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Captive Insurance Company Challenges Deficiencies, Penalties

OCT. 27, 2021

The People Series of Fortress Insurance LLC v. Commissioner

DATED OCT. 27, 2021
DOCUMENT ATTRIBUTES
  • Case Name
    The People Series of Fortress Insurance LLC v. Commissioner
  • Court
    United States Tax Court
  • Docket
    No. 28525-21
  • Cross-Reference

    Related petition.

  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Tax Analysts Document Number
    2021-42609
  • Tax Analysts Electronic Citation
    2021 TNTF 217-18

The People Series of Fortress Insurance LLC v. Commissioner

[Editor's Note:

The exhibits can be viewed in the PDF version of the document.

]

THE PEOPLE SERIES OF FORTRESS INSURANCE LLC,
Petitioner,
v.

COMMISSIONER OF INTERNAL REVENUE,
Respondent.

UNITED STATES TAX COURT

PETITION

Petitioner hereby petitions for a redetermination of the deficiencies and penalties determined by the Commissioner of Internal Revenue in his Notice of Deficiency dated August 12, 2021 for the tax years ending December 31, 2012, December 31, 2013, December 31, 2014, December 31, 2015, and December 31, 2016. As a basis for its case, petitioner alleges as follows:

1. Petitioner's place of incorporation is the State of Delaware.

2. Petitioner timely filed its Forms 1120-PC for the taxable year ended December 31, 2012, December 31, 2013, December 31, 2014, December 31, 2015, and December 31, 2016 (“years at issue”).

3. A Notice of Deficiency (a redacted copy of which is attached and marked as Exhibit A) was mailed to Petitioner on August 12, 2021 from Chicago, Illinois.

4. The proposed deficiencies and accuracy related penalties as determined are in the amounts, all of which are in dispute, as follows:

Tax Year Ended

Deficiency

Penalty (IRC 6662)

December 31, 2012

$397,105.00

$79,421.00

December 31, 2013

$407,042.00

$81,408.00

December 31, 2014

$243,336.00

$48,667.00

December 31, 2015

$244,842.00

$48,968.00

December 31, 2016

$254,266.00

$50,853.00

Respondent's Notice of Deficiency failed to include a copy of the written managerial approval for the determined penalties.

5. The determination set forth in the Notice of Deficiency is based upon the following errors:

a. Respondent erred in determining that the captive premiums received by Petitioner in the years at issue are not attributable to insurance transactions within the meaning of federal tax law.

b. Respondent erred in determining that Petitioner is not an insurance company for purposes of IRC §831(b).

c. Respondent erred in determining that Petitioner is not eligible for tax treatment under IRC §831(b).

d. Respondent erred in determining that the premiums paid to Petitioner in each of the years at issue are includible in income under IRC §61.

e. Respondent erroneously determined that the purported understatement of tax due for each year at issue is (a) attributable to negligence or disregard of rules and regulations, (b) a substantial understatement of income tax, or (c) is a substantial valuation overstatement.

6. Upon information and belief, the facts Petitioner relies upon as a basis for its case are as follows:

a. Petitioner, The People Series of Fortress Insurance LLC (“PSF” or “Petitioner”), is validly formed in the State of Delaware.

b. During the years at issue, the State of Delaware recognized PSF as an insurance company.

c. During the years at issue, the State of Delaware regulated PSF as an insurance company.

d. Artex Risk Solutions (“ARS”) was engaged to assist with the management and administrative operations of Petitioner.

e. ARS serves over 1,500 clients and manages more than 1,000 captive insurance companies, cells, and programs.

f. ARS has more than 30 years of experience as an insurance manager.

g. Arthur J. Gallagher & Co. (“Gallagher”) owns ARS.

h. Gallagher is recognized as a global leader in insurance, risk management, and consulting services.

i. Founded in 1927, Gallagher has almost 100 years of experience in the insurance and risk management fields.

j. Gallagher has been named one of the World's Most Ethical Companies for ten consecutive years.

k. During the years at issue, Timberline Fisheries Corp. (“Timberline”) purchased insurance from PSF.

l. Timberline sells among other products live pet food to retail locations, zoos, and hobbyists.

m. Timberline sells a premium Vita-bug product line to meet the nutritional requirements for various insect eating animals.

n. Timberline operates a bio-secure closed farm.

o. Timberline's product line also includes milled products that are processed at a plant that requires that no hormones or chemicals be present in order to protect its clients' animals.

p. Timberline delivers its customers' orders on a next day basis and provides 100% satisfaction guarantee.

q. Timberline's business of supplying live pet food necessitates encountering and overcoming unique insurable risks.

r. As part of its business, Timberline purchased insurance from Petitioner to protect Timberline from these unique risks.

s. Timberline earns approximately 70% of all revenue from two national customers.

t. The loss of one or both of these customers, or the bankruptcy of one or both customers, would financially devastate Timberline and threaten Timberline's continued operations.

u. Timberline bases its annual capital expansions upon the retention of both national customers.

v. PSF provided a loss of key customer policy insurance policy to Timberline to protect Timberline from the loss of either of Timberline's two national customers.

w. Due to the nature of Timberline's business, Timberline's employees endure difficult working conditions.

x. Despite employing best practices, Timberline suffers from a high employee turnover rate.

y. This high turnover rate increases Timberline's exposure to actions from government agencies such as the EEOC and OSHA as well as the risks associated with the ADA and HIPPA compliance.

z. PSF provided an administrative actions policy to Timberline to protect Timberline against actions related to governmental agencies.

aa. Due to the previously referenced business risks, Timberline faces enhanced litigation risks from its customers, current and former employees, and governmental agencies.

bb. PSF provided a legal expense policy to Timberline to protect the company from legal actions and the associated expenses.

cc. Timberline's unique market position and product necessitates employing highly specialized employees with a deep understanding of the unique business processes and risks.

dd. Timberline also entrusts its highly specialized employees with unfettered access to Timberline's proprietary systems and processes.

ee. The loss of highly specialized employees results in disruption to Timberline's business and financial operations.

ff. PSF provided loss of key employee policy to Timberline to protect Timberline against the loss of any key employees.

gg. Due to the size and scope of Timberline's operations, the company relies upon mechanical equipment to grow and distribute live pet food to customers.

hh. The growing environment used by Timberline must be temperature controlled within a narrow tolerance.

ii. A mechanical breakdown could potentially devastate Timberline's business and inventory.

jj. PSF provided a mechanical breakdown — difference in conditions policy to Timberline to protect Timberline against mechanical breakdowns.

kk. Timberline's business is based in Southern Illinois.

ll. Southern Illinois lies within the 150-mile long fault line known as the New Madrid Seismic Zone.

mm. Southern Illinois also lies within the Wabash Valley Seismic Zone.

nn. A 5.4 magnitude earthquake with an epicenter near Dale, Illinois occurred in 1968.

oo. In 2008, a 5.4 magnitude earthquake with an epicenter near West Salem and Mount Carmel, Illinois occurred.

pp. Since 1974, more than 4,000 earthquakes have been recorded in the seismic area around Timberline's business.

qq. Timberline purchased commercial insurance includes earthquake coverage.

rr. The commercial coverage requires a 10% deductible which could exceed $1,000,000 in the event of an earthquake.

ss. PSF provided a property deductible/SIR reimbursement policy to Timberline to protect Timberline against earthquakes and the high deductible required by Timberline's commercial insurance coverage.

tt. Timberline's commercial insurance policies exclude coverage for among other things, biohazards, temperature changes, and disease.

uu. PSF provided a difference in conditions policy to Timberline to protect Timberline from loss of inventory due to biohazards, temperature changes, and disease.

vv. PSF was formed under the insurance laws of the State of Delaware.

ww. PSF made a timely election with respondent under IRC section 831(b).

xx. The Delaware Department of Insurance recognizes PSF as being validly formed and operated.

yy. The Delaware Department of Insurance licensed PSF to operate as an insurance company during the years at issue.

zz. The Delaware Department of Insurance approved the lines of insurance coverage written by PSF and sold to Timberline.

aaa. The Delaware Department of Insurance approved the premiums for insurance written by PSF.

bbb. At all times, PSF met the solvency requirements of the Delaware Department of Insurance.

ccc. The Delaware Department of Insurance annually audited PSF.

ddd. The Delaware Department of Insurance reviewed and approved the draft policy forms used by PSF to issue insurance to Timberline.

eee. Artex employed an actuary to determine the insurance premiums charged by PSF.

fff. As previously described, PSF issued insurance policies to Timberline.

ggg. PSF issued written insurance policies to Timberline.

hhh. The insurance policies written by PSF were valid and binding on PSF and Timberline.

iii. The insurance coverages written by PSF involve insurance risk.

jjj. The captive insurance arrangement shifted risk from Timberline to PSF.

kkk. The agreements among PSF, Timberline, Artex, and Artex's risk pooling entities distributed risk.

lll. The arrangements between PSF and Timberline meet commonly accepted notions of insurance.

mmm. PSF operated as an insurance company at all relevant times.

nnn. PSF satisfied the Delaware Department of Insurance's laws and regulations.

ooo. The captive policies at issue are insurance for purposes of Delaware's insurance code.

ppp. The insurance premiums paid by Timberline to PSF for the years at issue were reasonable.

qqq. The insurance premiums paid by Timberline to PSF for the years at issue were actuarily determined.

rrr. The insurance transactions entered into for the years at issue had economic substance.

sss. The substance of the captive insurance transactions comported with the form of the transactions.

ttt. PSF and Timberline's primary motivations for entering into the insurance arrangements were for non-tax reasons.

uuu. Timberline entered into the insurance arrangements to insure previously uninsured or underinsured risks faced by Timberline.

vvv. In the alternative, to the extent the premium payments received by PSF does not constitute insurance premium for federal income tax purposes, the payments at issue are properly classified as contributions to capital.

www. Petitioner's income tax returns at issue are correct as filed with Respondent.

xxx. Both Petitioner and Timberline employed financial and tax professionals to review and approve the transactions at issue.

yyy. Petitioner cooperated with respondent's requests for information and documentation made during the audit.

zzz. Petitioner acted in good faith and made a reasonable attempt to comply with the provisions of the Internal Revenue Code.

aaaa. Petitioner was not negligent and did not disregard applicable rules and regulations.

bbbb. Petitioner kept proper books and records.

cccc. Petitioner substantiated the items claimed on petitioner's tax returns.

dddd. Petitioner relied in good faith upon professional advice.

eeee. Petitioner's reliance on professionals' advice was reasonable

ffff. Petitioner's advisers were competent tax professionals.

gggg. Petitioner provided all necessary and accurate information to its professionals.

hhhh. Petitioner is not subject to the accuracy related penalties as determined under I.R.C. §6662.

iiii. Respondent failed to secure written managerial approval prior to asserting a penalty against petitioner.

WHEREFORE, Petitioners pray that this Court may try this case and find that there are no deficiencies and penalties due from Petitioner for the years at issue.

DATED this 25 day of October 2021.

DEREK W. KACZMAREK
Tax Court Bar No. KD0414
derek@kjtaxlaw.com

DAVID R. JOJOLA
Tax Court Bar No. JD0175
dave@kjtaxlaw.com
Kaczmarek & Jojola PLLC
10229 N. 92nd Street, Suite 103
Scottsdale, AZ 85258
(602) 899-6200

Counsel for Petitioners

DOCUMENT ATTRIBUTES
  • Case Name
    The People Series of Fortress Insurance LLC v. Commissioner
  • Court
    United States Tax Court
  • Docket
    No. 28525-21
  • Cross-Reference

    Related petition.

  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Tax Analysts Document Number
    2021-42609
  • Tax Analysts Electronic Citation
    2021 TNTF 217-18
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