tcmemo_2008_251 united_states tax_court leslie b bennett petitioner v commissioner of internal revenue respondent docket no 22699-05l filed date dean a hrbacek for petitioner susan greene and marilyn ames for respondent memorandum opinion holmes judge leslie bennett offered the commissioner nearly dollar_figure to settle her tax debt of more than dollar_figure the commissioner admits that bennett’s offer is more than ten times what the commissioner himself calculated to be the amount she could reasonably pay but the commissioner nevertheless refused her offer because he wanted to place part of her debt in currently not collectible status--letting him try to collect more were her finances to improve the question is whether his refusal to accept bennett’s offer is an abuse_of_discretion background bennett failed to file her tax returns from through she also failed to pay over the taxes for four quarters between and that had been withheld from employees of a company she helped run in the commissioner began an audit and asked bennett to file the missing tax returns she did-- filing the missing returns in several batches she also filed her return months after it was due the return showed that she owed nearly dollar_figure but she failed to include any payment with the return the commissioner subsequently sent bennett a notice that he intended to levy upon her property to collect the tax debt he later put a lien on her property to secure the payment of both the income-tax and other tax debts that she owed bennett asked for a collection_due_process cdp hearing at the hearing bennett claimed that she had gotten right with the tax system promising that she was owed a refund on her taxes which she would apply to her taxes the commissioner set a deadline for bennett to provide copies of both her and returns along with proof of payment bennett complied but her return showed not only that she wasn’t putting in for a refund but that she actually owed more than dollar_figure as with her taxes she did not pay bennett also sent the irs a copy of a check for dollar_figure which she said was an estimated payment of her liability as well as an offer to compromise her and income-tax debts and the trust-fund-recovery penalties she still owed for four quarters between and this first offer was for dollar_figure which the commissioner promptly rejected as not in the government’s best interest it was also based on a list of income and expenses that the commissioner concluded were excessive or unverifiable bennett responded by submitting more documentation to support her position after review the commissioner sent a counteroffer for dollar_figure but then the commissioner suspended negotiations having discovered that bennett’s dollar_figure estimated_tax payment for never posted--it turned out that bennett had sent in only a copy of the check and not the check itself what had happened was that bennett’s mother who had seemed to be willing to help get taxes that employers withhold from their employees’ wages are known as trust_fund_taxes because they are deemed a special fund in trust for the united_states under sec_7501 436_us_238 the commissioner may collect unpaid employment_taxes from a responsible_person within the company ie someone who was required to pay over the tax the money that’s collected is called a trust-fund-recovery-penalty tax sec_6672 unless otherwise indicated all section references are to the internal_revenue_code her daughter out of tax trouble had changed her mind and now would help only if the commissioner would agree to a single lump- sum payment to discharge all her daughter’s tax_liability this was news to the commissioner he told bennett that she could try another offer-in-compromise but must prove that she had filed her return and fully paid any_tax due bennett accepted this suggestion and in late date filed her form_1040 and fully paid the amount due bennett also included proof of a dollar_figure estimated_tax payment for and she submitted a second compromise offer of dollar_figure following much computational give-and-take between the two parties the commissioner tendered a second counteroffer of dollar_figure bennett then won a variety of favorable concessions on various monthly living_expenses leading the commissioner to recalculate his offer a final time lowering it to dollar_figure the fluidity of these negotiations sprang from the commissioner’s finding that many of bennett’s expenses including transportation_expenses and tuition for her son were unverifiable or somehow improper bennett’s leased mercedes which was the largest part of her claimed dollar_figure monthly transportation expense for instance was in fact registered to and paid for by her mother bennett had agreed to reimburse her mother for the monthly payments by check but the commissioner discovered that bennett’s mother had never cashed any of them bennett’s claim for dollar_figure in monthly tuition costs for her son was likewise undermined when the commissioner discovered that her mother had paid most of those costs during late and early all of this haggling ultimately went nowhere bennett submitted another financial update in late date showing that her income had dropped to an average of dollar_figure in the last seven months while her monthly expenses averaged dollar_figure with bennett now dependent on family loans for living_expenses the commissioner recommended rejection of her offer_in_compromise and placement of her debt on currently not collectible status based on this determination the commissioner sent her a notice_of_determination stating that he would indefinitely suspend his collection activities for all years pending an improvement in bennett’s finances the commissioner’s notice_of_determination cited internal_revenue_manual irm part date which states that a rejection may also be based on a determination that acceptance of the offer is not in the ‘best interest of the government’ per policy statement p-5-100 the commissioner also cited language from the irm authorizing rejection when a taxpayer has an egregious history of noncompliance and a probable likelihood of noncompliance in the future he stated as well that rejection of the offer was also based on the time left on the collection statutes the taxpayer’s age earning capability over the next several years and the fact that her business has the ability to generate a large profit in the near future bennett timely filed an appeal of the commissioner’s rejection and his decision to place her debt in currently- not-collectible status she argues that because her offer of dollar_figure exceeds her dollar_figure collection potential it is in the government’s best interest according to the commissioner’s own policy statement and so the commissioner had no justification to reject it discussion tax debts are typically settled in one of three ways the commissioner may allow a taxpayer to pay his tax debt over time via an installment_agreement he may declare the debt currently not collectible and take no collection action until and unless the taxpayer’s finances improve or he may accept a taxpayer’s offer to compromise for less than the full debt owed irm pt date date and date the parties agree that the question in this case is whether the commissioner abused his discretion in rejecting bennett’s offer and instead classifying her tax debt as currently not collectible we therefore look to see if the commissioner’s decision was grounded on an error of law or rested on a clearly erroneous finding of fact or whether he applied the correct law to fact findings that weren’t clearly erroneous but ruled in an irrational manner indus investors v commissioner tcmemo_2007_93 citing 249_f3d_1121 9th cir see also 496_us_384 the commissioner is guided in his consideration of offers in compromise by regulations and policies aimed at balancing the values of treating taxpayers in similar situations similarly and considering the special facts and circumstances of each case sec_301_7122-1 proced admin regs states no offer to compromise may be rejected solely on the basis of the amount of the offer without evaluating that offer under the provisions of this section and the secretary’s policies and procedures regarding the compromise of cases these policies and procedures are laid out in the irm irm pt the regulations also instruct the determination whether to accept or reject an offer to compromise will be based upon consideration of all the facts and circumstances sec_301_7122-1 proced admin regs the commissioner accepts an offer_in_compromise on one of three bases doubt as to liability doubt as to collectibility or promotion of effective tax_administration sec_301 b proced admin regs bennett put her offer in the doubt- as-to-collectibility pigeonhole and we look to the rules on those kinds of offers irm part states that offers in compromise are to be evaluated in terms of what is in the ‘best interest of the government’ per policy statement p-5-100 that policy in turn states the commissioner will accept offers when it is unlikely that the tax_liability can be collected in full and the amount offered reasonably reflects collection potential bennett believes that this language from policy statement p- date conclusively defines the government’s best interest and she argues that she meets both of policy statement p-5-100’s requirements first as the commissioner admits her full debt is not collectible second her offer of dollar_figure not only meets but greatly exceeds her collection potential of dollar_figure bennett believes these two facts mean her offer is in the government’s best interest--and that the commissioner’s refusal to accept it is an abuse_of_discretion policy statement p-5-100 is not a stand-alone statement however but only part of another section of the internal_revenue_manual irm part irm part states a doubt as to collectibility datc offer amount must equal or exceed a taxpayers sic reasonable collection potential rcp in order to be considered for acceptance emphasis added this language contrary to bennett’s contention doesn’t require that the commissioner accept an offer_in_compromise whenever the amount exceeds the collection potential rather it only establishes grounds for winning consideration even policy statement p-5-100 does not draw a bright line-- stating not that the irs will accept any offer exceeding reasonable collection potential but only that it will do so when the amount offered reasonably reflects collection potential it goes on to state that taxpayers are expected to provide reasonable documentation to verify their ability to pay and irm part lists as one example of an offer_in_compromise that the commissioner might reject as not in the best interest of the government an offer from a taxpayer who has an egregious history of past noncompliance and our analysis of his current finances reveals that it will be highly unlikely the taxpayer will be able to remain in compliance during the offer period the record here also shows that the commissioner based his determination in part on his finding that there was a possibility that bennett’s circumstances might change in the near future ie before the statute_of_limitations for collecting her taxes runs out because bennett had so delayed filing her returns we find no error in the commissioner’s conclusion that there were eight years or more remaining before the statute would run on most of the years in question we also find no clear error in the commissioner’s conclusion that bennett had several more years of earning capability the commissioner recognized that her business a public relations firm had not been enormously successful but we note that she had quite low overhead she ran it out of her home so we don’t find the commissioner to be clearly erroneous in deciding it had potential to be more successful in the future we thus find no abuse_of_discretion in the commissioner’s determination bennett argues however that our decision in oman v commissioner tcmemo_2006_231 supports her argument as a matter of law in oman we also confronted the interplay between irm part and policy statement p-5-100 oman with a debt of more than dollar_figure and irregular and often poor earnings since a personal financial catastrophe offered dollar_figure to compromise his tax debt the commissioner refused the offer as not being in the government’s best interest citing as his reasons oman’s past noncompliance and doubt as to oman’s likelihood of remaining compliant in the future as in bennett’s case the commissioner in oman cited irm part and its emphasis on past and future compliance as the definition of best interest oman riposted by citing policy statement p-5-100 and arguing that he met its two-part requirement the debt be currently not collectible and the offer be greater than the taxpayer’s current collection potential bennett claims that in oman the court analyzed policy statement p-5-100 and irm pt and concluded as applied in this case they appear to be inconsistent regarding the ‘best interest of the government ’ the same inconsistency holds true in the current case unfortunately this is the most favorable contention bennett can extract from oman oman in fact led only to a remand for a further hearing not a decision for the taxpayer it offered no firm conclusions resolving the possible conflict between irm part and policy statement p-5-100 furthermore a close reading of our conclusion shows that our main concern with the record to that point was the unclear reasoning for the best interest -based rejection oman tcmemo_2006_231 the commissioner on the other hand compares our facts to those of oman and points out a crucial difference unlike the absent record there this case boasts a full record that makes the commissioner’s reasoning quite clear because irm part and policy statement p-5-100 are both contained in the commissioner’s manual of policies and procedures they would seem to hold equal weight but both guidelines are in the end just that--language guiding the commissioner’s consideration of all the facts and circumstances as mandated by the regulation that is unquestionably binding sec_301_7122-1 proced admin regs that regulation does not compel him to accept any particular offer but to consider the facts and circumstances of the case before him that is what he did here the commissioner has diligently presented an exhaustive narrative to justify his conclusion that accepting bennett’s offer would be in neither his best interest nor hers given the commissioner’s adherence to statutory prescription we cannot say that his rejection represents an abuse_of_discretion decision will be entered for respondent


t c memo united_states tax_court syzygy insurance co inc et al petitioners v commissioner of internal revenue respondent docket nos filed date leroy l metz ii brian t must and joshua d baker for petitioners john p healy dawn l danley-nichols robin lynne herrell daniel m trevino and james d hill for respondent 1cases of the following petitioners are consolidated herewith john w jacob and melinda l jacob docket no michael vanlenten and elizabeth jacob vanlenten docket no vincent j jacob and marjorie b jacob docket no and robert e jacob and mary ann jacob docket no memorandum findings_of_fact and opinion ruwe judge these cases were consolidated for purposes of trial briefing and opinion the commissioner determined deficiencies in petitioners’ federal_income_tax and accuracy-related_penalties under sec_6662 as follows docket no 2140-15--syzygy insurance co inc year deficiency dollar_figure big_number big_number docket no 2141-15--john w and melinda l jacob year deficiency dollar_figure big_number big_number penalty sec_6662 dollar_figure dollar_figure dollar_figure penalty sec_6662 dollar_figure dollar_figure dollar_figure 2unless otherwise indicated all section references are to the internal_revenue_code code in effect for the years in issue and all rule references are to the tax_court rules_of_practice and procedure docket no 2142-15--michael and elizabeth jacob vanlenten year deficiency dollar_figure big_number big_number docket no 2143-15--vincent j and marjorie b jacob year deficiency dollar_figure big_number big_number docket no 2182-15--robert e and mary ann jacob year deficiency dollar_figure big_number big_number penalty sec_6662 dollar_figure dollar_figure dollar_figure penalty sec_6662 dollar_figure dollar_figure dollar_figure penalty sec_6662 dollar_figure dollar_figure dollar_figure the issues for decision are whether payments through a microcaptive insurance arrangement from highland tank manufacturing co highland tank and its affiliates to syzygy insurance co inc syzygy and its fronting carriers are deductible as insurance premiums whether syzygy’s sec_831 election is invalid for the years in issue whether the purported premium payments are otherwise included in syzygy’s income if we find the arrangement is not insurance and whether petitioners are liable for accuracy- related penalties for the years in issue findings_of_fact some of the facts have been stipulated and are so found the first amended first supplemental and second supplemental stipulations of facts and the attached exhibits are incorporated herein by this reference syzygy’s principal_place_of_business was in pennsylvania when it filed its petition and all individual petitioners resided in pennsylvania when they filed their petitions petitioners syzygy is a microcaptive insurance_company established by john w jacob and michael vanlenten john w jacob is married to melinda l jacob and is highland tank’s chairman of the board secretary treasurer and a vice president he is responsible for highland tank’s overall management john w jacob’s parents are robert and mary ann jacob mr vanlenten is married to elizabeth jacob vanlenten and is highland tank’s president mrs vanlenten is john w jacob’s first cousin her father is vincent j jacob who is married to marjorie b jacob ht a highland tank is a family business based in stoystown pennsylvania that manufactures above-ground and below-ground steel tanks highland tank has been owned by the jacob family since various related companies have formed under the highland tank umbrella including highland tank of new york inc htny highland tank of north carolina inc htnc lowe engineering co inc lowe and bigbee steel tank co bigbee for all of the years in issue each company elected to be treated as an s_corporation for federal_income_tax purposes ht a had approximately employees at six different locations and during the years in issue had annual revenues of between dollar_figure and dollar_figure during all of the years in issue bigbee was owned by the john w jacob irrevocable_trust jacob trust and by the michael and elizabeth vanlenten irrevocable_trust vanlenten trust in 3highland tank htny htnc lowe and bigbee will sometimes be collectively referred to as ht a 4an s_corporation is a corporation governed under the laws of subchapter_s of the code s_corporations are not generally subject_to federal_income_tax but like partnerships are conduits through which income flows to their shareholders see 531_us_206 subchapter_s allows shareholders of qualified corporations to elect a ‘pass-through’ taxation system under which income is subjected to only one level of taxation john w jacob and mr vanlenten each owned of the remaining ht a entities the ownership structure of those entities changed in and each were owned by john w jacob by the john w jacob sr separate trust jacob trust by michael vanlenten and by the michael and elizabeth j vanlenten separate trust vanlenten trust in those same entities were owned by the jacob trust and by the vanlenten trust robert jacob was the grantor of the jacob trust vincent jacob was the grantor of the vanlenten trust john w jacob was the grantor of the jacob trust and mr vanlenten was the grantor of the vanlenten trust each trust was a grantor_trust and its income was taxable to the grantor ht a’s commercial insurance coverage john w jacob has considerable experience with insurance he sits on the board_of directors of columbus captive insurance and the luttner financial group a general agent for guardian life_insurance ht a had extensive commercial insurance coverage during each year in issue they maintained between and policies and paid premiums of between dollar_figure and dollar_figure the average rate-on-line for all of ht a’s commercial insurance policies wa sec_1 as calculated by the commissioner’s expert formation of syzygy in john w jacob explored forming a captive_insurance_company seubert associates an insurance broker eventually connected john w jacob with alta holdings llc alta alta a company based in irvine california ran a captive insurance program and provided management services for captive insurance_companies throughout alta and john w jacob had multiple discussions about forming a captive_insurance_company emanuel dinatale a certified_public_accountant c p a and then partner of alpern rosenthal who advised ht a on tax and business matters participated in some of these meetings on date alta regional director brian flinchum held a webinar with mr jacob and mr dinatale one version of the agenda for the meeting stated that a captive 5rate-on-line is an insurance policy’s premium divided by the occurrence limit 6alta was owned by bruce j molnar by donald b rousso and by greg taylor 7mr dinatale is now a partner of bdo which is alpern rosenthal’s successor insurance_company is not feasible unless there are at least dollar_figure of annual premiums and that alta had identified that amount and needed more information on how much more premium was achievable on date alta’s chief underwriter greg taylor sent an email to another alta employee saying that as a will ass guess he identified dollar_figure to dollar_figure of premiums sometime thereafter mr dinatale advised john w jacob that he should consider proceeding with a captive_insurance_company mr dinatale testified that he felt that the arrangement complied with the revenue laws and was appropriate from a business perspective on date john w jacob decided to proceed on date syzygy was incorporated in delaware and on date it received from the state of delaware department of insurance ddi a certificate of authority syzygy was initially capitalized with a dollar_figure irrevocable letter_of_credit naming the ddi as the beneficiary syzygy was owned by mv investment management mv llc and by mj investment management mj llc mv’s sole owner was the vanlenten trust and mr vanlenten was its manager mj’s sole owner was the jacob trust and john w jacob was its manager syzygy’s only officers were mr vanlenten and john w jacob mr vanlenten was president and john w jacob was secretary and treasurer operation of alta’s captive program and syzygy’s participation syzygy and ht a participated in alta’s captive insurance program participants in alta’s program consisted of companies purchasing captive insurance and their related captive insurance_companies typically participants did not directly purchase policies from their captive insurance_companies but from fronting carriers8 related to alta from until date the fronting carrier was u s risk associates insurance co spc ltd u s risk from the end of until the end of newport re inc newport re acted as the fronting carrier the fronting carriers’ policies were written on behalf of their segregated portfolios the policies issued by the fronting carriers had a maximum aggregate benefit of dollar_figure million syzygy directly wrote one policy to ht a for which 8fronting companies issue fronting policies which are a risk management technique in which an insurer underwrites a policy to cover a specific risk but then cedes the risk to a reinsurer 806_f3d_761 n 3d cir also had an aggregate maximum benefit of dollar_figure million all of the policies had a 12-month term and were claims-made policies ht a paid premiums directly to the fronting carriers but the fronting carriers ceded of the insurance risk each fronting carrier charged a fronting fee which was deducted from the gross premiums ht a paid to the fronting carrier u s risk charged of the gross premiums_paid but it is unclear what newport re chargeddollar_figure the responsibility for paying a covered claim can best be understood as a two-layered arrangement the first dollar_figure of a single loss was allocated to layer and any loss between dollar_figure and dollar_figure million was allocated to layer alta uniformly allocated of each captive participant’s premiums to layer and to layer syzygy reinsured the first dollar_figure of any ht a 9a claims-made policy is a n agreement to indemnify against all claims made during a specific period regardless of when the incidents that gave rise to the claims occurred black’s law dictionary 8th ed 10in the participation_agreement among syzygy ht a and newport re the stated fronting fee wa sec_3_5 of the gross premiums but it appears that newport re deducted only of the gross premiums_paid by ht a claim layer claims dollar_figure shortly after the fronting carriers received ht a’s premiums they ceded of the net_premiums to syzygydollar_figure for ht a’s claims between dollar_figure and dollar_figure million layer claims syzygy agreed to reinsure its quota-share percentage of losses the quota share was the ratio of the net premium ht a paid to that portfolio to the aggregate net_premiums the portfolio received for the insurance period additionally syzygy provided layer reinsurance for a diverse array of approximately policies issued to unrelated companies in the fronting carriers’ pools syzygy reinsured approximately to unrelated companies per pool 11in 106_tc_274 we explained reinsurance is an agreement between an initial insurer the ceding company and a second insurer the reinsurer under which the ceding company passes to the reinsurer some or all of the risks that the ceding company assumes through the direct underwriting of insurance policies generally the ceding company and the reinsurer share profits from the reinsured policies and the reinsurer agrees to reimburse the ceding company for some of the claims that the ceding company pays on those policies 12the net_premiums were the gross premiums_paid by ht a to the fronting carriers less the fronting fees three and one-half months after the policy periods ended the fronting carriers ceded the remaining of net_premiums to syzygy less the amount of any claims paid for layer losses during the years in issue ht a paid gross premiums to the fronting carriers and the fronting carriers ceded net_premiums to syzygy as follows gross premiums_paid to fronting carrier dollar_figure big_number big_number big_number layer net_premiums ceded to syzygy dollar_figure dollar_figure dollar_figure dollar_figure layer net_premiums ceded to syzygy dollar_figure dollar_figure dollar_figure dollar_figure fronting fee dollar_figure big_number big_number tax_year total 1for the net_premiums and fronting fee do not add up to the gross premiums_paid by ht a because syzygy contributed dollar_figure to a layer claim which is discussed later in the opinion 2the record is conflicted as to how much ht a was charged as a fronting fee for allocation of premiums between layer sec_1 and alta requested that taylor-walker associates inc taylor-walker an actuarial consulting firm based in midvale utah provide input regarding the allocation of premiums between layer sec_1 and dollar_figure randall ross an associate of the casualty actuarial society and a member of the american academy of actuaries worked on the request in response to alta’s request mr ross sent an email on date to alta’s chief financial officer stating we reviewed various industry indications and simulated distributions to determine the reasonableness of the proposed split between the primary layer dollar_figure-dollar_figure and the excess layer dollar_figure-dollar_figure based on our review we would expect more than of the loss experience to fall in the primary layer given the proposed limits our review of industry experience by layer suggests that a reasonable portion of experience to attribute to the primary layer might range from roughly to depending on the type of coverage offered however we did find one medical malpractice liability increased limits factor that implied a breakdown into the respective layers additionally we attempted to model loss experience in such a manner that would support the proposed split of in order to achieve such a split we determined that we would have to assume an average unlimited claim size in excess of dollar_figure while some claims can be expected to exceed this amount we would expect the average severity over all claims to be significantly lower we note that the proposed split between primary and excess experience may be more easily supported by either lowering the 13it is unclear when alta made the request but the commissioner claims that it was in attachment point to something below dollar_figure or increasing the limit to something greater than dollar_figure million on date mr ross sent alta another email estimating that of the losses would occur in layer and in layer alta did not change the premium allocation in response to mr ross’ findings mr ross was unaware of why alta allocated of premiums to layer and to layer and never asked john w jacob testified that the purpose of the allocation was to take advantage of a tax-related safe_harbor dollar_figure policies and premiums although john w jacob testified that the original intent behind forming a captive_insurance_company was to obtain coverage for potential warranty claims ht a did not purchase a captive warranty policy for the years in issuedollar_figure for and u s risk issued ht a the following policies 14mr ross testified that as discussed in the email the primary layer is layer and it is clear from his testimony that the excess layer is layer 15the safe_harbor is almost certainly revrul_2002_89 2002_2_cb_984 16highland tank did purchase warranty insurance for 17the policies issued for and were in effect respectively from date to date date to date and date to date policy type administrative actions bankruptcy preference cyber liability deductible reimbursement legal expense intellectual_property defense intellectual_property enforcement property dic2 total premiums premium premium dollar_figure big_number big_number big_number dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number big_number 1ht a did not procure an administrative actions policy for 2dic means difference in conditions for syzygy directly wrote the intellectual_property enforcement policy to ht a ht a procured the following policies from newport re for policy type premium administrative actions bankruptcy preference cyber liability deductible reimbursement legal expense intellectual_property property dic total premiums dollar_figure big_number big_number big_number big_number big_number big_number big_number excluding ht a’s life health and workers’ compensation policies the deductible reimbursement policies had the third highest premiums of any ht a policy procured for and and the fourth highest for the legal expense intellectual_property intellectual_property enforcement administrative actions and property dic policies were excess-coverage policies under which the insurer agreed to indemnify against a loss only if it exceeded the amount covered by another policy the policies did not provide for pro_rata refunds if they were canceled during the policy terms claims could be made only within seven days after the policy period closed and there was no option to purchase an extended claims reporting_period the premiums for the policies were set by mr taylor who is not an actuary before mr taylor set the premiums ht a provided alta with a series of answers to underwriting questionnaires and accompanying documents mr taylor then created an underwriting report recommending premiums for which is dated date it appears that mr taylor relied on the information provided by ht a however the underwriting report does not detail mr taylor’s rating model calculations or any other detailed analysis describing how he arrived at the premiums the report provided only general information about projected losses previous claims and information about ht a’s other insurance there is nothing in the underwriting report that suggests that mr taylor used comparable premium information to price the premiums alta hired taylor-walker to create an actuarial feasibility study for syzygydollar_figure the feasibility study was prepared in support of syzygy’s captive insurance application mr ross prepared and cosigned the feasibility study which is dated date the feasibility study mentions the premium prices but its primary purpose was to determine syzygy’s ability to remain solvent not to determine whether the premiums were reasonable 18greg taylor did not have an ownership_interest in taylor-walker mr ross testified that he did not have a role in pricing the premiums and did not look at publicly available state rating models when preparing the feasibility study with respect to the premiums the study states that syzygy’s selected premium levels appear to be somewhat conservative in relationship to the insured risks and policy limits for this reason it is our opinion that syzygy is feasible from a financial solvency perspective mr ross testified that conservative meant not too low in preparing the report mr ross did not use any independent data but only data provided by alta the report goes on to state we accepted without audit the premium and loss assumptions provided to us it is our opinion that these assumptions represent the best available information from which to project losses and premiums for the captive we reviewed these assumptions for reasonableness and consistency however we acknowledge that these assumptions are highly subjective after syzygy submitted its application a ddi contractor performed an initial examination of syzygy that offered no recommendations the initial examination included an actuarial review william white director of captive insurance for the ddi during syzygy’s application process and the actuarial review testified that the actuarial review focused on whether the premiums were sufficient for syzygy to remain solvent and that the ddi was unconcerned with premiums being too high the initial report sheds no light on whether the contractor evaluated the reasonableness of syzygy’s premiums the parties’ experts calculated an average rate-on-line of to for ht a’s captive insurance policies during the years in issue neither u s risk nor newport re timely issued a policy to ht a during the years in issue newport re did not issue policies until after the policy years ended projected losses and claims alta’s underwriting report projected that syzygy would pay annual layer claims under the legal expense property difference in condition and deductible reimbursement policies the feasability study projected that syzygy would have an overall loss and loss adjustment expense llae ratio of overall and in layer from to dollar_figure syzygy’s actual llae ratio wa sec_1 the llae ratio was for layer and for layer ht a did not file any claims under their captive program policies during the years in issue but did file multiple claims under their commercial insurance policies and incurred deductibles in response to alta’s underwriting questionnaires ht a stated that they did not keep specific records of the 19the llae ratio is the cost of losses and loss adjustment expenses divided by the total premiums the feasability study did not provide a specific llae ratio for layer incurred deductibles they paid because the deductibles were too numerous to list although the deductible reimbursement policies issued by u s risk for and state that they applied only to one specific policy--stico policy no plr0009-04--john w jacob testified that all deductibles were covered except for workers’ compensation and health insurance from to ht a made payments for a dollar_figure deductible resulting from a claim filed under stico policy no plr0009-04 petitioners do not dispute that coverage was available for an additional dollar_figure of deductibles paid_or_incurred during the years in issue john w jacob spent significant time working on ht a’s insurance matters during the years in issue he testified that he did not file captive program claims because of time management issues and that they did not hit his radar screen john w jacob acknowledged that ht a did not have a claims management system in place for their captive program but had different processes in place depending on the claim for their commercial policies syzygy paid dollar_figure to satisfy its quota-share responsibility of an approximately dollar_figure layer claim in dollar_figure the claim was filed by 20u s risk withheld dollar_figure from the layer net_premiums ceded to syzygy for pyrotek inc pyrotek under an intellectual_property policy for the period of date to date it is unlikely that the loss was covered but u s risk settled the claimdollar_figure syzygy did not investigate whether the loss was covered syzygy’s capitalization and assets syzygy met delaware’s minimum capitalization requirements during the years in issue syzygy was initially capitalized with a dollar_figure irrevocable letter_of_credit of which the ddi was the beneficiarydollar_figure syzygy’s assets were listed on audited financial statements for each year in issue by the end of syzygy’s listed assets totaled dollar_figure and consisted of the dollar_figure letter_of_credit dollar_figure of cash and cash equivalents and dollar_figure of unceded premiums by the end of syzygy’s listed assets increased to dollar_figure and consisted of the dollar_figure letter_of_credit dollar_figure of cash and cash equivalents dollar_figure of unceded premiums and two life_insurance policies worth dollar_figure by the end of syzygy’s listed assets decreased to 21according to alta the claim was not covered because its was not timely reported and pyrotek did not disclose the loss when the policy was written although it knew about the loss 22the letter_of_credit was canceled in and it seems this was done with the consent of the ddi dollar_figure and consisted of dollar_figure of cash and cash equivalents dollar_figure of unceded premiums a dollar_figure certificate of deposit mutual funds holding bonds worth dollar_figure and two life_insurance policies worth dollar_figure syzygy did not own the life_insurance policies listed on the financial statements rather they were owned by the jacob trust and the vanlenten trustdollar_figure syzygy was not a beneficiary of either policy the policies’ respective beneficiaries were the trusts on date matthew michael jacob was appointed as special investment adviser to the jacob trust and the vanlenten trust in his capacity as special investment adviser matthew michael jacob had the sole authority to direct the trustee regarding all life_insurance policies on the lives of john w jacob and mr vanlenten on the same day of matthew michael jacob’s appointment as special investment adviser syzygy entered into separate split-dollar_life_insurance agreements with the respective trusts regarding the life_insurance policies under the terms of the agreements syzygy agreed to pay premiums for a life_insurance_policy insuring john w jacob and a separate policy insuring mr vanlenten the 23the policy insuring mr vanlenten’s life lists the owner as stewart management co as trustee of the vanlenten separate trust policy insuring john w jacob’s life had a face_amount of dollar_figure and the policy insuring mr vanlenten’s life had a face_amount of dollar_figure syzygy’s only rights to the policies’ proceeds were defined in the split- dollar agreements upon the death of an insured syzygy was entitled to the greater of the premiums that it had paid with respect to the policy or the policy’s cash_value if the policy was terminated during the life of an insured syzygy was entitled to the total amount payable under the policy syzygy was prohibited from accessing the cash values of the policies borrowing against the policies surrendering or canceling the policies or taking any other action with the respect to the polic ies syzygy and the trusts were allowed to assign their rights the agreements could be terminated only through the mutual consent of syzygy the respective insured and the respective trust within days of termination the owner had the option to obtain a release of syzygy’s interest in the policy to obtain the release the policy owner was required to pay syzygy the greater of the premiums that it paid with respect to the policy or the policy’s cash_value if the policy owner did not obtain a release ownership of the policy reverted to syzygy syzygy paid dollar_figure of premiums for the life_insurance policies in both and neither the policies nor the agreements were terminated during the years in issue syzygy’s exit from alta’s captive program in syzygy decided to exit alta’s captive insurance program syzygy’s premiums dropped by more than dollar_figure in john w jacob sent an email to alta explaining that syzygy was changing managers because among other things he was displeased with the decrease in premiums at trial john w jacob testified the he was disappointed in the premium decrease because there were fixed costs associated with a captive manager and it makes the most sense to have as much coverage as possible with the captive manager returns and notices of deficiency petitioners each filed returns for the years in issue syzygy made a sec_831 election and reported no taxable_income for any of the years in issue the premium payments to the fronting carriers were apportioned among the various entities under the highland tank umbrella and the entities deducted those payments because ht a were s_corporations the deductions flowed through to the shareholders the deductions that flowed through to the trusts were claimed by the trusts’ grantors the commissioner selected petitioners’ returns for examination and timely issued notices of deficiency with respect to syzygy the commissioner determined that syzygy did not engage in insurance transactions and was not an insurance_company accordingly the commissioner determined that the sec_831 election was invalid and the premiums syzygy received were taxable_income the commissioner also imposed accuracy-related_penalties with respect to the individual petitioners the commissioner determined the arrangement was invalid for lack of economic_substance the premium payments were not payments for insurance and the amounts deducted were not ordinary and necessary business_expenses accordingly the commissioner disallowed the deductions and imposed accuracy-related penaltiesdollar_figure petitioners timely filed petitions with this court 24the notices of deficiency for issued to john w jacob and melinda l jacob and michael vanlenten and elizabeth jacob vanlenten have a computational discrepancy that the parties do not explain in the explanation of items portion of the notices the commissioner stated that he disallowed dollar_figure of insurance expenses paid_by highland tank however only dollar_figure of the total premiums_paid for was allocated to highland tank opinion the commissioner’s determinations in a notice_of_deficiency are generally presumed correct and the taxpayer bears the burden of proving that the determinations are incorrect rule a 290_us_111 deductions are a matter of legislative grace and taxpayers bear the burden of proving that they are entitled to any deduction claimed 503_us_79 292_us_435 under sec_7491 if the taxpayer provides credible_evidence concerning any factual issue relevant to ascertaining the taxpayer’s liability and complies with certain other requirements the burden_of_proof shifts to the commissioner as to the factual issue at trial on date petitioners filed a motion to shift the burden_of_proof on date we issued a pretrial order requiring t hat all motions to shift the burden_of_proof will be filed by date therefore petitioners violated the pretrial order and we will issue an order denying their motion to shift the burden_of_proof the issues we must decide are whether the amounts received by syzygy as premiums are excluded from its gross_income and whether the individual petitioners are entitled to the benefit of deductions taken by their s_corporations for insurance under sec_162 petitioners argue that the premiums received by syzygy were payments for insurance and therefore these premiums are excluded from syzygy’s income under sec_831 and the individual petitioners are entitled to deduct the premiums as payments for insurance under sec_162 the commissioner argues that the premiums syzygy received were not insurance premiums and therefore are not excluded under sec_831 and the premium payments are not deductible under sec_162 as payments for insurance we begin our discussion by briefly explaining the taxation and deductibility of microcaptive insurance payments insurance companies--other than life_insurance companies--are generally taxed on their income in the same manner as other corporations see sec_11 sec_831 however sec_831 provides an alternative taxing structure for certain small insurance_companies during the years in issue an insurance_company with net written premiums or if greater direct written premiums that did not exceed dollar_figure million for the year could elect to be taxed under sec_831dollar_figure sec_831 a small insurance_company 25the amendments to sec_831 increased the premium ceiling to dollar_figure million--adjusted for inflation--and added new diversification requirements continued that makes a valid sec_831 election is subject_to tax only on its investment_income sec_831 these companies are not subject_to tax on their earned premiums and are commonly referred to as microcaptive insurance_companies see sec_831 typically amounts paid for insurance are deducible under sec_162 as ordinary and necessary expenses paid_or_incurred in connection with a trade_or_business sec_1_162-1 income_tax regs sec_162 does not prohibit deductions for microcaptive insurance premiums an inherent requirement for a company to make a valid sec_831 election is that it must transact in insurance see avrahami v commissioner 149_tc_144 likewise the deductibility of insurance premiums depends on whether the premiums were truly payments for insurance thus these cases hinge on whether the captive insurance arrangement meets the definition of insurance i whether the arrangement is insurance neither the code nor the regulations define insurance and we are guided by caselaw in determining whether a transaction constitutes insurance for federal continued that an insurance_company must meet to be eligible to make a sec_831 election see consolidated appropriations act pub_l_no sec_333 sec_129 stat pincite income_tax purposes avrahami v commissioner t c pincite courts have looked to four criteria in deciding whether an arrangement constitutes insurance the arrangement involves insurable risks the arrangement shifts the risk of loss to the insurer the insurer distributes the risk among its policy holders and the arrangement is insurance in the commonly accepted sense 96_tc_45 aff’d 979_f2d_1341 9th cir 96_tc_18 aff’d 979_f2d_162 9th cir these four nonexclusive criteria establish a framework for determining the existence of insurance for federal_income_tax purposes amerco subs v commissioner t c pincite we consider all of the facts and circumstances in the light of the criteria outlined above see 142_tc_1 we will first look at risk_distribution a risk_distribution petitioners argue that syzygy distributed risk by participating in the u s risk and newport re captive insurance pools and reinsuring unrelated risks therefore before we can decide whether syzygy distributed risk through the fronting carriers we must decide whether those carriers were bona_fide insurance_companies see avrahami v commissioner t c pincite citing rent-a- center inc v commissioner t c pincite in determining whether an entity is a bona_fide insurance_company we have considered factors such as whether it was created for legitimate nontax reasons whether there was a circular flow of funds whether the entity faced actual and insurable risk whether the policies were arm’s-length contracts whether the entity charged actuarially determined premiums whether comparable coverage was more expensive or even available whether it was subject_to regulatory control and met minimum statutory requirements whether it was adequately capitalized and whether it paid claims from a separately maintained account id see rent-a-center inc v commissioner t c pincite many of these factors are interrelated and we will address those most relevant circular flow of funds under the arrangements with the fronting carriers ht a paid premiums to the carriers the fronting carriers then reinsured all of the risk making sure that syzygy received reinsurance premiums equal to the net_premiums paid_by ht a less syzygy’s liability for any layer claims for the years in issue this resulted in ht a’s paying the fronting carriers dollar_figure of gross premiums and the fronting carriers’ ceding dollar_figure of reinsurance premiums to syzygy in considering similar circumstances we have determined that w hile not quite a complete loop this arrangement looks suspiciously like a circular flow of funds avrahami v commissioner t c pincite see also reserve mech corp v commissioner tcmemo_2018_86 at quoting avrahami v commissioner t c pincite arm’s-length contracts ht a’s captive program policy premiums had an average rate-on-line of while the policies they purchased outside of the captive program had an average rate-on-line of this amounts to ht a’s paying upwards of five times more for their captive program policies than noncaptive program policies a higher rate-on-line means that insurance coverage is more expensive per dollar of coverage thus a higher rate-on-line leads to a greater deduction for premiums various terms in the captive program policies indicate that ht a should have paid less for the captive program policies than the noncaptive policies during each year in issue at least half of ht a’s captive program policies were for excess coverage which should result in a lower rate-on-line see avrahami v commissioner t c pincite none of the captive program policies provided for a refund of premiums upon cancellation the commissioner’s expert james macdonald explained in his expert report that this was unusual petitioners argue that mr macdonald conceded there are commercial policies with premiums earned at inception but petitioners have not pointed to any of ht a’s noncaptive policies that does not provide for a refund of unearned premiums of ht a’s noncaptive program policies that the court looked at each provides a refund for unearned premiums each captive program policy also required claims to be filed within the earlier of days after the loss was incurred or days after the policy expired in these cases the problem centers on the seven-day period after the policy expired in his expert report mr macdonald explained that the seven-day reporting_period would not be acceptable in an arm’s-length transaction because it simply does not allow enough time for a policyholder to become aware of an incident that may result in a formal claim at trial mr macdonald testified that the claims-made policies typically provide a period of to days after a policy’s expiration to report claims for no additional premium petitioners argue that mr macdonald conceded that there are commercial claims-made insurance policies with shorter reporting periods than ht a’s but petitioners have not pointed to any of ht a’s noncaptive program claims-made policies with a reporting_period of seven days or less of the policies that the court reviewed none had a reporting_period of less than days petitioners contend that the rate-on-line analysis is flawed because mr macdonald testified at trial that he would never price a commercial policy premium by averaging an insured’s other commercial policies however mr macdonald did not use the average rate-on-line for ht a’s noncaptive program policies to properly price another individual policy he used it to show that on average ht a paid more for their captive program coverage than their noncaptive program coverage thus we think the rate-on-line analysis is appropriate there is nothing in the record that justifies why ht a on average paid higher premiums for policies with more restrictive provisions than their commercial policies the higher average rate-on-line coupled with the policies’ restrictive provisions leads us to conclude that the policies were not arm’s-length contracts additionally john w jacob’s email to alta stating that one of the reasons ht a was leaving the alta program was the decrease in premiums deepens our view that the policies were not arm’s-length contracts it is fair to assume that a purchaser of insurance would want the most coverage for the lowest premiums in an arm’s-length negotiation an insurance purchaser would want to negotiate lower premiums instead of higher premiums seemingly the main advantage of paying higher premiums is to increase deductions therefore the fact that john w jacob sought higher premiums leads us to believe that the contracts were not arm’s-length contracts but were aimed at increasing deductions actuarially determined premiums neither the code caselaw nor regulations define actuarially determined premiums in the context of captive insurance but our cases have provided some guidance we have held that premiums charged by a captive_insurance_company were actuarially determined when the company relied on an outside consultant’s reliable and professionally produced and competent actuarial studies to set premiums and we have looked favorably upon an outside actuary’s determining premiums to be reasonable rent-a-center inc v commissioner t c pincite buch j concurring noting that premiums were actuarially determined when set in reliance on an actuarial study see securitas holdings inc v commissioner tcmemo_2014_225 we have held that premiums were not actuarially determined when there has been no evidence to support the calculation of premiums and when the purpose of premium pricing has been to fit squarely within the limits of sec_831 see avrahami v commissioner t c at reserve mech corp v commissioner at in the instant cases there are two issues with respect to actuarially determined premiums the reasonableness of captive program premiums and the to allocation of premiums between layer and layer we will begin by discussing the first issue the only detailed evidence in the record relevant to how the premiums were set concerns the premiums petitioners argue that the premiums were actuarially determined because they were set by mr taylor using a quantitative risk analysis and then mr ross reviewed the premiums and loss assumptions further they contend that the premiums were reviewed by actuaries contracted by the ddi we disagree mr taylor is not an actuary we recognize that premiums can be set by nonactuaries but mr taylor’s underwriting report has no calculations showing how he arrived at the premium prices mr taylor does not appear to have used any type of actuarial rating model or compared premium prices with similar publicly available policies as stated by mr taylor he was using a will ass guess at one point during the pricing process petitioners’ argument that the actuarial reviews by mr ross and the ddi- contracted actuaries prove that the premiums were actuarially determined is not supported by the record mr ross testified that he reviewed the premiums in the context of syzygy’s solvency and that the purpose of the review was not to determine whether the premiums were reasonable additionally the director of captive insurance for the ddi during syzygy’s application process testified that the main purpose of the ddi actuarial review was also to determine syzygy’s solvency there is nothing in the ddi initial examination_report that indicates that the examination focused on whether the premiums were reasonable accordingly the policies issued by the fronting carriers did not have actuarially determined premiums there are also problems with the allocation of premiums between layer and layer mr ross sent two emails to alta stating that the majority of the premiums should be allocated to layer but alta did not change the allocation john w jacob testified that he understood that the purpose of the allocation was to take advantage of a tax-related safe_harbor as in avrahami and reserve mech corp we are concerned with one-size-fits-all approaches see avrahami v commissioner t c pincite reserve mech corp v commissioner at accordingly we find that the allocation of premiums between layer and layer was not actuarially determined all of the above-mentioned factors indicate that u s risk and newport re were not bona_fide insurance_companies which in turn means that they did not issue insurance policies see avrahami v commissioner t c pincite this means syzygy’s reinsurance of those policies did not distribute risk therefore syzygy did not accomplish sufficient risk_distribution for federal_income_tax purposes through the fronting carriersdollar_figure b insurance in the commonly accepted sense syzygy’s absence of risk_distribution by itself is enough to conclude that the transactions among syzygy ht a and the fronting carriers were not insurance transactions avrahami v commissioner t c pincite but as an alternative ground we can also look at whether the transactions constituted insurance in the commonly accepted sense id pincite to determine whether an arrangement constitutes insurance in the commonly accepted sense we look at numerous factors including whether the company was organized operated and regulated as an insurance_company whether it was adequately capitalized whether the policies were valid and binding whether premiums were reasonable and the result of arm’s-length transactions and whether claims were paid r v i guar co subs v commissioner 145_tc_209 26we have found as a fact that syzygy wrote a single policy to ht a for see supra pp we need not consider whether syzygy achieved any type of risk_distribution with respect to that policy because we conclude below that the arrangement is not insurance in the commonly accepted sense see rent-a-center inc v commissioner t c pincite harper grp v commissioner t c pincite we will address each of these factors in turn organization operation and regulation syzygy was organized as an insurance_company and regulated in the state of delaware the commissioner however argues that syzygy ran afoul of various insurance regulations we will not address this as it does not affect the outcome of these cases the important question is whether syzygy was operated as an insurance_company in making this determination we must look beyond the formalities and consider the realities of the purported insurance transactions hosp corp of am v commissioner tcmemo_1997_482 wl at citing 62_f3d_835 6th cir rev’g t c memo we have concerns with syzygy’s operation the first problem is claims during the years in issue ht a did not submit a single claim to a fronting carrier or syzygy john w jacob testified that there were various claims that were eligible for coverage under the deductible reimbursement policy that were not submitted and petitioners do not dispute that approximately dollar_figure worth of claims was covered additionally john w jacob testified that ht a had no claims process for the captive program claims but did have different processes for their other claims the deductible reimbursement policy was one of ht a’s most expensive insurance policies and ht a’s failure to submit claims after paying deductibles is indicative of the arrangement’s not constituting insurance in the commonly accepted sense our concern is bolstered by ht a’s statement on the underwriting questionnaire that before their incurred deductibles were too numerous to list petitioners’ contention that john w jacob was too busy to submit claims does not lead us to believe the arrangement was insurance in the commonly accepted sense because ht a had claims processes for commercial policies that they did not implement for the captive program policies the problem with claims also extends to the sole claim syzygy paid it is unclear whether the claim was covered yet syzygy did not investigate coverage before paying the claim syzygy’s investment choices are also troubling at the end of the life_insurance policies insuring john w jacob and mr vanlenten totaled more than of syzygy’s assets and were its largest investments under the terms of the split-dollar agreements syzygy could neither access the cash_value of the policies borrow against the policies surrender or cancel the policies nor unilaterally terminate the agreements with the trusts we do not think that an insurance_company in the commonly accepted sense would invest more than of its assets in an investment that it could not access to pay claims the arrangement is even more troublesome because the jacob trust and the vanlenten trust were the beneficiaries of the policies if syzygy needed to access the policies to pay a claim it could not do so without the trusts’ special investment adviser’s consent the special investment adviser would potentially be deterred from allowing syzygy to access the policies because that would be detrimental to the respective trusts’ beneficiaries’ interests petitioners contend that steven kinion--who has been director of captive insurance for the ddi since mid-2009--had no issues with the life_insurance policies however mr kinion’s testimony is unclear as to whether he had knowledge of the terms of syzygy’s split-dollar agreements when asked whether it was irrelevant that syzygy could not access the policies’ cash values mr kinion stated once we became aware of these types of policies where a captive_insurance_company for instance could not access cash values we would go to the captive manager and seek out a change to those requirements this does not amount to mr kinion’s having no issues with syzygy’s inability to access the policies’ cash values to pay claims we find that the circumstances surrounding syzygy’s life_insurance investments weigh heavily against syzygy’s being an insurance_company in the commonly accepted sense petitioners did not call any alta employees as trial witnesses to explain how the insurance arrangement worked or discuss whether the fronting carriers operated in a bona_fide fashion capitalization syzygy met delaware’s minimum capitalization requirements in avrahami v commissioner t c pincite we discussed how a consensus of our caselaw has held that an insurer is adequately capitalized if it meets the relevant jurisdiction’s minimum capitalization requirements valid and binding policies the caselaw is not entirely clear on what makes a policy valid and binding we have held that policies were valid and binding when e ach insurance_policy identified the insured contained an effective period for the policy specified what was covered by the policy stated the premium amount and was signed by an authorized representative of the company securitas holdings inc v commissioner at in r v i guar co v commissioner t c pincite we found that policies were valid and binding when the insured filed claims for covered losses and the captive_insurance_company paid them we have also looked at factors beyond whether the policies are simply binding such as conflicting policy terms and whether the policies were simply cookie cutter avrahami v commissioner t c pincite examining conflicting policy terms reserve mech corp v commissioner at describing that policies were cookie cutter and not necessarily appropriate here the dispute surrounding valid and binding policies centers on whether the policies were timely issued identified the insured and specified what was covered by the policies during the years in issue neither syzygy nor the fronting carriers timely issued a policy to ht a the policies for and were not even issued until after the policy years ended despite the late issuances petitioners contend that the risk binders issued by the fronting carriers bound coveragedollar_figure although petitioners’ expert dr michael angelina testified that late issuances are common in the insurance industry we conclude that the failure to 27an insurance binder is a written instrument used when a policy cannot be immediately issued to evidence that the insurance coverage attaches at a specified time and continues until the policy is issued or the risk is declined and notice thereof is given 274_fedappx_169 3d cir quoting harris v sachse a 2d pa super ct there is no dispute that the binders for and were timely issued but there is a dispute as to timely issue even a single policy weighs against the arrangement being insurance in the commonly accepted sense the policies issued to ht a have ambiguities and conflict as to whether ht a were insured or whether only highland tank was insured in response to informal_discovery requests petitioners stated that highland tank htny htnc lowe and bigbee were insured the and policies name highland tank as the insured but the risk binders for name highland tank’s nominees affiliates and subsidiaries of affiliates as insureds there are also various ambiguities and conflicts concerning what the policies covered for example john w jacob testified that the deductible reimbursement policies applied to all of ht a’s insurance policies except for workers’ compensation and health insurance the deductible reimbursement policies for and stated that they applied only to stico insurance_policy no plr00004-04 that stico policy was not in effect in additionally the deductible reimbursement policy for stated that it applied to only five specific policies we recognize petitioners’ argument that ambiguous policy terms are a major source of insurance litigation petitioners contend that regardless of the ambiguities and conflicting terms the intent of the parties is controlling and the policies are therefore binding the meaning of valid and binding for federal tax purposes also looks at policy ambiguities and conflicting terms and how they fit in with the spirit of a transaction obviously ambiguous and conflicting terms do not prevent every policy from being insurance for tax purposes but related-party transactions are given heightened scrutiny 652_f3d_475 3d cir citing 154_f3d_61 3d cir rev’g in part vacating in part t c memo mazzei v commissioner t c slip op pincite date viewing the policies’ late issuances ambiguities and conflicting terms in the context of a related-party transaction leads us to conclude that the valid and binding policies factor weighs against petitioners reasonableness of premiums as discussed in considering whether the policies were arm’s-length contracts the premiums were unreasonable this factor weighs against petitioners payment of claims the only claim submitted to syzygy during the years in issue was the pyrotek layer claim as discussed in connection with the organization operation and regulation factor see supra pp the claim was paid but there are problems with the way that it was handled this factor weighs slightly in petitioners’ favor but we do not regard this as overwhelming evidence that the arrangement constituted insurance in the commonly accepted sense because of the way the claim was handled although syzygy was organized and regulated as an insurance_company met delaware’s minimum capitalization requirements and paid a claim these insurance-like traits do not overcome the arrangement’s other failings syzygy was not operated like an insurance_company the fronting carriers charged unreasonable premiums and late-issued policies with conflicting and ambiguous terms c arrangement not insurance the arrangement among ht a syzygy and the fronting carriers lacked risk_distribution and was not insurance in the commonly accepted sense thus the arrangement is not insurance for federal_income_tax purposes and we need not address the commissioner’s economic_substance arguments ii effect on syzygy because the arrangement is not insurance syzygy’s sec_831 election is invalid and it must recognize the premiums it received as income therefore we sustain the commissioner’s determinations with respect to syzygy iii effect on the individual petitioners the individual petitioners cannot deduct the purported premium payments or any fees as payments for insurance because the payments were not for insurance nevertheless petitioners contend that the purported premium payments are payments for indemnification that are deductible as ordinary and necessary business_expenses additionally they contend that the commissioner argues against revrul_2008_8 2008_1_cb_340 and revrul_2005_40 2005_2_cb_4 by disallowing deductions for the purported premium payments a deductibility as indemnification payments there is little precedent addressing whether amounts paid for an invalid insurance arrangement can nevertheless be deductible under sec_162 and neither party cites any cases to be deductible under sec_162 an expense must be both ordinary and necessary welch v helvering u s pincite an expense is necessary if it is appropriate and helpful to the development of the taxpayer’s business 383_us_687 welch v helvering u s pincite in the context of captive insurance there may be instances where noninsurance payments for indemnification protection might be appropriate and helpful to the development of the insured but at the bare minimum for such payments to be considered appropriate and helpful the indemnified party must intend to seek indemnification if a covered event occurs otherwise there is no valid purpose for making such payments in these cases ht a’s failure_to_file claims that they thought were covered under the deductible reimbursement policies leads us to find that there was no intent to seek indemnification for covered losses accordingly the payments are not deductible as ordinary and necessary expenses b the revenue rulings revrul_2005_40 c b pincite states a n arrangement that purports to be an insurance_contract but lacks the requisite risk_distribution may instead be characterized as a deposit arrangement a loan a contribution_to_capital to the extent of net value if any an indemnity arrangement that is not an insurance_contract or otherwise based on the substance of the arrangement between the parties the proper characterization of the arrangement may determine whether the issuer qualifies as an insurance_company and whether amounts paid under the arrangement may be deductible the commissioner is required to follow his revenue rulings and we have treated revenue rulings as concessions by the commissioner where those rulings are relevant to the disposition of a case 119_tc_157 for a taxpayer to rely on a revenue_ruling however the facts of the taxpayer’s transaction must be substantially the same as those in the 28rev rul 2008_1_cb_340 says nearly the same thing ruling barnes grp inc subs v commissioner tcmemo_2013_109 at aff’d 593_fedappx_7 2d cir sec_601_601 statement of procedural rules revrul_2008_8 supra and revrul_2005_40 supra both describe circumstances where the commissioner determined that various transactions either were or were not insurance with respect to those transactions that were not insurance the commissioner did not describe the precise characterization of the arrangements that were not insurance or the precise tax treatment of each characterization thus it is unclear how petitioners can rely on the revenue rulings to deduct the payments the rulings do not have substantially_similar facts providing for a deduction for premium payments in relation to an arrangement that is not insurance accordingly petitioners cannot rely on the rulings to deduct the purported premiums petitioners also argue that if the payments to syzygy are not deductible they should not be taxable to syzygy while the revenue rulings suggest the possibility that an arrangement that purports to be an insurance_contract may instead be characterized as a deposit arrangement a loan a contribution_to_capital or otherwise there is no evidence that any such recharacterization is appropriate see reserve mech corp v commissioner at iv penalties in the notices of deficiency the commissioner determined that petitioners were each liable for sec_6662 accuracy-related_penalties sec_6662 and b and authorizes a penalty on the portion of an underpayment attributable to n egligence or disregard of rules or regulations and a ny substantial_understatement_of_income_tax negligence includes any failure to make a reasonable attempt to comply with the revenue laws and disregard of rules or regulations includes any careless reckless or intentional disregard sec_6662 negligence is determined by testing a taxpayer’s conduct against that of a reasonable prudent person 731_f2d_1417 9th cir aff’g 79_tc_714 for individual taxpayers there is a substantial_understatement_of_income_tax if the amount of the understatement for the taxable_year exceeds the greater of of the tax required to be shown on the return or dollar_figure sec_6662 for corporations there is an understatement of income_tax if the amount of the understatement for the taxable_year exceeds the lesser_of of the tax required to be shown on the return for the taxable_year or if greater dollar_figure or dollar_figure million sec_6662 under sec_7491 the commissioners bears the burden of production for penalties related to individual petitioners but not corporations 126_tc_191 116_tc_438 once the commissioner meets his burden of production however the burden_of_proof remains with the taxpayer including the burden of proving the penalty is inappropriate because of reasonable_cause under sec_6664 see rule a higbee v commissioner t c pincite we need not decide whether the commissioner met his burden for the individual petitioners because they have established reasonable_cause through good_faith reliance on mr dinatale’s professional advice sec_6664 provides that the penalty under sec_6662 shall not apply to any portion of an underpayment if it is shown that there was reasonable_cause for the taxpayer’s position and he acted in good_faith see higbee v commissioner t c pincite this determination is made on a case-by-case basis taking into account all of the pertinent facts and circumstances sec_1_6664-4 income_tax regs for underpayments related to passthrough items we look at all pertinent facts and circumstances including the taxpayer’s own actions as well as the actions of the passthrough_entity sec_1_6664-4 income_tax regs reliance on professional advice may constitute reasonable_cause and good_faith but only if considering all the circumstances such reliance was reasonable 89_tc_849 aff’d f 2d 5th cir aff’d 501_us_868 sec_1_6664-4 income_tax regs reasonable_cause exists if a taxpayer relies in good_faith on the advice of a qualified_tax adviser where the following three elements are present the adviser was a competent professional who had sufficient expertise to justify the reliance the taxpayer provided necessary and accurate information to the adviser and the taxpayer actually relied in good_faith on the adviser’s judgment 115_tc_43 aff’d 299_f3d_221 3d cir reliance may be unreasonable if the adviser is a promoter of the transaction id pincite a promoter is an adviser who participated in structuring the transaction or is otherwise related to has an interest in or profits from the transaction 136_tc_67 quoting tigers eye trading llc v commissioner tcmemo_2009_ slip op pincite aff’d 684_f3d_84 d c cir we find that mr dinatale was a competent professional with sufficient expertise he is a c p a who advises ht a on tax and business matters his testimony strongly indicates that he familiarized himself with relevant captive insurance law when advising ht a and we credit his testimony accordingly we find that mr dinatale was a competent professional with sufficient expertise we find that mr dinatale was provided with all of the necessary and accurate information he sat through meetings with john w jacob and alta and was familiar with ht a’s business we find petitioners relied on mr dinatale in good_faith mr dinatale was not a promoter in the context of microcaptive insurance we have found a taxpayer’s reliance on professional advice coupled with the lack of precedent in the area to be indicative of good_faith see avrahami v commissioner t c pincite taking into account all of the facts and circumstances the good_faith reliance extends to all petitioners in these cases accordingly petitioners are not liable for the accuracy-related_penalties in reaching our decision we have considered all arguments made by the parties and to the extent not mentioned or addressed they are irrelevant or without merit to reflect the foregoing decisions will be entered for respondent as to the deficiencies and for petitioners as to the accuracy-related_penalties under sec_6662


t c memo united_states tax_court dan r and ann p kunze petitioners v commissioner of internal revenue respondent docket no filed date ps along with approximately similarly situated taxpayers are u s persons who earned_income from working in antarctica on their federal_income_tax return ps excluded income earned during from working in antarctica r issued a notice_of_deficiency for in which r determined that the income ps earned during from working in antarctica is not excludable from income held the income ps earned in antarctica is not excludable from income pursuant to sec_911 126_tc_89 affd 473_f3d_790 7th cir followed larry d harvey for petitioners randall l preheim for respondent memorandum opinion vasquez judge this case is before the court on respondent’s motion for summary_judgment pursuant to rule after a concession the sole issue for decision is whether petitioners can exclude from income wages earned during from working in antarctica background at the time they filed the petition petitioners resided in lander wyoming during petitioners performed services at mcmurdo station in ross island antarctica on their federal_income_tax return petitioners excluded wage income earned and received during for services performed in antarctica unless otherwise indicated all rule references are to the tax_court rules_of_practice and procedure and all section references are to the internal_revenue_code in effect for the year in issue respondent has filed similar motions for summary_judgment in dockets of the similarly situated taxpayers who are u s persons who earned_income from working in antarctica respondent concedes that no penalty pursuant to sec_6662 is due from petitioners for discussion i summary_judgment rule a provides that either party may move for summary_judgment upon all or any part of the legal issues in controversy full or partial summary_judgment may be granted only if it is demonstrated that no genuine issue exists as to any material fact and that the legal issues presented by the motion may be decided as a matter of law see rule b 98_tc_518 affd 17_f3d_965 7th cir we conclude that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law ii in general sec_61 provides that gross_income means all income from whatever source derived accordingly citizens of the united_states generally are taxed on income earned outside the geographical boundaries of the united_states unless the income is specifically excluded from gross_income 117_tc_95 affd sub nom 68_fedappx_44 9th cir affd sub nom 357_f3d_1108 10th cir exclusions from income are construed narrowly and taxpayers must bring themselves within the clear scope of the exclusion id iii sec_911 in 126_tc_89 473_f3d_790 7th cir arnett ii we addressed the arguments made by the parties herein regarding sec_911 the u s court_of_appeals for the seventh circuit agreed with our analysis of sec_911 and affirmed our conclusion that antarctica is not a foreign_country pursuant to sec_911 and the regulations thereunder arnett v commissioner f 3d pincite we shall not repeat our analysis from arnett i herein we follow our analysis and holding in arnett i and the analysis and holding of the court_of_appeals in arnett ii in 126_tc_89 affd 473_f3d_790 7th cir we concluded our opinion with a citation of sec_863 suggesting that sec_863 provided an additional reason to rule against the taxpayer id pincite see also sec_863 providing that income earned in antarctica by a u_s_person is sourced in the united_states in arnett v commissioner f 3d pincite the u s court_of_appeals for the seventh circuit addressed sec_863 in greater detail stating at the outset we think that it is important to note that considering antarctica not to be a foreign_country is compatible with the general statutory scheme notably sec_911 is found under subtitle a chapter subchapter_n of the irc which is designated tax based on income from sources within or without the united_states part i of this subchapter entitled source_rules and other general rules relating to foreign_income deems any activity in antarctica to be space_or_ocean_activity in turn the united_states is designated the source country of income from such activity when earned by a citizen_of_the_united_states sec_863 although this provision does not provide a definitive answer as to whether antarctica is a foreign_country it supports the conclusion that sec_911 is not intended to apply to continued iv conclusion accordingly for the reasons stated in arnett i arnett ii and herein we conclude that petitioners cannot exclude from gross_income wages earned during from working in antarctica to reflect the foregoing an appropriate order and decision will be entered continued income earned for services provided in antarctica we take this opportunity to state our agreement with the court of appeals’ conclusion set forth above see also 450_us_1


internal_revenue_service number release date index number -------------------- -------------------------- ---------------------------- in re --------------------------------------- department of the treasury washington dc third party communication date of communication month dd yyyy person to contact ------------------------------ id no ------------ --------- telephone number --------------------- refer reply to cc psi b09 plr-152200-05 date date ------------------------ ------------------------------------- ------------------------------------------------- ----------------------------- ------- ------- ------- ----------- legend legend taxpayer trust law firm advisor year year year x dear ---------------- this is in response to your letter dated date and subsequent correspondence requesting an extension of time under sec_2642 of the internal_revenue_code and sec_301_9100-1 and sec_301_9100-3 of the procedure and administration regulations to make allocations of generation-skipping_transfer gst_exemption to a_trust the facts submitted and the representations made are as follows in year taxpayer retained law firm to draft trust and prepare any gift_tax_return required in connection with trust article i of trust provides that during the life of taxpayer’s daughter the independent_trustee has the discretion to distribute trust income and principal for the benefit of any one or more of a group consisting of taxpayer’s daughter taxpayer’s lineal_descendants and charity there is no requirement to equalize distributions among beneficiaries taxpayer’s daughter has an intervivos and testamentary special_power_of_appointment over the trust property upon the death of taxpayer’s daughter to the extent the intervivos and testamentary powers of appointment have not been exercised trust’s remaining assets are to be held in further trust for the benefit of the lineal_descendants of taxpayer’s daughter if any if none the assets are to be distributed to the estate of taxpayer’s daughter plr-152200-05 in year taxpayer contributed dollar_figurex in cash to trust law firm failed to advise taxpayer that a gift_tax_return would be required to report the transfer to trust and to allocate taxpayer’s gst_exemption to the transfer to trust this failure was discovered in year when taxpayer and her family retained advisor to review various income and estate_tax matters in year taxpayer reported the year transfer on a late filed gift_tax_return for year but taxpayer did not allocate gst_exemption to the year transfer on this late filed return it has been represented that taxpayer currently has gst_exemption available to allocate to the year transfer to trust taxpayer is requesting an extension of time under sec_2642 and sec_301_9100-3 to allocate her available gst_exemption to the year transfer to trust the allocation is to be effective as of the original date of transfer and is to be made based on the value of the transferred property as of the date of transfer as if a timely gift_tax_return had been filed the federal gift_tax value of the transfer is to be used in determining the gst_exemption to be allocated to produce an inclusion_ratio that is equal to zero law and analysis sec_2601 imposes a tax on every gst a gst is defined under sec_2611 as a taxable_distribution a taxable_termination and a direct_skip sec_2602 provides that the amount of the tax is the taxable_amount multiplied by the applicable_rate sec_2641 defines applicable_rate as the product of the maximum_federal_estate_tax_rate and the inclusion_ratio with respect to the transfer sec_2642 provides the method for determining the inclusion_ratio sec_2631 in effect at the time of the transfer provides that for purposes of determining the inclusion_ratio every individual shall be allowed a gst_exemption of dollar_figure adjusted for inflation under sec_2631 which may be allocated by such individual or his executor to any property with respect to which such individual is the transferor sec_2631 provides that any allocation under sec_2631 once made shall be irrevocable sec_2632 provides that any allocation by an individual of his or her gst_exemption under sec_2631 may be made at any time on or before the date prescribed for filing the estate_tax_return for such individual’s estate determined with regard to extensions regardless of whether such a return is required to be filed sec_2632 provides that any portion of an individual's gst_exemption which has not been allocated within the time prescribed by sec_2032 shall be deemed to be allocated as follows-- a first to property which is the subject of a direct_skip occurring at such individual's death and b second to trusts with respect to which such individual is the transferor and from which a taxable_distribution or a taxable_termination might plr-152200-05 occur at or after such individual's death sec_26_2632-1 provides that an allocation of gst_exemption to property transferred during the transferor’s lifetime other than in a direct_skip is made on form_709 sec_26_2632-1 of the generation-skipping_transfer_tax regulations provides that a decedent's unused gst_exemption is automatically allocated on the due_date for filing form_706 to the extent not otherwise allocated by the decedent's executor on or before that date the automatic allocation occurs whether or not a return is actually required to be filed unused gst_exemption is allocated pro_rata subject_to the rules of sec_26_2642-2 on the basis of the value of the property as finally determined for purposes of chapter chapter value first to direct skips treated as occurring at the transferor's death the balance if any of unused gst_exemption is allocated pro_rata subject_to the rules of sec_26_2642-2 on the basis of the chapter value of the non-exempt portion of the trust property or in the case of trusts that are not included in the gross_estate on the basis of the date of death value of the trust to trusts with respect to which a taxable_termination may occur or from which a taxable_distribution may be made the automatic allocation of gst_exemption is irrevocable and an allocation made by the executor after the automatic allocation is made is ineffective sec_2642 provided that except as provided in sec_2642 if the allocation of the gst_exemption to any transfers of property is made on a gift_tax_return filed on or before the date prescribed by sec_6075 for such transfer or is deemed to be made under ' b or c b a the value of such property for purposes of sec_2642 shall be its value as finally determined for purposes of chapter within the meaning of sec_2001 or in the case of an allocation deemed to have been made at the close of an etip its value at the time of the close of the etip and b such allocation shall be effective on and after the date of such transfer or in the case of an allocation deemed to have been made at the close of an etip on and after the close of such etip sec_2642 provides that the secretary shall by regulation prescribe such circumstances and procedures under which extensions of time will be granted to make an allocation of gst_exemption described in sec_2642 such regulations shall include procedures for requesting comparable relief with respect to transfers made before the date of the enactment of sec_2642 which was enacted into law on date sec_2642 provides that in determining whether to grant relief the secretary shall take into account all relevant circumstances including evidence of intent contained in the trust instrument or instrument of transfer and such other factors as the secretary deems relevant sec_2642 further provides that for purposes of determining whether to grant relief the time for making the allocation shall be treated as if not expressly prescribed by statute plr-152200-05 notice_2001_50 2001_2_cb_189 provides that under sec_2624 the time for allocating the gst_exemption to lifetime transfers and transfers at death the time for electing out of the automatic allocation rules and the time for electing to treat any trust as a gst_trust are to be treated as if not expressly prescribed by statute the notice further provides that taxpayers may seek an extension of time to make an allocation described in sec_2642 or b or an election described in sec_2632 or c under the provisions of sec_301_9100-3 sec_301_9100-1 provides that the commissioner has discretion to grant a reasonable extension of time under the rules set forth in sec_301_9100-2 and sec_301_9100-3 to make a regulatory election or a statutory election but no more than months except in the case of a taxpayer who is abroad under all subtitles of the code except subtitles e g h and i sec_301_9100-3 provides the standards used to determine whether to grant an extension of time to make an election whose due_date is prescribed by a regulation and not expressly provided by statute under sec_301_9100-1 a regulatory election includes an election whose due_date is prescribed by a notice published in the internal_revenue_bulletin in accordance with sec_2642 and notice_2001_50 taxpayers may seek an extension of time to make an allocation described in sec_2642 under the provisions of sec_301_9100-3 requests for relief under sec_301_9100-3 will be granted when the taxpayer provides the evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government sec_301_9100-3 provides that a taxpayer is deemed to have acted reasonably and in good_faith if the taxpayer reasonably relied on a qualified_tax professional including a tax professional employed by the taxpayer and the tax professional failed to make or advise the taxpayer to make the election based on the facts submitted and the representations made we conclude that the requirements of sec_301_9100-3 have been satisfied therefore taxpayer is granted an extension of time of sixty days from the date of this letter to allocate taxpayer’s available gst_exemption to the year transfer to trust the allocation will be effective as of the date the transfer was made to trust and will be based on the value of the assets taxpayer contributed to trust on that date trust will have an inclusion_ratio of zero provided the amount of gst_exemption allocated to trust is equal to the federal gift_tax value of the assets contributed to trust on the date of transfer except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter specifically no opinion is expressed or implied concerning the value for federal transfer_tax purposes of the assets taxpayer contributed to trust in year plr-152200-05 this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination sincerely heather c maloy heather c maloy associate chief_counsel passthroughs special industries enclosures copy for ' purposes copy of this letter