November 20, 2020

Internal Revenue Service Settlement Initiatives for Conservation Easement and Micro-Captive Insurance Transactions

By Patrick Mullin, Director, Tax & Business Services

Internal Revenue Service Settlement Initiatives for Conservation Easement and Micro-Captive Insurance Transactions Tax Advisory Services

The Internal Revenue Service (“IRS”) is providing settlement opportunities for taxpayers who have participated in syndicated conservation easement or micro-captive insurance transactions. They have viewed these transactions as abusive and have made it a priority to identify and audit taxpayers that have claimed tax benefits for participation in these transaction. The IRS has been very successful in Tax Court of late, and as a result, the Service is providing taxpayers a path to resolution that can reduce penalties and costs of litigation.

Syndicated Conservation Easements

The IRS chief counsel released a notice which contains information regarding a settlement initiative for certain pending Tax Court cases for taxpayers that participated in a syndicated conservation easement transaction.

While some promotors are attempting to distinguish their arrangements as different, or better, than the ones involved in the court cases, the IRS has many arguments for disallowing the tax benefits claimed in a conservation easement transaction. The IRS is encouraging taxpayers to seek competent, independent advice from an advisor experienced in and knowledgeable about these transactions who is not affiliated with or recommended by the transaction promoter.

The IRS has been very successful in litigating syndicated conservation easement transactions is coordinating with agents and chief counsel attorneys to identify cases for fraud possibilities and the possible imposition of a 75% civil fraud penalty or referrals to criminal investigation.

The settlement requires the concession of the tax benefits claimed and imposes penalties. The initiative will allow participants to deduct the cost of acquiring their partnership interest and will require a penalty of at least 10%. Promoters will not be allowed any deductions and must pay the maximum penalty, typically 40%.

Micro-Captive Insurance

The IRS will be sending settlement offers to taxpayers who participated in micro-captive insurance transactions with at least one open year under exam. Taxpayers who rejected the first settlement offer may be eligible, but with less favorable terms than the original settlement offer from the IRS. Taxpayers with unresolved years with the Office of Appeals may be eligible, but taxpayers with cases in Tax Court generally are not.

The settlement offer follows the initial round of settlement offers in 2019 after a number of IRS victories in Tax Court. The IRS is encouraging taxpayers to consult with an independent tax advisor knowledgeable about these transactions and to consider exiting these arrangements and not claiming the tax benefits.

The IRS continues to aggressively identify abusive captive arrangements and deny tax benefits claimed in these transactions. Because these transactions involve related parties, the tax increase can occur on both sides of the transaction. This can be the denial of a deduction to one entity and an increase in taxable income to the other. In addition to the tax increases, penalties are likely apply to both of the related entities as well. The total tax, penalties, and interest can approach or exceed the amounts invested in the micro-captive arrangement.

The settlement requires a substantial concession of the tax benefits claimed and imposes penalties that may be mitigated if the taxpayer meets certain criteria. Taxpayers that do not participate can expect to have a full disallowance of the tax benefits and the full imposition of all applicable penalties.

In both situations, participating taxpayers can expect to have the tax benefits reversed under audit. As the IRS ramps up its audit efforts in these areas, it may be a good time for participating taxpayers to seek independent advice and review these settlement options to determine if a settlement may be the best course of action.

Contact your Marcum professional with any questions or for further assistance.