Rewrite the The U.S. Tax Court Rejects 501(c)(15) Status For Commonwealth Underwriting & Annuity Services, Inc.

Some particular person unknown, who will probably be referred to herein as “Proprietor” created an organization in Belize known as Commonwealth Underwriting & Annuity Providers, Inc., of which she or he was the only shareholder and the only officer. Though the corporate’s identify means that it’s an insurance coverage firm, apparently Commonwealth didn’t purchase an insurance coverage license, however quite operated beneath Belize company regulation which didn’t limit the operations of an funding firm.

Nonetheless, Commonwealth bought annuity contracts to varied people. The premiums paid for these annuity contracts have been positioned in a segregated belief account, and the segregated belief account had an impartial Trustee who had no relation to Proprietor.

The Trustee took these premiums and positioned them into subaccounts that have been arrange for every investor, and these funds have been then invested in numerous funding funds. Commonwealth apparently did nothing, however quite the Trustee was answerable for paying on the annuity contracts and investing the segregated accounts for every investor. Nonetheless, Commonwealth claimed that the moneys in these investments accounts have been owned by it (Commonwealth) quite than every particular person purchaser of the annuity contracts.

The payouts beneath the annuity insurance policies have been tied to the quantities in every purchaser’s segregated account throughout the belief, which additionally meant that they have been topic to funding income and losses, much like a variable annuity contract. The annuity contracts did have a cost for a demise profit and for bills, plus every contract paid for no matter funding advisory bills have been incurred of their specific segregated account. If the purchaser died earlier than the coverage annuitized, the designated beneficiary would obtain a demise profit equal to the quantity in that purchaser’s segregated account as of the time of demise, much less sure costs.

In 2013, Commonwealth took in a little bit greater than $82.1 million in premiums and was paid about $150,000 in charges, and greater than $2.1 million in premiums and about $195,000 in charges for 2014.

In 2014, Commonwealth utilized to the IRS for a willpower letter that Commonwealth was an insurance coverage firm that certified beneath Inside Income Code § 501(c)(15). That part states that an insurance coverage firm is exempt from taxes if principally three situations are met:

(1) The corporate is an insurance coverage firm, however is just not a life insurance coverage firm;

(2) The corporate’s gross receipts for every taxable yr is not more than $600,000; and

(3) Greater than 50% of the corporate’s gross receipts are premiums obtained.

Not surprisingly, the IRS decided that precisely none of those three situations have been met, nonetheless, and denied Commonwealth’s utility. Commonwealth then initiated a lawsuit for declaratory judgment earlier than the U.S. Tax Court docket, and that resulted within the opinion in Commonwealth Underwriting & Annuity Services, Inc. v. Comm’r, T.C.Memo 2023-27 (Mar. 2, 2023), to which we are going to now flip our consideration.

It’s a very brief opinion, being solely seven paragraphs, which maybe displays on simply how badly Commonwealth missed on its try and qualify as a 501(c)(15) insurance coverage firm. For starters, the Tax Court docket merely assumed, with out discovering, that Commonwealth was an insurance coverage firm for functions of the Inside Income Code. As a substitute, the Tax Court docket seemed on the premiums that Commonwealth obtained in 2013 and 2014, each nicely in extra of the $600,000 restrict of 501(c)(15) and decided that Commonwealth merely didn’t qualify for that exemption.

In response, Commonwealth made an argument to the impact that the moneys paid by purchasers for the annuity contracts “do no comprise premium revenue”, and that Commonwealth didn’t retain these moneys since they have been as a substitute dumped into the segregated accounts. Thus, in Commonwealth’s view, the one “premiums” that it obtained have been the $150,000 in charges in 2013 and 195,000 in charges for 2014. This argument was simply foolish and the Tax Court docket rejected it:

“Petitioner acknowledges that the acquisition funds ‘constituted the funds used to make annuity funds.’ This seems to suit squarely throughout the definition of a premium. See Nationwide Affiliation of Insurance coverage Commissioners, Assertion of Statutory Accounting No. 51—Life Contracts, para. 5 (explaining {that a} premium ‘shall be acknowledged as revenue on the gross foundation (quantity charged to the policyholder) when due from policyholders’). Petitioner’s rivalry that the acquisition funds weren’t ‘retained, managed or utilized by’ petitioner is contradicted by its personal annuity contracts, which give that the property held within the segregated belief accounts and subaccounts ‘stay the property of’ petitioner. Furthermore, petitioner has not supplied any authority suggesting that the premiums weren’t premium revenue. Subsequently, petitioner has not established that its gross receipts didn’t exceed $600,000 throughout both yr in difficulty, thereby failing to fulfill the monetary check in part 501(c)(15)(A).”

The Tax Court docket then went on to look at that even when it purchased Commonwealth’s argument that the funds for the annuities weren’t “premiums”, then Commonwealth nonetheless had not supplied any proof that its different expense charges have been within the nature of premiums. So, Commonwealth misplaced in that path as nicely.

The underside line is that Commonwealth didn’t qualify for therapy beneath 501(c)(15) and the IRS had appropriately denied its a willpower letter to that impact.

ANALYSIS

In some ways, this Commonwealth deal appears very acquainted to the Foster & Dunhill scheme which concerned bogus personal placement life insurance coverage (PPLI) insurance policies, and which ended within the prison indictments of the concerned promoters. The story in all these offers is principally the identical: Purchaser purchase “insurance coverage” from an offshore insurance coverage firm, their cash goes right into a segregated account, their cash is managed offshore, they usually attempt to keep away from the revenue taxes on the funding revenue by claiming that the cash is not theirs. Right here, the scheme concerned annuities as a substitute of PPLI, however principally to the identical impact.

Each few years, we see a deal like this which is designed so badly that it solely takes a number of milliseconds to conclude that whoever put this collectively did not have the primary actual clue as to what they have been doing. This scheme is a catastrophe, an offshore planning prepare wreck of epic proportions. The tax place of Commonwealth right here is definitely a lot worse than the Tax Court docket writes up.

For example, the Tax Court docket glossed over whether or not Commonwealth was not a life insurance coverage firm, even assuming that it certified as any insurance coverage firm in any respect. Insuring annuity contracts is basically a life insurance coverage enterprise; principally, an annuity insures towards an individual dwelling too lengthy, which is solely the flip-side of life insurance coverage which insures towards an individual dying too early. Subsequently, if the Tax Court docket had spent even a modicum of time on the topic, it could have concluded that Commonwealth couldn’t qualify beneath 501(c)(15) as a result of it was a life insurance coverage firm, if an insurance coverage firm in any respect.

Was Commonwealth even an insurance coverage firm of any form? No. The Tax Court docket merely ignored this too, as a result of it was really easy to reject Commonwealth’s case on the gross receipts difficulty. However had the Tax Court docket thought-about the problem, Commonwealth would have gone down in flames. To be an insurance coverage firm, Commonwealth would have needed to show it was engaged within the enterprise of insurance coverage. Whether or not one thing constitutes “insurance coverage” sometimes requires three issues:

(1) There may be an insurance coverage contract. Commonwealth most likely satisfies this prong as a result of it was issuing annuity contracts to purchasers, and annuity contracts are basically insurance coverage contracts. Notice that the opposite was Commonwealth’s principal argument, so ironicallly Commonwealth was arguing towards the one factor that it acquired proper.

(2) There may be danger shifting from the insured to the insurer. Right here, purchaser merely put cash in, and acquired a reimbursement, plus or minus their funding return, and fewer charges and bills. Commonwealth was not on the hook for any legal responsibility if anyone outlived their life expectancy, and wouldn’t have made any further revenue if anyone had died early. In different phrases, Commonwealth took on no danger in any respect, and thus there was no danger shifting. Commonwealth thus can’t fulfill this prong of the check.

(3) There may be danger distribution between insureds. Insurance coverage firms function in accordance with the statistical Legislation of Massive Numbers, i.e., over a lot of insureds the income and losses of their insurance coverage contracts will revert to close the anticipated imply. Since Commonwealth right here was merely taking insured’s cash in and giving it again to them, with out regard to how lengthy or brief they lived, there was no pooling of danger and thus no danger distribution. Thus, Commonwealth can’t fulfill this prong of the check both.

The underside line is that whereas Commonwealth facially seemed to be performing as an insurer by issuing annuity contracts, in actual fact there was no insurance coverage occurring no less than within the tax sense. Commonwealth tried to say that its minor expense costs have been insurance coverage, however that was simply foolish to the purpose of being wholly specious. As a result of Commonwealth was not engaged within the enterprise of insurance coverage within the tax sense, Commonwealth couldn’t qualify for therapy as an insurance coverage firm beneath any provision of the U.S. Inside Income Code.

A dialogue of the insurance coverage difficulty would have required a way more in-depth evaluation of what Commonwealth was doing, and the Tax Court docket clearly didn’t need to waste any time going by means of that, nor did it must. Plainly, Commonwealth had taken in gross receipts far in extra of $600,000 and that was the top of the story. Even when the Tax Court docket had purchased Commonwealth’s argument that its small bills costs was the actual insurance coverage, then the Commonwealth’s case nonetheless died stillborn since these costs weren’t no less than 50% of gross receipts. The one thriller right here is why anyone not dosing closely on mescaline thought that Commonwealth might qualify for a willpower letter beneath 501(c)(15).

It’s not essential that an organization have an insurance coverage license to be an insurance coverage firm for tax functions, though definitely it’s higher for optics. It’s essential, nonetheless, that the corporate be performing like an insurance coverage firm by way of shifting and distributing danger, and Commonwealth apparently did none of these issues. The Tax Court docket opinion doesn’t elaborate a lot on what else Commonwealth was doing or not doing, however the secure guess could be that Commonwealth additionally fell far brief when it got here to such capabilities as underwriting and actuarial determinations contemplating the character of the way it was conducting its annuity enterprise.

What we do have right here seems to be little greater than an especially amateurish try at an offshore tax dodge, like one thing {that a} fifth grade elementary college class would draw up as a venture after spending a few hours researching offshore tax shelters on the web. It’s troublesome, if not unimaginable, for any minimally discovered tax skilled to have a look at this scheme and say, “Which may work.” There was no probability of this working as a 501(c)(15) insurance coverage firm from the outset. None.

The Tax Court docket opinion doesn’t give us any indication of who owned Commonwealth, or who the purchasers of the annuities have been. As a result of Commonwealth was searching for therapy beneath the U.S. Inside Income Code, nonetheless, we are able to safely infer that these purchasers have been ― immediately or not directly ― U.S. individuals. If these, that they had all higher hope that that they had well timed filed their Overseas Financial institution Account Reporting (FBAR) types, as a result of all of them had an curiosity in a international account that required the submitting of FBARs, and the penalties for not well timed submitting FBARs are harsh, to be form. Equally, all these of us ought to have reported the funding revenue inside their segregated accounts on their tax returns, or arguably they dedicated offshore tax evasion.

However these of us won’t even get all of their a reimbursement. The reason being that as a result of Commonwealth didn’t qualify as a 501(c)(15) firm (and for that matter, most likely can’t qualify as any type of insurance coverage firm for the aforementioned causes), all of that $82.3 million that it obtained will probably be handled as unusual revenue to Commonwealth, and Commonwealth should pay taxes on the company fee on all that unusual revenue, presumably at 21% so about $17 million. Until Commonwealth and its proprietor have that type of cash able to ship to the IRS, the chances are most likely fairly excessive that will probably be deducted from the segregated accounts earlier than cash is returned to purchasers.

In different phrases, what stays after this failed 501(c)(15) willpower letter utility is a large tax mess, about like what one would count on the category of fifth graders to finish up with.

My guess is that the information relating to Commonwealth is simply starting, so keep tuned.