Terence J. Keating & Janet D. Keating

Related Cases

                             United States Tax Court
    
                                            T.C. Memo. 2024-2
    
          TERENCE J. KEATING AND JANET D. KEATING, ET AL., 1
                             Petitioners
    
                                                         v.
    
                     COMMISSIONER OF INTERNAL REVENUE,
                                 Respondent
    
                                                  —————
    
    Docket Nos. 15066-18, 15067-18,                                            Filed January 4, 2024.
                15068-18.
    
                                                  —————
    
    Kacie N.C. Dillon, Jonathan A. Halmi, and Tim Alan Tarter, for
    petitioners.
    
    Andrea M. Faldermeyer, Estevan D. Fernandez, Marco Franco, John
    Robert Gordon, Erin Kathleen Salel, and Emerald G. Smith, for
    respondent.
    
                                       TABLE OF CONTENTS
    
    MEMORANDUM FINDINGS OF FACT AND OPINION ..................... 4
    
    FINDINGS OF FACT .............................................................................. 6
    
    I.    RMS ................................................................................................... 6
    
          A.     Background ............................................................................... 6
    
          B.     Petitioners’ Roles at RMS ......................................................... 7
    
    II.   Commercial Insurance Coverage ..................................................... 8
    
    
    
           1 Cases of the following petitioners are consolidated herewith: Cheryl L. Doss,
    
    Docket No. 15067-18; and Arthur D. Candland and Michelle M. Candland, Docket No.
    15068-18.
    
    
    
                                             Served 01/04/24
                                                         2
    
    [*2] A.      Contractual Insurance Obligations .......................................... 8
    
          B.     Commercial Insurance Policies ................................................ 8
    
                 1.     Background ........................................................................ 8
    
                 2.     Workers’ Compensation Policies ....................................... 9
    
                 3.     Mr. Hill’s Brokering Efforts .............................................. 9
    
                 4.     Commercial Policies in Effect During the Years at
                        Issue ................................................................................. 10
    
    III. Captive Insurance Program ........................................................... 13
    
          A.     Background ............................................................................. 13
    
          B.     Formation of Captive Insurance Program ............................. 14
    
          C.     Captive Owner Operations Manual ....................................... 15
    
          D.     Structure of Captive Insurance Program ............................... 17
    
          E.     Captive Policies ....................................................................... 19
    
                 1.     Coverages, Policy Limits, and Premium Amounts......... 19
    
                 2.     Coverage Selection and Policy Terms ............................. 26
    
          F.     Operations and Practices ........................................................ 27
    
                 1.     Transaction Documentation Practices............................ 27
    
                 2.     Underwriting Process, Premium Determination, and
                        Premium Payments ......................................................... 29
    
                 3.     Claims Handling .............................................................. 32
    
                 4.     Related-Party Loans and Payments ............................... 37
    
                 5.     Risk Retention ................................................................. 41
    
                 6.     Capitalization of Provincial and Provincial Pool............ 42
    
    IV. Dividends ........................................................................................ 43
                                                         3
    
    [*3]
    V. Sale of RMS..................................................................................... 43
    
    VI. Tax Reporting ................................................................................. 43
    
          A.     RMS ......................................................................................... 43
    
                 1.     2012 .................................................................................. 44
    
                 2.     2013 .................................................................................. 44
    
                 3.     2014 .................................................................................. 44
    
          B.     Risk Retention ......................................................................... 44
    
          C.     Petitioners ............................................................................... 45
    
    OPINION ................................................................................................ 45
    
    I.    Evidentiary Matters ....................................................................... 45
    
    II.   Jurisdiction and Burden of Proof ................................................... 46
    
    III. Credibility and Fact-Finding ......................................................... 48
    
    IV. Microcaptive Arrangement ............................................................ 50
    
          A.     Whether the Arrangement Is Insurance ................................ 51
    
                 1.     Commonly Accepted Notions of Insurance ..................... 53
    
                 2.     Conclusion ........................................................................ 64
    
          B.     Effect on Petitioners................................................................ 64
    
                 1.     Section 162 ....................................................................... 64
    
                 2.     Section 165 ....................................................................... 66
    
                 3.     Dividends ......................................................................... 70
    
    V.    Accuracy-Related Penalties............................................................ 73
                                                 4
    
    [*4]     MEMORANDUM FINDINGS OF FACT AND OPINION
    
           MARVEL, Judge: During the years 2012–14 (years at issue),
    petitioners Terence J. Keating, Cheryl L. Doss, and Arthur D.
    Candland 2 were shareholders of Risk Management Strategies, Inc.
    (RMS), an S corporation in the business of acting as a sole employer for
    its clients, which were primarily banks administering special needs
    trusts. 3 RMS assumed the employer liability resulting from the
    employment of caregivers who worked for special needs trusts, handled
    payroll, and generally carried out the responsibilities of being an
    employer to caregivers and other employees that would have otherwise
    fallen on its clients. For each year at issue RMS reported incurring
    approximately $1.2 million of expenses for purported insurance
    coverage provided through an arrangement among its affiliated captive
    insurance company, Risk Retention, Ltd. (Risk Retention), and other
    entities.
    
          Respondent contends, among other things, that this arrangement
    did not actually provide insurance and that petitioners cannot deduct
    the amounts that RMS paid for the purported insurance and related fees
    nor take advantage of a preferential rate for dividends paid by Risk
    Retention. Respondent also contends that petitioners are liable for
    accuracy-related penalties. Petitioners disagree, arguing that the
    deductions and preferential dividend rate were proper because the
    arrangement provided insurance. They also assert a reasonable-cause-
    and-good-faith defense to the accuracy-related penalties. We agree with
    respondent that the challenged deductions and preferential dividend
    rate were improper and that accuracy-related penalties are appropriate.
    
           On May 11, 2018, respondent determined deficiencies in
    petitioners’ federal income tax and accuracy-related penalties under
    section 6662(a) 4 as follows:
    
    
    
             2 Petitioners Janet D. Keating and Michelle M. Candland had no involvement
    
    in the transactions at issue in these cases, and we do not discuss them further.
            3 In addition, some of its employees provided services to grantor trusts, family
    
    offices, and other entities.
            4 Unless otherwise indicated, statutory references are to the Internal Revenue
    
    Code, Title 26 U.S.C. (Code), in effect at all relevant times, regulation references are
    to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times,
    and Rule references are to the Tax Court Rules of Practice and Procedure. Some
    monetary amounts have been rounded to the nearest dollar.
                                        5
    
    [*5] Docket No. 15066-18—Terence J. Keating and Janet D. Keating
    
              Year                  Deficiency            § 6662(a) Penalty
    
              2012                   $274,039                 $54,808
    
              2013                   244,578                   48,916
    
              2014                   317,682                   63,536
    
    
    
    
    Docket No. 15067-18—Cheryl L. Doss
    
              Year                  Deficiency            § 6662(a) Penalty
    
              2012                   $18,039                   $3,608
    
              2013                    21,299                   4,260
    
              2014                    21,510                   4,302
    
    
    
    
    Docket No. 15068-18—Arthur D. Candland and Michelle M. Candland
    
              Year                  Deficiency            § 6662(a) Penalty
    
              2012                   $287,535                 $57,507
    
              2013                   244,578                   48,916
    
              2014                   312,275                   62,455
    
    
    
    
          Petitioners timely filed Petitions in these cases on August 2, 2018,
    contesting respondent’s determinations. These cases were consolidated
    pursuant to Rule 141 for purposes of trial, briefing, and opinion.
    
          The issues for decision are (1) whether transactions conducted
    through a purported microcaptive insurance arrangement among RMS,
    Risk Retention, and other entities during the years at issue constitute
    insurance for federal income tax purposes; (2) whether expenses RMS
    incurred during the years at issue (a) through the purported
                                              6
    
    [*6] microcaptive insurance arrangement or (b) to Artex Risk Solutions,
    Inc. (Artex), or PRS Insurance (PRS) for services rendered in connection
    with the arrangement constitute ordinary and necessary business
    expenses deductible under section 162; (3) if not, whether any of those
    expenses are deductible as losses under section 165; (4) whether
    dividends paid by Risk Retention to Mr. Keating and Mr. Candland in
    their 2012 and 2014 taxable years are qualified dividends or ordinary
    dividends; and (5) whether petitioners are liable for accuracy-related
    penalties imposed under section 6662(a) for the years at issue. We also
    address deferred evidentiary rulings.
    
                                 FINDINGS OF FACT
    
           Some of the facts have been stipulated and are so found. The
    First, Second, Third, and Fourth Stipulations of Facts and the
    accompanying Exhibits are incorporated herein by this reference.
    Petitioners resided in California when they filed their Petitions. 5 Use
    of the terms “insurance,” “insurer,” “insured,” “policy,” “premium,”
    “claim,” “reinsurance,” “reinsurer,” and other insurance-related terms in
    this Opinion replicate the terminology used by the parties throughout
    the litigation and do not imply that we have determined that any
    financial arrangement constitutes insurance, or that any company is an
    insurance company, as a matter of fact or law for federal income tax
    purposes.
    
    I.     RMS
    
           A.      Background
    
           Mr. Keating and Mr. Candland incorporated RMS, also known as
    Trust Employee Administration & Management or TEAM, in 2003. At
    the time of incorporation, they split RMS’s ownership evenly, with each
    owning 50% of RMS’s stock.
    
           RMS’s primary business was the employment, administration,
    and management of service providers for the benefit of trusts.
    Specifically, RMS acted as the sole employer for caregivers, guardians,
    case managers, household staff, and others who provided services for
    special needs trusts, grantor trusts, family offices, and other entities.
    Most of RMS’s employees provided services to special needs trust
    beneficiaries. RMS contracted its services primarily to national banks,
    
           5 Unless otherwise agreed by the parties in writing, venue for an appeal is the
    
    U.S. Court of Appeals for the Ninth Circuit. See § 7482(b)(1)(A).
                                       7
    
    [*7] and specifically to their wealth management and private banking
    departments. RMS also provided payroll and human resources services,
    benefits administration, and legal consultation.
    
            RMS had contracts with its bank clients in their capacities as
    trustees. Pursuant to these contracts, the parties agreed that it was
    their “mutual intention” that “RMS shall do all acts necessary to employ
    individuals who will be the employees of RMS . . . and that Trustee shall
    not in any manner be deemed to be the employer of such persons,
    whether in its corporate or fiduciary capacity.” The contracts also
    obligated RMS to secure and maintain “workers’ compensation benefits,
    unemployment insurance and the like,” as well as commercial general
    liability insurance. An exhibit to the contracts disclosed applicable
    service fees, including amounts for payroll taxes and insurance,
    amounts for benefits chosen and paid for by the trustee, and a monthly
    administrative fee.
    
           After the enactment of the Affordable Care Act, RMS had to offer
    health insurance coverage to its employees. RMS could not obtain a
    guaranteed-cost group health plan because many of its employees were
    parents of disabled trust beneficiaries. Instead, RMS formed a
    voluntary employees’ beneficiary association (VEBA) to provide health
    coverage to its employees and contracted with a stop-loss insurance
    carrier and a claims administrator.
    
          B.     Petitioners’ Roles at RMS
    
           In 2003 Mr. Candland and Mr. Keating recruited Ms. Doss to
    work at RMS. In 2005 or 2006 Mr. Candland and Mr. Keating gave Ms.
    Doss a 5% stake in RMS in the form of nonvoting stock in the
    corporation. She eventually became director of client services for RMS,
    a role she held during the years at issue.
    
           During the years at issue RMS was a California corporation and
    had a valid S corporation election in effect with the Internal Revenue
    Service (IRS) pursuant to section 1362. RMS was owned 47.5% by Mr.
    Keating, 47.5% by Mr. Candland, and 5% by Ms. Doss during the years
    at issue. Mr. Keating was president of RMS and oversaw operations,
    including managing payroll, human resources, and customer relations.
    Mr. Candland was the chief financial officer of RMS. Ms. Doss served
    as director of client services and assisted with onboarding new clients,
    paperwork completion, and dealing with the state agencies that licensed
    RMS.
                                             8
    
    [*8] RMS contracted with Charter Management Services, Inc.
    (Charter), a California corporation formed in November 2003 and owned
    by Mr. Keating, Mr. Candland, and Ms. Doss, during the years at issue
    to provide administration and management services to RMS and to
    serve as the employer of the staff handling the day-to-day operations of
    RMS. Charter handled payroll, human resources, and benefits and
    administration functions for RMS’s employees. Charter also had a legal
    department. Ms. Doss oversaw Charter’s employees, who included
    payroll specialists, human resources employees, and accountants.
    
    II.   Commercial Insurance Coverage
    
          A.      Contractual Insurance Obligations
    
           In its service contracts with its clients during the years at issue,
    RMS agreed that it would secure and maintain “workers’ compensation
    benefits, unemployment insurance and the like” and “commercial
    general liability insurance.” Specifically, RMS agreed that it would
    maintain at least the following coverages (with specified minimum
    policy limits): commercial general and professional liability, including
    personal injury; nonowned automobile liability; workers’ compensation
    and employer’s liability; employment practices liability insurance; and
    third-party fidelity coverage.      No other insurance coverage was
    specifically required by the contracts.
    
          B.      Commercial Insurance Policies
    
                  1.      Background
    
            During the years at issue RMS worked with BB&T, an insurance
    brokerage, to purchase insurance policies in the commercial
    marketplace. Specifically, Mr. Keating and Mr. Candland worked with
    John Hill and Geoff Shelton, insurance brokers at BB&T. Mr. Hill, a
    commercial property and casualty insurance broker at BB&T, is a
    certified insurance counselor and an accredited advisor of insurance. 6
    Mr. Hill acts as an intermediary between policyholders and insurance
    companies and assists with negotiating insurance coverages and
    managing insurance programs.
    
          Mr. Hill first met Mr. Candland and Mr. Keating when they asked
    Mr. Shelton to help with their insurance program sometime in the
    mid-2000s. Mr. Shelton then asked Mr. Hill to assist with RMS’s
    
          6 Mr. Hill testified only as a fact witness, however, not as an expert witness.
                                              9
    
    [*9] account. When Mr. Hill first started brokering insurance for RMS,
    it had a series of workers’ compensation policies through individual
    state insurance funds. 7 Mr. Hill was able to find one workers’
    compensation policy for RMS that replaced approximately 17
    independent state fund policies.
    
                   2.      Workers’ Compensation Policies
    
          From at least July 1, 2006, to July 1, 2008, RMS had a workers’
    compensation policy with the Employers Insurance Co. of Wausau
    (Wausau).     The Wausau workers’ compensation policy was a
    retrospectively rated policy. 8 Beginning in July 2008 and continuing
    through the years at issue, RMS had workers’ compensation insurance
    with Crum & Forster through United States Fire Insurance Co.
    Crum & Forster applied discounts to RMS’s workers’ compensation
    premiums for large deductibles, schedule modifications, and loss
    experience, among other items.
    
                   3.      Mr. Hill’s Brokering Efforts
    
           During the years at issue Mr. Hill sought insurance coverage for
    RMS in both the retail market and the wholesale market. 9 Mr. Hill is a
    retail broker. Retail brokers have a direct relationship with a
    policyholder and standard insurance companies but must engage with
    wholesale brokers to access the wholesale market. Mr. Hill provided
    RMS with marketing summaries, which summarized each insurance
    company approached for certain insurance coverages and the results of
    those efforts, annually throughout the years at issue. We discuss RMS’s
    commercial insurance policies immediately below.
    
    
    
    
          7 State insurance funds are insurance carriers of last resort when the private
    
    marketplace is unable or unwilling to provide the coverage.
           8 With a retrospectively rated policy, the insurance company collects a deposit
    
    premium, but at the end of the policy period it performs a calculation based on the
    number and cost of claims that occurred during the policy period. If claims are lower
    than anticipated, then the policyholder receives money back. If claims are higher than
    anticipated, then the policyholder shares the cost of those claims by paying additional
    sums to the insurance company. The deposit premium for the July 2006–July 2007
    Wausau policy was $728,303, and the deposit premium for the July 2007–July 2008
    Wausau policy was $729,307.
          9 We sometimes refer to policies obtained in either of these markets as
    
    commercial insurance policies.
                                               10
    
    [*10]           4.        Commercial Policies in Effect During the Years at
                              Issue
    
          RMS purchased the following commercial insurance policies that
    were in effect during the years at issue:
    
            Coverage Type          Insurer          Coverage Period      Premiums
                                                                         and Fees
    
                 Crime             Chubb             “2011-2012” 10      Unknown
    
                 Crime             Chubb            June 1, 2012, to          $3,644
                                                     June 1, 2013
    
                 Crime             Chubb             “2013-2014”               3,910
    
                 Crime             Chubb             “2014-2015”               4,447
    
            Cyber liability        Chubb          January 20, 2011,           39,308
                                                   to June 1, 2012
    
            Cyber liability       Lloyd’s of        June 1, 2012, to          25,614
                                   London            June 1, 2013
    
            Cyber liability       Lloyd’s of        June 1, 2013, to          18,628
                                   London            June 1, 2014
    
            Cyber liability       Lloyd’s of        June 1, 2014, to          21,113
                                   London            June 1, 2015
    
             Employment           Lloyd’s of        June 1, 2011, to          43,750
              practices        London through        June 1, 2012
               liability           Beazley
                                Insurance Co.,
                                     Inc.
    
    
    
    
            10 Only one crime policy for the years at issue (with a coverage period of June 1,
    
    2012, to June 1, 2013) is in the record. For the other three policies, the parties have
    stipulated that they had coverage periods of “2011-2012”, “2013-2014”, and “2014-
    2015”, respectively. The record does not provide any additional detail about what that
    means.
                                           11
    
    [*11] Coverage Type       Insurer           Coverage Period    Premiums
                                                                   and Fees
    
           Employment        Lloyd’s of         June 1, 2012, to       63,882
            practices     London through         June 1, 2013
             liability        Beazley
                           Insurance Co.,
                                Inc.
    
           Employment        Lloyd’s of         June 1, 2013, to       73,500
            practices     London through         June 1, 2014
            liability         Beazley
                           Insurance Co.,
                                Inc.
    
           Employment        Lloyd’s of         June 1, 2014, to       75,000
            practices     London through         June 1, 2015
             liability        Beazley
                           Insurance Co.,
                                Inc.
    
              Excess         Nautilus           June 1, 2011, to       31,617
             liability     Insurance Co.         June 1, 2012
    
              Excess         Nautilus           June 1, 2012, to       36,824
             liability     Insurance Co.         June 1, 2013
    
              Excess         Nautilus           June 1, 2013, to       37,475
             liability     Insurance Co.         June 1, 2014
    
              Excess         Nautilus           June 1, 2014, to       37,611
             liability     Insurance Co.         June 1, 2015
    
             General         Nautilus           June 1, 2011, to       12,047
             liability     Insurance Co.         June 1, 2012
    
             General         Nautilus           June 1, 2012, to       14,217
             liability     Insurance Co.         June 1, 2013
    
             General         Nautilus           June 1, 2013, to       14,601
             liability     Insurance Co.         June 1, 2014
    
             General         Nautilus           June 1, 2014, to       14,641
             liability     Insurance Co.         June 1, 2015
                                               12
    
    [*12] Coverage Type            Insurer          Coverage Period      Premiums
                                                                         and Fees
    
             Professional        Nautilus           June 1, 2011, to          51,812
               liability       Insurance Co.         June 1, 2012
    
             Professional        Nautilus           June 1, 2012, to          60,143
               liability       Insurance Co.         June 1, 2013
    
             Professional        Nautilus           June 1, 2013, to          61,471
               liability       Insurance Co.         June 1, 2014
    
             Professional        Nautilus           June 1, 2014, to          61,635
               liability       Insurance Co.         June 1, 2015
    
               Property          Greenwich          June 1, 2011, to           2,577
                               Insurance Co.         June 1, 2012
    
               Property          Greenwich          June 1, 2012, to           3,387
                               Insurance Co.         June 1, 2013
    
               Property          Greenwich          June 1, 2013, to           3,451
                               Insurance Co.         June 1, 2014
    
               Property          Greenwich          June 1, 2014, to           3,435
                               Insurance Co.         June 1, 2015.
    
               Workers’       Crum & Forster        July 1, 2011, to       536,590 11
             compensation     through United         July 1, 2012
                                States Fire
                               Insurance Co.
    
               Workers’       Crum & Forster        July 1, 2012, to       424,242 12
             compensation     through United         July 1, 2013
                                States Fire
                               Insurance Co.
    
    
    
    
            11 This figure is after the policy’s annual audit.   Before the annual audit, the
    total cost for the policy was $487,216.
           12 This figure is after the policy’s annual audit. Before the annual audit, the
    
    estimated annual cost for the policy was $378,734.
                                              13
    
    [*13] Coverage Type           Insurer          Coverage Period    Premiums
                                                                      and Fees
    
              Workers’       Crum & Forster        July 1, 2013, to      500,615 13
            compensation     through United         July 1, 2014
                               States Fire
                              Insurance Co.
    
              Workers’       Crum & Forster        July 1, 2014, to      563,334 14
            compensation     through United         July 1, 2015
                               States Fire
                              Insurance Co.
    
    
    
    
    III.   Captive Insurance Program
    
           A.      Background
    
           In addition to its commercial insurance, RMS was the insured on
    several purported insurance policies maintained through a captive
    insurance program 15 during the years at issue. RMS’s captive insurance
    program began in 2008. In an email exchange with an external auditor
    on June 18, 2012, Mr. Candland described the captive insurance
    program as “RMS self-insur[ing]” (emphasis added) workers’
    compensation claims although the scope of the captive program was not
    limited to policies relating to workers’ compensation. In a later email
    exchange with a potential buyer of RMS on October 24, 2012, Mr.
    Candland also described the captive insurance program as a vehicle for
    funding workers’ compensation and liability insurance deductibles and
    for covering esoteric risks that either could not be covered commercially
    or had such low risks that it made no sense to purchase them
    
    
    
    
             13 This figure is before the policy’s annual audit, unlike the figures for the
    
    2011–12 and 2012–13 policies. An October 16, 2014, email from a Crum & Forster
    representative to Mr. Candland referencing an attached audit statement for this policy
    is in the record, but the record does not disclose the results of the audit.
           14 This figure represents the estimated annual cost for the policy before the
    
    annual audit, unlike the figures for the 2011–12 and 2012–13 policies. The results of
    the annual audit are not in the record.
            15 We sometimes also refer to the captive insurance program interchangeably
    
    as the captive program, the captive arrangement, the microcaptive arrangement, the
    captive insurance arrangement, or the microcaptive insurance arrangement.
                                              14
    
    [*14] commercially. He explained that “[t]ypically we pay premium of
    just under $1[,]200,000 per year.”
    
            B.      Formation of Captive Insurance Program
    
           Mr. Candland had at least three discussions with Ken Kotch (Mr.
    Kotch), a vice president at Tribeca Strategic Advisors, LLC (Tribeca),
    from May to October 2008. Mr. Candland did not believe Mr. Kotch was
    qualified to discuss or underwrite insurance risks. Mr. Candland’s
    handwritten notes from these discussions focus on the topics of federal
    income taxation, fees, and formation of the captive insurer (including
    Anguillan 16 regulatory requirements), but none of the notes contain any
    description of insurance needed by RMS. Mr. Candland wrote down that
    “upon termination of the captive the funds return as capital gains” and
    referred to “[section] 831(b) captives” (i.e., microcaptive insurers), as
    well as to the fact that Mr. Kotch was “an . . . [attorney with] emphasis
    in taxation[.]” The notes also refer to IRS Revenue Rulings 2002-89,
    2002-90, and 2002-91 (concerning risk distribution for insurance
    companies) and to an IRS “safe harbor” for risk distribution. In addition,
    the notes reflect Mr. Candland’s understanding that $1.2 million was
    “the max[imum] we can put into [the] captive” insurer each year and
    that “of the funds deposited to the captive, 51% will go into [a risk pool]
    for 366 days [and] then be transferred to [the] captive. 49% will stay in
    [the] captive [and] we can invest [those funds].”
    
           Contemporaneously with these discussions, Tribeca prepared a
    feasibility study for RMS dated August 27, 2008. 17 According to the
    feasibility study, RMS was motivated to create the captive in part
    because it wanted “platinum-level coverage” and was willing to pay
    “platinum-level premiums” for that coverage. However, the feasibility
    study also stated that one of the advantages of forming a captive insurer
    was the elimination or reduction of certain costs that commercial
    insurers face and predicted that a captive insurer could generate
    expense savings of up to 35% of the costs of conventional insurance. The
    feasibility study contained financial forecast models for RMS that
    assumed RMS would have no direct insured claim losses, nor any claims
    against the risk pool (described below), for the first six years of
    
    
             Anguilla is an island of the British West Indies.
            16                                                            See Monahan v.
    Commissioner, 109 T.C. 235, 236 (1997).
            17 Two different versions of the feasibility study are in the record although the
    
    differences are immaterial for purposes of this discussion, and we refer to them as a
    single study.
                                               15
    
    [*15] operations. Instead, the models assumed that RMS would have
    annual pretax income of $2 million and pay annual captive insurance
    premiums of $1.2 million each year for six years and that the captive
    would provide RMS with a total net benefit of $3,279,823 over six years.
    This net benefit was derived from (1) savings on the amount of income
    taxes paid and (2) having greater assets available for investment in each
    year beginning with the second year because of the decrease in income
    taxes paid and a lack of claims. The models included no estimate of
    savings from commercial insurance expenses despite the study’s
    statement that such savings were potentially a significant advantage
    from using a captive insurer. The feasibility study identified policies
    that RMS never purchased, such as ones covering goodwill or identity
    protection, as among “the most likely to be incorporated into a new
    captive insurance program.” Conversely, the study omitted any mention
    of policies relating to workers’ compensation, which RMS did purchase.
    
           On October 31, 2008, Mr. Candland and Mr. Keating signed an
    engagement letter on behalf of RMS agreeing to pay Tribeca $40,000 to
    form a captive insurer, Risk Retention. 18 The feasibility study was
    submitted to Anguilla regulators as part of Risk Retention’s license
    application along with, inter alia, a business plan. The business plan
    states that Risk Retention would “underwrite highly customized policies
    carefully tailored to the specific needs of its insured,” but it also
    repeatedly refers to Risk Retention’s intended insured erroneously as
    “GTI” rather than RMS.
    
           Risk Retention was formed in November 2008. 19              On
    November 25, 2008, the Anguilla Financial Services Commission issued
    Risk Retention a Class B Insurance License following an application by
    Risk Retention. The Anguilla Financial Services Commission renewed
    the license for each of the years at issue.
    
            During the years at issue Risk Retention had no employees.
    
            C.      Captive Owner Operations Manual
    
         Tribeca provided a Captive Owner Operations Manual (Owners’
    Manual) to Mr. Candland and Mr. Keating on May 12, 2009. The
    
    
            18 Risk Retention is not a party to these cases.
    
             19 Risk Retention was initially capitalized with $100,000, and it maintained its
    
    $100,000 paid-in capital during the years at issue. Risk Retention had signed bylaws
    in effect as of November 24, 2008.
                                        16
    
    [*16] Owners’ Manual set out the responsibilities of the owner of a
    captive insurer and noted that while Tribeca managed a captive insurer,
    the owners of the captive insurer had ultimate decision-making
    authority.
    
           The Owners’ Manual stated that Tribeca could not properly
    underwrite captive insurance policies without a completed underwriting
    application for each insured. It also stated that captive owners should
    determine the amount of coverage and premiums for the next policy year
    before the end of the current policy year. Tribeca stated in the Owners’
    Manual that it required owners of captive insurers to notify it of any
    changes to the amount of premiums paid to the captive insurer for the
    current policy year by November 15 and that it “strongly recommends
    that premiums be paid during the policy period on a regular schedule,
    and not after the end of the policy period.” In particular, Tribeca stated
    that “[i]n traditional insurance companies, premiums are usually paid
    in monthly, quarterly or annual payments. Premiums are usually
    considered due either before the policy period begins or in equal
    installments during the policy period.” Tribeca stated that any premium
    payments due must be sent by December 31 of the coverage year and
    received by January 8 of the following year.
    
           Tribeca strongly discouraged owners of captive insurers from
    using their captive insurers to make loans, especially loans from the
    captive insurer to an insured or affiliated party. The Owners’ Manual
    stated that loans to related parties could increase the likelihood that the
    IRS would find that a captive insurer was a sham or that a circular flow
    of cash existed. For captive insurers that decided to make loans despite
    Tribeca’s advice, the Owners’ Manual advised that loans must be
    evidenced by a promissory note or other written document; must be
    enforceable; must contain commercially reasonable repayment terms
    and interest rates; should be secured; and must be repaid timely.
    Tribeca also stated that “it is critical that we receive full documentation
    on all transactions involving the Captive and that you notify us in
    advance regarding any proposed transaction . . . or movement of funds
    involving the Captive.” It advised owners of captive insurers to “strictly
    follow the policies of this manual” in view of legal authority taking into
    account all of the facts and circumstances in determining what
    constitutes insurance or an insurance company.
    
          Regarding claims handling, the Owners’ Manual stated that if an
    insured incurred a claim, it should notify Tribeca of the claim in writing.
    The Owners’ Manual also stated that Tribeca would provide the insured
                                             17
    
    [*17] with a claim form, that the insured would need to submit
    supporting documentation to substantiate the loss, and that the insured
    “should make a claim for any loss covered by insurance.”
    
           D.      Structure of Captive Insurance Program
    
            The purported captive insurance arrangement between Risk
    Retention and RMS did not primarily involve Risk Retention simply
    issuing insurance policies to RMS. Instead, two different general
    structures were used, one from 2008 to 2010 and the other from 2011 to
    2014. Both structures shared commonalities, including that Risk
    Retention participated in a risk pool with other captive insurers
    managed by Tribeca or, later, Artex. 20 However, the structures varied
    in other respects. We describe the structure used from 2008 to 2010 first
    because it forms the basis for our discussion of the structure later used
    during the years at issue. Except as otherwise indicated, our findings of
    fact in this subsection concern the structures set forth by the transaction
    documentation and do not address other relevant practices by the
    parties to the arrangement.
    
           From 2008 to 2010 RMS and other insureds of Tribeca-managed
    captive insurers participating in the risk pool purchased (1) a primary
    (or direct) layer of purported insurance coverage for each insured risk
    directly from their respective captive insurer and (2) an excess (or
    quota-share) layer of purported insurance coverage for each same risk
    from Procedant Insurance Co., Inc., a Nevada insurer that we do not
    discuss further, or Provincial Insurance, PCC (Provincial), a fronting
    insurer organized, licensed, and domiciled in Anguilla as of December
    2009. 21 Tribeca allocated the total net premiums received from each
    insured approximately 49% to the primary layer and approximately 51%
    to the excess layer. An agent, PRS, collected payment from the insured,
    
    
    
    
           20 Arthur J. Gallagher & Co., Inc. (Gallagher), an insurance brokerage and risk
    
    management services firm based in Illinois, acquired the assets of Tribeca in 2010.
    The acquisition was announced on December 21, 2010. While the record is unclear as
    to whether the acquisition had also closed by December 21, 2010, we generally refer to
    Artex rather than Tribeca with respect to events occurring after this date. After the
    acquisition, the operations formerly conducted by Tribeca continued out of its Mesa,
    Arizona, office under the direction of Gallagher’s wholly owned subsidiary, Artex.
           21 The record discloses that Provincial was organized in the British Virgin
    
    Islands as Provincial Insurance, Ltd, before its organization in Anguilla in
    December 2009.
                                            18
    
    [*18] retained a 2.5% administrative fee, and transmitted to the captive
    insurer and Provincial the net amounts owed to them.
    
           Considering the primary and excess layers of coverage and their
    policy limits together, the primary layer insured any covered loss up to
    25% of the combined policy limits, and the excess layer insured the
    portion of any loss exceeding the primary coverage, subject to a cap
    equal to 75% of the combined policy limits (sometimes described as “75%
    x/s 25%” or 75%-in-excess-of-25% coverage). Therefore, a smaller
    covered loss might be completely covered by the primary layer, while the
    excess layer applied to relatively larger covered losses and would pay
    out the lesser of (1) the portion of a loss exceeding the policy limits of the
    primary layer or (2) its own policy limit (which was triple the amount of
    the primary layer’s policy limit and therefore constituted 75% of the
    combined policy limits).
    
           Regarding the excess layer, Provincial ceded the risks and
    premiums from the excess layer (also known as quota-share risks and
    quota-share premiums, respectively) to each of the captive insurers
    participating in a risk pool. The risk pool was a purported reinsurance
    arrangement conducted pursuant to Master Reinsurance Contracts or
    Master Reinsurance Agreements (each also known as quota-share
    agreements). The risk pool is known as the Provincial Pool.
    
          Each captive insurer participating in the Provincial Pool,
    including Risk Retention, bore a fixed quota-share percentage of any loss
    covered by the excess coverage and was allotted the same quota-share
    percentage of the premiums allocated to the Provincial Pool. 22 A captive
    insurer later received from Provincial its quota share of the premiums
    remaining after reduction by its quota share of any claims allowed
    against the excess layer coverage. From at least 2009 to 2014 Risk
    Retention’s quota share of pool premiums was equal to the net premiums
    Provincial received from RMS for excess coverage. Therefore, if there
    were no allowed claims or other withheld amounts, 23 Risk Retention
    would receive the same amount from the Provincial Pool as RMS had
    paid Provincial for excess coverage (net of the 2.5% administrative fee).
    
    
    
           22 The quota-share percentage was calculated by computing the ratio of the
    
    premiums paid by a captive insurer’s related insured (here, RMS) for excess coverage
    to the total premiums received from all insureds by the Provincial Pool.
           23 As discussed below, there were eventually some allowed claims and withheld
    
    amounts.
                                       19
    
    [*19] The structure used from 2011 to 2014 retained this basic model
    with some modifications. First, Artex replaced Tribeca as manager of
    the captive insurers after the latter’s assets were acquired by the
    former’s parent company in December 2010.
    
           Second, insureds no longer purchased a primary layer of coverage
    directly from their affiliated captive insurer but instead purchased a so-
    called facultative layer of coverage from Provincial. Provincial then
    ceded the associated risks and premiums (sometimes called facultative
    risks and facultative premiums, respectively) to the affiliated captive
    insurer under Reinsurance Contracts (also known as Facultative
    Reinsurance Contracts or Facultative Reinsurance Agreements). Risk
    Retention remained responsible for all of the losses allowed under the
    facultative layer of coverage, albeit through a Facultative Reinsurance
    Contract or Agreement rather than by directly issuing insurance policies
    to RMS. Artex still allocated approximately 49% of total net premiums
    to Risk Retention for this coverage, and Provincial wired these
    premiums to Risk Retention within two weeks of receipt. Approximately
    51% of total net premiums remained allocable to the Provincial Pool.
    Finally, Artex made changes in its practices that we discuss further
    below.
    
          E.     Captive Policies
    
                 1.     Coverages, Policy Limits, and Premium Amounts
    
           We summarize RMS’s captive coverages, policy limits, and
    premium amounts for the years at issue here. The captive insurance
    policies for the years at issue were all claims-made policies, meaning
    that they applied only to claims reported during the coverage period or
    extended reporting period. The general terms and conditions common
    to all Provincial policies during the years at issue included a 45-day
    extended reporting period, among other terms. The policies in effect
    during the years at issue all had coverage periods running from
    January 1 to the following January 1.
    
           RMS paid premiums approximating $1.2 million for each year at
    issue. Below, we set forth charts outlining (1) RMS’s captive coverages
    and policy limits for the years at issue and (2) the premium amounts
    applicable to each coverage for the years at issue. Both in these charts
    and throughout the rest of this Opinion, we refer to the concept of a
    self-insured retention (SIR), which is a dollar amount specified in an
    insurance policy that must be paid by the insured before the insurance
                                              20
    
    [*20] policy will respond to a loss. SIRs generally operate slightly
    differently from deductibles, such as with respect to how they erode the
    policy limit or whether the insurer has an obligation for indemnity and
    defense costs before the deductible or SIR is paid, but they serve a
    similar overall function and purpose.
    
                          a.        2012
    
          The following chart shows the coverages and policy limits in the
    Risk Retention captive insurance program for 2012:
    
         Coverage       Self-Insured       Total Policy   Facultative    Pool Limit
                         Retention            Limit       Policy Limit
    
     Administrative      $250,000           $750,000          —              $750,000
     actions
    
     Employment                —             100,000       $100,000         —
     practices
     deductible / SIR
     reimbursement
    
     Legal expense             —            1,000,000       250,000           750,000
    
     Loss of key          250,000            750,000          —               750,000
     contract
    
     Loss of key               —            1,000,000       250,000           750,000
     customer
    
     Professional              —            1,000,000       250,000           750,000
     liability
     difference in
     conditions
    
     Worker’s [sic]            —             100,000        100,000         —
     compensation
     deductible / SIR
     reimbursement
    
      Total              $500,000          $4,700,000      $950,000        $3,750,000
                                            21
    
    [*21] The following chart shows the premium amounts applicable to
    these coverages for 2012:
    
        Coverage        Gross       Administrative      Net       Facultative     Pool
                       Premium          Fee          Premium       Premium      Premium
    
    Administrative     $157,281        $3,932        $153,349         —         $153,349
    actions
    
    Employment          145,500         3,638         141,862      $141,862       —
    practices
    deductible / SIR
    reimbursement
    
    Legal expense       175,051         4,376         170,675       83,631        87,044
    
    Loss of key         167,340         4,184         163,156         —          163,156
    contract
    
    Loss of key         194,294         4,857         189,437       92,824        96,613
    customer
    
    Professional        183,723         4,593         179,130       87,774        91,356
    liability
    difference in
    conditions
    
    Worker’s            167,500         4,188         163,312      163,312        —
    compensation
    deductible / SIR
    reimbursement
    
     Total             $1,190,689      $29,768       $1,160,921   $569,403      $591,518
                                               22
    
    [*22]                  b.        2013
    
          The following chart shows the coverages and policy limits in the
    Risk Retention captive insurance program for 2013:
    
         Coverage        Self-Insured       Total Policy   Facultative    Pool Limit
                          Retention            Limit       Policy Limit
    
     Administrative       $250,000           $750,000          —              $750,000
     actions
    
     Employment                 —             100,000       $100,000         —
     practices
     deductible / SIR
     reimbursement
    
     General liability          —             50,000         50,000          —
     deductible / SIR
     reimbursement
    
     Legal expense              —            1,000,000       250,000           750,000
    
     Loss of key           250,000            750,000          —               750,000
     contract
    
     Loss of key           250,000            750,000          —               750,000
     customer
    
     Professional               —            1,000,000       250,000           750,000
     liability
     difference in
     conditions
    
     Worker’s                   —             100,000        100,000         —
     compensation
     deductible / SIR
     reimbursement
    
      Total               $750,000          $4,500,000      $750,000        $3,750,000
                                             23
    
    [*23] The following chart shows the premium amounts applicable to
    these coverages for 2013:
    
        Coverage         Gross       Administrative      Net       Facultative     Pool
                        Premium          Fee          Premium       Premium      Premium
    
    Administrative      $137,699        $3,442        $134,257         —         $134,257
    actions
    
    Employment           159,500         3,988         155,512      $155,512       —
    practices
    deductible / SIR
    reimbursement
    
    General liability     89,000         2,225          86,775       86,775        —
    deductible / SIR
    reimbursement
    
    Legal expense        171,287         4,282         167,005       81,832        85,173
    
    Loss of key          146,506         3,663         142,843         —          142,843
    contract
    
    Loss of key          158,715         3,968         154,747         —          154,747
    customer
    
    Professional         179,773         4,494         175,279       85,887        89,392
    liability
    difference in
    conditions
    
    Worker’s             181,500         4,538         176,962      176,962        —
    compensation
    deductible / SIR
    reimbursement
    
     Total              $1,223,980      $30,600       $1,193,380   $586,968      $606,412
                                               24
    
    [*24]                  c.        2014
    
          The following chart shows the coverages and policy limits in the
    Risk Retention captive insurance program for 2014:
    
         Coverage        Self-Insured       Total Policy   Facultative    Pool Limit
                          Retention            Limit       Policy Limit
    
     Administrative       $250,000           $750,000          —              $750,000
     actions
    
     Employment                 —             400,000        400,000         —
     practices
     deductible / SIR
     reimbursement
    
     General liability          —             100,000        100,000         —
     deductible / SIR
     reimbursement
    
     Legal expense         250,000            750,000          —               750,000
    
     Loss of key           250,000            750,000          —               750,000
     contract
    
     Professional               —            1,000,000       250,000           750,000
     liability
     difference in
     conditions
    
     Regulatory            250,000            750,000          —               750,000
     change
    
     Worker’s              100,000           1,000,000      1,000,000        —
     compensation
     deductible / SIR
     reimbursement
    
      Total              $1,100,000         $5,500,000     $1,750,000       $3,750,000
                                              25
    
    [*25] The following chart shows the premium amounts applicable to
    these coverages for 2014:
    
         Coverage         Gross       Administrative      Net       Facultative     Pool
                         Premium          Fee          Premium       Premium      Premium
    
     Administrative      $118,923        $2,973        $115,950         —         $115,950
     actions
    
     Employment           159,500         3,988         155,512      155,512        —
     practices
     deductible / SIR
     reimbursement
    
     General liability     89,000         2,225          86,775       86,775        —
     deductible / SIR
     reimbursement
    
     Legal expense        134,851         3,371         131,480         —          131,480
    
     Loss of key          140,329         3,508         136,821         —          136,821
     contract
    
     Professional         157,290         3,932         153,358       75,145        78,213
     liability
     difference in
     conditions
    
     Regulatory           135,275         3,382         131,893         —          131,893
     change
    
     Worker’s             255,543         6,389         249,154      249,154        —
     compensation
     deductible / SIR
     reimbursement
    
      Total              $1,190,711      $29,768       $1,160,943   $566,586      $594,357
    
    
    
    
           As shown in the tables above, throughout the years at issue Artex
    increasingly allocated risks and premiums from individual RMS policies
    solely either (1) to the Provincial Pool (i.e., to pool premium and the pool
                                              26
    
    [*26] limit) or (2) to Risk Retention (i.e., to facultative premium and the
    facultative policy limit), and it increasingly used SIRs. 24
    
                   2.      Coverage Selection and Policy Terms
    
          Mr. Hill, RMS’s commercial insurance broker, did not shop for
    insurance policies covering administrative actions, loss of a key
    customer, or regulatory change because Mr. Candland never asked him
    to shop for these policies in the commercial marketplace. Mr. Hill did
    not know what administrative action or loss of key customer policies
    were. Mr. Candland did not direct Mr. Hill to seek out a zero-dollar
    deductible workers’ compensation policy in the commercial
    marketplace. 25
    
           During the years at issue the general terms and conditions
    common to all Provincial policies contained a number of coverage
    exclusions, including for claims that were the subject of any notice given
    under other insurance before the inception date of the policies; for claims
    based upon circumstances or events that any insured knew about before
    the policy period; for criminal, dishonest, or deliberately fraudulent acts,
    including sexual abuse or molestation or fraud of any insured; and for
    personal profit, remuneration, or advantage gained by any insured to
    which it was not legally entitled.
    
         We pause to discuss some terms and context regarding RMS’s
    Worker’s Compensation Deductible / SIR Reimbursement policy given
    
    
           24  In an email dated August 2, 2011, an Artex underwriter explained that
    deductible reimbursement policies were “no longer being insured through the pool.”
    However, without adjustment, reinsuring deductible reimbursement policies entirely
    with Risk Retention would have caused over 49% of Risk Retention’s premium volume
    to come from RMS and under 51% to come from reinsuring its quota-share percentage
    of the Provincial Pool. To address this perceived problem, Artex “needed to put 2 other
    policies 100% in the pool to achieve [the] 49%/51% split that the IRS likes to see for
    risk distribution.” For 2011 and 2012 the policies whose risks and premiums were
    allocated completely to the Provincial Pool were the Administrative Actions and Loss
    of Key Contract policies. This, however, could have exposed the Provincial Pool to
    small claims on those policies that previously would have been retained in the primary
    coverage layer. Therefore, in order “[t]o protect the pool in these instances,” Artex
    added a $250,000 SIR to each policy that “mimics the 25%/75% limit split the standard
    structure would have between the captive and the pool.”
            25 In fact, Mr. Candland emailed an Artex employee during the years at issue
    
    to inform him that RMS had raised its deductible from $100,000 to $250,000 on the
    Crum & Forster policy and stated: “This should make it easier to justify our $1,200,000
    captive contribution.”
                                       27
    
    [*27] its importance to the issues in these cases. This policy covered
    losses within the deductible or SIR of RMS’s commercial workers’
    compensation policy.
    
           Artex did not separately adjust underlying workers’
    compensation claims because RMS’s commercial carrier was responsible
    for the settlement of claims and then billed RMS for amounts within the
    deductible. Instead, RMS filed claims under its workers’ compensation
    policy with Crum & Forster, its commercial workers’ compensation
    insurance carrier. Crum & Forster adjusted each claim and invoiced
    RMS monthly for the deductible portion of any approved claims. When
    RMS received a monthly deductible billing invoice from
    Crum & Forster, Risk Retention paid it on RMS’s behalf by issuing a
    check to United States Fire Insurance Co., which received it on behalf of
    Crum & Forster. On one occasion during the years at issue, Mr.
    Candland raised the deductible on RMS’s commercial workers’
    compensation policies to “make it easier to justify our $1,200,000 captive
    contribution.”
    
          F.     Operations and Practices
    
           The operations and practices of RMS, Risk Retention, Provincial,
    Artex, and petitioners provide additional context to the transactions
    among them beyond what is evident from the transaction structure or
    captive policies alone. We describe those operations and practices that
    are relevant in this subsection.
    
                 1.     Transaction Documentation Practices
    
           The Master Reinsurance Contracts or Agreements, under which
    Provincial ceded risks and premiums to the captive insurers
    participating in the Provincial Pool, were not executed by the captive
    insurers participating in the Provincial Pool. Instead, Artex employees
    executed these contracts. In some cases, Karl Huish, a co-founder of
    Tribeca who remained involved with the business after the sale of
    Tribeca’s assets to Artex’s parent company, executed both sides of the
    same contract, including during the years at issue. In addition, both
    before and during the years at issue, policy documents were sometimes
    irregularly dated, and policy or coverage periods often began
    retroactively relative to policy issuance. We describe some of these
    occurrences during the years at issue below.
                                             28
    
    [*28]                  a.     2012
    
          RMS’s 2012 policy documents were not actually issued until
    May 24, 2012, 26 more than four months into the 2012 coverage period. 27
    Furthermore, on January 28, 2013, Artex prepared a Change
    Endorsement for RMS’s 2012 Worker’s Compensation Deductible / SIR
    Reimbursement policy with an effective date of January 1, 2013.
    
           The Change Endorsement stated that losses under the Worker’s
    Compensation Deductible / SIR Reimbursement policy would be paid
    either directly to RMS’s commercial insurer or to a collateral account
    held by the insurer unless otherwise directed by RMS. Nonetheless,
    Risk Retention had already begun paying RMS’s commercial insurer
    directly (rather than paying Provincial) in 2011.            The Change
    Endorsement is thus anomalous not only in its effectiveness on
    January 1, 2013, a date both before its execution and coinciding with the
    end of the applicable coverage period, but also in its late documentation
    of a payment practice that had already begun much earlier. 28
    
                           b.     2013 and 2014
    
           Beginning in 2013, Artex’s practice was to have Provincial issue
    policy documents only once a captive had paid at least 10% of its annual
    premiums. Artex finalized RMS’s 2013 and 2014 captive insurance
    policies only on June 19, 2013, and July 3, 2014, respectively, well into
    the applicable coverage periods. Even the essential terms of the policies
    were not always agreed upon before the beginning of each applicable
    coverage period. For example, Artex prepared a renewal policy
    summary for RMS’s 2013 captive insurance policies dated
    
    
            26 On February 1, 2012, Artex provided RMS with a renewal policy summary,
    
    describing the coverage period, coverage type, limits, SIR, premium, and policy
    number. Although an Artex underwriter testified that a policy summary is “like a
    binder,” we find that the renewal policy summary was on its face simply a summary of
    the intended policy issuance; that the record contains no credible contemporaneous
    evidence that it was intended to have any binding effect; and that the renewal of the
    policies was actually completed no earlier than May 24, 2012.
            27 RMS’s renewal endorsements during the years at issue refer to a renewal
    
    period rather than a coverage period. We refer to renewal periods as coverage periods
    throughout in order to avoid undue confusion.
           28 An Artex employee raised the issue that RMS’s Worker’s Compensation
    
    Deductible / SIR Reimbursement policy did not permit Risk Retention to pay RMS’s
    commercial insurer directly on January 17, 2013, 11 days before the Change
    Endorsement was executed on January 28, 2013.
                                             29
    
    [*29] January 23, 2013, and a revised renewal policy summary dated
    March 19, 2013, both after the 2013 coverage period was underway.
    Comparing the revised renewal policy summary to the original one,
    Artex (1) increased RMS’s 2013 gross premiums from $1,217,018
    to $1,223,980, (2) added a General Liability Deductible / SIR
    Reimbursement policy, and (3) either increased or decreased the
    premium amounts applicable to each of RMS’s other 2013 policies.
    
                   2.      Underwriting Process, Premium Determination, and
                           Premium Payments
    
           Mr. Candland provided Tribeca or Artex with the amount that he
    was willing to pay, and provided a target premium for all policies
    purchased by RMS, both before and during the years at issue. 29
    Regarding premium payments, Artex required only that RMS (1) pay its
    pool premiums and 2.5% administrative fee by December 31 of the
    applicable policy year and (2) pay its facultative premiums by the end of
    the first quarter of the following year.
    
           We now describe some additional practices of petitioners, RMS,
    Provincial, and Artex pertaining to the underwriting process, premium
    determination, and premium payments during the years at issue. We
    discuss these topics together because RMS generally decided how and
    when to pay its premiums, and Artex adapted its purported
    underwriting after the fact to accommodate its preferred payment
    amounts and schedule. We specifically find that petitioners, RMS,
    Provincial, or Artex (as applicable) engaged in the following practices
    related to underwriting, premium determination, and premium
    payments during the years at issue:
    
       •   The Provincial policies were not objectively rated by evaluating
           the risk and magnitude of loss on a prospective basis informed by
           detailed underwriting. The premiums that RMS paid for its
           captive coverages were inappropriately inflated by subjective,
           judgment-driven factors that made little sense under the
           circumstances here. The premiums were not supported by
    
    
    
    
           29 Mr. Candland claimed the opposite in a sworn interview with respondent in
    
    September 2015, stating that he told Tribeca he was interested in particular types of
    coverage rather than in paying a certain dollar amount of premiums. Mr. Candland
    changed his answers in this regard at trial.
                                               30
    
    [*30] actuarial analysis, 30 nor was Artex’s allocation of 49% of
          premiums to individual captives and 51% of premiums to the
          Provincial Pool.
    
        •   Insurance transactions, including premium pricing and premium
            payments, were completed after the fact even though in a typical
            insurance program they would be completed prospectively. Artex
            backdated policy changes and permitted the late issuance of
            insurance contracts and late premium payments.
    
        •   Artex did not obtain sufficient information from RMS to support
            the underwriting process.
    
        •   Artex placed undue weight in its purported underwriting on
            target premium figures provided by RMS without regard to
            whether the target premiums were supported by objective
            exposure information.
    
        •   Artex permitted its clients, including RMS, to alter their
            coverages or total premiums well into coverage periods in a
            manner that rendered clients’ decisions of whether to fund the
            policies and in what amount as essentially optional and
            retrospective, not binding and prospective.
    
        •   RMS and Mr. Candland sometimes requested premium increases
            to $1.2 million. 31
    
    
            30 The primary actuarial report Provincial relied on for pricing was prepared
    
    by James Rech (Mr. Rech), an actuary, in 2008. In it, Mr. Rech stated it was his opinion
    that “the rating methodology, pricing models, rating factors and rate parameters are
    reasonable.” Nonetheless, Mr. Rech did not opine on the ratings for any individual
    policies, and his report therefore does not constitute an actuarial endorsement of those
    premiums. Mr. Rech did not testify at trial, and Artex’s underwriters never
    documented how they derived rating factors.
             Mr. Rech’s analysis attempted to provide support for a “Captive Risk Factor,”
    which is not a typical rating factor used in the insurance industry. In his definition of
    this factor Mr. Rech implied that the adjustment was necessary because an additional
    premium is necessary for the first five or more years of a captive’s existence to be viable
    in the event of unusual losses. This is not a typical or industry standard adjustment
    made by actuaries and would not be a viable business methodology in the commercial
    market due to the competitive disadvantage created by excessive premiums.
            31 Mr. Candland also requested a premium decrease on one occasion if Artex
    
    did not permit RMS to pay a portion of its premiums after the coverage period. Artex
    ultimately relented and permitted the late payment, however.
                                              31
    
    [*31] •    RMS paid a disproportionate share of its captive premiums
               during the years at issue toward the end of, or after, each
               coverage period, and Artex acquiesced in this practice.
    
        •   The premiums RMS paid for coverage from Provincial were not
            reasonable compared to typical industry pricing. 32 RMS’s total
            premiums were always remarkably close to the $1.2 million limit
            for nontaxable premium income under section 831(b), regardless
            of any variation in coverage.
    
        •   Artex generally relied on existing information in its purported
            underwriting of RMS’s policies instead of requesting up-to-date
            information. Artex’s relatively small underwriting staff was
            ill-prepared to underwrite the many different types of policies
            that Artex provided.
    
        •   Artex caused Provincial to issue RMS’s policy documents well into
            the coverage periods that the policies purported to cover without
            binders in place.
    
        •   Provincial wired facultative premiums to Risk Retention within
            about two weeks of receipt.
    
        •   Provincial often released pool premiums to Risk Retention within
            a few weeks after RMS paid them.
    
        •   RMS and Artex did not consistently recognize RMS’s premium
            payments for the insurance written by Provincial as constituting
            separate amounts from the amounts that Provincial ostensibly
            paid to Risk Retention for (1) providing reinsurance to unrelated
            members of the Provincial Pool pursuant to Master Reinsurance
    
            32 For example, the average rate-on-line for RMS’s captive policies during the
    
    years at issue was more than ten times greater than the average rate-on-line for
    comparable commercial insurance policies, even though RMS did not have major issues
    with its existing commercial insurance coverage, or in obtaining the insurance
    required by its client contracts. A higher rate-on-line means that insurance coverage
    is more expensive per dollar of coverage and could therefore lead to a greater deduction
    for premiums. See Syzygy Ins. Co. v. Commissioner, T.C. Memo. 2019-34, at *31.
            The pricing for some individual policies did not make sense on its face. For
    example, the Employment Practices Deductible / SIR Reimbursement policy had
    premiums of $145,500 for 2011 and 2012 and $159,500 for 2013 but had a per-
    occurrence limit of $100,000. This cost does not make sense unless RMS anticipated
    multiple high-dollar claims per year (or a very large volume of small-dollar claims). In
    fact, however, RMS filed only one claim against the policy, for $3,452.
                                            32
    
    [*32] Contracts or Agreements or (2) providing reinsurance to
          Provincial pursuant to Facultative Reinsurance Contracts or
          Agreements. 33
    
                   3.     Claims Handling
    
           Artex’s director of underwriting, Deborah Inman, was involved
    with the claims process at Artex during the years at issue. Ms. Inman
    supervised the claims function at Artex until 2018. In March 2014 Artex
    hired a licensed claims adjuster. 34
    
          The general terms and conditions for all Provincial policies during
    the years at issue provided that if an insured incurred a claim, it was
    required to give Artex prompt notice of the claim. The general terms
    and conditions further stated that an insured was required to give Artex
    a description of the events and circumstances that led to the claim as
    soon as possible.
    
    
    
    
           33 For example, on November 4, 2013, Mr. Candland asked an Artex employee:
    
    “If I wire a captive premium, how long before you can turn the funds around and
    deposit [them] in [Risk Retention’s] bank account?” The employee told Mr. Candland
    that direct premiums were “returned” three to five business days after payment and
    that pool premiums were “returned” within ten business days. On December 3, 2013,
    Mr. Candland told that Artex employee that he would be wiring $300,000 for a captive
    insurance premium and instructed him to deposit the funds “back into” Risk
    Retention’s bank account. The employee responded that he would “make sure” that
    those funds ended up “back at” Risk Retention’s bank. On January 7, 2014, Mr.
    Candland asked the same employee for help in getting other premium payments
    “moved through the system and back” because “[t]he previous premium took one week
    to turn around and I had anticipated the same for this last payment.” Provincial
    transferred the direct premiums to Risk Retention that day.
           34 Before the hiring of a licensed claims adjuster, an underwriting assistant
    
    and Artex’s risk pool administrator assisted Ms. Inman with handling claims.
                                              33
    
    [*33]                   a.      RMS’s Claims
    
         Risk Retention paid claims filed by RMS in the following
    amounts:
    
                                    Year              Amount
    
                                    2008                 —
    
                                    2009                     $2,450
    
                                    2010                     34,354
    
                                    2011                  323,379
    
                                    2012                  231,455
    
                                    2013                  400,868
    
                                    2014                     81,094
    
    
    
    
          All paid claims filed by RMS under its 2012–14 captive policies
    were filed against its Worker’s Compensation Deductible / SIR
    Reimbursement policy. We make the following findings regarding the
    handling of RMS’s claims during the years at issue:
    
        •   RMS generally did not submit the deductible billing invoices or
            other claim documents it received from Crum & Forster to Artex
            before Risk Retention paid the deductibles billed, and it did not
            otherwise await approval from Artex. 35 Artex performed little
    
    
    
    
             35 Petitioners’ expert witness Michael Angelina opined that “since the
    
    [Worker’s Compensation Deductible / SIR Reimbursement] policy is a deductible
    reimbursement policy, there is no real need for Artex to ‘re-adjust’ a claim that has
    already been handled by the claims team of the commercial insurer (Crum & Forster).
    . . . While the approach to pay the claims in a ‘batch mode’ . . . was ‘not the norm’ for
    Artex, it was an approved process by Artex for these claims.” We reject as unsupported
    by the record any suggestion that Artex had no obligation to adjust claims for
    deductible or SIR amounts under RMS’s Worker’s Compensation Deductible / SIR
    Reimbursement policy simply because Crum & Forster had adjusted the underlying
                                              34
    
    [*34] timely review of these claims. It is not a typical practice in the
          insurance industry to approve a claim after it has already been
          paid.
    
       •   An objective coverage assessment could have resulted in a denial
           of most of RMS’s workers’ compensation deductible claims
           because the underlying losses had been previously reported
           before the inception of the applicable captive insurance policies.
    
       •   RMS sometimes notified Artex of claims after both the coverage
           period and the extended reporting period for a policy had lapsed.
           Risk Retention nonetheless issued payments for such claims.
    
       •   RMS used, and Artex acquiesced in the use of, board resolutions
           to authorize the payment of claims that should have been denied.
           RMS’s use of a board resolution to permit a settlement payment
           to Wausau, RMS’s former workers’ compensation carrier, under
           the Worker’s Compensation Deductible / SIR Reimbursement
           policy was intentionally misleading. 36
    
    
    workers’ compensation      claims   under   RMS’s    separate   commercial    workers’
    compensation policy.
            Even if Risk Retention had been permitted to pay RMS’s workers’
    compensation deductibles directly without any approval from Artex, this would be a
    major process deficiency because it allowed Risk Retention to pay claims that should
    not have been covered and to escape independent claims adjustment. There was a
    need for such claims adjustment to determine whether the deductibles charged by
    Crum & Forster were covered under the terms of each captive policy during the years
    at issue. For example, an objective coverage assessment could have resulted in a denial
    of most of RMS’s workers’ compensation deductible claims because the underlying
    losses had been previously reported before the inception of the applicable captive
    insurance policies.
           36 On May 10, 2012, Mr. Candland notified Artex that RMS had settled a
    dispute regarding 2007 workers’ compensation claims with its former workers’
    compensation carrier, Wausau. The Wausau claim arose from RMS’s nonpayment of
    disputed retrospective premium adjustments on its 2007–08 policy with Wausau; the
    retrospective adjustments were calculated on February 9, 2010, and January 31, 2011.
           Ms. Inman accurately enumerated several issues with the claim on
    May 11, 2012. First, according to Ms. Inman, Mr. Candland “wants to make payment
    from the captive for claims that occurred in 2006 & 2007 which is before the captive
    was formed so the captive didn’t have any policies in force during that time.” Second,
    he “had knowledge of these claims when he started his captive and any . . . [workers’
    compensation] policies that were written for him when the captive started. Claims of
    which the insured has prior knowledge are excluded.” Third, “[t]he claims would be
                                             35
    
    [*35] •   Risk Retention, a purported reinsurer, inappropriately paid
              certain workers’ compensation deductible claims directly to the
              commercial carrier instead of paying Provincial. The January
              28, 2013, Change Endorsement that Artex prepared for RMS’s
              2012 Worker’s Compensation Deductible / SIR Reimbursement
              policy provided belated approval at best for this practice.
    
                           b.     Provincial Pool Claims
    
           The Provincial Pool paid a single claim in 2011 of $8,274,
    representing about 0.016% of the $51,702,549 in pool premiums for that
    year. The Provincial Pool paid $210,615 on account of three claims in
    2012, which amounts to 0.324% of total pool premiums for 2012. In 2013
    the Provincial Pool paid $2,631,536 on account of nine claims, which
    amounts to 3.322% of total pool premiums for 2013. The Provincial Pool
    had paid $2,507,682 in pool claims for the 2014 policy year as of
    February 17, 2021. This amounts to 3.019% of total pool premiums
    for 2014.
    
          Risk Retention’s quota share of pool claims and loss adjustment
    expenses from 2012 to 2014, in dollars and as a percentage of pool
    premiums paid by RMS, was as follows:
    
               Year                     Quota Share               Quota Share as
                                                              Approximate Percentage
                                                             of Pool Premiums Paid by
                                                                        RMS
    
               2012                        $1,921                      0.325%
    
               2013                        20,209                      3.333%
    
               2014                        18,732                      3.152%
    
    
    
    considered as late reported even if they were covered by the 2008 policy.” Fourth,
    “[b]ecause Risk Retention is now and was in 2011 a reinsurer of Provincial instead of
    a direct insurer, claims should be authorized by and paid through Provincial instead
    of directly from the captive.”
           Nonetheless, Artex informed RMS that Risk Retention could pay Wausau if
    Risk Retention executed a board resolution authorizing the payment. On May 15,
    2012, Risk Retention passed a board resolution authorizing Risk Retention to pay
    Wausau (and a related insurer, Liberty Mutual) $235,000. On the same day, Ms.
    Inman signed a proof of claim form approving the claim, and Risk Retention wired
    $235,000 to Wausau.
                                             36
    
    [*36] We make the following findings regarding Artex and Provincial’s
    handling of claims in the Provincial Pool:
    
       •   The low ratio of losses to premiums in the Provincial Pool
           compared to the insurance industry as a whole contributed to
           nearly a full round trip of pool premiums paid by RMS to Risk
           Retention, through various entities managed by Artex.
    
       •   Artex added or altered policies for its clients retroactively in order
           to permit them to file claims against the Provincial Pool or to
           reduce their premiums if they were unable to pay in full.
    
       •   Artex did not consistently enforce the prior-knowledge
           limitation 37 when adjusting claims, or treat claims as uncovered
           because no coverage was in effect at the time of a loss, even
           though it should have. It also did not consistently enforce the
           requirement that a claim be promptly submitted after an insured
           learned about it.
    
       •   There was inappropriate overlap between the claims and
           underwriting functions at Artex. On one occasion, Ms. Inman
           backdated a policy document to a date that preceded her
           employment at Artex in order to facilitate a client’s filing of claims
           under a retroactively added policy. 38 The claims were ultimately
           paid.
    
       •   Artex permitted its clients to use board resolutions to obtain
           claims payment for claims that should have been denied.
    
       •   Artex encouraged the submission of pool claims during the years
           at issue in order to improve the public perception of the legitimacy
           of the Provincial Pool, regardless of whether those claims should
           have been denied.
    
       •   Artex required only slight documentation in support of some pool
           claims.
    
    
    
    
           37 The general terms and conditions to the captive policies excluded claims for
    
    which an insured had knowledge of a covered cause of loss before the coverage period.
           38 The client was Lanter Delivery Systems, Inc.
                                              37
    
    [*37]          4.      Related-Party Loans and Payments
    
           Before and during the years at issue, Risk Retention made loans
    to RMS to fund various business expenses of RMS and made other
    related-party payments. We describe those loans and payments here.
    
                           a.      Premium Finance Agreements
    
           Beginning in 2009 and continuing through the years at issue RMS
    executed eight premium finance agreements (PFAs) with Risk Retention
    in order to finance premiums on certain of RMS’s commercial insurance
    policies. 39 On August 19, 2009, Mr. Candland sent an email to an Artex
    employee explaining that “[i]n the past we have chosen to finance these
    premiums in an effort to cash flow the payment, rather than take an
    annual hit to our cash. Is there any legal reason why we can’t use some
    of our captive money and run the financing through our captive?” Mr.
    Candland also stated that “we would feel comfortable paying to Risk
    Retention” an interest rate for premium financing that “is much higher
    than we have paid in the past.” Mr. Candland prepared the PFAs on
    behalf of Risk Retention and signed each one on behalf of RMS.
    
           Under the terms of the PFAs, Risk Retention paid commercial
    insurers directly for the full amount of certain of RMS’s annual
    commercial insurance policy premiums. RMS was then required to
    repay the total premiums plus an interest or finance charge to Risk
    Retention over the course of 12 months, except that the term for the
    fourth PFA, which was executed on January 24, 2011, was 16 months.
    All of the PFAs carried an annual interest rate of 10% with 12 or 16
    equal monthly payments, as applicable. RMS sometimes notified Artex
    of the execution of PFAs only after the fact. 40
    
    
    
    
            39 The parties stipulated that RMS and Risk Retention executed seven PFAs
    
    during these years, but we note that eight PFAs for these years have been received
    into the record. We find that RMS and Risk Retention executed eight PFAs during
    these years. See Cal-Maine Foods, Inc. v. Commissioner, 93 T.C. 181, 195 (1989)
    (holding that we are not obliged to accept a stipulation between the parties when it is
    clearly contrary to facts disclosed by the record).
            40 For example, Mr. Candland notified an Artex employee on June 15, 2011, of
    
    the June 1, 2011, execution of the fifth PFA. Likewise, he informed Artex of the
    execution of the fourth PFA only on the same day that he executed it, which was
    January 24, 2011.
                                       38
    
    [*38] We do not discuss the first three PFAs further. RMS executed the
    fourth through eighth PFAs as follows:
    
        PFA          Execution Date         Amount of      Type of Premiums
                                            Premiums           Financed
                                            Financed
    
       Fourth       January 24, 2011         $39,308      Cyber liability policy
    
        Fifth         June 1, 2011           144,642    Crime, general liability,
                                                         professional liability,
                                                          excess liability, and
                                                         employment practices
                                                            liability policies
    
        Sixth         June 19, 2012          210,162      Crime, employment
                                                           practices liability,
                                                         commercial property,
                                                            general liability,
                                                         professional liability,
                                                          excess liability, and
                                                         cyber liability policies
    
       Seventh        June 6, 2013           217,763       Crime, employment
                                                            practices liability,
                                                            property, general
                                                          liability, professional
                                                        liability, excess liability,
                                                            and cyber liability
                                                                  policies
    
       Eighth         June 14, 2014          224,033       Crime, employment
                                                            practices liability,
                                                            property, general
                                                          liability, professional
                                                        liability, excess liability,
                                                            and cyber liability
                                                                  policies
    
    
    
    
    RMS timely repaid the principal and interest on each PFA in accordance
    with its terms.
    
                       b.     Life Insurance Policy Payments
    
          During the years at issue, RMS also purchased various life
    insurance policies for Mr. Keating, Mr. Candland, and Ms. Doss. Risk
                                              39
    
    [*39] Retention financed the premiums on these life insurance policies
    by paying the commercial life insurance carriers directly and in full.
    Artex and RMS considered this arrangement a loan. Risk Retention
    accounted for the payments to commercial insurance carriers for life
    insurance as notes receivable in its books and records. RMS repaid Risk
    Retention periodically for the life insurance premiums with interest.
    Nonetheless, petitioners have not produced a promissory note or any
    other writing evidencing a loan or another financing arrangement
    permitting Risk Retention to finance petitioners’ personal life insurance
    premiums nor one permitting RMS to repay Risk Retention with
    interest.
    
           Artex characterized amounts paid in excess of principal
    repayment as captive insurance premiums rather than solely as
    interest. 41 Furthermore, in an email dated August 26, 2011, an Artex
    employee also described the “extra” money as being “circled back out
    pretty quickly” because it was used for RMS to pay further life insurance
    premiums. In 2012 Risk Retention financed life insurance premiums on
    behalf of Mr. Keating, Mr. Candland, and Ms. Doss of approximately
    $72,000.
    
           Throughout most of 2012 Artex recorded the life insurance
    policies themselves as “Other Assets” in Risk Retention’s books and
    records. However, on December 1, 2012, Mr. Candland informed Artex
    that the policies were not owned by Risk Retention; instead they were
    used to fund a buy-sell agreement between Mr. Keating and himself, and
    each personally owned the policy taken out on the other. He further
    stated: “We have never intended for the life insurance policies to be
    owned by the captive, unless there is a significant tax advantage.”
    
    
    
    
            41 In an email dated August 3, 2011, an Artex employee described the process
    
    used by Risk Retention to finance the life insurance premiums by stating that RMS
    “make[s] monthly payments directly to the captive each month for loans that they took.
    When they make these payments, they pay ‘extra money’ directly into the captive that
    the captive then turns around and pays to buy life insurance policies. This extra money
    is considered premiums paid so at the end of the year when I calculate what they still
    owe(direct premiums, risk pool premiums, and 2.5% fee) everything worked out right
    to the very last zero.” (Emphasis added.)
                                       40
    
    [*40]               c.    Miscellaneous Loans
    
           Risk Retention also made loans to RMS to finance software,
    hardware, and excess self-funded group health plan claims. We describe
    those loans here.
    
                              i.     Software Note
    
           On July 16, 2012, Risk Retention lent $126,000 to RMS to finance
    new computer software. The loan was evidenced by a promissory note
    although the promissory note stated that RMS’s obligation to make
    24 monthly payments began on August 1, 2012, and ended on a maturity
    date of July 31, 2012, a patent error. The loan carried an annual interest
    rate of 10% and was secured through a security agreement. RMS made
    monthly payments of principal and interest to Risk Retention and
    repaid the loan in full on July 21, 2014.
    
                              ii.    Hardware Note
    
          On August 20, 2012, Risk Retention lent $71,000 to RMS for the
    purchase of computer hardware. The loan was evidenced by a
    promissory note and required 24 monthly payments. The loan carried
    an interest rate of 10% and was secured through a security agreement.
    RMS made monthly payments of principal and interest to Risk
    Retention and repaid the loan in full on August 21, 2014.
    
                              iii.   Group Health Plan Notes
    
           On November 1, 2013, Risk Retention lent $300,000 to RMS to
    finance the portion of RMS’s self-funded group health plan claims that
    exceeded premiums received in 2013. The November 1, 2013, loan was
    evidenced by a promissory note (First Stop Loss Bridge Note), and a
    security agreement was also executed on the same date. The loan
    carried an interest rate of 10%. Mr. Candland informed Artex of this
    loan through an email dated December 18, 2013. The First Stop Loss
    Bridge Note required repayment of all outstanding principal, interest,
    and other amounts on its maturity date, April 1, 2014, but RMS had not
    made any payments toward it as of that date.
    
           Risk Retention made a second $300,000 loan to RMS in respect of
    its excess self-funded group health plan claims on January 8, 2014,
    which was also evidenced by a promissory note (Second Stop Loss Bridge
    Note). The loan carried an annual interest rate of 10%. Although the
    Second Stop Loss Bridge Note states that it was secured by a
                                        41
    
    [*41] contemporaneous security agreement, petitioners did not produce
    a copy of the security agreement. The Second Stop Loss Bridge Note
    required repayment of all outstanding principal, interest, and other
    amounts on its maturity date, May 1, 2014, but RMS had not made any
    payments toward it as of that date. Risk Retention did not take any
    action to enforce repayment of either the First or Second Stop Loss
    Bridge Note following default. On June 10 and September 29, 2014,
    RMS made payments to Risk Retention of $500,000 and $132,822,
    respectively, for its liabilities on both notes.
    
          Risk Retention made a third $300,000 loan to RMS on
    December 10, 2014, which was also evidenced by a promissory note
    (VEBA Stop Loss Note). The loan carried an annual interest rate of 10%.
    Although the VEBA Stop Loss Note states that it was secured by a
    contemporaneous security agreement, petitioners did not produce a copy
    of the security agreement. The VEBA Stop Loss Note came due on
    March 1, 2015. The VEBA Stop Loss Note was repaid in full on March 2,
    2015.
    
                       d.    Deductible Agreements
    
           RMS and United States Fire Insurance Co., the company through
    which RMS obtained workers’ compensation insurance from
    Crum & Forster, executed a deductible agreement in 2009. RMS and
    Risk Retention together executed various deductible agreements with
    United States Fire Insurance Co. beginning in July 2011 and continuing
    throughout the years at issue. Under its agreements with RMS and
    Risk Retention, United States Fire Insurance Co. was responsible for
    making initial payment of any deductibles owed under the applicable
    workers’ compensation policies, and RMS and Risk Retention were
    responsible for reimbursing it. The agreements required RMS and Risk
    Retention to ensure that a collateral fund contained a minimum amount
    of cash. Risk Retention paid substantial sums into the collateral fund
    before and during the years at issue.
    
                5.     Risk Retention
    
           Mr. Keating and Mr. Candland owned Risk Retention equally
    during the years at issue, and Risk Retention’s board of directors
    consisted of Mr. Keating and Mr. Candland. Risk Retention held annual
    board meetings during the years at issue. More than 60% of Risk
    Retention’s assets were highly liquid assets during the years at issue.
                                              42
    
    [*42] Risk Retention’s books and records included a general ledger, a
    balance sheet, a profit and loss statement, and an adjusted trial balance.
    
                   6.      Capitalization of Provincial and Provincial Pool
    
           We first discuss the capitalization of Provincial generally because
    Provincial was a fronting insurer under both the facultative and
    quota-share reinsurance agreements. We then specifically discuss the
    capitalization of the Provincial Pool, which is relevant only to the
    quota-share reinsurance portion of the captive arrangement.
    
                           a.      Provincial
    
          Although Provincial reported substantial cash on hand
    throughout the years at issue, Provincial held minimal capital by other
    measures. Provincial’s reported current liabilities either exceeded, or
    were only marginally exceeded by, its current assets on each of its
    balance sheets for the years at issue. The disparity was most marked at
    yearend 2014, when Provincial had only $21,861,284 in current assets,
    compared to $34,982,548 in current liabilities. 42
    
                           b.      Provincial Pool
    
          Beginning on June 1, 2013, Artex withheld 2% of the pool
    premiums paid by each captive insurer as a risk pool claim reserve. 43
    Artex was unable to pay pool claims quickly before that date because it
    generally collected funds from each pool member as each claim arose. 44
    
    
    
    
           42  Provincial also had little equity to draw upon to meet its liabilities.
    Provincial reported $1,193,735 in equity at yearend 2012 compared to $89,037,865 in
    current liabilities; $1,181,908 in equity at yearend 2013 compared to $132,933,824 in
    current liabilities; and $368,427 in equity at yearend 2014 compared to $34,982,548 in
    current liabilities.
           43 Artex held the claim reserves in a non-interest-bearing “Reserve Account”
    
    that was recorded as an asset on each captive insurer’s balance sheet and other
    financial documents.
            44 Jeremy Huish at Artex described the change in an email on May 1, 2013,
    
    stating: “[W]e are starting a reserve account to pay pool claims in the future. Under
    our current system, we can’t pay out a pool claim until the middle of the next year
    because of the time it takes to gather funds from everyone. While a slow insurance
    payment has been fine in the fast [sic], there may be claims in the future where a quick
    payment is needed.”
                                             43
    
    [*43] In 2013 and 2014 45 the Master Reinsurance Agreements also
    required all captive insurers participating in the Provincial Pool to
    provide funds as collateral to support potential pool claims, either by
    allowing Provincial to hold the funds or by holding the funds in a
    collateral account. Risk Retention had provided pledged accounts to the
    Provincial Pool pursuant to a separate pledge agreement before this
    time although the record is not clear with respect to participating
    reinsurers other than Risk Retention.
    
    IV.     Dividends
    
          In 2012 Risk Retention paid Mr. Candland and Mr. Keating
    dividends of $500,000 each. In April 2014 Risk Retention paid Mr.
    Candland and Mr. Keating dividends of $200,000 each. In October 2014
    Risk Retention paid Mr. Candland and Mr. Keating additional dividends
    of $300,000 each. In both 2012 and 2014 Risk Retention issued copies
    of Form 1099–DIV, Dividends and Distributions, reporting the
    dividends paid to Mr. Candland and Mr. Keating.
    
    V.      Sale of RMS
    
            In 2015 petitioners sold a controlling interest in RMS to a third
    party. Before that sale, in 2012, Mr. Candland discussed a sale of RMS
    with a potential buyer. Mr. Candland emailed a calculation of EBITDA
    (i.e., earnings before interest, taxes, depreciation, and amortization) to
    the potential buyer. The EBITDA calculation provided by Mr. Candland
    added back into earnings the amounts paid to Risk Retention as
    insurance premiums (less claims), as well as other amounts not typically
    understood as interest, taxes, depreciation, or amortization, such as
    $200,000 in “[p]erks” for petitioners.
    
    VI.     Tax Reporting
    
            A.        RMS
    
          RMS was an accrual basis taxpayer during the years at issue.
    RMS timely filed its Form 1120S, U.S. Income Tax Return for an
    S Corporation, for each year at issue.
    
    
    
    
            45    The 2012 Master Reinsurance Contract did not address the subject of
    collateral.
                                              44
    
    [*44]           1.      2012
    
          RMS reported gross receipts of $65,750,508 and net ordinary
    business income of $59,397 on its Form 1120S for its 2012 taxable year.
    RMS deducted $1,229,089 that is in dispute here, comprising $1,160,921
    in captive insurance premiums, $38,400 in fees paid to Artex, 46 and
    $29,768 for the 2.5% administrative fee.
    
                    2.      2013
    
          RMS reported gross receipts of $78,078,987 and net ordinary
    business income of $270,269 on its Form 1120S for its 2013 taxable year.
    RMS deducted $1,262,380 that is in dispute here, comprising $1,193,380
    in captive insurance premiums, $38,400 in fees paid to Artex, and
    $30,600 for the 2.5% administrative fee.
    
                    3.      2014
    
          RMS reported gross receipts of $84,464,179 and a net ordinary
    business loss of $226,863 on its Form 1120S for its 2014 taxable year.
    RMS deducted $1,229,111 that is in dispute here, comprising $1,160,943
    in captive insurance premiums, $38,400 in fees paid to Artex, and
    $29,768 for the 2.5% administrative fee.
    
            B.      Risk Retention
    
          Risk Retention filed an election as a foreign insurance company
    to be treated as a domestic corporation under section 953(d) on
    February 18, 2009, which the IRS accepted. Risk Retention filed a
    Form 1120–PC, U.S. Property and Casualty Insurance Company Income
    Tax Return, for each year at issue. Risk Retention attached its Foreign
    Insurance Company Election under section 953(d) and a Small
    
    
    
    
             46 Regarding the fees paid to Artex, Artex would periodically issue invoices for
    
    its captive management services to RMS. Artex typically invoiced RMS $3,200
    monthly for these services during the years at issue. An October 6, 2008, engagement
    letter between Tribeca and RMS states that the management fee paid for the following
    fees and services: insurance management fees; costs for annual reviews regarding
    policies and premiums; reviewing and determining insurable risks; underwriting and
    drafting policies; consultation regarding qualification of the captive insurance
    company; preparations of financial statements; auditing fees; consultation regarding
    business operations; preparation and filing of tax returns; annual insurance license
    fees; and annual corporate fees for the captive.
                                            45
    
    [*45] Insurance Company Election under section 831(b) to its income
    tax return for each of the years at issue. 47
    
           C.      Petitioners
    
           Petitioners timely filed Forms 1040, U.S. Individual Income Tax
    Return, for each year at issue. Mr. Candland and Mr. Keating reported
    the dividends they received from Risk Retention in both 2012 and 2014
    as qualified dividends on their respective individual income tax returns
    for each year and paid tax on the dividends at the qualified dividend
    rate. See § 1(h)(11).
    
                                       OPINION
    
    I.     Evidentiary Matters
    
          As a preliminary matter, the Court must address the
    admissibility of certain documentary or other nontestimonial evidence
    introduced at trial but for which we reserved ruling. Our evidentiary
    rulings are determined under the Federal Rules of Evidence. See § 7453;
    Rule 143(a).
    
           Under the Federal Rules of Evidence, irrelevant evidence is not
    admissible. See Fed. R. Evid. 402. An item of evidence is relevant to the
    extent it tends to make a fact more or less probable and the fact is
    consequential to determining the action. See Fed. R. Evid. 401. When
    the relevance of evidence depends on a fact, proof must be introduced
    sufficient to support a finding that the fact does exist. See Fed. R.
    Evid. 104(b); see also David S. Schwartz, A Foundation Theory of
    Evidence, 100 Geo. L.J. 95, 140 (2011) (“[C]onditional relevance is a
    requirement that foundations be complete rather than relying on
    generalizations to do the work of case-specific, evidenced facts.”).
    
            Most of the outstanding evidentiary determinations involve
    instances where (1) we advised the offering party that the proposed item
    of evidence required a foundation to be established at trial or (2) the
    offering party advised us that the proposed item of evidence could be
    introduced during the course of trial or explored further in conjunction
    with witness testimony. Cf. Jerden v. Amstutz, 430 F.3d 1231, 1237 (9th
    Cir. 2005) (stating that a trial court “may not exclude evidence before
    trial [on the ground of lack of foundation] without allowing the parties
    
            47 Risk Retention did not request that the Secretary of the Treasury revoke
    
    either of these elections for its 2008–14 taxable years.
                                              46
    
    [*46] to lay a foundation for its admission”). The offering party never
    examined any witness about, or else failed to establish an adequate
    foundation for, the following Exhibits: 17-R, 18-R, 19-R, 21-R, 22-R,
    23-R, 29-R, 30-R, 31-R, 32-R, 33-R, 34-R, 35-R, 57-P, 58-P, 60-R, 61-R,
    100-R, 523-R, 524-R, 525-R, 1503-R, 1714-R, 1715-R, 1716-R, and
    1717-R. The relevance of these Exhibits is entirely speculative without
    an adequate foundation established through witness testimony or other
    means at trial. We therefore exclude them from evidence.
    
           Other evidentiary determinations involve instances where we
    excluded an Exhibit at trial but did not expressly rule on the
    admissibility of a related Exhibit. Our review of the following Exhibits
    shows that they lack an adequate foundation, and their relevance is
    entirely speculative, in view of our exclusion of related Exhibits: 1-R,
    526-R, and 528-R. We therefore exclude them from evidence.
    
           Finally, Exhibit 50-P is a spreadsheet in Excel format that shows
    statistics regarding certain captives as of March 3, 2021. Exhibit 49-P
    is a copy of the same spreadsheet in another format that we excluded at
    trial because petitioners did not adequately establish that it was an
    accurate summary of voluminous records pursuant to Rule 1006 of the
    Federal Rules of Evidence. Cf. United States v. Lynch, 735 F. App’x 780,
    785 (3d Cir. 2018) (“Rule 1006 summaries . . . must be supported by a
    foundation showing that the exhibit is an accurate summary of the
    underlying materials . . . .”); United States v. Scales, 594 F.2d 558, 563
    (6th Cir. 1979) (“[E]ven under Rule 1006, the summary or chart must be
    accurate, authentic and properly introduced before it may be admitted
    in evidence.”). Exhibit 50-P is the same document, albeit in a different
    format, and we exclude it for the same reason.
    
    II.    Jurisdiction and Burden of Proof
    
          Where a notice of deficiency issued to an S corporation
    shareholder includes adjustments to both S corporation items and other
    items unrelated to the S corporation, 48 we have jurisdiction to determine
    the correctness of all adjustments in the shareholder-level deficiency
    
    
            48 An S corporation is governed under the rules in subchapter S of chapter 1 of
    
    subtitle A of the Code. S corporations are not generally themselves subject to federal
    income tax but, like partnerships, are conduits through which income flows to their
    shareholders. See § 1366; Gitlitz v. Commissioner, 531 U.S. 206, 209 (2001)
    (“Subchapter S allows shareholders of qualified corporations to elect a ‘pass-through’
    taxation system under which income is subjected to only one level of taxation.”).
                                            47
    
    [*47] proceeding. 49 See Johnson v. Commissioner, 160 T.C. 18, 28 (2023)
    (citing Winter v. Commissioner, 135 T.C. 238, 245–46 (2010)). We thus
    have jurisdiction to redetermine the correctness of respondent’s
    adjustments to petitioners’ flowthrough share of RMS’s income and any
    other determinations in the notice of deficiency.
    
           The Commissioner’s determinations in a notice of deficiency are
    generally presumed correct, and the taxpayer bears the burden of
    proving that the determinations are incorrect. See Rule 142(a)(1); see
    also Welch v. Helvering, 290 U.S. 111, 115 (1933); Rockwell v.
    Commissioner, 512 F.2d 882, 885–87 (9th Cir. 1975), aff’g T.C. Memo.
    1972-133. However, if the Commissioner raises a new matter, seeks an
    increase in deficiency, or asserts an affirmative defense, the
    Commissioner has the burden of proof as to the new matter, increased
    deficiency, or affirmative defense. Rule 142(a)(1).
    
           Gross income generally includes all income from whatever source
    derived, including dividends. See § 61(a); Commissioner v. Glenshaw
    Glass Co., 348 U.S. 426, 429–30 (1955); Wilcox v. Commissioner, 848
    F.2d 1007, 1008 (9th Cir. 1988), aff’g T.C. Memo. 1987-225; Treas. Reg.
    §§ 1.61-1(a), 1.61-9(a). Deductions are a matter of legislative grace, and
    taxpayers bear the burden of proving that they are entitled to any
    deduction claimed. See INDOPCO, Inc. v. Commissioner, 503 U.S. 79,
    84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).
    A taxpayer claiming a deduction on a federal income tax return must
    demonstrate that the deduction is provided for by statute and must
    maintain records sufficient to enable the Commissioner to determine the
    correct tax liability. See § 6001; Hradesky v. Commissioner, 65 T.C. 87,
    89–90 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir. 1976); Treas. Reg.
    § 1.6001-1(a).
    
            Under section 7491(a), if the taxpayer provides credible evidence
    concerning any factual issue relevant to ascertaining the taxpayer’s
    liability and complies with certain other requirements, the burden of
    proof shifts to the Commissioner as to the factual issue. Petitioners do
    not contend that the burden of proof shifts to respondent under
    
    
            49 RMS is not a party to these cases. The unified subchapter S corporation
    
    audit and litigation procedures formerly set forth in subchapter D of chapter 63 of
    subtitle F of the Code were repealed for taxable years beginning after December 31,
    1996. See Allen Family Foods, Inc. v. Commissioner, T.C. Memo. 2000-327, slip op.
    at 5 & n.3. Neither RMS nor respondent has revoked or terminated RMS’s
    S corporation election.
                                              48
    
    [*48] section 7491(a) as to an issue of fact. 50 Therefore, petitioners bear
    the burden of proof on all issues. 51 We discuss the burden of proof
    applicable to the accuracy-related penalties that respondent has
    determined against petitioners separately in connection with our
    discussion of those penalties.
    
    III.    Credibility and Fact-Finding
    
            “The most important and most crucial action the courts take in [a
    trial] is to resolve facts.” United States v. Gainey, 380 U.S. 63, 88 (1965)
    (Black, J., dissenting); see Diaz v. Commissioner, 58 T.C. 560, 564 (1972)
    (“[T]he distillation of truth from falsehood . . . is the daily grist of judicial
    life.”). The fact-finding process often requires the Court as the finder of
    fact to evaluate the credibility of witness testimony before making
    findings on the basis of that testimony. This Court has stated that in
    determining credibility,
    
            [w]e observe the candor, sincerity, and demeanor of each
            witness in order to evaluate his or her testimony and
            assign it weight for the primary purpose of finding disputed
            facts. We determine the credibility of each witness, weigh
            each piece of evidence, draw appropriate inferences, and
            choose between conflicting inferences in finding the facts of
            a case. The mere fact that one party presents unopposed
            testimony on his or her behalf does not necessarily mean
            that the elicited testimony will result in a finding of fact in
            that party’s favor. We will not accept the testimony of
            witnesses at face value if we find that the outward
    
            50 Petitioners asserted in their respective Petitions that “the Commissioner has
    
    the burden of proof with respect to all issues raised in his Notice of Deficiency,” but
    they have not raised this issue on brief. We therefore deem any argument by
    petitioners that section 7491(a) is applicable to have been waived or conceded. See
    Estate of Atkinson v. Commissioner, 115 T.C. 26, 35 (2000) (deeming issue not
    addressed in posttrial brief to be waived or conceded), aff’d, 309 F.3d 1290 (11th Cir.
    2002); Estate of Blount v. Commissioner, T.C. Memo. 2004-116, slip op. at 55 n.29
    (deeming burden of proof shift under section 7491 waived when the taxpayer failed to
    raise it), aff’d in part, rev’d and remanded in part, 428 F.3d 1338 (11th Cir. 2005); see
    also Mendes v. Commissioner, 121 T.C. 308, 312–13 (2003) (“If an argument is not
    pursued on brief, we may conclude that it has been abandoned.”).
            51 This statement does not apply to respondent’s invocation of the duty of
    
    consistency, which is an affirmative defense as to which respondent bears the burden
    of proof. See Estate of Ashman v. Commissioner, T.C. Memo. 1998-145, slip op. at 5,
    aff’d, 231 F.3d 541 (9th Cir. 2000). Nonetheless, as explained below, we find it
    unnecessary to reach respondent’s duty of consistency argument.
                                        49
    
    [*49] appearance of the facts in their totality conveys an
          impression contrary to the spoken word.
    
    Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 84 (2000), aff’d,
    299 F.3d 221 (3d Cir. 2002). As the trier of fact we may credit evidence
    in full, in part, or not at all. We may credit the part of a witness’s
    testimony that is not self-serving, while requiring some form of
    corroboration before crediting the portion that is. See Factor v.
    Commissioner, 281 F.2d 100, 114 n.27 (9th Cir. 1960) (“The Tax Court
    may accept parts and reject other parts of a witness’s testimony.”), aff’g
    T.C. Memo. 1958-94; Baumgardner v. Commissioner, 251 F.2d 311, 321
    (9th Cir. 1957) (“The Tax Court was willing to accept in part the
    taxpayer’s claim of alleged profits from buying and selling improvement
    bonds. It was not required to accept it in full.”), aff’g T.C. Memo.
    1956-112.
    
           It is “the exclusive province of the fact finder to determine the
    credibility of witnesses, resolve evidentiary conflicts, and draw
    reasonable inferences from proven facts.” United States v. Hubbard,
    96 F.3d 1223, 1226 (9th Cir. 1996); see Anderson v. City of Bessemer City,
    N.C., 470 U.S. 564, 573–74 (1985) (stating that if the trial court’s view
    of the evidence is plausible in light of the record, a reviewing court may
    not disturb it absent clear error, even when the trial court’s findings “do
    not rest on credibility determinations, but are based instead on physical
    or documentary evidence or inferences from other facts”); United States
    v. Yellow Cab Co., 338 U.S. 338, 342 (1949) (stating that where there are
    two permissible views of the evidence, the factfinder’s choice between
    them is not clearly erroneous); United States v. U.S. Gypsum Co.,
    333 U.S. 364, 395 (1948) (stating that a finding is clearly erroneous
    when “the reviewing court on the entire evidence is left with the definite
    and firm conviction that a mistake has been committed”); Estate of Rau
    v. Commissioner, 301 F.2d 51, 54 (9th Cir. 1962) (“The Tax Court
    personally observed the witnesses . . . and from that vantage point was
    in a position to evaluate their testimony in the light of their attitude and
    demeanor while being interrogated.”), aff’g T.C. Memo. 1959-117. As
    the Ninth Circuit has stated in relation to the allowability of deductions
    in particular, “[t]he question of whether a taxpayer is allowed a
    deduction for particular expenses is a question of fact to be established
    by the taxpayer’s evidence, the credibility of the taxpayer, and the
    credibility of supporting witnesses. . . . [T]he Tax Court determines the
    credibility of the proffered testimony.” Schachter v. Commissioner,
    255 F.3d 1031, 1034 (9th Cir. 2001), aff’g T.C. Memo. 1998-260,
    supplemented by 113 T.C. 192 (1999); see Norgaard v. Commissioner,
                                             50
    
    [*50] 939 F.2d 874, 878 (9th Cir. 1991), aff’g in part, rev’g in part
    T.C. Memo. 1989-390; see also McKay v. Commissioner, 886 F.2d 1237,
    1238 (9th Cir. 1989), aff’g 89 T.C. 1063 (1987). We determine the
    credibility of witnesses, resolve evidentiary conflicts, and draw
    inferences from the voluminous record developed by the parties with
    this framework in mind.
    
    IV.    Microcaptive Arrangement
    
          We begin by briefly explaining the taxation of microcaptive
    insurance companies and the deductibility of payments to them. We
    have recently considered other purported microcaptive insurance
    arrangements. See Avrahami v. Commissioner, 149 T.C. 144 (2017);
    Caylor Land & Dev., Inc. v. Commissioner, T.C. Memo. 2021-30; Syzygy
    Ins. Co., T.C. Memo. 2019-34; Reserve Mech. Corp. v. Commissioner,
    T.C. Memo. 2018-86, aff’d, 34 F.4th 881 (10th Cir. 2022); cf. Patel v.
    Commissioner, T.C. Memo. 2020-133 (deciding the issue of timely
    supervisory approval for penalties pursuant to section 6751(b) in the
    context of a purported microcaptive insurance arrangement).
    
          Insurance companies (other than life insurance companies) are
    generally taxed on their income in the same manner as other
    corporations. See §§ 11, 831(a). However, section 831(b) provides an
    alternative taxing structure for certain small insurance companies.
    During the years at issue, an insurance company with net written
    premiums (or, if greater, direct written premiums) that did not exceed
    $1.2 million for the year could elect to be taxed under section 831(b). 52
    § 831(b)(2). A small insurance company that makes a valid section
    831(b) election is subject to tax only on its investment income,
    § 831(b)(1), and is not subject to tax on its earned premiums, see id.
    When a captive insurance company 53 makes a section 831(b) election, it
    is commonly referred to as a microcaptive insurance company.
    
           Typically, amounts paid for insurance are deductible under
    section 162(a) as ordinary and necessary expenses paid or incurred in
    
           52 Amendments to     section 831(b) in 2015 increased the premium ceiling to
    $2.2 million (adjusted for inflation) and added new diversification requirements that
    an insurance company must meet to be eligible to make a section 831(b) election. See
    Syzygy Ins. Co., T.C. Memo. 2019-34, at *27 n.25.
            53 A captive insurance company is typically a corporation whose stock is owned
    
    by one or a small number of shareholders and which handles all or a part of the
    insurance needs of its shareholders or affiliates. See Harper Grp. v. Commissioner,
    96 T.C. 45, 46 n.3 (1991), aff’d, 979 F.2d 1341 (9th Cir. 1992).
                                              51
    
    [*51] connection with a trade or business. See Treas. Reg. § 1.162-1(a).
    Section 162(a) does not prohibit deductions for microcaptive insurance
    premiums. When such a deduction is available, an insured may be able
    to deduct a premium payment to its affiliated microcaptive insurance
    company without a corresponding inclusion of the premium in income
    by the microcaptive insurance company.          See Syzygy Ins. Co.,
    T.C. Memo. 2019-34, at *28.
    
           Nonetheless, the deductibility of insurance premiums depends on
    whether they were truly payments for insurance. See Avrahami,
    149 T.C. at 174, 199; Syzygy Ins. Co., T.C. Memo. 2019-34, at *28; see
    also Clougherty Packing Co. v. Commissioner, 811 F.2d 1297, 1300 (9th
    Cir. 1987) (“In lieu of purchasing insurance, one may elect to self-insure,
    paying off claims as they arise or setting aside fixed sums into a reserve
    account to pay off intermittent losses. While insurance premiums are
    deductible, amounts placed into self-insurance reserves are not. . . . The
    appropriate starting point of our analysis is the meaning of
    ‘insurance.’”), aff’g 84 T.C. 948 (1985); Caylor Land & Dev., Inc.,
    T.C. Memo. 2021-30, at *31. In addition, as explained below, the
    characterization of the dividends paid by Risk Retention to Mr.
    Candland and Mr. Keating as ordinary or qualified dividends depends
    on whether Risk Retention transacted in insurance. Thus, these cases
    hinge on whether the captive insurance arrangement meets the
    definition of insurance. 54
    
           A.      Whether the Arrangement Is Insurance
    
           Neither the Code nor the Treasury Regulations define insurance,
    and we are guided by caselaw in determining whether a transaction
    constitutes insurance. See Avrahami, 149 T.C. at 174; Syzygy Ins. Co.,
    T.C. Memo. 2019-34, at *28–29. Courts have looked to four criteria in
    deciding whether an arrangement constitutes insurance: (1) the
    arrangement involves an insurance risk; (2) the arrangement shifts the
    
            54 In his Simultaneous Opening Brief respondent argues that we should apply
    
    various substance-over-form doctrines in order to disregard the transactions at issue.
    However, because we consider the transactions at issue in accordance with their actual
    form and particular facts (i.e., without resort to recharacterizing their form) and
    conclude that they do not constitute insurance for federal income tax purposes, we need
    not decide whether any substance-over-form doctrine would apply in these cases. See
    Avrahami, 149 T.C. at 197 (“In light of our holding [that the transactions at issue are
    not insurance for federal tax purposes] we need not address the Commissioner’s other
    arguments—i.e., that the amounts deducted as insurance expenses should be
    disallowed under the economic-substance, substance-over-form, and step-transaction
    doctrines.”).
                                         52
    
    [*52] risk of loss to the insurer; (3) the insurer distributes its risk among
    its policyholders; and (4) the arrangement is insurance in the commonly
    accepted sense. See Avrahami, 149 T.C. at 177; Rent-A-Center, Inc. v.
    Commissioner, 142 T.C. 1, 13 (2014); Black Hills Corp. v. Commissioner,
    101 T.C. 173, 182 (1993), supplemented by 102 T.C. 505 (1994), aff’d,
    73 F.3d 799 (8th Cir. 1996); Harper Grp., 96 T.C. at 58; AMERCO &
    Subs. v. Commissioner, 96 T.C. 18, 38 (1991), aff’d, 979 F.2d 162 (9th
    Cir. 1992); Syzygy Ins. Co., T.C. Memo. 2019-34, at *29. Each part of
    the test must be satisfied. Harper Grp., 96 T.C. at 58. These four
    criteria are “nonexclusive,” Avrahami, 149 T.C. at 177, although we
    have noted they are “rarely supplemented,” Caylor Land & Dev., Inc.,
    T.C. Memo. 2021-30, at *32. Respondent concedes on brief that we “can
    assume without deciding that the transaction involved risk shifting,” so
    we assume that point. Respondent has also made a similar concession
    regarding insurance risk, so we assume that the arrangement involved
    insurance risks.
    
           We find for the reasons stated below that petitioners have not met
    their burden of proof to show that the microcaptive arrangement is
    insurance in the commonly accepted sense, and we therefore determine
    that it is not insurance for federal income tax purposes. See Avrahami,
    149 T.C. at 190–91 (“[T]he cases tell us that in deciding whether an
    arrangement is insurance we can also look at whether it looks like
    insurance in the commonly accepted sense. This is an alternative
    ground.”); Rent-A-Center, Inc., 142 T.C. at 13 (“[T]he arrangement must
    . . . meet commonly accepted notions of insurance.”); Harper Grp.,
    96 T.C. at 58 (stating that “each part” of our test for “determining the
    propriety of claimed insurance deductions by a parent or affiliated
    company to a captive insurance company . . . must be satisfied,”
    including “whether the arrangement was for ‘insurance’ in its commonly
    accepted sense”); Syzygy Ins. Co., T.C. Memo. 2019-34, at *37 & n.26; see
    also Reserve Mech. Corp. v. Commissioner, 34 F.4th at 913–16
    (upholding finding that microcaptive insurance policies “did not satisfy
    the requirement that they be insurance in the commonly accepted
    sense”); AMERCO v. Commissioner, 979 F.2d at 165; Caylor Land &
    Dev., Inc., T.C. Memo. 2021-30, at *39. It is unnecessary for us to
    address whether the arrangement involves risk distribution. After
    outlining the reasons for our conclusion that the microcaptive
    arrangement is not insurance in the commonly accepted sense, and
    therefore does not constitute insurance for federal income tax purposes,
    we discuss the legal effect of that conclusion in the next subsection.
                                       53
    
    [*53]        1.    Commonly Accepted Notions of Insurance
    
           To determine whether an arrangement constitutes insurance in
    the commonly accepted sense, we look at numerous factors including:
    (1) whether the insuring company was organized, operated, and
    regulated as an insurance company; (2) whether it was adequately
    capitalized; (3) whether the policies were valid and binding; (4) whether
    premiums were reasonable and the result of arm’s-length transactions;
    and (5) whether claims were paid. See Avrahami, 149 T.C. at 191 (first
    citing R.V.I. Guar. Co. v. Commissioner, 145 T.C. 209, 231 (2015); then
    citing Rent-A-Center, Inc., 142 T.C. at 24–25; then citing Harper Grp.,
    96 T.C. at 60; and then citing Securitas Holdings, Inc. & Subs. v.
    Commissioner, T.C. Memo. 2014-225, at *27); see also Caylor Land &
    Dev., Inc., T.C. Memo. 2021-30, at *39–40; Syzygy Ins. Co., T.C. Memo.
    2019-34, at *37–38; Reserve Mech. Corp., T.C. Memo. 2018-86, at *48; cf.
    Syzygy Ins. Co., T.C. Memo. 2019-34, at *41 (noting that “whether the
    fronting carriers operated in a bona fide fashion” is also relevant). We
    will address each of these factors in turn.
    
                       a.     Organization, Operation, and Regulation
    
           Risk Retention and Provincial were organized as insurance
    companies in Anguilla, and they were regulated by the Anguilla
    Financial Services Commission. Generally, they complied with the
    requirements of Anguillan law. They obtained insurance licenses,
    satisfied Anguilla’s low capitalization requirements, and filed required
    documents with regulators. The record also shows that Risk Retention
    held annual board meetings, kept organizational books and records, and
    maintained separate bank accounts. Apart from generally observing the
    requisite formalities, however, the facts demonstrate that Risk
    Retention and Provincial were not operated as insurance companies. Cf.
    Reserve Mech. Corp., T.C. Memo. 2018-86, at *50.
    
           Under the management of Artex, and with some significant input
    by Mr. Candland, Risk Retention and Provincial operated during the
    years at issue in a manner in which only unthinking insurance
    companies would operate. Insurance transactions, including premium
    pricing, premium payments, and claims approval, were completed after
    the fact, even though in a typical insurance program they would be
    completed prospectively. Cf. Caylor Land & Dev., Inc., T.C. Memo.
    2021-30, at *41–42. Underwriting for policies in the Risk Retention
    captive program often occurred well into the coverage period or after the
    coverage period had expired. In any case, underwriting was based on
                                               54
    
    [*54] woefully inadequate information and methods, and it was
    disproportionately influenced by meeting target premiums near the
    $1.2 million section 831(b) limit, regardless of the coverage being
    provided. Artex and Provincial backdated documents, approved of
    retroactive policy changes, and permitted the late issuance of insurance
    contracts 55 and even later premium payments.             RMS paid a
    disproportionate share of its captive premiums during the years at issue
    toward the end of, or after, each coverage period. RMS never paid
    premiums on a regular schedule of any kind, as opposed to making
    payments whenever it decided to do so. Artex’s own invoice to one of its
    other clients that is in the record makes the point best: “One typical
    attribute of an insurance transaction[] is that premium is paid up front,
    monthly, or quarterly. It is not commonly paid in one lump sum at the
    end of the policy term.”
    
             Mr. Candland, Mr. Keating, and RMS also treated Risk Retention
    as if it were a tax-free savings account rather than a bona fide insurance
    company with which they were dealing at arm’s length. Risk Retention
    posted collateral with United States Fire Insurance Co. to fund
    deductibles under RMS’s commercial workers’ compensation policy
    without any clear obligation for it to do so, other than its self-imposed
    one under the deductible agreements. Risk Retention never documented
    its purported loan to finance Mr. Keating’s and Mr. Candland’s buy-sell
    life insurance policy premiums on each other, and it is unclear whether
    these loans were enforceable or secured. Artex also characterized the
    purported loan repayments from RMS to Risk Retention in excess of
    principal repayment not solely as interest but also as (1) premiums paid
    and (2) as “extra” money that is “circled back out pretty quickly” to pay
    further life insurance premiums. 56
    
          While RMS and Risk Retention documented miscellaneous loans
    for hardware, software, and excess group health plan claims with
    promissory notes and repaid some of them in accordance with their
    terms, other aspects of these loans are concerning. RMS failed to repay
    
            55 Despite petitioners’ assertion to the contrary, we do not see any credible
    
    evidence in the record that binders were in place during the coverage period until final
    insurance policies were issued.
             56 These characterizations are consistent with petitioners’ use of Risk
    
    Retention as a de facto tax-free savings account because a bona fide insurance company
    would require interest on a loan to compensate it for its impairment to its capital base,
    its ability to pay claims, and its ability to generate investment income. It would not
    likely treat interest as “extra” money that it could “circle[] back out pretty quickly” to
    fund further loans or related-party expenses unless it expected few claims.
                                      55
    
    [*55] the First and Second Stop Loss Bridge Notes timely and indeed
    had not made any payments by their maturity dates. Risk Retention
    did not take any action to enforce either note following default. The
    Second Stop Loss Bridge Note and the VEBA Stop Loss Note were not
    accompanied by any security agreement that is in the record. The
    July 16, 2012, promissory note documenting the software loan contained
    a patent error on its face that calls its enforceability into question.
    
           While RMS repaid the PFAs timely in accordance with their
    terms, Mr. Candland notified Artex of the PFAs only after the fact,
    instead of obtaining advance approval from Artex for the related-party
    dealings he was organizing. His commitment to paying a “much higher”
    interest rate to Risk Retention than RMS had paid in the past to finance
    its commercial insurance policy premiums is not supported by any
    legitimate business purpose discernible from the record. In any case, it
    casts doubt on the reasonableness of the interest rate charged in the
    PFAs.
    
           We also have significant concerns about the reinsurance aspects
    of the microcaptive arrangement. We agree with respondent’s expert
    James MacDonald that Artex’s failure to disclose that it reserved the
    right to cede 100% of the premium for some coverages to either the
    captive or the Provincial Pool was a significant departure from
    applicable reinsurance customs and practices. Neither is there any
    credible evidence in the record that Risk Retention performed adequate
    due diligence on the quota-share risks that it assumed through the
    Provincial Pool. Overall, in numerous facets of their operations, Risk
    Retention and Provincial did not operate as bona fide insurers or
    reinsurers would.
    
           We also accord some weight to the nontax characterizations of the
    microcaptive arrangement by the parties to it. See Sears, Roebuck & Co.
    v. Commissioner, 96 T.C. 61, 101–02 (1991) (considering whether “the
    arrangements . . . are characterized as insurance for essentially all
    nontax purposes”), supplemented by 96 T.C. 671 (1991), aff’d in part,
    rev’d and remanded in part, 972 F.2d 858 (7th Cir. 1992). The parties
    to the arrangement did not characterize it as insurance for essentially
    all nontax purposes. RMS and Artex did not consistently recognize
    RMS’s premium payments as separate from the amounts that Risk
    Retention ostensibly received for providing facultative or quota-share
                                              56
    
    [*56] reinsurance to Provincial. 57 This characterization is consistent
    with a near-circular flow of funds or, when considering it together with
    the various loans, dividends, and other disbursements that Risk
    Retention made, a circular one. 58 Mr. Candland also described the
    arrangement to an external auditor as a means by which RMS self-
    insured workers’ compensation claims. Furthermore, Mr. Candland
    emailed an EBITDA calculation to a potential buyer of RMS that added
    back into earnings the amounts paid to Risk Retention as insurance
    premiums (less claims), as well as other amounts not typically
    understood as interest, taxes, depreciation, or amortization, such as
    $200,000 in “[p]erks” for petitioners. We take this to mean that a
    potential buyer of RMS did not need to subtract the captive insurance
    expenses from this metric of RMS’s profitability because they did not
    detract from RMS’s profitability in an economic sense. Overall, the
    characterizations of the arrangement by the parties to it reflect their
    understanding that Artex’s approach gave RMS the benefit of an
    upfront, tax-deductible premium charge without a loss of control over its
    disposition of the funds that had proverbially been moved from one
    pocket to another (i.e., to Risk Retention).
    
                           b.      Capitalization
    
           We have consistently held that an insurer is adequately
    capitalized if it meets the relevant jurisdiction’s minimum capitalization
    requirements. See Avrahami, 149 T.C. at 193; Caylor Land & Dev., Inc.,
    T.C. Memo. 2021-30, at *43; Syzygy Ins. Co., T.C. Memo. 2019-34, at *41;
    Reserve Mech. Corp., T.C. Memo. 2018-86, at *53. Risk Retention and
    Provincial met Anguilla’s minimum capitalization requirements during
    the years at issue. We do not upset the consensus here.
    
    
    
    
           57 For example, during the years at issue, Mr. Candland asked for Artex’s help
    
    in getting a premium deposited “back into” Risk Retention’s bank account and “moved
    through the system and back,” and he also asked how long it would take to “turn the
    funds around and deposit [them] in [Risk Retention’s] bank account.”
            58 This is further supported by the facts that (1) Risk Retention’s quota share
    
    of pool premiums was equal to the net premiums Provincial received from RMS for
    excess coverage from at least 2009 to 2014 and (2) Risk Retention’s quota share of pool
    claims and loss adjustment expenses was relatively low as a percentage of the pool
    premiums paid by RMS for each year at issue (0.325% for 2012, 3.333% for 2013, and
    3.152% for 2014). We also think that intent and absence of mistake are demonstrated
    by the feasibility study that Tribeca prepared for RMS, which assumed no claim losses
    and payment of a $1.2 million premium each year.
                                          57
    
    [*57]                c.      Valid and Binding Policies
    
           We have held that policies were valid and binding when “[e]ach
    insurance policy identified the insured, contained an effective period for
    the policy, specified what was covered by the policy, stated the premium
    amount, and was signed by an authorized representative of the
    company.” Securitas Holdings, Inc., T.C. Memo. 2014-225, at *28; see
    also R.V.I. Guar. Co., 145 T.C. at 231 (finding that policies were valid
    and binding when the insured filed claims for covered losses and the
    captive insurance company paid them). We have also examined factors
    beyond whether the policies are simply binding such as conflicting or
    cookie-cutter policy terms or the delivery of claims-made policies after
    the end of the claims period. See Avrahami, 149 T.C. at 194 (examining
    conflicting policy terms); Caylor Land & Dev., Inc., T.C. Memo. 2021-30,
    at *44 (“Writing and delivering ‘claims made’ insurance policies after the
    claim period is, we find, abnormal and is to any reasonable observer just
    plain silly.”); Reserve Mech. Corp., T.C. Memo. 2018-86, at *54
    (describing policies as cookie-cutter and not necessarily appropriate); see
    also Syzygy Ins. Co., T.C. Memo. 2019-34, at *42 (“Here the dispute
    surrounding valid and binding policies centers on whether the policies
    were timely issued, identified the insured, and specified what was
    covered by the policies.”). Overly restrictive provisions generally
    indicate that the parties to an arrangement intended their arrangement
    to look like insurance without actually providing it. Cf. Syzygy Ins. Co.,
    T.C. Memo. 2019-34, at *32.
    
           We find that the policies were not valid and binding. Our first
    concern is the delivery of claims-made policies well into the coverage
    period without binders in place in the interim. 59 See Caylor Land &
    Dev., Inc., T.C. Memo. 2021-30, at *44. While RMS’s captive policies
    during the years at issue were issued midway through their coverage
    periods, rather than after, the late issuances still create substantial
    doubt about the validity and binding effect of the policies. In the absence
    of a binder, an insurer might choose to increase premiums or change the
    policy terms before issuing the policies, or simply not issue the policies
    at all, if, for example, a covered loss occurred between the coverage
    period inception date (i.e., January 1) and the policy issuance
    
    
    
    
           59 Similarly, we are also concerned by the January 28, 2013, Change
    
    Endorsement that materially changed RMS’s Worker’s Compensation Deductible / SIR
    Reimbursement policy after the end of the coverage period.
                                              58
    
    [*58] date. 60 It is also unclear whether Provincial or Risk Retention
    would have been obligated to pay a claim made between those dates
    under a policy that had not yet been issued.
    
           The only apparent purpose for issuing restrictive claims-made
    policies was to accommodate the desire of pool participants to receive
    their funds back relatively quickly after they were paid. The policies
    also contained ambiguous wording. For example, an independent
    adjuster could have concluded that the Workers’ Compensation
    Deductible / SIR Reimbursement policies applied only to accidents
    occurring during the policy year that resulted in a deductible invoice
    received during the policy period. The failure of the policies to make
    clear whether this was the case is a significant failing given that all paid
    claims that RMS filed under its 2012–14 captive policies were made
    under this policy. Cf. Avrahami, 149 T.C. at 194 (discussing a policy
    with terms indicative of both a claims-made policy and an occurrence
    policy).
    
           The 2013 and 2014 general terms and conditions also conditioned
    claims payment on a requirement that the insured be in compliance with
    all terms of its engagement letter with Artex, as well as all terms of the
    Master Reinsurance Agreement between Provincial and any applicable
    reinsurer, and remain an ongoing client of Artex. The binding effect of
    the policies, if any, therefore depended in substantial part on
    considerations extraneous to the policies themselves.
    
           The parties to the arrangement did not themselves treat the
    policies as valid and binding. They used board resolutions to pay claims
    when the terms of the policies did not support the claims, or to document
    claims that had already been paid. Alternatively, RMS simply took and
    repaid loans from the captive on its own terms if a policy did not cover a
    desired use of the funds. Mr. Candland sometimes decided the amount
    
             60 While, in addition to the annual coverage periods, evergreen policy periods
    
    nominally allowed each policy to remain in force until canceled, the record is clear that
    the essential terms of each policy were set forth in annual renewal endorsements that
    used an annual coverage period. The policies are devoid of any indication, for example,
    of whether any additional premiums were due and owing during an evergreen period
    for which no renewal endorsement was in place; what coverage obtained during the
    interregnum (e.g., the coverage for the last renewal endorsement or the coverage for a
    later-issued renewal endorsement that purported to have a retroactive coverage
    period); how claims made during it were to be handled; or whether procedures differed
    depending on whether a later renewal endorsement was or was not issued. We regard
    it as nothing more than an attempt by Artex and Provincial to imbue their practice of
    belatedly issuing insurance contracts with a legitimacy on paper that it lacked in fact.
                                       59
    
    [*59] of premiums that he wished to pay at the end of the year, and
    Artex facilitated this practice.
    
           Other discrepancies underscore our lack of confidence that the
    policies were valid and binding. The provision in the general terms and
    conditions that all premiums were earned at inception exclusively
    benefits the insurer at the expense of the insured and is at odds with the
    typical insurance industry practice of providing refunds (less early
    cancellation penalties). Cf. Syzygy Ins. Co., T.C. Memo. 2019-34, at *32.
    While such a provision is not necessarily fatal, we view its inclusion as
    unusual under the circumstances here. The feasibility study’s failure to
    mention RMS’s workers’ compensation needs, which featured
    prominently in the captive program, while mentioning goodwill and
    identity protection policies, which RMS never purchased, undermines
    petitioners’ contention that the policies were intended to provide valid
    and binding coverage for actual insurance needs. In sum, the policies
    were designed only to resemble insurance policies superficially while in
    reality giving the parties to the arrangement the option to proceed, or
    not to proceed, with funding the policies until well into the coverage
    period.
    
                        d.    Reasonableness of Premiums
    
           The next question is whether Provincial’s premiums were
    reasonable and the result of an arm’s-length transaction. See Avrahami,
    149 T.C. at 194–96. We find that they were not. Mr. Candland provided
    Artex with an amount he was willing to pay or a target premium for all
    policies purchased regardless of coverage. Mr. Candland sometimes
    requested increases in RMS’s premiums.            Cf. Syzygy Ins. Co.,
    T.C. Memo. 2019-34, at *33–34 (“In an arm’s-length negotiation, an
    insurance purchaser would want to negotiate lower premiums instead
    of higher premiums.”). The target premiums Mr. Candland provided
    played an outsized role in Artex’s purported underwriting.
    
           Before discussing premium determination and underwriting in
    detail, we pause to consider RMS’s coverage needs. RMS had a
    comprehensive program of insurance obtained in the commercial
    marketplace, some of which it negotiated at arm’s length with its clients.
    While some carriers that Mr. Hill approached declined coverage, there
    is no credible evidence that RMS was unable to obtain any type of
    insurance coverage that it sought or that it did not maintain a robust
    program of commercial insurance during the years at issue.
                                              60
    
    [*60] Given that RMS agreed to insurance requirements in its client
    contracts and passed on insurance costs to its clients, it is odd that there
    is no evidence that RMS consulted in any detail with its clients about
    the massive insurance costs that it incurred through the captive
    program. In any case, the reasons Mr. Candland offered at trial for
    obtaining each policy were largely pretextual. While we grant that some
    of his testimony may explain why he chose a given coverage over other
    captive coverages that Tribeca or Artex offered, they do not explain why
    he would have paid such exorbitant sums for them in the context of
    RMS’s business. Taking RMS’s tax returns literally, the amounts paid
    for insurance reduced RMS from a profitable enterprise to one that was
    approximately breaking even. Most of the captive coverages were not
    required by RMS’s contracts with its clients, and there is no credible
    evidence indicating that RMS replaced any of its commercial coverages
    with any of the captive coverages. 61 A much more detailed explanation
    of the need for such expensive policies was warranted than the ones
    provided by Mr. Candland. This is especially true given RMS’s
    specialization in dealing with insurance issues on behalf of its clients.
    
           Moving on to premium determination, the Provincial policies
    were not objectively rated by evaluating the risk and magnitude of loss
    on a prospective basis informed by detailed underwriting. The
    premiums were also inflated by numerous subjective, judgment-driven
    factors, each of which could modify the premiums significantly; and
    there is very little documentation to support how Artex applied these
    factors. The captive risk factor was especially inappropriate because its
    stated object should have been addressed by making capital
    
           61  Regarding the Worker’s Compensation Deductible / SIR Reimbursement
    policies, petitioners argue that the premiums RMS paid for this coverage were
    “significantly less than the discount provided by Crum & Forster for the large
    deductible.” Petitioners thus appear to argue that these policies replaced the
    deductible amount on the corresponding Crum & Forster policies in a cost-effective
    manner.
             We are not convinced. Mr. Candland emailed an Artex employee during the
    years at issue to inform him that RMS had raised its deductible from $100,000 to
    $250,000 on the Crum & Forster policy and stated: “This should make it easier to
    justify our $1,200,000 captive contribution.” It thus appears that petitioners used the
    deductible amount on the Crum & Forster policies to justify the captive contribution,
    not that the captive coverage replaced the Crum & Forster deductible amount in a
    demonstrably cost-effective manner. Furthermore, petitioners did not present credible
    evidence to prove how Crum & Forster calculated the discount listed on its billing
    statements for large deductibles, how the amount of the discount varied with the
    amount of the deductible, or that Artex incorporated the amount of the deductible or
    the large deductible discount in its purported underwriting of the captive policies.
                                             61
    
    [*61] contributions or obtaining aggregate stop-loss reinsurance, not
    charging the insured additional premiums. See Caylor Land & Dev.,
    Inc., T.C. Memo. 2021-30, at *47. This is not merely an academic
    proposition: RMS’s own VEBA had stop-loss insurance coverage.
    Furthermore, total annual premiums on RMS’s captive coverages
    always hovered around $1.2 million, the section 831(b) limit, even when
    coverage types or limits varied or RMS’s revenue or payroll changed.
    
           The amounts of premiums charged were also patently
    unreasonable. The average rate-on-line for RMS’s captive policies
    during the years at issue was more than ten times greater than the
    average rate-on-line for comparable commercial insurance policies, even
    though there is no credible evidence indicating that RMS had major
    issues with its existing commercial insurance coverage, or in obtaining
    the insurance required by its client contracts. A higher rate-on-line
    means that insurance coverage is more expensive per dollar of coverage
    and could therefore lead to a greater deduction for premiums. See
    Syzygy Ins. Co., T.C. Memo. 2019-34, at *31. There is no credible
    evidence in the record that these charges were justified by a substantial
    loss history from RMS or the pool. 62
    
           We are also unconvinced that the Artex underwriting staff had
    sufficient expertise to exercise the judgment required by these
    subjective factors and the numerous types of policies they underwrote.
    Moreover, Artex did not take into account the fact that it was often
    underwriting claims-made policies toward the end of the applicable
    claims period when it priced premiums. While captive insurance
    companies may legitimately be more profitable than large commercial
    insurance companies in some cases, the substantial profits during the
    years at issue here appear to be derived mostly from a failure to
    determine the premiums actuarially.
    
           The premium determination process was not adequately
    supported by detailed underwriting. While Artex appeared familiar
    with the practice of obtaining detailed applications in insurance
    underwriting, it obtained virtually no information from RMS that would
    have informed the underwriting process. Nor did Artex underwriters
    adequately account for RMS’s loss experience over time. The Provincial
    policies could hardly have had reasonable premiums without adequate
    
    
           62 Neither is there any credible evidence in the record indicating that Artex,
    
    the Provincial Pool, or Risk Retention were burdened by unusually high overhead
    expense.
                                       62
    
    [*62] information and expertise to price the policies. While the
    proverbial broken clock may be right twice a day, this is an inadequate
    method for pricing insurance policies.
    
           Neither is there any credible evidence in the record that RMS
    achieved cost savings through the captive program. Risk Retention
    actually had a significant enough surplus during the years at issue that
    it financed some of RMS’s commercial insurance premiums through the
    use of the captive insurance premiums that it received. Risk Retention
    also financed group health plan claims for RMS and buy-sell life
    insurance premiums for Mr. Keating and Mr. Candland, and it extended
    miscellaneous loans to RMS to finance its operations and posted
    collateral for its workers’ compensation deductibles. Repeated execution
    of these agreements shows confidence on RMS’s and petitioners’ part
    that Risk Retention’s surplus would not be needed to pay substantial
    claims on the captive policies and that Provincial was overcharging for
    the coverage provided. Likewise, petitioners’ failure to consult Mr. Hill
    or another qualified insurance broker about whether the captive
    coverages were available on a more cost-effective basis in the
    commercial marketplace shows their intent not to use the captive
    arrangement to provide actual insurance.
    
           We also briefly discuss some issues related to premium
    determination in the Provincial Pool specifically. There is no apparent
    reason for allocating each captive’s premiums approximately 51% to the
    pool policies and 49% to the facultative policies other than to come
    within a perceived IRS safe harbor. In a typical captive arrangement
    involving quota-share reinsurance, one would expect members to pay
    individually and actuarially determined premiums based on the
    expectation of each member’s losses. A one-size-fits-all approach to
    allocating premiums between layers of reinsurance, like the one used
    here, suggests that the allocation is inconsistent with an actual
    actuarial determination. See Avrahami, 149 T.C. at 186; Syzygy Ins.
    Co., T.C. Memo. 2019-34, at *36; Reserve Mech. Corp., T.C. Memo.
    2018-86, at *43. The one-size-fits-all approach was particularly strange
    here because the Provincial Pool reinsured dozens of lines of coverage
    during the years at issue, not a homogenous pool of risks, and because
    other insureds operated businesses that were highly dissimilar to
    RMS’s. Cf. Avrahami, 149 T.C. at 186–88 (finding a one-size-fits-all
    approach to risk pool premium pricing objectionable even when only one
    form of coverage was at issue).
                                        63
    
    [*63]               e.     Payment of Claims
    
           Risk Retention and Provincial paid claims. Nonetheless, the
    process by which those claims were handled was abnormal. See Caylor
    Land & Dev., Inc., T.C. Memo. 2021-30, at *42–43, *48 (holding that the
    abnormal payment of claims supports a conclusion that an arrangement
    is not insurance in the commonly accepted sense).
    
           RMS used a board resolution to pay the legal settlement with
    Wausau from Risk Retention’s funds despite numerous defects with that
    claim. Throughout the years at issue RMS also frequently provided
    Artex with deductible billing invoices on its workers’ compensation
    policy with Crum & Forster only after Risk Retention had already paid
    the invoices. Not only is it highly unusual for claims approval to occur
    after claims payment, but it also shows that Artex gave little timely
    review to these claims.
    
          Artex effectively allowed RMS to manage its own claims under
    the Worker’s Compensation Deductible / SIR Reimbursement policy.
    Artex also failed to place proper controls on RMS’s insistence that it be
    allowed to directly manage the claims process as though no formal
    captive insurance program were in place. Risk Retention, a purported
    reinsurer, played an inappropriate role in the direct payment of claims.
    
           For 2012, 2013, and 2014 the Provincial Pool paid claims
    amounting to 0.324%, 3.322%, and 3.019% of total pool premiums,
    respectively, which resulted in $1,921, $20,209, and $18,732
    quota-share payments by Risk Retention for the respective years at
    issue.    These amounts are relatively small compared to the
    approximately $1.2 million that RMS paid in captive premiums each
    year, or even compared only to the 51% or so of those premiums that
    Artex allocated to pool premiums. The Provincial Pool had a very low
    ratio of losses to premiums compared to the insurance industry as a
    whole, which resulted in nearly a full round trip of premiums,
    considering that the captives participating in it were affiliated with
    their insureds.
    
            Perhaps more concerning, however, is the manner in which Artex
    and Provincial handled the claims. Artex added or altered policies for
    its clients retroactively in order to permit them to file claims against the
    Provincial Pool or to reduce their premiums if they were unable to pay
    in full. It did not consistently enforce the prior-knowledge limitation
    when adjusting claims or treat claims as uncovered because no coverage
                                         64
    
    [*64] was in effect at the time of the loss, even though it should have. It
    also approved some claims on the basis of only slight documentation.
    Furthermore, the contractual linkage of consulting, insurance, and
    reinsurance agreements had an inappropriate influence on claims
    management, as did the staffing overlap between Artex’s underwriting
    and claims functions.
    
          Artex facilitated the use of board resolutions to provide an
    end-run around the claims process. Routine use of these ex gratia
    payments is counter to standard claims procedures. While a bona fide
    insurance company may settle a claim with an insured because of a
    reasonable expectation of coverage, its relationship with a client, or an
    acknowledgment that the insurance company could have done
    something better, there is no credible evidence indicating that these
    reasons motivated Artex’s decision-making. Instead, the claims process
    was largely illusory, and Artex used board resolutions precisely to
    address situations where insureds wanted to access funds held by their
    captive insurer but had no reasonable expectation of coverage.
    
                 2.     Conclusion
    
          Petitioners have not proven that RMS’s payments that they seek
    to deduct as insurance expenses were for insurance in the commonly
    accepted sense. Petitioners have therefore failed to prove that the
    payments were for insurance for federal income tax purposes.
    
          B.     Effect on Petitioners
    
           Having determined that the microcaptive arrangement among
    petitioners, RMS, Risk Retention, Provincial, and Artex was not
    insurance, we proceed to discuss the legal effect of that conclusion on
    petitioners for the years at issue.
    
                 1.     Section 162
    
           Section 162(a) allows taxpayers a deduction for all ordinary and
    necessary expenses paid or incurred during the taxable year in carrying
    on any trade or business. To be deductible under section 162(a), an
    expense must be both ordinary and necessary. Welch v. Helvering,
    290 U.S. at 113. An expense is necessary if it is appropriate and helpful
    to the development of the taxpayer’s business. Commissioner v. Tellier,
    383 U.S. 687, 689 (1966); Welch v. Helvering, 290 U.S. at 113. An
    ordinary expense is one that is “normal, usual, or customary. . . . [T]he
    transaction which gives rise to it must be of common or frequent
                                        65
    
    [*65] occurrence in the type of business involved.” Deputy v. Du Pont,
    308 U.S. 488, 495 (1940). It is “the kind of transaction out of which the
    obligation [to pay] arose and its normalcy in the particular business
    which are crucial and controlling.” Id. at 496. In addition to being
    ordinary and necessary, as well as paid or incurred during the taxable
    year, a deductible business expense must be reasonable in amount. See
    United States v. Haskel Eng’g & Supply Co., 380 F.2d 786, 788–89
    (9th Cir. 1967) (“An expenditure may be, by its nature, ordinary and
    necessary, but at the same time it may be unreasonable in amount. In
    such a case only the portion which was reasonable would qualify for a
    deduction under § 162(a).”); Hopkins v. Commissioner, T.C. Memo.
    2005-49, slip op. at 16–17. Whether an expense is deductible under
    section 162 is a question of fact to be decided on the basis of all relevant
    facts and circumstances. See Cloud v. Commissioner, 97 T.C. 613, 618
    (1991).
    
           Premium payments to a captive insurance company that are not
    for insurance are generally not ordinary and necessary business
    expenses and cannot be deducted under section 162(a). See Avrahami,
    149 T.C. at 174, 199. We have recognized, however, that “[i]n the context
    of captive insurance there may be instances where noninsurance
    payments for indemnification protection might be appropriate and
    helpful to the development of the insured.” Syzygy Ins. Co., T.C. Memo.
    2019-34, at *46; cf. id. at *47–48. Nonetheless, “[t]he cases tell us to be
    more skeptical about expenses between related parties. . . . The reason
    is that ‘expenses’ from one related party to another are more likely to be
    distributions of profits, which are not deductible.” Caylor Land & Dev.,
    Inc., T.C. Memo. 2021-30, at *29.
    
           Petitioners have not established that the captive premium
    payments were ordinary. The payments were not for insurance. RMS’s
    clients did not require RMS to obtain the captive coverages, even though
    they required RMS to maintain certain insurance coverage. Mr. Hill
    had never heard of some of the captive coverages, and petitioners never
    directed him or any other insurance broker to seek out many of the
    coverages in the commercial marketplace before implementing the
    captive program. Petitioners have not attempted to establish that
    businesses similar to RMS typically relied on the types of coverages
    provided by Artex, on the terms provided by Artex, for their coverage
    needs.      While petitioners made some claims for deductible
    reimbursements, we see no credible evidence in the record indicating
    that businesses like petitioners’ typically purchase deductible or SIR
    reimbursement policies rather than simply paying their deductibles
                                       66
    
    [*66] directly. Even if they do, we have not been directed to any
    evidence that they purchase policies with the restrictive or ambiguous
    terms found in the Artex and Provincial policies. Likewise, we have seen
    no evidence that similar businesses purchase policies from insurance
    companies using the irregular pricing and claims handling practices
    that Artex and Provincial used.
    
           Regarding the fees paid to Artex and PRS in particular,
    petitioners have not proven that captive management fees, or fees for a
    paying agent controlled by a captive management company, are normal,
    usual, or customary in RMS’s line of business. Cf. Reserve Mech. Corp.,
    T.C. Memo. 2018-86, at *50 (finding a captive’s management entirely by
    a captive management company to be a factor weighing against a
    determination that the captive operates as an insurance company).
    
           Petitioners argue that “insurance is normal, usual and customary
    for many businesses, as risk shifting has been around since groups
    gathered in Lloyds coffee house in London to indemnify ship owners for
    cargo they might lose at sea.” Nonetheless, our concern is not with the
    ordinariness of insurance or indemnification payments in general, but
    with the ordinariness of the particular “kind of transaction out of which
    the obligation [to pay] arose and its normalcy in the particular business”
    here. Deputy v. Du Pont, 308 U.S. at 496. Given that petitioners have
    failed to establish that the expenses were ordinary, we need not decide
    whether the expenses met the other requirements for deductibility
    under section 162. We also need not address petitioners’ argument that
    the reasonable portions of the premiums should be allowed.
    
                 2.     Section 165
    
          Petitioners argue that “[i]f the Court determines the premiums
    paid are not deductible under I.R.C. § 162 or that the transaction is not
    insurance or otherwise lacks economic substance, the losses paid are
    deductible by RMS in the year they were sustained and paid by Risk
    Retention.” Specifically, petitioners argue,
    
          The Court must decide whether the premiums paid by
          RMS are deductible insurance expenses or reserves set
          aside for self-insurance. . . . If the Court determines that
          the transaction is not insurance for federal income tax
          purposes, the transaction should be treated as a
          self-insured reserve. . . . [I]f the taxpayer utilizes a self-
          insured reserve fund, the allowable deduction is limited to
                                              67
    
    [*67] the losses actually incurred and paid out of the reserve. . . .
          Deductions are allowed for losses sustained during a
          taxable year, for which a taxpayer is not compensated by
          insurance, or otherwise.
    
    Petitioners thus appear to argue that we should characterize the
    arrangement as a self-insurance reserve and permit deductions as
    “claims” (generally, workers’ compensation deductible payments63) were
    made. Respondent disputes this argument on the merits and has also
    affirmatively invoked the duty of consistency.
    
           Petitioners’ proposed characterization of Risk Retention, a
    corporation and a separate taxpayer from both RMS and petitioners, as
    a mere reserve or account of RMS is not borne out by the record. Even
    if it was RMS’s pocketbook, it was an incorporated one and therefore a
    separate entity. 64 See Moline Props., Inc. v. Commissioner, 319 U.S. 436,
    438–39 (1943) (“Whether the purpose be to gain an advantage under the
    law of the state of incorporation or to avoid or to comply with the
    demands of creditors or to serve the creator’s personal or undisclosed
    convenience, so long as that purpose is the equivalent of business
    activity or is followed by the carrying on of business by the corporation,
    the corporation remains a separate taxable entity.” (Footnotes
    omitted.)).
    
           A taxpayer generally may not deduct another person’s expense or
    loss. See Deputy v. Du Pont, 308 U.S. at 493–94. The Ninth Circuit has
    stated that
    
            if a taxpayer chooses to conduct business through a
            corporation, he will not subsequently be permitted to deny
            the existence of the corporation if it suits him for tax
            purposes. . . . In particular corporate shareholders will not
            be permitted to claim deductions for ordinary and
    
            63 In 2012 Risk Retention also paid $3,452 for a claim filed under RMS’s 2011
    
    Employment Practices Deductible / SIR Reimbursement policy.
            64 Notwithstanding our conclusion below that Risk Retention’s section 953(d)
    
    elections were invalid for the years at issue by reason of its failure to satisfy
    section 953(d)(1)(B), we regard the section 953(d) elections that Risk Retention filed as
    prima facie evidence that it was a foreign corporation because only foreign corporations
    are eligible to make a section 953(d) election. See § 953(d)(1). We also deem
    petitioners’ argument that Risk Retention’s section 953(d) elections were valid to be a
    concession that Risk Retention was a foreign corporation if the section 953(d) elections
    were not valid.
                                       68
    
    [*68] necessary expenses incurred by the corporation even
          though paid by the shareholders.
    
    Betson v. Commissioner, 802 F.2d 365, 368 (9th Cir. 1986), aff’g in part,
    rev’g in part T.C. Memo. 1984-264. Neither respondent nor petitioners
    dispute that RMS shifted risks, including liability for payment of certain
    commercial insurance policy deductibles, to Risk Retention, a separate
    taxable entity, in exchange for making premium payments. The parties
    dispute whether the arrangement by which it did so was insurance or
    was otherwise a deductible expense or loss, but there is no factual basis
    for a finding that RMS retained the liabilities it shifted to Risk
    Retention or incurred the losses when they came due. Risk Retention’s
    assumption of RMS’s liability for workers’ compensation deductibles is
    also evidenced by Risk Retention’s repeated execution of deductible
    agreements with United States Fire Insurance Co. and the substantial
    sums that Risk Retention paid into the collateral fund before and during
    the years at issue pursuant to the deductible agreements. Petitioners
    could have set up an unincorporated self-reserve fund or account and
    deducted the losses as they occurred, but they did not do so. Petitioners’
    argument also ignores the requirement that a corporation affirmatively
    make an S corporation election in order for it and its shareholders to
    receive passthrough entity treatment. See generally § 1362; Treas. Reg.
    § 1.1362-6. Risk Retention never did so.
    
           Petitioners read our and the Ninth Circuit’s caselaw as requiring
    a binary choice between a finding that the arrangement involved either
    payments for insurance or a finding that petitioners set funds aside in a
    reserve for self-insurance. Although we are skeptical of this reading, we
    need not decide whether it is correct because petitioners have not
    suggested any other characterizations of the arrangement; and even if
    Risk Retention was a reserve for self-insurance, it was an incorporated
    one. Petitioners chose to transact business through the corporate form
    rather than on RMS’s or their own account; it follows that deductions
    arising from the liabilities they took pains to shift to Risk Retention
    belong to Risk Retention. The general rule that losses from a
    self-insurance reserve are deductible as they are incurred does not
    conflict with a finding that such deductions belong to a taxpayer other
    than petitioners. Petitioners have failed to meet their burden of proving
    that the amounts paid by Risk Retention as claims were losses incurred
    by RMS.
    
          Petitioners argue that Spring Canyon Coal Co. v. Commissioner,
    43 F.2d 78 (10th Cir. 1930), aff’g 13 B.T.A. 189 (1928), provides support
                                         69
    
    [*69] for their position. In that case a taxpayer self-insured its workers’
    compensation obligations by setting up a separate fund into which it
    paid premiums. Id. at 78–79. The court held that the taxpayer was not
    entitled to deduct the self-insurance premiums but noted that “its right
    to deduct payments made out of the fund,” id. at 79, was not in dispute.
    This case is inapposite because the taxpayer “carried the fund on its
    books as an asset,” id., whereas here Risk Retention was a separate
    entity. Expenses or losses paid out of the taxpayer’s fund in Spring
    Canyon Coal Co. were the taxpayer’s own expenses or losses; but the
    expenses or losses arising under the deductible reimbursement policies
    that RMS purchased were Risk Retention’s.
    
           Petitioners also invoke Anesthesia Service Medical Group, Inc. v.
    Commissioner, 825 F.2d 241 (9th Cir. 1987), aff’g 85 T.C. 1031 (1985),
    for support. In that case, the court held that a taxpayer’s contributions
    to a grantor trust it established to pay potential malpractice claims
    against its employees were not deductible. The court stated that
    “[a]mounts placed into self-insurance reserves are not deductible
    business expenses under I.R.C. § 162(a). . . . Rather, the taxpayer must
    wait until a loss recognizable under I.R.C. § 165 occurs.” Id. at 242. We
    agree with this general statement of the law, but the Ninth Circuit also
    held that the taxpayer’s “ability to use Trust funds to discharge its
    potential vicarious liability requires taxing the Trust’s income” to the
    taxpayer. Id. at 243. The cited case is therefore distinguishable on the
    ground that it did not involve a separate entity to which the deductions
    were attributable.        Instead, it involved only a grantor trust.
    Furthermore, the cited case is distinguishable because the taxpayer
    never shifted its risk of loss to the trust; on the contrary, it was obligated
    to reimburse the trust for any shortfall caused by claims. See Anesthesia
    Serv. Med. Grp., Inc., 85 T.C. at 1039–41 (holding that a contributory
    agreement between the taxpayer and its trust alone indicated that the
    risk of loss did not shift from the taxpayer). In the cases at bar, neither
    petitioners nor respondent disputes that RMS shifted risks to Risk
    Retention through the captive arrangement. Risk Retention, a separate
    entity, in fact retained the risks that RMS shifted to it, and the tax
    treatment follows from that fact.
    
           Finally, petitioners argue that generally accepted accounting
    principles (GAAP) support a finding that transactions not qualifying as
    insurance should be treated as reserves or deposit arrangements.
    Regardless of whether petitioners’ application of the accounting rules it
    cites to the circumstances here is correct, nontax rules of accounting do
    not control, or even necessarily inform, the determination of a taxpayer’s
                                        70
    
    [*70] tax liability.      See AMERCO, 96 T.C. at 35–36 (rejecting
    Commissioner’s expert’s reliance on GAAP in a captive insurance case
    as “simply irrelevant to the tax law considerations before this Court”
    and stating that “[i]t is clear that the Federal income tax does frequently
    perceive related corporate entities as separate enterprises and
    taxpayers”); see also Foster v. United States, 303 U.S. 118, 120–22
    (1938); Old Colony R. Co. v. Commissioner, 284 U.S. 552, 562 (1932).
    Given our holding that the deductions at issue belonged to Risk
    Retention, not RMS, we do not reach respondent’s alternative argument
    that the duty of consistency applies to bar the deductions.
    
                 3.     Dividends
    
           We must decide the tax characterization of the distributions that
    Risk Retention made to Mr. Keating and Mr. Candland in 2012 and
    2014. Under section 301(c), a corporation’s distribution of property to a
    shareholder generally may, in whole or in part, (1) constitute a dividend,
    (2) reduce the adjusted basis of the shareholder’s stock to the extent it
    is not a dividend, or (3) be treated as gain from the sale or exchange of
    property to the extent it both exceeds the adjusted basis of the stock and
    is not a dividend. Section 316(a) generally defines a dividend as a
    distribution of property made by a corporation to its shareholders out of
    its earnings and profits accumulated after February 28, 1913, or out of
    its earnings and profits of the taxable year without regard to the amount
    of earnings and profits at the time the distribution was made.
    Petitioners conceded in both their Simultaneous Opening Brief and their
    Errata to Petitioners’ Simultaneous Opening Brief that “the dividends
    were paid from earnings and profits.” We therefore deem petitioners to
    have conceded that the distributions are dividends for purposes of
    sections 301(c)(1) and 316(a).
    
          Petitioners attempt to walk back their concession in their
    Simultaneous Answering Brief, in which they argue:
    
          Respondent has failed to calculate Risk Retention’s
          earnings and profits if the transaction is not insurance for
          federal income tax purposes, establishing that the
          payments petitioners’ [sic] Keating and Candland received
          were still paid out of earnings and profits, [and] therefore,
          are dividends. Changing the character of the payments to
          Risk Retention to something other than premiums would
          change the earnings and profit calculation for Risk
          Retention. . . . [Section 964(a)] provides the earnings and
                                       71
    
    [*71] profits of a foreign controlled corporation are calculated in
          the same manner as a domestic corporation. Funds that
          are paid out of a C Corporation that are not paid out of
          earnings and profits are taxed as return of capital. I.R.C.
          § 301.
    
    Petitioners’ late attempt to withdraw their earlier concession subverts
    our briefing schedule and takes respondent by surprise by not
    permitting him to respond to this new argument. We decline to allow
    the withdrawal of the concession.          See Estate of DeMuth v.
    Commissioner, T.C. Memo. 2022-72, at *8–9 (enforcing concession that
    opposing party relied on in drafting its simultaneous answering brief),
    aff’d, No. 22-3032, 2023 WL 4486739 (3d Cir. July 12, 2023).
    
           Because Risk Retention’s distributions to Mr. Keating and Mr.
    Candland in 2012 and 2014 were dividends, the only issue is whether
    they were ordinary or qualified dividends. Section 1(h)(11) provides
    preferential tax rates for “qualified dividend income” if the dividend is
    received from a domestic corporation or a qualified foreign corporation.
    See § 1(h)(11)(B)(i); Avrahami, 149 T.C. at 199. We start with the latter
    category. A qualified foreign corporation is generally any foreign
    corporation that is either (1) incorporated in a possession of the United
    States or (2) eligible for the benefits of a comprehensive income tax
    treaty with the United States which the Secretary determines is
    satisfactory and which includes an exchange of information program.
    See § 1(h)(11)(C). Anguilla is not a possession of the United States. The
    IRS has published a list of income tax treaties satisfying the statutory
    requirements, see I.R.S. Notice 2011-64, 2011-37 I.R.B. 231, and
    Anguilla is not on it, cf. Smith v. Commissioner, 151 T.C. 41, 57 (2018).
    Risk Retention was not a qualified foreign corporation during the years
    at issue.
    
           This leaves us to decide whether Risk Retention’s election under
    section 953(d) to be treated as a domestic corporation is valid. To make
    a valid section 953(d) election, a controlled foreign corporation, as
    defined in section 957(a), must qualify under part I (life insurance
    companies) or II (other insurance companies) of subchapter L. See
    § 953(d)(1)(B); Avrahami, 149 T.C. at 198. To qualify for either part, a
    company must meet the definition of “insurance company” in section
    816(a). See §§ 816(a) (flush language), 831(c), 953(d)(1)(B); Avrahami,
    149 T.C. at 198. This means that more than half of its business during
    the taxable year must be the issuing of insurance or annuity contracts
    or the reinsuring of risks underwritten by insurance companies. We
                                        72
    
    [*72] have already held that the captive arrangement did not constitute
    insurance, and petitioners have not proven that Risk Retention had
    other business that constituted insurance. Risk Retention was not an
    insurance company for the years at issue, and its section 953(d) elections
    were invalid. We therefore hold that the distributions Risk Retention
    made to petitioners in 2012 and 2014 should be taxed at ordinary income
    rates.
    
           Petitioners argue that the dividends are qualified because section
    953(d)(2)(B) provides that if a corporation which made a section 953(d)
    election fails to meet the requirements of section 953(d)(1)(B) “for any
    subsequent taxable year, such election shall not apply to any taxable
    year beginning after such subsequent taxable year.” (Emphasis added.)
    Therefore, petitioners argue, “if respondent determined that during
    2012 Risk Retention first failed to meet the requirements for its [section]
    953(d) election, then the election would become inapplicable beginning
    in 2013.” As an initial matter, this argument, taken on its own terms,
    does not aid petitioners with respect to the characterization of the 2014
    dividends. In addition, this argument is wrong on the merits.
    
           We consider the validity of a section 953(d) election at the time it
    was made before deciding whether it was terminated under section
    953(d)(2)(B). See Chapman Glen Ltd. v. Commissioner, 140 T.C. 294,
    318–20 (2013). Risk Retention’s section 953(d) election states that it
    “shall be effective as of the first day of the corporation’s taxable year
    (including a short taxable year) commencing” on November 24, 2008.
    Petitioners have failed to meet their burden of proving that Risk
    Retention was an insurance company within the meaning of section
    953(d)(1)(B) in 2008. During that year Mr. Candland met with Mr.
    Kotch; and while his handwritten notes show that they discussed the
    taxation of a captive insurer, they do not reflect any discussion of RMS’s
    coverage needs. After Risk Retention was formed on November 25,
    2008, RMS paid it only $500,000 in 2008, despite initially setting a
    premium budget of $800,000 for this period of little over a month. Artex
    did not even finalize the policies until 2009. After another payment in
    March 2009, RMS ultimately paid over $670,000 for purported
    insurance policies that, viewed charitably, offered little more than a
    month of coverage. Cf. Reserve Mech. Corp., T.C. Memo. 2018-86, at *57
    (noting a large amount paid for only one month of insurance coverage).
    The declaration pages in the record are backdated to December 10, 2008,
    and the coverage was made retroactive to November 25, 2008, despite
    the policies’ preparation in 2009. This is not an insurance arrangement.
                                             73
    
    [*73] Petitioners have failed to prove that Risk Retention was a life or
    nonlife insurance company in 2008, and Risk Retention’s section 953(d)
    election was accordingly invalid when made. Furthermore, petitioners
    have failed to prove that even if Risk Retention’s section 953(d) election
    was valid when made, Risk Retention continued to meet the
    requirements of section 953(d)(1)(B) for 2009, 2010, and 2011 as would
    be necessary to prevent a termination under section 953(d)(2)(B) before
    the years at issue. 65 Our review of the record shows that, if anything,
    virtually all aspects of the purported insurance arrangement were even
    more deficient in 2009–11 than they were during the years at issue.
    
           Petitioners argue that section 953(d)(2)(A) provides that the
    section 953(d) election, once made, applies for subsequent taxable years
    unless revoked with the consent of the Secretary.              This is a
    misstatement of section 953(d)(2)(A), which provides that its rule
    applies “[e]xcept as provided in subparagraph (B).” Petitioners also
    argue that Revenue Procedure 2003-47 provides support for their
    position. It does not, because it expressly states that “[o]nce approved,
    the election generally remains effective for each subsequent taxable year
    in which the requirements of this revenue procedure and section 953(d)
    are satisfied unless revoked by the electing corporation with the consent
    of the Commissioner.” Rev. Proc. 2003-47, § 4.02(1), 2003-2 C.B. 55, 55
    (emphasis added). In sum, Risk Retention was a foreign corporation,
    not a domestic corporation, and its dividends in 2012 and 2014 were not
    qualified because Anguilla did not have a comprehensive income tax
    treaty with the United States during the years at issue.
    
    V.     Accuracy-Related Penalties
    
           The last issue is whether accuracy-related penalties under
    section 6662(a) are justified. Respondent determined accuracy-related
    penalties on grounds of negligence or disregard of rules or regulations,
    see § 6662(b)(1), (c), or in the alternative, on grounds of substantial
    understatements of income tax, see § 6662(b)(2), (d). Respondent bears
    the burden of production with respect to the accuracy-related penalties.
    See § 7491(c). Once respondent comes forward with sufficient evidence
    
            65 The evidentiary objections that petitioners made to some items of evidence
    
    on the grounds that they concerned taxable years prior to the years at issue are
    somewhat confusing in view of the necessity of such evidence for petitioners to prove
    that Risk Retention’s section 953(d) election did not terminate before the years at
    issue. At a minimum, even without considering other grounds for their relevance,
    petitioners opened the door to such evidence by placing the qualified dividend rate at
    issue.
                                        74
    
    [*74] to show that it is appropriate to impose a particular penalty,
    petitioners have the burden of proof to show that respondent’s penalty
    determination is incorrect, including the burden of proving that
    penalties are inappropriate because of reasonable cause. See Higbee v.
    Commissioner, 116 T.C. 438, 446–47 (2001). The parties have stipulated
    that respondent complied with the written supervisory approval
    requirements of section 6751(b) for the accuracy-related penalties
    determined against petitioners for each year at issue.
    
           Section 6662(a) imposes a 20% penalty on the portion of an
    underpayment of tax attributable to any substantial understatement of
    income tax, see § 6662(b)(2), or negligence or disregard of rules or
    regulations, see § 6662(b)(1). An understatement is substantial if it
    exceeds the greater of (1) 10% of the tax required to be shown on the
    return for the taxable year, or (2) $5,000. See § 6662(d)(1)(A).
    Negligence includes any failure to make a reasonable attempt to comply
    with the provisions of the Code, and disregard includes any careless,
    reckless, or intentional disregard. See § 6662(c). The understatements
    in these cases are substantial as an arithmetic matter for all petitioners
    and for all years at issue. It is therefore unnecessary for us to determine
    whether the underpayments are attributable to negligence or disregard
    of rules or regulations. See Avrahami, 149 T.C. at 204–05; see also
    Treas. Reg. § 1.6662-2(c) (providing that only one accuracy-related
    penalty for a given year may be applied with respect to any given portion
    of an underpayment, even if that portion is subject to the penalty on
    more than one ground). Respondent has met his burden of production
    with regard to the accuracy-related penalties, and petitioners have the
    burden of proof to show that respondent’s penalty determinations are
    incorrect.
    
          Petitioners assert that they had reasonable cause for, and acted
    in good faith with respect to, the underpayments. Section 6664(c)(1)
    provides that the penalty under section 6662(a) shall not apply to any
    portion of an underpayment if it is shown that there was reasonable
    cause for the taxpayer’s position and the taxpayer acted in good faith.
    See Higbee, 116 T.C. at 448. This determination is made on a
    case-by-case basis, taking into account all of the pertinent facts and
    circumstances. See Treas. Reg. § 1.6664-4(b)(1). Generally, the most
    important factor is the extent of the taxpayer’s effort to assess the
    taxpayer’s proper tax liability. See id. For underpayments related to
    passthrough items, we look at all pertinent facts and circumstances,
    including the taxpayer’s own actions, as well as the actions of the
    passthrough entity. See id. para. (e). Reliance on professional advice
                                        75
    
    [*75] may constitute reasonable cause and good faith, but only if,
    considering all the circumstances, such reliance was reasonable. See id.
    paras. (b)(1), (c)(1); see also Freytag v. Commissioner, 89 T.C. 849, 888
    (1987), aff’d, 904 F.2d 1011 (5th Cir. 1990), aff’d, 501 U.S. 868 (1991).
    Advice is “any communication . . . setting forth the analysis or
    conclusion of a person, other than the taxpayer, provided to (or for the
    benefit of) the taxpayer and on which the taxpayer relies, directly or
    indirectly, with respect to the imposition of the section 6662 accuracy-
    related penalty.” Treas. Reg. § 1.6664-4(c)(2). Advice does not have to
    be in any particular form. Id.
    
           Reasonable cause exists if a taxpayer relies in good faith on the
    advice of a qualified tax adviser where the following three elements are
    present: (1) the adviser was a competent professional who had sufficient
    expertise to justify the reliance; (2) the taxpayer provided necessary and
    accurate information to the adviser; and (3) the taxpayer actually relied
    in good faith on the adviser’s judgment. See Neonatology Assocs., P.A.,
    115 T.C. at 99. Reliance may be unreasonable if the adviser is a
    promoter of the transaction. Id. at 98. A promoter is “an adviser who
    participated in structuring the transaction or is otherwise related to, has
    an interest in, or profits from the transaction.”             106 Ltd. v.
    Commissioner, 136 T.C. 67, 79 (2011) (quoting Tigers Eye Trading, LLC
    v. Commissioner, T.C. Memo. 2009-121, slip op. at 48), aff’d, 684 F.3d 84
    (D.C. Cir. 2012).
    
           There is no credible evidence in the record that petitioners or
    RMS took any substantial steps to ascertain their proper tax liability.
    Petitioners rely upon advice purportedly given by Tom Goddard, an
    accountant who testified at trial, to establish reasonable cause and good
    faith. Petitioners argue that they “relied upon Mr. Goddard’s advice in
    reporting the captive insurance premiums paid as deductible business
    expenses” during the years at issue. Although Mr. Goddard was not a
    promoter, petitioners’ argument lacks merit.
    
            Neither any written tax opinion nor other contemporaneous
    documentary evidence concerning any advice Mr. Goddard may have
    given to Mr. Candland or RMS is in the record. Mr. Goddard did not
    even testify that he provided any express advice to petitioners regarding
    the tax treatment of the captive insurance arrangement. Instead, he
    testified he would receive RMS’s books for the year, which included a
    captive insurance deduction, and that “the communication was . . . we
    weren’t objecting to their deduction in that year for the insurance
    captive. To me, it was an ordinary expense, ordinary insurance expense,
                                             76
    
    [*76] and I felt it was necessary and reasonable.” We specifically find
    that Mr. Goddard did not provide any advice to petitioners about the
    microcaptive arrangement. Mr. Goddard’s lack of objection to captive
    insurance deductions that petitioners had already been taking for years
    before they hired him does not itself constitute advice on which
    petitioners may rely in good faith. See Neonatology Assocs., P.A.,
    115 T.C. at 100 (“The mere fact that a certified public accountant has
    prepared a tax return does not mean that he or she has opined on any
    or all of the items reported therein.”); Caylor Land & Dev., Inc.,
    T.C. Memo. 2021-30, at *52 (stating that taxpayers in microcaptive cases
    could not “rely on advice that was not given”); Flume v. Commissioner,
    T.C. Memo. 2020-80, at *37 (“Simply employing a tax return preparer
    for the years at issue does not permit [the taxpayers] to avoid
    accuracy-related penalties.”).
    
           We also specifically find that Mr. Goddard did not review, nor did
    petitioners provide him with, some of the information that would have
    been necessary to form an opinion on the deductibility of the captive
    expenses. 66 Furthermore, the evidence of petitioners’ actual reliance,
    let alone good-faith reliance, on any judgment that Mr. Goddard may
    have reached is underwhelming. Cf. Avrahami, 149 T.C. at 207 (stating,
    as part of a finding of reasonable reliance on professional advice, that
    the adviser credibly testified that specific advice was given and that the
    taxpayer credibly testified that he proceeded with a microcaptive
    arrangement because of the adviser’s blessing).
    
           Petitioners also argue that the issues are novel and complex and
    were essentially ones of first impression at the time their returns were
    filed and that they should be excused from accuracy-related penalties.
    While the issues were somewhat novel at the time, this does not excuse
    petitioners from penalties in the absence of any efforts on their part to
    ascertain their correct tax liabilities or apply well-settled principles of
    taxation to their situation.         See Neonatology Assocs., P.A. v.
    Commissioner, 299 F.3d at 234–35 (stating that taxpayers could not
    avoid accuracy-related penalties, even though they were without direct
    precedent to guide them, because their case “does not involve novel
    questions of law but rather is concerned with the application of
    
    
             66 Mr. Goddard did not review the actual policies issued by Risk Retention.
    
    Neither did he review Risk Retention’s formation documents, engagement letter with
    Tribeca, business plan, or various reinsurance contracts and agreements. In addition,
    he did not review the Owners’ Manual, any of the general terms and conditions in force
    for the captive insurance arrangement, or Artex’s claims handling practices.
                                       77
    
    [*77] well-settled principles of taxation to determine whether certain
    expenditures made by close corporations are deductible as ordinary and
    necessary business expenses”). While we observed as part of our
    analysis of good faith in Avrahami that “[t]his is a case of first
    impression,” 149 T.C. at 207, we did so only after finding that the
    taxpayers actually and reasonably relied on advice from a competent
    professional, see id. at 206–07. These cases are more like Caylor in that
    petitioners did not actually “get advice or a professional’s judgment that
    they could have reasonably relied upon.” Caylor Land & Dev., Inc.,
    T.C. Memo. 2021-30, at *53. Petitioners are liable for accuracy-related
    penalties across the board.
    
          We have considered the parties’ other arguments and, to the
    extent they are not discussed herein, find them to be irrelevant, moot,
    or without merit.
    
          To reflect the foregoing,
    
          Decisions will be entered under Rule 155.