This IRS Notice, effective November 1, 2016, identifies certain “micro-captive transactions” as “transactions of interest” because these types of transactions may have the potential for tax-avoidance or evasion. This notice recognizes that many micro-captive transactions are utilized for risk management purposes and do not involve tax avoidance. However, the IRS has identified companies taking advantage of IRC §831(b) (“Investment Income Reinsurance Companies”) as a transaction of interest and has mandated that all the participants (dealership, dealership shareholders, agents and underwriters) involved in such reinsurance transactions must disclose the transaction details to the IRS. A participant who fails to make the required disclosure may be subject to a $50,000 penalty. The deadline for the filing of the IRS disclosure was originally January 30, 2017, but was extended to May 1, 2017 by IRS Notice 2017-08.
In addition to the immediate IRS disclosure obligation, each participant in a micro-captive transaction during a tax year will be required to file similar disclosures with its annual income tax return. The same penalties apply if a participant fails to make an annual disclosure.
Our interpretation of IRS Notice 2016-66 is that it applies to reinsurance companies that have dealer obligor business ceded to them. Typical examples of this type of business include gap waiver and limited warranties (these are usually products included at the sale of the vehicle and the vehicle purchaser does not pay a fee for them). We recommend that all reinsurers with these type products file a “protective” IRS disclosure for the reinsurance company to avoid these penalties, even if it is later determined that the IRS Notice does not apply. An exception to filing is granted for companies with a loss ratio in excess of 70% for all periods covered.
In addition, our interpretation of IRS Notice 2016-66 is that all other participants, as defined above, should disclose the transaction or potentially be subject to the $50,000 penalty. We encourage you to consult a trusted tax advisor as it relates to any disclosures for the reinsurance company as well as all other participants.
If a reinsurer has Gap or Limited Warranty business and has loss ratio under 70%, who must file?