelter?

3. Can the section 6700 penalty be asserted against the members, officers or
   employees of a promoter, in addition to asserting it against the promoter itself?
   POSTU-130868-18 2

CONCLUSIONS

1. There are two types of statements that fall within the statutory bar of section
   6700(a)(2)(A): statements directly addressing the availability of tax benefits and
   those concerning factual matters that are relevant to the availability of the tax
   benefits. See United States v. Campbell, 897 F2d 1317, 1320 (5th Cir. 1990).

2. Yes. The statute provides that the government is directed to assess a section
   6700 penalty that is 50 percent of the gross income derived or to be derived from
   the organization or sale of a tax shelter, if the organization or sale involves false
   or fraudulent statements. Courts have found that section 6700 allows the
   government to assess a penalty on all gross income derived from the
   organization or sale of a tax shelter, including gross income derived after the
   formation of the tax shelter.

3. Yes. To the extent that an individual organizer or seller of the micro-captive
   program made, or caused to be made, false or fraudulent statements that the
   individual knew or had reason to know were false or fraudulent as to the
   availability of tax benefits, the Service may penalize each such individual under
   section 6700.

FACTS

X is -------------------------------------------------------------------that engaged in the promotion of
micro-captive insurance transactions. X does not dispute that it organized and sold
micro-captive insurance transactions. In a typical micro-captive insurance transaction, a
taxpayer attempts to reduce the aggregate taxable income of the taxpayer, related
persons, or both, using contracts that the parties treat as insurance contracts and a
related company that the parties treat as a captive insurance company. Each entity that
the parties treat as an insured entity under the contracts claims deductions for
premiums for insurance coverage. The related company that the parties treat as a
captive insurance company elects pursuant to section 831(b) to be taxed only on
investment income and therefore excludes the payments directly or indirectly received
under the contracts from its taxable income.

In Year 1, X marketed a micro-captive insurance transaction to prospective clients. X
held itself out as a “turn-key” service provider of a captive insurance program with the
requisite ability to provide all services needed for its clients to capitalize on their
participation. X marketed and represented the captive program to its clients and
prospective clients as an “insurance” program that would be respected by the IRS for
federal tax purposes and thereby provide tax benefits.

Under X’s micro-captive program, the insureds paid fees to X to facilitate formation of
their captives. Once established, the captives paid X monthly or annual fees to manage
their activities and obligations.
POSTU-130868-18 3

LAW AND ANALYSIS

Since January 1, 1990, section 6700 of the Code has imposed a penalty
on persons who promote abusive tax shelters. In pertinent part, the penalty applies
to any person who

(1)(A) organizes (or assists in the organization of) –
(i) a partnership or other entity,
(ii) any investment plan or arrangement, or
(iii) any other plan or arrangement, or

(B) participates (directly or indirectly) in the sale of any interest in, an entity
plan or arrangement . . . ,and

(2) makes or furnishes or causes another person to make or furnish (in
connection with such organization or sale)-

(A) a statement with respect to the allowability of any deduction or credit, the
excludability of any income, or the securing of any other tax benefit by reason
of holding an interest in the entity or participating in the plan or arrangement
which the person knows or has reason to know is false or fraudulent as to any
material matter. . . .

1. False Statements

A statement can be either written or oral. United States v. Music Masters, Ltd., 621
F.Supp 1046, 1058 (W.D. NC 1985). There are two types of statements that fall within
the statutory bar of section 6700(a)(2)(A): statements directly addressing the availability
of tax benefits and those concerning factual matters that are relevant to the availability
of the tax benefits. See United States v. Campbell, 897 F2d 1317, 1320 (5th Cir. 1990).
Advice and recommendations are considered statements for purposes of section 6700.
United States v. Stover, 650 F.3d 1099, 1108 (8th Cir. 2011). False statements under
section 6700 include representations that a plan qualifies for special tax treatment when
the plan does not comply with the law. See Koresko v. United States, 123 F. Supp. 3d
654, 682-689 (E.D. Pa. 2015).

Statements are false when assertions are not qualified and customers are not notified
that following the advice could subject them to IRS scrutiny. Stover, 650 F.3d at 1109-
1110. Where a promoter has knowledge of the risks incident to a tax shelter, the
promoter must clearly and unambiguously inform its agents, prospective clients, and
current clients of that risk. See Davison v. Commissioner, T.C. Memo. 2020-58, appeal
dismissed, No. 20-9002, 2020 WL 7033850 (10th Cir. Aug. 18, 2020).

Statements in the context of micro-captive insurance transactions include opinions,
promotional materials, reports, tax savings projections, or other statements (or materials
relied upon in making such statements) that are false or fraudulent as to any matter
POSTU-130868-18 4

material to exclusion of income under section 831(b) or tax deductions under section
162 for premiums paid by the insured.

2. Penalty Computation

Section 6700(a) provides that the “penalty shall be equal to 50 percent of the gross
income derived (or to be derived) from such activity by the person on which the penalty
is imposed” if the activity involves false or fraudulent statements. 26 U.S.C. § 6700(a).
The “activity” giving rise to a section 6700 penalty encompasses the entire promotion
facilitated and organized by the promoter. Tarpey v. United States, No. CV-17-94-
BMM, 2019 WL 5820727, at *2–3 (D. Mont. Nov. 7, 2019). Courts have found that
“[s]ection 6700 allows the government to assess a penalty on ‘gross income derived or
to be derived’ from the tax shelter activity.” In re MDL-731 Tax Refund Litig. of
Organizers & Promoters of Inv. Plans Involving Book Properties Leasing, 989 F.2d
1290, 1302 (2d Cir. 1993); Davison v. Commissioner, T.C. Memo. 2020-58, appeal
dismissed, No. 20-9002, 2020 WL 7033850 (10th Cir. Aug. 18, 2020). This language
contemplates assessments on current earnings, but also assessments on earnings to
be derived in the future from the facilitation and organization of an abusive tax shelter.
Id.

Recently, in Davison v, Commissioner, T.C. Memo. 2020-58, the Tax Court found that
section 6700 penalties were appropriately assessed and accurately calculated based on
the promoter’s gross income derived from the entire promotion. The promoter’s gross
income included amounts paid as a retainer for the promoter’s ongoing services in 2009
and 2010 for facilitating and organizing the tax shelter, including serving on a board of
directors, years after the formation of the abusive tax shelter. Id. In Tarpey v. United
States, No. CV-17-94-BMM, 2019 WL 5820727, at *2–3 (D. Mont. Nov. 7, 2019), the
district court found that the “activity” giving rise to the penalty against Tarpey, the
promoter, encompassed the entire promotion facilitated and organized by the promoter,
and included the promoter’s solicitation of timeshare donations, timeshare appraisals,
and direct profits to his other organizations.

These cases illustrate that section 6700 allows the government to assess a penalty on
gross income derived from the facilitation and organization of the entire promotion, and
the penalty is not limited temporally to activity occurring prior to the formation of the tax
shelter. In the context of micro-captive insurance transactions, section 6700 allows the
government to assess a penalty on a promoter’s gross income derived from the
facilitation and organization of the entire tax shelter by the promoter, not just gross
income pre-dating the formation of the micro-captive insurance company. For example,
this would include ongoing maintenance and management fees received related to the
continued facilitation and organization of the promotion as well as any other fees
relating to the continued facilitation and organization of the promotion.

3. Assertion of Penalty Against Persons Other Than X
   POSTU-130868-18 5

Whether X’s members’, officers’, or employees’ false or fraudulent statements as to the
availability of tax benefits or concerning factual matters that are relevant to the
availability of the tax benefits violated section 6700 requires consideration of the facts
and circumstances. The IRS must show that the person knew or had reason to know
that the statements they made were false or fraudulent as to a material matter. Section
6700(2)(A). Courts often look to three factors to determine whether a person had the
requisite scienter to violate section 6700: (1) the extent of the person’s reliance on
knowledgeable professionals; (2) the person’s level of sophistication and education; and
(3) the person’s familiarity with tax matters. See, e.g., United States v. Estate
Preservation Services, 202 F.3d 1093, 1103 (9th Cir. 2000). While these factors are not
always dispositive of the issue, they help the Service and the courts focus on the
relevant facts and circumstances. In addition, although section 6700 does not impose a
duty of inquiry, it “allows imputation of knowledge” as long as it is “commensurate with
the level of comprehension required by the [person’s] role in the transaction. United
States v. Campbell, 891 F.2d 1317, 1321-22 (5th Cir. 1990). Thus, the greater the
person’s involvement in the transaction, the more likely it is that the person knew or had
reason to know that the statements he made, or caused others to make, were false or
fraudulent. H.R. Rep. 101-247 at 1397 (1989).

To the extent that the organizers or sellers of the micro-captive program made, or
caused to be made, false or fraudulent statements that they knew or had reason to
know were false or fraudulent as to the availability of tax benefits, the Service may
penalize each of them under section 6700. Application of the penalty to each of these
persons will require a facts and circumstances analysis of their involvement in the
promotion and whether they knew or had reason to know that their statements as to the
availability of the tax benefits were false or fraudulent.

This writing may contain privileged information. Any unauthorized disclosure of this
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.

Please contact Branch 2 of Procedure and Administration if you have any further
questions.