What this means is found in Attachment 1 to the announcement, which is entitled "Micro-Captive Insurance Resolution Terms". Among other terms, 90% of the deductions taken for payments to the captive will be disallowed, which means that a captive owner can only take a 10% deduction. Then, captive owners who have not previously participated in another tax shelter (a/k/a "reportable transaction") will pay a 5% accuracy-related penalty, and captive owners who have previously participated in a tax shelter will pay a 10% accuracy-related penalty.
Under the global settlement there is a chance, however, for an 831(b) captive owner to avoid 5% of penalties if the captive owner can show good faith reliance — which means that the owner relied upon the advice of an independent tax adviser that the particular 831(b) arrangement was kosher, even if it turned out not to be. To get this additional 5% reduction, however, the tax adviser must sign a declaration on a form to be provided by the IRS.
Moreover, if the 831(b) captive was used as an estate planning tool, the benefits of the structure go away as taxpayers are required to either file gift tax returns and pay gift taxes, or use some of their lifetime gifting credit for the amount of the transfers made to the captive.
One key thing to note is that if this settlement offer is accepted, the captive must immediately shut down and liquidate (if it has not done so already), which of course will have the result of the captive owner having to pay whatever taxes arise upon liquidation; alternatively, captive owners could take a qualified distribution. This means that in addition to losing 90% of their deductions and paying penalties, the captive owner will now have to pay whatever taxes were due upon liquidation or the making of the qualified distribution -- these amounts would ultimately have been owed anyway somewhere down the road, but the captive owner will now almost certainly have to take them for the same tax year as the liquidation.
One significant advantage for 831(b) captive owners is that they do avoid the very significant risk of double-taxation, which was that the IRS both disallowed the deductions taken for insurance payments made by the operating business to the captive, and then also treated the money received by the captive as income, which was a very nasty double-whammy. It is because of this risk, and that of being hit with the 40% penalty, that 831(b) captive owners must very strongly consider settling their cases if they qualify.
Very simply, this a great deal for 831(b) captive owners. Christmas came early this year. Take the deal if you are one of the lucky ones to whom the IRS extends this offer.
But note that if you are inclined to accept this offer, then be sure to seek truly independent tax counsel and do not attempt to use the folks who got you into the captive or else you put your ability to safely accept the offer in possible jeopardy. Also, because the captive has to be closed immediately, if it has not been closed already, then you will need to immediately start taking steps to terminate the arrangement. Sometimes, that will be easier said than done, particularly if you are in a "program" as opposed to owning your own standalone captive.
Notably, this "global" settlement offer doesn't extend to all 831(b) captives, but only those to whom the IRS deems worthy. Everybody else gets to fight it out in the U.S. Tax Court as before. Notably excluded from this offer is anybody already in the jurisdiction of the IRS Counsel's office, i.e., those already in the U.S. Tax Court: "Taxpayers who also have unresolved years under the jurisdiction of the IRS Appeals may also be eligible, but those with pending docketed years under Counsel’s jurisdiction are not eligible." So, if you are in the U.S. Tax Court already, this offer is not for you.
Nor does this offer apply to promoters, i.e., the captive managers, actuaries, etc., who facilitated these deals and who are facing enormous promoter penalties. So this is not by any stretch of the imagination the end of the story regarding abusive 831(b) captive insurance companies. We're going to reading about those folks for some time to come.
But it is the beginning of the end.