United States Tax Court
T.C. Memo. 2024-34
SUNIL S. PATEL AND LAURIE MCANALLY PATEL, ET AL., 1
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket Nos. 24344-17, 11352-18, Filed March 26, 2024.
25268-18.
—————
Ps claimed deductions under I.R.C. § 162 on their
2013, 2014, 2015, and 2016 tax returns for amounts paid to
purported captive insurance companies A and B and to
entity C, which purported to reinsure a portion of its risk
with A and B. R denied the deductions and determined that
A’s and B’s elections under I.R.C. § 831(b) were invalid,
because the amounts paid did not qualify as insurance
premiums for federal income tax purposes.
Held: Amounts paid to A and B are not insurance
premiums for federal income tax purposes and are not
deductible under I.R.C. § 162.
—————
David D. Aughtry and Patrick J. McCann, Jr., for petitioners.
Sebastian Voth and Emerald G. Smith, for respondent.
1 Cases of the following petitioners have been consolidated herewith for
purposes of trial, briefing, and disposition: Sunil S. Patel and Laurie M. McAnally-
Patel, Docket Nos. 11352-18 and 25268-18.
Served 03/26/24
2
[*2] MEMORANDUM FINDINGS OF FACT AND OPINION
JONES, Judge: Sunil S. Patel, M.D. (Dr. Patel) and Laurie M.
McAnally-Patel, M.D. (Dr. McAnally-Patel) 2 seek redetermination of
deficiencies in federal income tax determined by the Internal Revenue
Service (IRS) for taxable years 2013, 2014, 2015, and 2016 (tax years at
issue).
Dr. Patel is the co-founder of an eye surgery center and the
founder of two research centers in the West Texas area. Beginning in
2011, Dr. Patel’s businesses supplemented their commercial insurance
coverage by purchasing assorted policies from purported microcaptive3
insurance companies—Magellan Insurance Company (Magellan) and
Plymouth Insurance Company (Plymouth)—that Dr. Patel also
controlled. The premiums paid to the microcaptives were substantially
more than the premiums paid to Dr. Patel’s commercial insurers,
creating substantial tax benefits for the Patels.
The IRS examined the purported insurance arrangements for
each of the tax years at issue and concluded that the purported
insurance premiums paid to Magellan and Plymouth could not be
treated or taxed under section 831(b). 4 Thus, it issued notices of
2 We sometimes refer to Dr. Patel and Dr. McAnally-Patel as the Patels.
3 “A ‘captive insurance company’ is a corporation whose stock is owned by one
or a small number of companies and which handles all or a part of the insurance needs
of its shareholders or their affiliates.” Caylor Land & Dev., Inc. v. Commissioner, T.C.
Memo. 2021-30, at *8 n.4; see also Harper Grp. v. Commissioner, 96 T.C. 45, 46 n.3
(1991), aff’d, 979 F.2d 1341 (9th Cir. 1992). In our prior cases, we have adopted the
term “microcaptive” to refer to “a small captive insurance company,” i.e., one that takes
in less than $1.2 or $2.2 million (adjusted for inflation) in premiums depending on the
tax year at issue. See Caylor Land & Dev., T.C. Memo. 2021-30, at *8 n.4; see also
Avrahami v. Commissioner, 149 T.C. 144, 179 (2017); Swift v. Commissioner, T.C.
Memo. 2024-13, at *2 n.1; Keating v. Commissioner, T.C. Memo. 2024-2, at *50 n.52
(explaining that amendments to section 831(b) increased the premium ceiling). The
Patels take issue with the term “microcaptive,” apparently viewing the word as
“diminutive” and asserting that “some [Court] opinions reflect that subtle, insidious,
inaccurate prejudice.” See Docket No. 24344-17, Pet’rs’ Reply Br. at 52 (Doc. 354). We
disagree. We do not view the word “microcaptive” as pejorative and will continue to
use the term consistent with our prior cases.
4 Unless otherwise indicated, statutory references are to the Internal Revenue
Code, Title 26 U.S.C. (Code), in effect at all relevant times, regulatory 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. All monetary
amounts are rounded to the nearest dollar.
3
[*3] deficiency that disallowed the claimed deductions and determined
accuracy-related penalties. 5
The issue for decision is whether the transactions involving
Magellan and Plymouth constituted insurance for federal income tax
purposes pursuant to section 831(b).
For the reasons set forth herein, we will sustain the
Commissioner’s determinations that the transactions at issue did not
constitute insurance for federal income tax purposes.
FINDINGS OF FACT
This case was tried during a special trial session in Washington,
D.C. The parties filed three stipulations of fact with accompanying
exhibits. We incorporate by this reference the stipulations of settled
issues and facts, the stipulated exhibits, and any exhibits admitted at
trial, except to the extent set forth herein.
The parties also filed a Fourth Stipulation of Facts (Fourth
Stipulation) and accompanying exhibits, subject to respondent’s
objections. After receiving the parties’ arguments at trial, the Court took
the Fourth Stipulation under advisement and allowed the parties to
make additional arguments in posttrial briefing. Having now considered
the parties’ arguments, the Court overrules respondent’s objections and
receives the Fourth Stipulation and accompanying exhibits into
evidence.
In our Findings of Fact, we use the terms “insurance,”
“reinsurance,” “risk,” “pooling,” “coverage,” “policy,” and similar terms
to describe the forms of the transactions at issue in these cases. But our
use of those terms does not reflect any ruling as a matter of fact or law
with respect to insurance or insurance companies within the meaning of
the Code. See Rsrv. Mech. Corp. v. Commissioner, T.C. Memo. 2018-86,
at *3, aff’d, 34 F.4th 881 (10th Cir. 2022).
The Patels resided in Texas when they timely petitioned this
Court.
5 We will address the IRS’s penalty determinations in a separate opinion.
4
[*4] I. The Patels and Their Businesses
A. Dr. Patel’s Early Life and Education
Dr. Patel was born in India and immigrated to the United States
as a child. Although he did not speak English when he started school at
the age of nine, he ultimately graduated from high school in the top five
percent of his class. He earned a bachelor of science degree in physics
from the University of California, Los Angeles in 1983. In 1989, he
earned a doctor of philosophy degree in immunology, and in 1991 he
earned a doctor of medicine degree, both from the University of Texas
Southwest. After completing a residency and fellowships in California,
Dr. Patel returned to Texas in 1997 to practice medicine.
B. Dr. McAnally-Patel’s Education and Career
During his quest for higher education, Dr. Patel met Dr.
McAnally-Patel; 6 they married in 1989. Dr. McAnally-Patel also
completed medical school and was licensed to practice medicine in Texas
from November 22, 1997, until May 5, 2015. However, she no longer
maintains an active medical license.
In 2009, Dr. McAnally-Patel obtained a certificate to teach high
school science. She now teaches physics at a high school in Abilene,
Texas.
C. Ophthalmology Specialists of Texas, Integrated Clinical
Research, and Strategic Clinical Research Group
In August 2000, Dr. Patel formed his own eye surgery practice,
Ophthalmology Specialists of Texas 7 (OST) doing business as West
Texas Retina Consultants. OST specializes in the evaluation and
management of eye-related medical conditions involving the retina,
vitreous, and macula. Providers at OST operate on eyeballs, including
conducting pneumatic retinopexy, retina laser surgery, biopsies of
ocular infections, and intraocular injections.
6 The record does not reflect that Dr. McAnally-Patel had any involvement in
the purported microcaptive transactions. Nonetheless, our decisions today will affect
her joint federal income tax returns. See infra Opinion Part IV.
7 OST was initially formed as a Texas professional association in August 2000,
but it was converted to a Texas professional limited liability company in November
2011.
5
[*5] In addition to his work with OST, Dr. Patel conducts clinical
research trials on experimental drugs for retina diseases through two
companies he established: Integrated Clinical Research, LLC (ICR) and
Strategic Clinical Research Group, LLC (SCR). OST refers 98 percent of
the ICR and SCR patients.
The same type of work is performed at ICR and SCR, but at
different locations. That is, they enter into contracts and clinical trial
protocols with pharmaceutical companies to test experimental drugs.
Human volunteers are tested to determine whether the drugs are safe.
The two companies also enter into agreements with the U.S. Food and
Drug Administration (FDA). The pharmaceutical companies may use
the data to obtain FDA approval of the drugs.
During the tax years at issue, the balance of OST, ICR, and SCR
procedures consisted of conducting surgeries and laser procedures as
well as inserting injections into eyeballs. Procedures involve a range of
potential patient risks, including pain, infection, inflammation,
bleeding, loss of vision, loss of an eyeball, and death.
All three entities face regulatory oversight from federal and state
authorities. Dr. Patel views this regulatory oversight as a “massive
burden.” He also believes that, as a retina specialist, he has a target
placed on his back by the government. During the tax years at issue, the
three entities had between seven and eight offices, five doctors, and
fewer than 100 employees. Several of the employees and physicians
overlap among the three entities. Further, the ICR and OST offices are
located at the same address.
II. The Patels’ Lawsuits and Introduction to Captive Insurance
In 2002, Dr. McAnally-Patel was sued by a patient for care she
provided at a regional hospital’s clinic for indigent patients. As a result,
in approximately 2003, the Patels consulted with an attorney to discuss
asset protection, including captive insurance. They ultimately opted not
to form a captive insurance company after the meeting. Instead, they
opted to form two separate family partnerships for asset protection.
In 2003, Dr. Patel and other physicians decided to form a hospital,
in part so that Dr. Patel would not have to wait for operating rooms for
his patients. Dr. Patel’s family, friends, and fellow physicians invested
with him to form the new hospital. In connection with this endeavor, Dr.
6
[*6] Patel formed two separate entities: (1) West Texas Hospital, Ltd. 8
(West Texas Hospital), to operate the new hospital; and (2) Hospital
Properties Management, LLP (Hospital Properties), to build and own
the hospital. In February 2004, Hospital Properties purchased land
across the street from OST and then built a hospital.
In 2005, West Texas Hospital opened as a 14-bed surgical hospital
in Abilene, Texas. Less than two years later, in January 2007, a patient
at West Texas Hospital suffered complications following spinal surgery
performed by a different doctor. The patient was transferred to another
hospital and ultimately died.
After the death, West Texas Hospital received negative publicity.
As a result, politicians and regulatory agencies began investigating
West Texas Hospital. Ultimately, just over two months after the
patient’s death, West Texas Hospital lost its Medicare provider contract,
thus losing 60 to 70 percent of its total revenue.
West Texas Hospital ceased operations after its Medicare
contract was officially terminated. Drs. Patel and McAnally-Patel, along
with West Texas Hospital and others affiliated with West Texas
Hospital, were sued by the estate of the deceased patient. That case
continued through September 28, 2015.
West Texas Hospital was not profitable during the time it
operated. Between personal money and personally guaranteed debt, Dr.
Patel and his family invested $3.1 million to open and fund West Texas
Hospital. Approximately two-thirds of the Patels’ total loss was related
to the commercial real estate purchased by Hospital Properties,
and one-third was related to West Texas Hospital. The commercial real
estate owned by Hospital Properties faced foreclosure in February 2008.
III. Formation of the Captives
A. Introduction to Christopher Fay and CIC Services
In May 2007, just a few months after the death of the West Texas
Hospital patient, Dr. Patel purchased a book about asset protection,
which included a chapter on captive insurance. At that time, Dr. Patel
considered forming a captive, but he ultimately did not do so. Four years
later, in May 2011, Dr. Patel purchased another copy of the same asset
8 Initially, Dr. Patel formed West Texas Specialty Hospital, Ltd., on March 26,
2003, but he changed the name to West Texas Hospital, Ltd., on July 18, 2003.
7
[*7] protection book he had purchased in 2007. In addition, he
purchased two books on captive insurance. 9
Around that same time, in approximately May 2011, Dr. Patel’s
business partner, Dr. Young Lee, introduced Dr. Patel to a financial
planner, Christopher Fay, to discuss financial and insurance products.
During Dr. Patel’s introductory call with Mr. Fay, Dr. Patel expressed
his interest in forming a captive insurance company. Dr. Patel already
knew he wanted to form a captive when he called Mr. Fay. The purpose
of his call with Mr. Fay was to identify someone to help him form a
captive, not to advise him about whether a captive was the right
decision.
Mr. Fay did not know much about captive insurance, so he
recommended that Dr. Patel meet with Sean King 10 of CIC Services,
LLC (CIC Services) to discuss forming a captive. In an email sent to
facilitate a meeting between Dr. Patel and Mr. Sean King, Mr. Fay
stated that Dr. Patel was the “MD paying almost 2.5M in income taxes
and did his own research on [captive insurance companies]. He wants to
talk with Sean about doing potentially 2 CIC[s].”
In addition to introducing Dr. Patel to Mr. Sean King, Mr. Fay
asked Dr. Patel to complete a feasibility study. According to Dr. Patel,
Mr. Fay emailed the feasibility study several times. At trial, Dr. Patel
disclaimed any interest in financial products offered by Mr. Fay.
According to Dr. Patel, he is a “savvy financial person” and he did not
want any advice. Rather, he knew that he wanted to form a captive
insurance company.
Eventually, Dr. Patel completed the feasibility study, although
the exact timing of when he completed it is a matter of dispute and not
entirely clear. At trial, Dr. Patel stated that he completed the study in
9 The names of the books are (1) Asset Protection: Concepts and Strategies for
Protecting Your Wealth by Jay Adkisson and Chris Riser; (2) Taken Captive: The Secret
to Capturing Your Piece of America’s Multi-Billion Dollar Insurance Industry by R.
Wesley Sierk, III; and (3) Adkisson’s Captive Insurance Companies: An Introduction to
Captives, Closely-Held Insurance Companies, and Risk Retention Groups by Jay
Adkisson.
10 Thomas King of CIC Services is Sean King’s father. Because both individuals
are discussed throughout this Opinion, we refer to them as Mr. Sean King and Mr.
Thomas King for clarity.
8
[*8] 2012 out of an apparent sense of obligation and “politeness” because
he would be working with Mr. Fay on and off.
However, at his deposition, Dr. Patel gave conflicting answers,
stating that he completed the feasibility study in 2011 because “we were
looking at possibly starting a captive insurance company” and later,
after several breaks and through questions posed by his own attorney,
changing his answer and stating that the feasibility study related to
financial services and not forming a captive. In any event, the feasibility
study he completed focused exclusively on wealth and estate planning.
It did not mention or discuss captive insurance. On the form, Dr. Patel
stated that his goals were aggressive growth and wealth accumulation.
In June 2011, Dr. Patel met with Mr. Sean King and Mr. Fay to
discuss forming a captive insurance company. At this juncture, Dr. Patel
had already determined that he wanted to form one. He was not seeking
advice about whether to form a captive. Rather, he was seeking advice
about structuring the captive and how to move forward.
Mr. Sean King advised that CIC Services could handle
management responsibilities for a captive insurance company. However,
he recommended attorneys Dr. Patel could contact to form a captive.
Although Mr. Sean King recommended several attorneys, he “really
liked” James Coomes.
In July 2011, without conducting any studies related to the need
to form a captive, Dr. Patel emailed Mr. Fay and stated that he wanted
to move forward with forming two captive insurance companies. In
response, Mr. Sean King suggested that they schedule a phone call that
included Mr. Coomes.
B. James Coomes and Capstone Reinsurance Co.
1. Background
Mr. Coomes has been an attorney since 1999. After obtaining a
master of laws degree in taxation at New York University, Mr. Coomes
joined a law firm where he spent roughly half of his practice focusing on
estate planning. Mr. Coomes also taught estate planning at the
University of Alabama Law School from approximately 2005 through
2011.
In 2011, Mr. Coomes formed his own practice, specializing in
captive insurance companies, business corporate work, and estate
9
[*9] planning. In connection with his work representing captive
insurance companies, Mr. Coomes drafted insurance policies. Mr.
Coomes does not have formal training in captive insurance or writing
insurance policies. Rather, he learned to write insurance policies by
reviewing commercial insurance policies, reading articles, and studying
books.
2. Formation of Capstone Reinsurance Company, Ltd.
In November 2012, Mr. Coomes formed Capstone Reinsurance
Company, Ltd. (Capstone), in the Turks and Caicos Islands. Capstone
operates as a reinsurance company, purportedly providing risk sharing
among captive insurance companies. Mr. Coomes and his wife served as
the officers and directors of Capstone during the tax years at issue. Mr.
Coomes served as the president, and Capstone had no other employees.
The details of the Capstone reinsurance program are discussed more
fully infra Findings of Fact Part III.F.
Beginning in 2014, Jennifer Stalvey of the Tennessee Department
of Commerce & Insurance (TDCI) examined Capstone as a reinsurance
pool. Based on its examination, TDCI approved Capstone Reinsurance
as a risk-distribution reinsurance pool for Tennessee captive insurance
companies. Similarly, TDCI approved CIC Services as a Tennessee
Captive Manager.
C. Magellan Insurance Co.
1. Formation of Magellan
In August 2011, Mr. Sean King and Mr. Coomes held a telephone
conference with Dr. Patel to discuss forming a captive. Ultimately, Dr.
Patel retained Mr. Coomes to handle the formation and operation of a
captive insurance program.
After engaging Mr. Coomes, Dr. Patel and his assistant, Lindsay
Guerrero, completed applications for captive insurance for OST and ICR
in November 2011. The applications included requests for information
regarding the size and nature of the business operations, the number of
business locations, the number of employees, their key customers and
suppliers, the coverages provided by their commercial carriers, and their
commercial loss history.
After receiving the applications, Mr. Coomes forwarded them to
an actuary, Allen Rosenbach of ACR Solutions Group, to price the
10
[*10] premiums for the policies. On one occasion, Mr. Coomes and Mr.
Rosenbach interviewed Dr. Patel about the applications. Mr. Coomes
and Mr. Rosenbach identified coverages for the insureds, including OST
and ICR.
Further, Mr. Coomes created a Business Plan for the proposed
insurance company, Magellan, outlining proposed insurance coverages
through the captive. The Business Plan set forth the business rationale
for forming the captive:
(i) obtaining the ability to insure risks which are otherwise
unavailable in the traditional commercial marketplace and
to design custom insurance policies, (ii) retaining profits
that would otherwise have to be paid to commercial
insurers in the form of premiums in excess of the amounts
repaid to cover losses, (iii) achieving flexibility in choosing
investments into which the premiums of [Magellan] may
be made, and (iv) obtaining access to the re-insurance
market if desired.
Pursuant to the Business Plan, Magellan intended to participate
in a risk pool “with other captive insurance companies” that “cover[s]
business risks relating to terrorist attacks.” In the first year, premiums
charged were expected to be in the range of $1,145,000. Further, the
Business Plan called for Magellan to file an election under section 953(d)
to enable it to be taxed as an insurance company in the United States.
The Business Plan also noted that “[i]t is also intended that [Magellan]
will limit its insurance activity to levels where its premiums are not in
excess of US $1,200,000 per annum.”
Through Mr. Coomes, and consistent with the Business Plan, Dr.
Patel submitted an application for Magellan to carry on as an insurance
business with the Federation of St. Christopher and Nevis (St. Kitts)
Financial Services Regulatory Commission (FSRC) on November 22,
2011. Magellan was incorporated in St. Kitts on December 8, 2011.
Additionally, that same day, Magellan filed its Memorandum and
Articles of Association with the FSRC, indicating that Magellan would
be engaged in “Group Captive Insurance, primarily, property and
casualty insurance.” Further, the Statutory Statement identified
Corporate Solutions, Ltd. and Heritor Management, Ltd. as Directors of
Magellan. Magellan’s application to carry on an insurance business was
approved, and on December 22, 2011, Magellan received its insurance
license from St. Kitts FSRC.
11
[*11] Although Mr. Coomes completed the Business Plan, neither he
nor anyone associated with Magellan completed a feasibility study to
determine the costs and merits of a captive arrangement for Dr. Patel’s
businesses. Respondent’s expert, Roberta Garland, explained that a
feasibility study “is an important aspect of setting up a captive” and a
proper feasibility study would explore the various alternatives and
perform a cost-benefit analysis of a captive before moving forward.
Moreover, neither Dr. Patel nor his advisers explored the cost and
availability of the same policies on the commercial market. The
feasibility study completed by Dr. Patel, at the request of Mr. Fay, did
not discuss captive insurance.
2. Ownership of Magellan and Investment of Assets
Magellan is owned by Odyssey Properties, LLC (Odyssey), a
limited liability company formed under the laws of Wyoming on
November 9, 2011. Initially, Odyssey was owned by Dr. Patel
(35 percent), Dr. McAnally-Patel (35 percent), and the Patel Business
Trust (30 percent).
Magellan’s substantial premiums, coupled with modest expenses
and claims history, meant that it had significant resources on hand. In
January 2012, Dr. Patel met with Mr. Sean King and Mr. Fay to discuss
investment of Magellan’s assets. On January 16, 2012, Dr. Patel signed
an application for a separate legal entity that had yet to be created,
Magellan Investments, LLC (Magellan Investments), to acquire an
“Eclipse Indexed Life” insurance plan. Ten days later, on January 26,
2012, Mr. Coomes filed articles of organization for Magellan
Investments, as a single-member limited liability company under the
laws of Wyoming. Magellan Investments is wholly owned by Magellan.
In April 2012, Magellan Investments completed the purchase of a
life insurance policy from Minnesota Life Insurance Company
(Minnesota Life), insuring the life of Dr. Patel, with planned annual
premiums of $1,150,000 and a death benefit of $43,348,241. The
Minnesota Life policy is Magellan Investments’ primary asset.
In 2016, the Patels transferred another thirty percent interest to
the Patel Business Trust. Thus, the Patels now each have a 20 percent
interest in Magellan through Odyssey. The Patel Business Trust now
owns 60 percent of Magellan through Odyssey. The Patel Business Trust
names the Patels’ three children as beneficiaries, meaning the Patels’
children own 60 percent of Magellan. The Patels decided to make this
12
[*12] change, in part, because of the increasing value of their
businesses. In August 2016, Mr. Fay sent an email to Mr. Coomes,
inquiring whether, now that Magellan was owned by a 60 percent trust
for the Patels’ children, “we assume that 60% of death proceeds are out
of Patel’s estate and not subject to taxes?” Mr. Coomes responded: “That
is a reasonable assumption.”
D. Plymouth Insurance Co.
In February 2016, Dr. Patel informed Mr. Fay that he wanted to
form a new captive. Dr. Patel claims that he decided to form the second
captive because of statutory changes enacted in 2015 that changed
ownership requirements for small captive insurance companies.
Contemporaneous records reveal a more complicated picture. It is true
that Dr. Patel and his advisers sought ways to comply with new
ownership requirements for small captives. However, as discussed in
more detail below, correspondence with Dr. Patel’s advisers reveals that
they were concerned about Dr. Patel’s ability to meet ownership
guidelines to retain favorable tax treatment (including increased limits
on deductibility) and reduce his potential estate tax exposure.
1. Decision to Form Plymouth
In February 2016, Mr. Fay emailed Mr. Sean King, informing him
that Dr. Patel “wants to get his estate planning in order and then move
forward with his new captive this year.” In that same email, Mr. Fay
stated that Dr. Patel’s accountant had been contacted by the IRS about
Dr. Patel’s captive. According to the email, several captives formed by
Mr. Coomes were being examined by the IRS.
The next day, Mr. Thomas King of CIC Services emailed Mr. Fay
to make sure he was aware of “the process of a captive of ours being
audited.” Mr. Thomas King advised that once a client receives notice of
their captive being audited, they should contact him by telephone and
then Mr. Coomes, who would take over and respond to any IRS requests.
Two days later, Mr. Thomas King emailed Mr. Fay and Mr. Sean
King, copying Bryan Ridgway of CIC Services and Mr. Coomes. He
stated that he informed Dr. Patel of the “audit situation” and that Dr.
Patel was “fine” with it and “really wants to start another captive.” Mr.
Thomas King also asked Mr. Fay whether he could “do the captive first
and then build the estate planning around it.”
13
[*13] In response, Mr. Sean King stated that “[t]he only estate planning
question with regard to the captive would be who should own it. If we
can firm that up, then proceeding with it shouldn’t impact the estate
planning too much.” Subsequent emails over the next several months
also discussed the ownership structure of Magellan and Dr. Patel’s
anticipated second captive, all for the purpose of determining the new
captive’s impact on Dr. Patel’s estate planning and income tax benefits.
In October 2016—after months of discussing the structure of a
new captive—Dr. Patel entered into a formal agreement with Mr.
Coomes and CIC Services to handle the formation and management of
a new captive. Dr. Patel decided to move forward despite being on notice
that the IRS was examining the captives formed by Mr. Coomes.
And this was not the first time Dr. Patel was made aware of
concerns regarding certain captives. In February 2015, Dr. Patel’s
nephew—a tax attorney—emailed him an article about captive
insurance companies being a “topic of conversation” for Congress and
the IRS, and the nephew noted that they will “likely be coming under
heightened review/scrutiny.”
On November 15, 2016, Mr. Fay sent an email to schedule a
conference call with Mr. Sean King, Mr. Coomes, and Norm Lofgren
(referred to by Mr. Fay as “Sunil’s tax attorney”) to discuss “ownership
of the new captive,” and he noted that Mr. Lofgren was included to
“explore all potential options to minimize future estate taxes.” Two days
later, on November 17, 2016, Mr. Fay sent an email to Ms. Guerrero and
asked her to inform Dr. Patel that he would be having a conference call
the following week with Mr. Coomes, Mr. Sean King, and Mr. Lofgren to
discuss “ownership for the captive and options to reduce future estate
taxes.”
2. Formation and Ownership of Plymouth
On November 27, 2016, Mr. Ridgway submitted a proposed
charter and bylaws for Plymouth to the TDCI. That charter was
approved on December 5, 2016, and on December 8, 2016, Dr. Patel
officially formed Plymouth as a licensed captive insurance company in
Tennessee.
Dr. Patel placed 100 percent ownership of Plymouth in Linus
Capital, LLC (Linus Capital), a Texas limited liability company. In turn,
Linus Capital is owned by the Sunil Patel 2016 Irrevocable Trust,
created on December 19, 2016.
14
[*14] In 2016, Plymouth was capitalized with $25,000 in cash and a
$225,000 Irrevocable Letter of Credit from Dr. Patel. On December 15,
2016, Mr. Fay inquired in an email whether the $25,000 was a loan or
capital. He noted that Dr. Patel would likely increase his contribution to
Plymouth “to approx[imately] $1 million while adding $1.1 million to
[the] other captive to meet the 2017 2.1-2.2 million increase” in tax
benefits for microcaptives. In response, Mr. Lofgren stated that Dr.
Patel’s “funds to the LLC will be in the form of a loan since we do not
want him to own any part of the underlying captive for federal estate
tax purposes.”
In 2017—after the tax years at issue—Plymouth purchased a
Flexible Premium Adjustable and Index-Linked Universal Life
Insurance policy with planned premiums of $348,179 and a death
benefit of $10 million. Mr. Thomas King believed the entire death
benefit of the life insurance policy would pass through Plymouth to Dr.
Patel’s family.
E. Policies Issued by Magellan and Plymouth
During the tax years at issue, Magellan—and Plymouth in 2016—
issued direct written policies to OST and ICR, and SCR. 11 Each year,
Mr. Coomes sent a Master Application and Supplemental Applications
to Dr. Patel and Ms. Guerrero. Mr. Coomes transmitted those
applications to Mr. Rosenbach, who then purportedly priced the
insurance premiums as discussed more fully infra Findings of Fact
Part III.H. Mr. Coomes drafted the policies that Magellan and Plymouth
issued to OST, ICR, and SCR.
The tables below outline the policies issued by Magellan and
Plymouth from 2013 through 2016. They include premium amounts,
occurrence limits, and aggregate limits for each policy.
Magellan (OST – 2013)
Policy Premium Occ. Limit Agg. Limit
Administrative Actions $86,000 $1,000,000 $2,000,000
Computer Operations and Data 45,300 1,000,000 2,000,000
Commercial Crime 19,400 1,000,000 2,000,000
Employment Practices 33,300 1,000,000 2,000,000
Litigation Defense Expense 70,300 1,000,000 2,000,000
Tax Indemnity 59,200 1,000,000 1,000,000
11 Direct written policies to SCR began in 2015.
15
[*15] Business Interruption (Loss of Key 100,800 1,000,000 1,000,000
Employee)/Extra Expense (EE)
Business Interruption (Competitors)/EE 59,200 1,000,000 3,000,000
Business Interruption (Reputational
102,700 1,000,000 3,000,000
Damage)/EE
Business Interruption (Reg. and Leg.
177,600 1,000,000 3,000,000
Change)/EE
Legal Expense 14,000 20,000 20,000
Special Catastrophic Risk 69,400 1,000,000 1,000,000
Magellan (ICR – 2013)
Policy Premium Occ. Limit Agg. Limit
Administrative Actions $38,800 $500,000 $500,000
Computer Operations and Data 23,100 500,000 500,000
Commercial Crime 11,100 500,000 500,000
Employment Practices 15,700 500,000 500,000
Litigation Defense Expense 30,500 500,000 500,000
Tax Indemnity 27,700 500,000 500,000
Business Interruption (Loss of Key
44,400 500,000 500,000
Employee)/EE
Business Interruption (Contract
57,300 500,000 500,000
Cancellation)/EE
Legal Expense 14,000 20,000 20,000
Special Catastrophic Risk 35,100 500,000 500,000
Magellan (OST – 2014)
Policy Premium Occ. Limit Agg. Limit
Administrative Actions $68,400 $1,000,000 $2,000,000
Computer Operations and Data 41,600 1,000,000 2,000,000
Commercial Crime 15,700 1,000,000 2,000,000
Employment Practices 30,500 1,000,000 2,000,000
Litigation Defense Expense 60,100 1,000,000 2,000,000
Tax Indemnity 62,900 1,000,000 1,000,000
Business Interruption (Loss of Key
96,200 1,000,000 1,000,000
Employee)/EE
Business Interruption (Competitors)/EE 56,400 1,000,000 3,000,000
Business Interruption (Reputational
97,100 1,000,000 3,000,000
Damage)/EE
Business Interruption (Reg. and Leg.
170,200 1,000,000 3,000,000
Change)/EE
Legal Expense 14,000 20,000 20,000
Special Catastrophic Risk 64,700 1,000,000 1,000,000
Magellan (ICR – 2014)
Policy Premium Occ. Limit Agg. Limit
Administrative Actions $28,700 $500,000 $500,000
Computer Operations and Data 26,800 500,000 500,000
Commercial Crime 8,300 500,000 500,000
16
[*16] Business Interruption (Loss of Key 49,900 500,000 500,000
Employee)/EE
Business Interruption (Contract 72,100 500,000 500,000
Cancellation)/EE
Special Catastrophic Risk 32,400 500,000 500,000
Legal Expense 14,000 20,000 20,000
Tax Indemnity 31,400 500,000 500,000
Litigation Defense Expense 25,900 500,000 500,000
Employment Practices Liability Insurance 12,000 500,000 500,000
Magellan (OST – 2015)
Policy Premium Occ. Limit Agg. Limit
Administrative Actions $74,000 $1,000,000 $2,000,000
Computer Operations and Data 35,100 1,000,000 1,000,000
Commercial Crime 14,800 1,000,000 1,000,000
Employment Practices 20,300 1,000,000 1,000,000
Litigation Defense Expense 43,500 1,000,000 2,000,000
Tax Indemnity 59,200 1,000,000 1,000,000
Business Interruption (Loss of Key
115,600 1,000,000 1,000,000
Employee)/EE
Business Interruption (Reputational
103,600 1,000,000 2,000,000
Damage)/EE
Business Interruption (Reg. and Leg.
181,300 1,000,000 2,000,000
Change)/EE
Legal Expense 14,000 20,000 20,000
Special Catastrophic Risk 55,500 1,000,000 1,000,000
Magellan (ICR – 2015)
Policy Premium Occ. Limit Agg. Limit
Administrative Actions $22,200 $500,000 $500,000
Computer Operations and Data 26,800 500,000 500,000
Commercial Crime 8,300 500,000 500,000
Employment Practices 8,300 500,000 500,000
Litigation Defense Expense 12,000 500,000 500,000
Tax Indemnity 29,600 500,000 500,000
Business Interruption (Loss of Key
66,600 500,000 500,000
Employee)/EE
Business Interruption (Contract
65,700 500,000 500,000
Cancellation)/EE
Legal Expense 14,000 20,000 20,000
Special Catastrophic Risk 27,700 500,000 500,000
Magellan (SCR – 2015)
Policy Premium Occ. Limit Agg. Limit
Administrative Actions 10,200 $500,000 $500,000
Computer Operations 9,200 500,000 500,000
Business Interruption (Contract
23,100 500,000 500,000
Cancellation)/EE
17
[*17] Commercial Crime 7,400 500,000 500,000
Employment Practices 5,500 500,000 500,000
Litigation Defense Expense 4,600 500,000 500,000
Tax Indemnity 17,600 500,000 500,000
Business Interruption (Loss of Key
16,600 500,000 500,000
Employee)/EE
Legal Expense 14,000 20,000 20,000
Special Catastrophic Risk 27,700 500,000 500,000
Magellan (ICR – 2016)
Policy Premium Occ. Limit Agg. Limit
Administrative Actions $24,000 $500,000 $500,000
Computer Operations and Data 26,800 500,000 500,000
Commercial Crime 8,300 500,000 500,000
Employment Practices 9,200 500,000 500,000
Litigation Defense Expense 13,900 500,000 500,000
Tax Indemnity 29,600 500,000 500,000
Business Interruption (Loss of Key
59,200 500,000 500,000
Employee)/EE
Business Interruption (Contract
96,200 500,000 500,000
Cancellation)/EE
Legal Expense 14,000 20,000 20,000
Special Catastrophic Risk 27,700 500,000 500,000
Crisis Coach 5,000 100,000 100,000
Magellan (SCR – 2016)
Policy Premium Occ. Limit Agg. Limit
Administrative Actions $11,100 $500,000 $500,000
Computer Operations and Data 9,200 500,000 500,000
Business Interruption (Contract
32,400 500,000 500,000
Cancellation)/EE
Commercial Crime 7,400 500,000 500,000
Employment Practices 5,500 500,000 500,000
Litigation Defense Expense 5,500 500,000 500,000
Tax Indemnity 17,600 500,000 500,000
Business Interruption (Loss of Key
13,900 500,000 500,000
Employee)/EE
Legal Expense 14,000 20,000 20,000
Special Catastrophic Risk 27,700 500,000 500,000
Crisis Coach 5,000 100,000 100,000
Plymouth (OST – 2016)
Policy Premium Occ. Limit Agg. Limit
Administrative Actions $78,600 $1,000,000 $2,000,000
Computer Operations and Data 35,100 1,000,000 1,000,000
Commercial Crime 14,800 1,000,000 1,000,000
Employment Practices 20,300 1,000,000 1,000,000
Litigation Defense Expense 41,600 1,000,000 2,000,000
18
[*18] Tax Indemnity 62,900 1,000,000 1,000,000
Business Interruption (Loss of Key
131,300 1,000,000 1,000,000
Employee)/EE
Business Interruption (Reputational
117,500 1,000,000 2,000,000
Damage)/EE
Business Interruption (Reg. and Leg. 62,000 1,000,000 2,000,000
Change)/EE
Legal Expense 14,000 20,000 20,000
Special Catastrophic Risk 55,500 1,000,000 1,000,000
Bus. Interruption (Natural Perils)/EE 32,400 1,000,000 2,000,000
Crisis Coach 5,000 100,000 100,000
Bus. Interruption (Property Damage)/EE 44,400 1,000,000 2,000,000
To summarize, the captive policies fell into the following
categories of coverage:
1. Administrative Actions
2. Business Interruption (Natural Peril)
3. Business Interruption (Broad Form Property Damage)
4. Business Interruption (Competitors)
5. Business Interruption (Customer Contract Cancellation)
6. Business Interruption (Loss of Key Employees)
7. Business Interruption (Regulatory & Legislative Change)
8. Business Interruption (Reputational Damage)
9. Commercial Crime
10. Computer Operations and Data
11. Crisis Coach
12. Employment Practices
13. Legal Expense
14. Litigation Defense Expense
15. Tax Indemnity
16. Special Catastrophic Risk
Summaries of the coverage for each of the policies are generally
contained in Coverage Summary forms. The following list describes, in
simplified terms, the coverages for Magellan for the tax years at issue.
Administrative Actions: “This covers losses (i.e., legal
expenses, fines and assessments) from investigations,
audits and proceedings brought against the Insured by
governmental bodies. Tax related administrative actions
are excluded.”
19
[*19] Business Interruption (also referred to as Business
Income) (Natural Perils) and Extra Expense
Insurance: This “covers loss of profits and extra expenses
resulting from the temporary suspension of the Insured’s
operations due to inclement weather conditions or a
natural disaster, including but not limited to, a flood,
earthquake or tornado.”
Business Interruption (also referred to as Business
Income) (Broad Form Property Damage) and Extra
Expense Insurance: This “covers loss of profits and extra
expenses resulting from the interruption of the Insured’s
operations due to (i) damage or breakdown of the Insured’s
property (including tangible and intangible personal
property and real property), (ii) utility service
interruptions including, but not limited to, interruptions of
the Insured’s telecommunications systems and (iii) loss of
access to the Insured’s premises by the Insured, its
employees, suppliers or customers.”
Business Interruption (also referred to as Business
Income) (Entrance by Competitors) and Extra
Expense Insurance: “This covers loss of profits resulting
from the entrance by a competitor in the Insured’s
business.”
Business Interruption (also referred to as Business
Income) (Customer Contract Cancellation) and
Extra Expense Insurance: This “covers loss of income
and extra expenses resulting from the cancellation of one
or more key contracts by a customer of the Insured or from
the bankruptcy or liquidation of any key customer who is a
party to such key contract.”
Business Interruption (also referred to as Business
Income) (Loss of Key Employee) and Extra Expense
Insurance: “This covers loss of profits resulting from the
retirement or voluntary departure of a key employee of the
Insured.
Business Interruption (also referred to as Business
Income) (Regulatory and Legislative Changes) and
Extra Expense Insurance: This “covers loss of profits
20
[*20] and extra expenses resulting from legislative, regulatory,
administrative and governmental changes adversely
affecting the Insured’s operations.”
Business Interruption (also referred to as Business
Income) (Reputational Damage) and Extra Expense
Insurance: This “covers loss of profits and extra expenses
resulting from negative publicity that cause damage to the
Insured’s reputation in the marketplace.”
Commercial Crime: This “covers losses resulting from or
related to theft or dishonesty committed by employees of
the Insured or by third parties including, but not limited
to, investigative expenses incurred by the Insured.”
Computer Operations and Data: This “covers losses (i.e.
expenses incurred and lost income) resulting from attacks,
breakdowns, and malfunctions and security breaches of the
Insured’s computers, computer programs and servers (and
related peripheral equipment) including but not limited to,
the cost to replace or restore data and computer programs,
the cost of data entry, the cost of reprogramming and
computer consultation service, public relations expenses
incurred to protect or restore your reputation, monetary
payments, fees, fines and penalties imposed against the
Insured by credit card associations and expenses related to
extortion threats that caused an interruption of the
Insured’s operations.”
Crisis Coach Insurance: “This covers crisis management
expenses resulting from a crisis event involving the Named
Insured.”
Employment Practices Insurance: “This covers losses
resulting from claims made by employees, former
employees, or potential employees of the Insured for
wrongful termination of employment, sexual harassment
and other employment-related allegations and certain
claims made by third parties for wrongful discrimination.”
Legal Expense Insurance: “This covers legal expenses
incurred by the Insured (or an employee, officer or director
of the Insured) for defending claims against the Insured (or
an employee, officer o[r] director of the Insured) or for the
21
[*21] consultation thereof, for prosecuting any claims by the
Insured against third parties and for the consultation
thereof, and for the Insured’s participation in any
arbitration, mediation or other alternative dispute
[resolution] proceeding.”
Litigation Defense Expense Insurance: “This covers
litigation expenses incurred by the Insured for defending
claims that fall outside certain specified commercial
liability policies of the Insured or for defending claims that
are in excess of the limits of such existing liability policies.
This Policy also covers the deductible(s) on such liability
policies. This insurance policy only applies to such
litigation expenses after the limits of the Legal Expense
Insurance Policy have been exhausted.”
Tax Indemnity Insurance: “This covers losses from tax
payments, including interest and penalties, and tax
assessments, including associated expenses (i.e. legal,
consulting and accounting expenses) which arise out of an
audit of any foreign, federal, state or local tax return of the
Insured.”
Special Catastrophic Risk Insurance: “This covers loss
of profits and property resulting from the accidental or
intentional disruption of critical infrastructure such as
transportation systems, electrical power systems, gas and
oil storage and transportation systems, banking and
finance, transportation systems and water supply
systems.”
Plymouth provided substantially similar insurance coverage beginning
in 2016.
The parties’ experts agree that the Magellan and Plymouth
policies generally contain terms one would typically see in insurance
policies. For example, David Russell, an expert offered by respondent,
observed that certain coverages are generally available in the
marketplace, including crime, employment practices, and computer
data. The Patels’ expert, Michael Angelina, also agrees that the policies
issued by Magellan and Plymouth contain terms that are similar to
those contained in commercial insurance policies, including policy forms
containing declarations, the insuring agreement, and other provisions.
22
[*22] However, the policies also contain atypical provisions. For
example, the policies operate under “claims made and reported” terms,
requiring the insured to report the loss before the expiration of the
policy. In the insurance industry, such provisions are considered
unfavorable to insureds. 12 The policies also contain a provision stating
that all policies provide excess insurance to other coverage, such as Dr.
Patel’s commercial insurance. However, high premiums are typically
indicative of primary insurance coverage. Another atypical provision is
that the policies cannot be canceled, and premiums are considered fully
earned at inception, meaning that no refund is due to the insured.
F. Capstone’s Reinsurance Program
From the beginning, Mr. Coomes recognized that a captive
insurance company is “required to ‘distribute risk’ in order to be treated
as an insurance company for tax purposes.” In a memorandum to
potential members of the Capstone reinsurance arrangement, Mr.
Coomes emphasized the need for a microcaptive to obtain risk
distribution and noted that the IRS considers the risk distribution
requirement satisfied if the “risk borne by your [microcaptive] is spread
among one or more insureds that are unrelated” to the captive. Further,
he stated that, according to caselaw, “30% of the total premiums
received by an insurance company from unrelated insureds represents
a significant portion of its risk.” He also stated that “safe harbor
provisions of the Revenue Ruling 2002-89 take a more strict position
requiring more than 50% of the total premiums received by an insurance
company to be received from unrelated insureds.”
Applying his analysis, Mr. Coomes sought to create a pooling
arrangement through Capstone to distribute risk among the captives he
formed. Captives participating in the pooling arrangement did so via two
instruments: (1) a Reinsurance Agreement; and (2) an accompanying
Quota Share Retrocession Agreement.
Under the Reinsurance Agreements for each year, Capstone
agreed to reinsure 51 percent of the Ultimate Net Loss of each Covered
Policy. Ultimate Net Loss is defined under the agreements as “the actual
loss paid or payable by [Magellan or Plymouth] from the settlement or
compromise of claims . . . arising from one or more Covered Policies.” In
other words, as part of the Reinsurance Agreements, Magellan and
12 In contrast, a typical claims-made policy permits an insured to report claims
for a certain period after the expiration of the policy.
23
[*23] Plymouth—and other captives—paid fifty-one percent of the
premiums they received from their insured customers—for example,
OST, ICR, and SCR—to Capstone.
Mr. Coomes billed Magellan and Plymouth yearly, and the
invoices represented 51 percent of the total premiums plus a “risk
distribution” ceding fee of $5,000 charged by Capstone. The Reinsurance
Agreements also provided that in the event of insolvency of the
reinsured, the maximum amount recoverable by the reinsured is the
amount of reinsurance premiums paid to Capstone.
As participants in the Capstone program, Magellan and
Plymouth were also parties to the Quota Share Retrocession Agreement.
Under that agreement, members of Capstone agreed to collectively
assume 100 percent of the losses Capstone incurred under the various
Reinsurance Agreements it entered with the participating captives in
the pool. According to the agreement, the captives participating in the
Capstone pooling arrangement were purportedly not liable for any
losses on policies they directly wrote to their own insureds. Presumably,
this provision was added to the Quota Share Retrocession Agreement
because of Mr. Coomes’s concern that the captives would not otherwise
appear to achieve risk distribution.
In exchange for their agreement to reinsure a quota share of
Capstone losses, Capstone paid its members a Quota Share Reinsurance
Premium. Within days, and no later than December 31 of the year,
Capstone returned half of the money paid by Magellan and Plymouth.
The remaining half was paid into the Capstone Trust, and within six to
seven months, Capstone returned 70 percent of the money held in the
trust. Thus, within six to eight months, approximately 85 percent of
money was returned to Magellan and Plymouth during the tax years at
issue. The remaining 15 percent was left in the trust until all claims
were paid. Thus, although only 15 percent remained to pay claims,
50 percent of exposure remained.
In other words, as participants in the Capstone arrangement,
Magellan and Plymouth paid 51 percent of their premiums into the
pooling arrangement. And in less than a year, they received a large
percentage of funds back as part of the quota share agreement. The
quota share that Magellan and Plymouth assumed under the quota
share agreement for each tax year at issue was calculated so that these
entities received payments from Capstone that were roughly equal to
24
[*24] the premiums Capstone was entitled to receive from Magellan and
Plymouth as part of the reinsurance agreement.
This flow of funds is best represented by the following figures
prepared by Mr. Russell. Figure A 13 represents the steps in the flow of
funds from OST, ICR, and SCR to Magellan (or Plymouth) to Capstone
and back again.
Further, as noted by Mr. Russell, accounting statements for
Capstone illustrate the flow of premiums between Magellan and
Capstone. For example, in 2013, Magellan ceded $578,799 in premiums
to Capstone for 2013 reinsurance coverage and assumed the exact same
amount for a quota share retrocession with Capstone. After a relatively
small amount in losses was ultimately assumed, Magellan received a
total of $551,284.89 back from Capstone, or over 95 percent of
premiums.
This pattern of a circular flow of funds is illustrated in Figure B,
prepared by Mr. Russell:
13 Figure A contains a typographical error original to Mr. Russell’s report. In
the “Steps in the Flow of Funds” box, the word “retocedes” should be “retrocedes.” In
addition, a “retrocessionaire” in Figure A refers to a reinsurer of Capstone. Magellan
and Plymouth are reinsurers, or retrocessionaires, of Capstone.
25
[*25]
At the time Dr. Patel’s entities joined the Capstone pooling
arrangement, he did not know anything about the other pool members,
including their risks, industries, ability to fulfill their quota share
claims, or captive insurance policies.
G. Dr. Patel’s Commercial Insurance Coverage
Despite obtaining numerous policies through his captives, Dr.
Patel also purchased insurance coverage with third-party commercial
insurers throughout the tax years at issue for each of his entities. OST
and ICR maintained commercial insurance policies that covered
regulatory, malpractice, worker’s compensation, automobile, and
umbrella risks and included a general business owners’ package.
Mr. Russell provided a general assessment of the commercial
insurance policies in place during the tax years at issue. The following
list is a summary he prepared that contains a nonexhaustive general
overview of the commercial policies:
Businessowners Package Policy (BOP): This policy
provides a package of several property and liability
coverages needed by a small business. The property
coverages include: 1) coverage for losses to a building
owned by the insured; 2) coverage for losses to the business
personal property (e.g. furnishings and equipment) owned
26
[*26] by the business; 3) coverage for lost profits and extra
expenses during an interruption to business from a covered
loss; and 4) several other smaller coverages including glass,
accounts receivable coverage (for records that have been
damaged or destroyed), fine art and other coverage
extensions. The liability protections include general
liability [GL] and medical payments coverage; these cover
losses and legal defense brought by third parties, not
including medical malpractice.
Business Auto Policy (Auto): This policy provides
liability and property protection to the insured against
claims brought by third parties as well as property damage
to the insured’s vehicles. This policy also provides
protection against injuries caused by uninsured and
underinsured motorists as well as personal injury
protection for injuries suffered by the insured and
passengers in the insured’s vehicles.
Umbrella Policy (Umbrella): This policy provides
additional liability coverage if the applicable coverage
limits of business auto or general liability coverages are
exhausted.
Workers Compensation and Employers Liability
(WC/EL): This policy provides the insured with protection
against employee injury obligations, including medical
expenses, lost wages and claims brought by third parties
as the result of worker injuries.
e-MD Network Security and Privacy/Broad
Regulatory Protection Plus (eMD/Regulatory+): This
policy provides a medical facility or office with a package of
coverages for losses and expenses that result from events
including breaches of digital privacy, Cyber Liability,
Cyber Terrorism, Cyber Extortion, Network Assets and
Breach Coverage. In addition, the policy includes coverage
(if permitted by law) for regulatory proceedings costs, fines
and penalties, shadow audit expenses and other claims
expenses for wrongful acts, errors and omissions.
27
[*27] The tables below present general summaries of the insurance
coverage the Patels maintained through commercial insurers for the tax
years at issue:
Occ.
Year Insured Insurer Coverage Prem. Agg. Limit
Limit
2012 OST + Travelers Auto $8,831 $1,000,000 $1,000,000
ICR Casualty
2012 OST + Travelers BOP/GL 11,791 1,000,000 2,000,000
ICR Lloyds
2012 OST + Travelers BOP Prop. 2,794,480 2,794,480
ICR Lloyds
2012 OST + Travelers BOP Bus. Pers. 3,075,791 3,075,791
ICR Lloyds Prop.
2012 OST Lloyds/ eMD/Regulatory 4,091 1,000,000 3,000,000
NAS +
2012 OST + Travelers Umbrella 2,123 2,000,000 2,000,000
ICR Indem.
2012 OST Texas WC/EL 11,829 1,000,000 1,000,000
Mutual
2012 OST OMIC Med. Mal./Prof. 30,253 1,000,000 3,000,000
Liability
Occ.
Year Insured Insurer Coverage Prem. Agg. Limit
Limit
2013 OST + Travelers Auto $11,119 $1,000,000 $1,000,000
ICR Casualty
2013 OST + Travelers BOP/GL 14,620 1,000,000 2,000,000
ICR Lloyds
2013 OST + Travelers BOP Prop. 2,906,259 2,906,259
ICR Lloyds
2013 OST + Travelers BOP Bus. Pers. 3,193,821 3,193,821
ICR Lloyds Prop.
2013 OST Lloyds/ eMD/Regulatory 6,609 1,000,000 5,000,000
NAS +
2013 OST + Travelers Umbrella 2,478 2,000,000 2,000,000
ICR Indem.
2013 OST Texas WC/EL 14,290 1,000,000 1,000,000
Mutual
2013 OST OMIC Med. Mal./Prof. 36,559 1,000,000 3,000,000
Liability
28
[*28]
Occ.
Year Insured Insurer Coverage Prem. Agg. Limit
Limit
2014 OST + Travelers Auto $11,336 $1,000,000 $1,000,000
ICR Casualty
2014 OST + Travelers BOP/GL 19,708 1,000,000 2,000,000
ICR Indem.
2014 OST + Travelers BOP Prop. 5,053,446 5,053,446
ICR Indem.
2014 OST + Travelers BOP Bus. Pers. 3,564,668 3,564,668
ICR Indem. Prop.
2014 OST Lloyds/ eMD/Regulatory 6,609 1,000,000 5,000,000
NAS +
2014 OST + Travelers Umbrella 2,825 2,000,000 2,000,000
ICR Indem.
2014 OST Texas WC/EL 16,031 1,000,000 1,000,000
Mutual
2014 OST OMIC Med. Mal./Prof. 43,365 1,000,000 3,000,000
Liability
Occ.
Year Insured Insurer Coverage Prem. Agg. Limit
Limit
2015 OST + Travelers Auto $11,238 $1,000,000 $1,000,000
ICR Casualty
2015 OST + Travelers BOP/GL 22,442 1,000,000 2,000,000
ICR Indem.
2015 OST + Travelers BOP Prop. 5,255,583 5,255,583
ICR Indem.
2015 OST Travelers BOP Bus. Pers. 3,702,253 3,702,253
Indem. Prop.
2015 OST Lloyds/ eMD/Regulatory 2,678 1,000,000 4,000,000
NAS +
2015 OST + Travelers Umbrella 2,994 2,000,000 2,000,000
ICR Indem.
2015 OST Texas WC/EL 15,456 1,000,000 1,000,000
Mutual
2015 OST OMIC Med. Mal./Prof. 40,112 1,000,000 3,000,000
Liability
29
[*29]
Occ.
Year Insured Insurer Coverage Prem. Agg. Limit
Limit
2016 OST + Travelers Auto $13,576 $1,000,000 $1,000,000
ICR Casualty
2016 OST + Travelers BOP/GL 36,787 1,000,000 2,000,000
ICR Indem.
2016 OST + Travelers BOP Prop. 6,000,000 6,000,000
ICR Indem.
2016 OST + Travelers BOP Bus. Pers. 6,832,912 6,862,912
ICR Indem. Prop.
2016 OST Lloyds/ eMD/Regulatory 3,249 1,000,000 3,000,000
NAS +
2016 OST + Travelers Umbrella 3,446 2,000,000 2,000,000
ICR Indem.
2016 OST Texas WC/EL 14,499 1,000,000 1,000,000
Mutual
2016 OST OMIC Med. Mal./Prof. 28,199 1,000,000 3,000,000
Liability
The combined commercial premiums for the tax years at issue
totaled $462,704 and ranged between approximately $68,000 and
$106,000 per year for the three entities. In contrast, during the same tax
years at issue, Dr. Patel’s businesses paid premiums to Dr. Patel’s
captives totaling just over $4.5 million.
The Patels maintained this commercial insurance coverage
despite Dr. Patel stating that he has an inherent distrust of commercial
insurance. Further, Dr. Patel did not place his medical malpractice
insurance coverage with his captives, despite also professing that one
purpose of forming the microcaptives stemmed from a medical
malpractice incident. Nor did he ever consult with his longtime
commercial insurance agent about forming a microcaptive, including
whether he could obtain comparable—or even cheaper—coverage
through his commercial carriers.
H. Premium Pricing
The parties’ experts agree that an insurance premium is typically
determined by an actuary who uses actuarially sound methodologies.
Here, there is evidence that premium pricing was determined in two
ways. First, Mr. Coomes hired Mr. Rosenbach to develop policy
30
[*30] premiums for Magellan and Plymouth. But there is also evidence
in the record indicating that Dr. Patel and his employee directed
premium amounts. We will address each in turn.
1. Mr. Rosenbach’s Captive Pricing
From the start, Mr. Rosenbach proved himself flexible in
preparing premium pricing. For each policy period, he prepared pricing
reports. According to the reports, he was hired to “[d]evelop reasonable
premium estimates for insurance policies expected to be issued” by
Magellan. In broad terms, Mr. Rosenbach’s reports state that “[w]here
comparable coverages were identified, the base rates and rating factors
developed in this report were based on a survey of rating plans obtained
from regulatory filings submitted by commercial insurance carriers” in
the United States. He also stated that “commercial rates and rating
factors selected represent a reasonable basis from which to develop
premium estimates for comparable coverages” provided by Magellan.
Where comparable coverages were not available, Mr. Rosenbach
used stock language in his pricing reports for each policy 14 and stated
that he used “professional judgment to develop reasonable rating
guidelines to reflect the expected loss potentials.” Finally, he stated that
base rates were created using “historical consistency and rate-on-line
ranges.” Despite these statements in the reports—which were created
contemporaneously at the time policies were issued by Magellan and
Plymouth—Mr. Rosenbach did not otherwise credibly or adequately
explain the basis for his premium amounts. Rather, the Premium
Development reports contain little to no explanation for how he arrived
at the amounts he ultimately recommended.
But in connection with this litigation, Mr. Rosenbach created an
expert report attempting to explain his premium calculations. According
to Mr. Rosenbach, his pricing process involved determining a base
premium for each policy and then adjusting that base by various factors.
He also claimed that he determined a base rate by using comparable
coverages, typically from public filings from Chubb, a large insurance
company, where available, and then applied additional factors to reach
the premium amounts for the captives.
14 The language Mr. Rosenbach used in his pricing reports in these cases
appears to be identical to language he used in such reports in Swift v. Commissioner,
T.C. Memo. 2024-13, at *16.
31
[*31] However, Mr. Rosenbach’s calculations and additional factors
resulted in premium amounts far removed from the Chubb premium
pricing. He used factors that are not typically used by actuaries, nor are
these factors defined in actuarial literature. Further, the additional
factors are undocumented and, as noted by Ms. Garland, so large that
they bear no relation to the commercial rates that he starts with.
Despite having several years’ worth of insurance data, he did not adjust
the pricing of the policies with the additional information that became
available over time, though his reports stated that he would do so.
The premium amounts Mr. Rosenbach calculated were
significantly higher than the commercial premium amounts for the
same or similar types of coverage. For example, the rate-on-line—a
measure of the cost of insurance—was up to 12 times higher for the
Patels’ captive insurance compared to their commercial insurance.
During the tax years at issue, the average rate-on-line for the captives’
policies ranged from over 4 percent to over 7 percent, depending on the
calculation method used. In contrast, the average rate-on-line for the
commercial policies was typically below 1 percent, depending on the
calculation method used.
As an example of the excessively high premium amounts for the
microcaptive policies, the limit of liability for legal expense policies
issued by Magellan and Plymouth for the tax years at issue is only
$20,000, but the premium is $14,000 a year, which amounts to a rate-
on-line of 70 percent. In contrast, Dr. Patel’s BOP commercial coverage
for the 2013 through 2014 period charged a similar premium amount
($16,981), but it covered property up to a limit of $4 million and
liability—including legal expense—up to a limit of $2 million. The BOP
policy has a rate-on-line of less than one percent.
In addition, Mr. Rosenbach stated that he developed the premium
pricing with the expectation that the coverages would be “high severity
and low frequency,” meaning that the insured entities would be loss free
for many years. Yet, contemporaneous records do not support Mr.
Rosenbach’s post hoc justification for high premiums. Records reveal
that Mr. Rosenbach anticipated loss ratios for Magellan between 56 and
57.1 percent. Relatedly, records reveal that Mr. Rosenbach expected
Plymouth to experience loss ratios of 40 percent to 70 percent. These
numbers are not consistent with Mr. Rosenbach’s assertion that he
expected Magellan to be loss free for many years.
32
[*32] Moreover, the high premium amounts are not consistent with Mr.
Rosenbach’s contention that the rates were developed for “low
frequency” lines of business. As noted by Ms. Garland, for a single
insured, “low frequency” would suggest a claim every 10 to 20 years.
However, a premium of nearly $1 million is consistent with a claim every
year in the range of $500,000 to $700,000. Neither Magellan nor
Plymouth had claim history supporting a claim every year. Yet the
Patels paid Magellan and Plymouth more than $1 million in policy
premiums each year.
Further, Mr. Coomes could not recall whether he ever instructed
Mr. Rosenbach to (1) increase or decrease a premium amount; (2) target
a certain premium level; or (3) increase or decrease premium amounts
based on a request from a client. But Mr. Rosenbach was aware of the
$1.2 million limit on exclusion from taxability under section 831(b),
which was later increased to $2.2 million. He also testified that he
believed the final pricing reports he prepared for Mr. Coomes’s clients
from 2011 to 2016 always totaled less than $1.2 million in premiums.
Further, in 2014, Mr. Coomes sought advice from another
attorney who handled captive insurance companies and asked him
whether there was a standard test “when speaking with prospective
clients in terms of the maximum amount of premiums that are
reasonable based upon the gross or net income of the business? The
question of course presumes that all premiums can be justified from an
actuarial standpoint.”
2. Dr. Patel’s Involvement in Premium Pricing
Although Mr. Coomes claimed that Mr. Rosenbach developed
premium pricing for Dr. Patel’s captives, the record reveals that Dr.
Patel and his employee provided Mr. Coomes with a target to be hit for
the Patel captives’ premiums. Contemporaneous emails during the tax
years at issue also reveal that Dr. Patel had input regarding the
insurance premiums he wanted to pay his captives, including asking for
higher premiums. For example, in December 2012, Mr. Ridgway emailed
Dr. Patel, inquiring about the amount of total casualty insurance
premiums that Dr. Patel would pay for that year. In response, Ms.
Guerrero responded that same day: “We are not positive on the amount
that should go in the box below. Dr. Patel is thinking the amt is
$1,150,000.00. Is this the amount that you are expecting. Please advise.”
Mr. Ridgway responded: “Yes, that’s around the amount we were
expecting.” Ms. Guerrero responded again that “Dr. Patel wanted to
33
[*33] know what the max is that we can pay into the captive,” to which
Mr. Ridgway responded “$1,200,000.”
Similarly, in 2014, Ms. Guerrero emailed Mr. Coomes and asked
why policy premiums were less than the year before because “Dr. Patel
was expecting a little closer to 1.2 million for the both.” Mr. Coomes
replied that he “simply renewed the same policies at the same limits as
last year,” premiums had dropped in the commercial market, and they
should look at adding other coverages or increasing limits the following
year, apparently to increase the total amount of insurance premiums
Dr. Patel was paying to the captive. In response, Dr. Patel informed Ms.
Guerrero that he wanted to add SCR as an insured in 2015. Thus, in
2015, Magellan began issuing policies to SCR. In August 2015, Ms.
Guerrero emailed Mr. Coomes and stated that “Dr. Patel would like to
add another company to the captive” and asked where to start.
3. Reinsurance Premium Pricing
With respect to Capstone’s premium pricing structure, Mr.
Coomes stated that an actuary developed the 51 percent reinsurance
premium for each captive. But there is no credible evidence to support
Mr. Coomes’s statement. There is no documentation demonstrating that
an actuary—whether Mr. Rosenbach or another person—determined
the reasonableness of the reinsurance premiums for each captive.
I. Claims Activity
CIC Services handled certain clerical functions for captives in the
Capstone pool, including for Magellan and Plymouth. In particular,
during the tax years at issue, CIC Services was responsible for reviewing
a portion of claims submitted by captives participating in Capstone.
Once claims were approved, CIC Services notified Capstone.
In 2013, the Reinsurance Agreement provided that the parties
agreed to be bound by the decision of a third-party claims adjuster for
any claims exceeding $20,000. However, claims that did not exceed
$20,000 would be submitted to the captive manager or a third-party
claims adjuster at the discretion of Capstone. From 2014 through 2016,
the Reinsurance Agreement provided that Capstone had the discretion
to submit all claims to the captive manager.
During the tax years at issue, Mr. Sean King, Mr. Ridgway, and
Mr. Thomas King—all with CIC Services—had ownership interests in a
captive insurance company that participated in the Capstone pool, while
34
[*34] at the same time they also approved claims for the Capstone pool.
In October 2014, Mr. Coomes raised concerns about employees of CIC
Services approving claims when they owned a captive in the same
pooling arrangement.
Further, for the 2015 policy period, approximately 14 percent of
all approved claims submitted to Capstone related to one claim for
$605,669 by Mr. Thomas King. The claim was for Thomas King’s loss of
income because Minnesota Life Insurance no longer offered life
insurance policies to captive insurance companies. Notably, the claim
was submitted in 2017, after the policy period was over and after Mr.
Thomas King sent an email informing Dr. Patel that the IRS was
examining his captives.
During the tax years at issue, Magellan and Plymouth did not pay
any claims for the direct policies they issued to OST, ICR, or SCR. They
did pay a share of Capstone pool claims, but those claims represent an
average loss ratio 15 of less than five percent for Magellan and three
percent for Plymouth. By contrast, commercial insurance carriers in the
property and casualty industry had an average loss ratio of
approximately 70 percent during the same period.
Finally, Capstone claims increased significantly after the IRS
began examining Capstone captives, including in subsequent years not
at issue here. Most of the claim activity for the 2015 reinsurance pool—
which represents the majority of claims activity during the years at
issue—occurred after the IRS began examining captives formed by Mr.
Coomes.
IV. The Patels’ Returns and IRS Examination
The IRS conducted examinations of the Patels’ joint federal
income tax returns for each of the tax years at issue and issued notices
of deficiency to them. For each tax year at issue, respondent determined
that neither Magellan nor Plymouth could be treated or taxed as a small
insurance company under section 831(b). As a result, the IRS disallowed
the amounts deducted as insurance premiums and determined the
following deficiencies for the tax years at issue:
15 The insurance industry uses a measure called the “loss ratio” to compare
losses and adjustment expenses with premiums earned. As explained by Ms. Garland,
a loss ratio of 60 percent means that 60 cents of each premium dollar earned is used to
pay claims and associated expenses.
35
[*35] Year Deficiency
2013 $247,892
2014 484,420
2015 475,186
2016 529,949
OPINION
I. Burden of Proof
The determinations in a notice of deficiency bear a presumption
of correctness, see Welch v. Helvering, 290 U.S. 111, 115 (1933), and the
taxpayer generally bears the burden of proving them erroneous in
proceedings in this Court, see Rule 142(a)(1). 16 The taxpayer bears the
burden of proving entitlement to any deduction claimed. INDOPCO, Inc.
v. Commissioner, 503 U.S. 79, 84 (1992). Thus, 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).
If, in any court proceeding, the taxpayer puts forth credible
evidence with respect to any factual issue relevant to ascertaining the
liability of the taxpayer and meets certain other requirements, the
burden of proof shifts to the Commissioner. § 7491(a)(1) and (2). 17 When
each party has satisfied its burden of production, then the party
supported by the weight of the evidence will prevail; and thus a shift in
the burden of proof has real significance only in the event of an
evidentiary tie. See Knudsen v. Commissioner, 131 T.C. 185, 189 (2008),
supplementing T.C. Memo. 2007-340.
16 The Patels once again ask the Court to shift the burden of proof to
respondent. The Court has already considered and denied petitioners’ pre-trial motion
requesting the same relief (see Docket No. 24344-17, Order, Doc. 217), and we decline
to reconsider their renewed motion.
17 The U.S. Court of Appeals for the Fifth Circuit, to which an appeal in these
cases would presumptively lie, see § 7482(b)(1), has also held that if an “assessment is
arbitrary and erroneous, the burden shifts to the government to prove the correct
amount of any taxes owed,” Portillo v. Commissioner, 932 F.2d 1128, 1133 (5th Cir.
1991), aff’g in part, rev’g and remanding in part T.C. Memo. 1990-68.
36
[*36] We do not perceive an evidentiary tie in these cases and are able
to decide the issues on the preponderance of the evidence. See, e.g.,
Swift, T.C. Memo. 2024-13, at *26; Bordelon v. Commissioner, T.C.
Memo. 2020-26, at *11.
II. Evaluation of Evidence
In deciding whether a taxpayer has carried his burden of proof,
witness credibility is an important consideration. Ishizaki v.
Commissioner, T.C. Memo. 2001-318, 2001 WL 1658189, at *7. “[T]he
distillation of truth from falsehood . . . is the daily grist of judicial life.”
Diaz v. Commissioner, 58 T.C. 560, 564 (1972). “As a trier of fact, it is
our duty to listen to the testimony, observe the demeanor of the
witnesses, weigh the evidence, and determine what we believe.” Kropp
v. Commissioner, T.C. Memo. 2000-148, 2000 WL 472840, at *3.
Both parties presented experts to support their respective
positions. See Fed. R. Evid. 702; Crimi v. Commissioner, T.C. Memo.
2013-51, at *40 (“An expert witness may be allowed to testify in a
proceeding before this Court when his or her scientific, technical, or
other specialized knowledge might help us to understand the evidence
or decide a fact in issue.”). Although experts are helpful, we are not
bound by any particular expert opinion. Hunt & Sons, Inc. v.
Commissioner, T.C. Memo. 2002-65, 2002 WL 398703, at *9. In addition,
we are free to accept only a portion of an expert’s opinion. Estate of
Jackson v. Commissioner, T.C. Memo. 2021-48, at *64; see also Parker v.
Commissioner, 86 T.C. 547, 562 (1986). We focus our analysis on the
degree to which an expert’s opinions are supported by the evidence in
the record. See Helvering v. Nat’l Grocery Co., 304 U.S. 282, 295 (1938);
Estate of Davis v. Commissioner, 110 T.C. 530, 538 (1998).
With this framework in mind, we determine the credibility of
witnesses, resolve evidentiary conflicts, and draw inferences from the
voluminous record developed by the parties. Keating, T.C. Memo.
2024-2, at *50.
III. Taxation of Insurance
We begin our discussion by briefly explaining the taxation and
deductibility of microcaptive insurance payments. 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 tax years at issue, an
37
[*37] insurance company with net written premiums (or, if greater,
direct written premiums) that did not exceed $1.2 million (or $2.2
million beginning in 2016) for the year could elect to be taxed under
section 831(b). See § 831(b)(2). A microcaptive that makes a valid section
831(b) election is subject to tax only on its investment income.
Further, amounts paid for insurance are deductible under section
162(a) as ordinary and necessary expenses paid or incurred in
connection with a trade or business. See Treas. Reg. § 1.162-1(a). Section
162(a) does not prohibit deductions for microcaptive insurance
premiums. But an inherent requirement for a company to make a valid
section 831(b) election is that it must transact in insurance. See
Avrahami, 149 T.C. at 175–76. Likewise, the deductibility of insurance
premiums depends on whether the premiums were truly payments for
insurance. Syzygy Ins. Co. v. Commissioner, T.C. Memo. 2019-34, at *28.
These rules are even more complicated when the insurer and the
insureds are related. Avrahami, 149 T.C. at 176. Although insurance
premiums may be deductible, amounts set aside in a loss reserve as a
form of self-insurance are not. See, e.g., Caylor Land & Dev., T.C. Memo.
2021-30, at *31.
Thus, these cases hinge on whether the Patels’ microcaptive
insurance arrangement meets the definition of insurance. But neither
the Code nor the regulations define “insurance.” Id. Thus, we are guided
by caselaw in determining whether a particular transaction constitutes
insurance for federal income tax purposes. See Helvering v. Le Gierse,
312 U.S. 531, 539–40 (1941); Estate of Chew v. Commissioner, 148 F.2d
76, 78 (5th Cir. 1945), aff’g 3 T.C. 940 (1944); Avrahami, 149 T.C. at 177.
Courts have examined four criteria in deciding whether an
arrangement constitutes insurance for federal income tax purposes:
(1) the insurer distributes the risk among its policy holders; (2) the
arrangement is insurance in the commonly accepted sense; (3) the
arrangement shifts the risk of loss to the insurer; and (4) the
arrangement involves insurable risks. Helvering v. Le Gierse, 312 U.S.
at 539–40; Avrahami, 149 T.C. at 177 (first citing Rent-A-Center, Inc. v.
Commissioner, 142 T.C. 1, 13 (2014); then citing R.V.I. Guar. Co. &
Subs. v. Commissioner, 145 T.C. 209, 225 (2015); then citing Harper
Grp., 96 T.C. at 58; and then citing AMERCO & Subs. v. Commissioner,
96 T.C. 18, 38 (1991), aff’d, 979 F.2d 162 (9th Cir. 1992)).
“These four nonexclusive criteria establish a framework for
determining the existence of insurance for Federal income tax
38
[*38] purposes.” Rsrv. Mech. Corp., T.C. Memo. 2018-86, at *33. We will
first look at risk distribution.
A. Risk Distribution
Risk distribution is one of the common characteristics of
insurance identified by the Supreme Court. See Helvering v. Le Gierse,
312 U.S. at 539. It occurs when the insurer pools a large enough
collection of unrelated risks. Rent-A-Center, 142 T.C. at 24; see also
Caylor Land & Dev., T.C. Memo. 2021-30, at *33. This concept is based
on the law of large numbers—“a statistical concept that theorizes that
the average of a large number of independent losses will be close to the
expected loss.” Avrahami, 149 T.C. at 181. “By assuming numerous
relatively small, independent risks that occur randomly over time, the
insurer smoothes out losses to match more closely its receipt of
premiums.” Clougherty Packing Co. v. Commissioner, 811 F.2d 1297,
1300 (9th Cir. 1987), aff’g 84 T.C. 948 (1985).
In prior captive insurance cases, taxpayers have attempted to
show risk distribution in two ways: (1) participating in a pooling
arrangement whereby the pool performs the functions 18 of an insurance
company; or (2) issuing direct written policies to affiliate entities with a
large enough pool of unrelated risks. Swift, T.C. Memo. 2024-13, at *29.
On both points, Magellan and Plymouth fail to demonstrate risk
distribution.
1. The Pooling Arrangement
To decide whether Magellan and Plymouth distributed risk by
participating in a captive insurance pool, we must determine whether
Capstone performed the functions of an insurance company. See
Avrahami, 149 T.C. at 185 (citing Rent-A-Center, Inc., 142 T.C. at 10).
18 As noted by respondent, our prior opinions have examined reinsurance
pooling arrangements by determining whether the arrangement operated as a bona
fide insurance company. Avrahami, 149 T.C. at 192; Syzygy Ins. Co., T.C. Memo. 2019-
34, at *29–30; Rsrv. Mech. Corp., T.C. Memo. 2018-86, at *38. The U.S. Court of
Appeals for the Tenth Circuit’s opinion affirming Reserve Mechanical noted that this
Court did not invalidate a quota share arrangement on the ground that it failed to
meet the formal definition of an insurance company. Rsrv. Mech. Corp. v.
Commissioner, 34 F.4th at 912. Rather, this Court invalidated the quota share
arrangement on the ground that, as a matter of substance, the pooling arrangement
did not perform the functions of an insurance company. Id. Regardless of the label, our
analysis focuses on whether Capstone performed the functions of an insurance
company.
39
[*39] To determine whether an entity is performing the functions of an
insurance company, we have considered a number of factors, including:
(1) whether it was created for legitimate nontax reasons;
(2) whether there was a circular flow of funds;
(3) whether the entity faced actual and insurable risk;
(4) whether the policies were arm’s-length contracts;
(5) whether the entity charged actuarially determined premiums;
(6) whether comparable coverage was more expensive or even
available;
(7) whether it was subject to regulatory control and met minimum
statutory requirements;
(8) whether it was adequately capitalized; and
(9) whether it paid claims from a separately maintained account.
Id. at 185; Syzygy Ins. Co., T.C. Memo. 2019-34, at *29–30. We will
address the most relevant factors in our analysis. See Rsrv. Mech. Corp.,
T.C. Memo. 2018-86, at *38–39.
a. Circular Flow of Funds
Under the arrangement with Capstone, each pool member paid
51 percent of its written premiums to Capstone in exchange for
purported reinsurance. But within a few days, Capstone returned half
the reinsurance premium to each pool member. Capstone returned
another 35 percent within 7 or 8 months. For the tax years at issue,
Magellan and Plymouth received payments from Capstone that were
roughly equal to the premiums Capstone was entitled to receive from
Magellan and Plymouth as part of the reinsurance agreement.
Further, although some claims were paid in the pool during the
tax years at issue, the amounts were minimal, resulting in Magellan and
Plymouth receiving nearly all of their premiums back as reinsurance
premiums during the tax years at issue. In considering similar
circumstances, we have determined that “[w]hile not quite a complete
loop, this arrangement looks suspiciously like a circular flow of funds.”
Syzygy Ins. Co., T.C. Memo. 2019-34, at *30–31 (quoting Avrahami, 149
40
[*40] T.C. at 186); see also Swift, T.C. Memo. 2024-13, at *33; Rsrv.
Mech. Corp., T.C. Memo. 2018-86, at *41.
b. Arm’s-Length Contracts
There is no evidence of any arm’s-length negotiations in
determining the premiums paid to Capstone. As noted above, there is no
actuarial determination of the reasonableness of the 51 percent of
premiums ceded to Capstone. Magellan’s and Plymouth’s captive
arrangement’s rate-on-line was 12 times higher than the premiums for
the commercial policies. Dr. Patel accepted these amounts despite not
attempting to determine whether commercial insurance policies would
offer the same or similar coverage for less.
As noted by the Court when discussing the lack of arm’s-length
contracts for a similar reinsurance pool:
It is fair to assume that a purchaser of insurance would
want the most coverage for the lowest premiums. In an
arm’s-length negotiation, an insurance purchaser would
want to negotiate lower premiums instead of higher
premiums. Seemingly, the main advantage of paying
higher premiums is to increase deductions.
Syzygy Ins. Co., T.C. Memo. 2019-34, at *33–34. Similarly here, the lack
of negotiation regarding premium prices—and Dr. Patel’s desire to pay
higher premiums to maximize his deductions and the amount flowing
through the captives—demonstrate a lack of arm’s-length transactions.
Moreover, Dr. Patel entered the reinsurance pool with other
members without performing due diligence regarding the other pool
members, including their risks, industries, ability to fulfill quota share
claims, or captive insurance policies. This lack of due diligence is
indicative of a lack of arm’s-length negotiations.
c. Actuarially Determined Premiums
We also look at whether the entity charged actuarially
determined premiums. Avrahami, 149 T.C. at 186. We have previously
held that premiums were actuarially determined when the company
relied upon an outside consultant’s “‘reliable and professionally
produced and competent actuarial studies’ to set premiums.” Syzygy Ins.
Co., T.C. Memo. 2019-34, at *34 (quoting Rent-a-Center, 142 T.C. at 27
(Buch, J., concurring)). In contrast, “[w]e have held that premiums were
41
[*41] not actuarially determined when there has been no evidence to
support the calculation of premiums and when the purpose of premium
pricing has been to fit squarely within the limits of section 831(b).” Id.
Here, Capstone charged its pool members a reinsurance premium
of exactly 51 percent of their captive premium amounts, without
accounting for the different risks of pool members, the types of
businesses of pool members, or the geographical location of pool
members. As in our prior cases, we are concerned with a one-size-fits-all
approach to pricing. See Avrahami, 149 T.C. at 186–87; Syzygy Ins. Co.,
T.C. Memo. 2019-34, at *36; Rsrv. Mech. Corp., T.C. Memo. 2018-86,
at *43. As noted by Ms. Garland—whom we found credible—there is no
evidence that the 51 percent of premium ceded to Capstone was
actuarially determined. In contrast, Mr. Coomes’s memorandum to
captive owners implies that the amount was arbitrarily selected to
comply with caselaw and a perceived safe harbor for risk distribution.
Furthermore, although Mr. Coomes testified that an “actuary”
determined premium amounts and the 51 percent reinsurance
premium, we found that his testimony lacked credibility.
d. Approval by the TDCI
Finally, the Patels argue that because the TDCI determined that
Capstone is a reinsurer, the Court should show deference to that state
regulatory agency. We disagree. Although the TDCI regulates insurance
companies, it does not have the authority to determine whether an
entity operates as an insurance company within the meaning of the
Code. See, e.g., Grp. Life & Health Ins. Co. v. United States, 434 F.2d
115, 120 (5th Cir. 1970); Cuesta Title Guar. Co. v. Commissioner, 71 T.C.
278, 285 (1978), aff’d, 639 F.2d 787 (9th Cir. 1981) (unpublished table
decision). We recognize that Congress has delegated to the states the
authority to regulate the business of insurance. See AMERCO & Subs.,
96 T.C. at 42. But our focus is on whether Capstone was operated as an
insurance—or reinsurance—company for federal tax purposes, looking
beyond the formalities and considering the realities of the transactions.
See Syzygy Ins. Co., T.C. Memo. 2019-34, at *38. Here, although
Capstone was organized and regulated as a reinsurance company under
42
[*42] state and international law, 19 these insurance-like traits cannot
overcome its other failings. See id.
e. Conclusion
Based on the foregoing, we find that the facts surrounding the
Capstone pooling agreement indicate that Capstone did not perform the
functions of an insurance company. 20 See Rsrv. Mech. Corp. v.
Commissioner, 34 F.4th at 912. Accordingly, Magellan and Plymouth
have not achieved sufficient risk distribution via the Capstone pooling
arrangement.
2. Direct Written Policies
Sufficient risk distribution may also be achieved by issuing
policies to the Patels’ affiliated entities. See Avrahami, 149 T.C. at 182.
As noted by Ms. Garland, risk distribution “is achieved by insuring risks
that are spread out and independent of each other, either by
geographical region, type of exposure, line of business, or other criteria.”
The Patels’ expert, Mr. Angelina, agrees that with the law of large
numbers, the goal is to get an exposure base of statistically independent
risks.
In Rent-A-Center, 142 T.C. at 24, we concluded that the captive
assumed and pooled premiums for “a sufficient number of statistically
independent risks” and achieved risk distribution because it issued
policies for its affiliates that covered more than 14,000 employees, 7,100
vehicles, and 2,600 stores in all 50 states. We found that the captive in
19 As set forth supra Findings of Fact Part III.B.2, Capstone was initially
formed under the laws of the Turks and Caicos Islands. However, the Patels do not
argue that the Court should show deference to the Turks and Caicos regulators.
20 The Patels urge the Court to find that Capstone mirrors the Green Island
Insurance Treaty, a reinsurance pool that both parties’ experts consider to be one of
the best reinsurance pools for captive insurance. However, there are obvious,
significant differences between Capstone and Green Island. In the Green Island pool,
(1) premiums are tailored to establish rates based on an individual participant’s
unique risk profile and loss experience; (2) the pool members are very large publicly
traded companies with many independent exposures; (3) there are financial standards
for both the captive and the parent; (4) Green Island is managed by a worldwide firm,
not the same individual who also formed the captives; (5) premiums are tailored and
revised annually based on historical losses; and (6) a participants’ committee vets each
company that wants to join the pool and requires the approval of a supermajority of 75
percent of committee members for a new company to join the pool. The record reflects
that Capstone does not have any of these characteristics.
43
[*43] Securitas Holdings, Inc. & Subs. v. Commissioner, T.C. Memo.
2014-225, at *26–27, distributed risk effectively, for a number of
reasons, including that it provided worker’s compensation coverage for
more than 200,000 employees, automobile coverage for more than 2,200
vehicles, and other coverages for more than 25 separate entities.
By contrast, in Avrahami, 149 T.C. at 181, we found that the
captive’s issuance of seven types of direct policies covering exposures for
four related entities was insufficient to distribute risk. In Rsrv. Mech.
Corp., T.C. Memo. 2018-86, at *35–36, we found that the captive’s
issuance of eleven and thirteen types of policies for three insureds was
insufficient to achieve risk distribution. Similarly, in Caylor Land &
Dev., T.C. Memo. 2021-30, at *35, we found that having zero risks from
an unrelated party, with all risks in the same geographic area, was
insufficient for risk distribution. We determined that there was no risk
distribution where the taxpayer’s captive insured, at most, two to three
entities with six to nine lines of coverage. Swift, T.C. Memo. 2024-13,
at *29.
We reach the same conclusion here. Magellan and Plymouth
issued policies to only three (or fewer) related entities during the tax
years at issue. From 2013 through 2014, Magellan directly insured only
two related entities—OST and ICR. In 2015, Magellan directly insured
only three related entities—OST, ICR, and SCR. In 2016, Magellan
insured two related entities: ICR and SCR, and Plymouth insured just
one entity: OST. Thus, Magellan’s and Plymouth’s issuance of policies
to, at most, one to three entities is insufficient to achieve risk
distribution.
The Patels would have us focus on the number of patient visits
and procedures at each entity, not the number of insured entities. They
argue that there were between 27,442 and 34,443 patient visits and
between 6,621 and 9,084 procedures, creating over 88,200 points of
exposure for OST across multiple offices and surgical locations for one
year. We disagree. As noted by Ms. Garland, the number of patient visits
is not relevant to most of the coverages insured by Magellan and
Plymouth. Rather, the number of visits or patients is an indicator of risk
for Dr. Patel’s professional liability and general liability policies—the
commercial policies he maintained despite forming Magellan and
Plymouth. Similarly, a larger number of employees would increase the
workers compensation exposure and medical professional liability
exposure. But, again, these are coverages Dr. Patel maintained through
his commercial insurance coverage, not the microcaptives.
44
[*44] Moreover, as we found, the standard in the industry is to look at
the number of doctors when evaluating risk, see Swift, T.C. Memo.
2024-13, at *30, and “using the doctor-patient interaction as the
appropriate unit of measurement for risk exposure would be tantamount
to treating as the correct unit of measurement for risk exposure in the
automobile insurance context every time a car is put into gear,” id. n.13.
And we do not think the number of physicians at Dr. Patel’s entities
sufficient for risk distribution. See id. at *30. At most, the entities had
five physicians. We do not believe that this is an adequate number of
risk exposures, concentrated in one line of insurance, for the operation
of the law of large numbers. In short, the captives “face[d] a number of
independent risks that are at least a couple orders of magnitude smaller
than the captives in cases where we’ve found sufficient distribution of
risk.” Caylor Land & Dev., T.C. Memo. 2021-30, at *37.
Regardless, when determining whether an arrangement
distributes risk, we also analyze the number of independent risk
exposures, Avrahami, 149 T.C. at 183, and the Patels’ captives did not
face independent risks. As noted above, we found independent risks in
R.V.I., 145 T.C. at 228–29, when an insurance company issued 951
policies covering more than 750,000 vehicles, 2,000 real estate
properties, and 1.3 million equipment assets in 7 different geographic
regions. The captive in Rent-A-Center, 142 T.C. at 24, had sufficient
independent risk exposures when it provided workers compensation,
automobile, and general liability policies that covered more than 14,000
employees, 7,100 vehicles, and 2,600 stores in all 50 states. Independent
risk exposure was achieved in Securitas Holdings, T.C. Memo. 2014-225,
at *26–27, when the captive provided workers compensation coverage
for more than 200,000 employees, automobile coverage for
approximately 2,200 vehicles, and other coverages for more than 25
separate entities.
In considering whether Magellan’s and Plymouth’s risk exposures
were independent, we find that they fall well short of the situations
described above. Magellan and Plymouth issued 22 to 36 policies to 3
health care entities owned by Dr. Patel during the tax years at issue.
The insureds were all OST, ICR, and SCR: medical entities in the same
geographic area of West Texas with fewer than 100 employees and 5
surgeons, some of which overlap, all operating in the same “well-defined
slices of the medical field.” See Swift, T.C. Memo. 2024-13, at *31. Thus,
the lack of independent exposures is readily apparent and another
reason the captives failed to achieve risk distribution. See id.
45
[*45] 3. Revenue Rulings
Finally, the Patels claim that the IRS provides risk distribution
“safe-harbors” via Revenue Ruling 2002-89, 2002-2 C.B. 984, and
Revenue Ruling 2002-90, 2002-2 C.B. 985. The Commissioner is
required to follow his revenue rulings, and we have treated revenue
rulings as concessions by the Commissioner where those rulings are
relevant to the disposition of a case. Rauenhorst v. Commissioner, 119
T.C. 157, 171–73 (2002). But for a taxpayer to rely on a revenue ruling,
the facts of the taxpayer’s transaction must be substantially the same
as those in the ruling. Barnes Grp., Inc. v. Commissioner, T.C. Memo.
2013-109, at *37–38, aff’d, 593 F. App’x 7 (2d Cir. 2014).
Both rulings addressed situations involving parties who
“conduct[ed] themselves consistently with the standards applicable to
an insurance arrangement between unrelated parties.” Rev. Rul.
2002-89, 2002-2 C.B. at 984; see also Rev. Rul. 2002-90. However, the
rulings do not have facts substantially similar to those present here.
For example, both revenue rulings require risk distribution. See
Rev. Rul. 2002-89; Rev. Rul. 2002-90. For the reasons discussed supra
Opinion Part III.A.1 and 2, we find that risk distribution is not present
here. Further, in Revenue Ruling 2002-89, premiums were established
via customary industry rating formulas, which also are not present here.
See supra Opinion Part III.A.1.c, B.4. In Revenue Ruling 2002-90, the
premiums were the result of arm’s-length transactions, which also did
not occur here. See supra Opinion Part III.A.1.b. Accordingly, the Patels
cannot rely on the revenue rulings to deduct the purported premiums.
See Syzygy Ins. Co., T.C. Memo. 2019-34, at *48.
4. Conclusion Regarding Risk Distribution
We conclude that Magellan and Plymouth did not achieve risk
distribution, either through Capstone or through its affiliated entities.
Risk distribution is a necessary component of insurance, and its absence
here leads us to conclude that Magellan’s and Plymouth’s transactions
during the tax years at issue were not insurance transactions. See
Avrahami, 149 T.C. at 190.
B. Insurance in the Commonly Accepted Sense
The absence of risk distribution is enough for us to conclude that
the Magellan and Plymouth transactions were not insurance
transactions. See Avrahami, 149 T.C. at 190; Swift, T.C. Memo. 2024-13,
46
[*46] at *37. But as an alternative ground, we also look at whether the
transactions constitute insurance in the commonly accepted sense.
Caylor Land & Dev., T.C. Memo. 2021-30, at *39. In making this
determination, we examine a number of factors, including:
(1) whether the 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;
(5) whether claims were paid;
(6) whether policies covered typical insurance risks; and
(7) whether there was a legitimate business reason for acquiring
insurance from the captive.
Avrahami, 149 T.C. at 191; see also Syzygy Ins. Co., T.C. Memo. 2019-34,
at *37. Below, we examine the most salient factors to our analysis.
1. Organization, Operation, and Regulation
First, we consider whether Magellan and Plymouth were
organized, operated, and regulated as insurance companies. In
considering whether Magellan and Plymouth operated as insurance
companies, we “look beyond the formalities and consider the realities of
the purported insurance transactions.” See Avrahami, 149 T.C. at 192
(quoting Hosp. Corp. of Am. v. Commissioner, T.C. Memo. 1997-482,
1997 WL 663283, at *24). There is no dispute that Magellan was
incorporated and regulated as a captive insurance company in St. Kitts.
Further, Plymouth was incorporated and regulated in Tennessee.
However, aside from these organizational formalities, the facts
demonstrate that Magellan and Plymouth were not operated as
insurance companies. See Swift, T.C. Memo. 2024-13, at *37; Keating,
T.C. Memo. 2024-2, at *53. Magellan’s and Plymouth’s planning,
incorporation, and operations during the tax years at issue were
managed almost entirely by Capstone and Mr. Coomes. Magellan and
Plymouth had no employees of their own that performed services.
47
[*47] In the shadow of litigation, Dr. Patel paints a sympathetic and
compelling story about the downfall of the West Texas Hospital. We
believe Dr. Patel’s testimony about the end of the West Texas Hospital
and its impact on him and his family. But a close examination of the
evidence does not support his testimony that his experience with West
Texas Hospital was the reason he decided to form captive insurance
companies. Simply put, we did not find Dr. Patel’s testimony on this
point to be credible.
Further, there is no credible evidence that Dr. Patel’s
conversations about forming a captive centered around preventing a
future disaster. Indeed, Dr. Patel stated that he did not need advice
about forming a captive. Rather, he knew he was ready to proceed after
studying books about asset protection and “the secret to capturing . . .
[a] piece of America’s multi-billion dollar industry.” This is particularly
poignant given that Dr. Patel maintained all of his regular commercial
insurance coverage, including malpractice insurance, during the tax
years at issue.
Moreover, other than Dr. Patel’s self-study and the Business Plan
created for Magellan, there is no evidence that any feasibility study was
conducted to determine whether a captive was necessary and, if so, what
policies were required. There is also no evidence that due diligence was
conducted to determine whether a second captive was necessary. Rather,
it appears that a desire to take advantage of increased tax benefits came
first, and the justification to form a second captive came second.
Relatedly, there is no evidence that Dr. Patel performed any due
diligence with respect to the reinsurance or quota share agreements that
Magellan and Plymouth executed with Capstone. As we noted in Swift,
T.C. Memo. 2024-13, at *37, “[t]his omission would seem bizarre if these
were actual insurance companies.”
In reality, Capstone orchestrated Magellan’s and Plymouth’s
activities so that they appeared to be engaged in the business of issuing
insurance contracts. But the facts establish that they were not operated
as insurance companies in the commonly accepted sense. See Swift, T.C.
Memo. 2024-13, at *39; Rsrv. Mech. Corp., T.C. Memo. 2018-86, at *53.
This factor weighs against the Patels.
2. Capitalization
Next, we turn to capitalization. The parties agree that Magellan
met the minimum capitalization requirements of St. Kitts, and
48
[*48] Plymouth met the minimum capitalization requirements of
Tennessee. This is the same as adequate capitalization. See Swift, T.C.
Memo. 2024-13, at *39; Keating, T.C. Memo. 2024-2, at *56. This factor
favors the Patels.
3. Valid and Binding Policies
Next, we examine whether the policies were valid and binding.
The caselaw is not entirely clear on what makes a policy “valid and
binding.” 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, T.C. Memo. 2014-225, at *28. In R.V.I.,
145 T.C. at 231, we found that policies were valid and binding when the
insured filed claims for covered losses and the captive insurance
company paid them. We have also looked at factors beyond whether the
policies are simply binding such as conflicting policy terms. Avrahami,
149 T.C. at 194.
Generally, Magellan’s and Plymouth’s direct written policies
contained the necessary terms to make them valid and binding
insurance contracts. Nonetheless, the Magellan and Plymouth policies
also contain atypical provisions that are not common within the
insurance industry. Examples include (1) claims-made provisions that
are unfavorable to the insureds; (2) excess policy provisions despite high
premiums that are indicative of primary policies; and (3) an inability to
cancel the policies and receive refunds. Swift, T.C. Memo. 2024-13,
at *39 (noting that the policies at issue contained “questionable
draftsmanship, with several of the policies acting effectively as excess
coverage masquerading as primary”).
Given that evidence regarding the validity of Magellan’s and
Plymouth’s policies is mixed, we conclude that this factor is neutral for
the Patels. See id.; Rsrv. Mech. Corp., T.C. Memo. 2018-86, at *54–55.
4. Reasonableness of Premiums
Next, we examine whether Magellan’s and Plymouth’s premiums
were reasonable and the result of arm’s-length transactions. For the
reasons noted supra Opinion Part III.A.1.b and c, we find that
Magellan’s and Plymouth’s premiums were wholly unreasonable.
49
[*49] First, it is apparent that Dr. Patel targeted the monetary limit of
section 831(b) by telling his advisers how much he wanted to pay to the
captives. When Magellan premiums dropped as a result of a change in
the commercial insurance market, he chose to add SCR as an insured to
get the total of premiums closer to the $1.2 million target. “As a general
matter, we have serious reservations about the reasonableness of
premiums developed to hit a preordained target for tax purposes, as
here.” Swift, T.C. Memo. 2024-13, at *40.
Second, we give very little weight to Mr. Rosenbach’s premium
calculations. The record establishes that Mr. Rosenbach’s calculations
were aimed at targeting total premiums as close as possible to $1.2
million. Mr. Rosenbach used ill-defined factors to increase the premium
amounts to reach the $1.2 million limit. He was aware of the $1.2 million
limit and never priced premiums above that amount.
Relatedly, during the tax years at issue, the average rate-on-line
for the Patels’ captives’ policies was up to 12 times higher than the rate-
on-line for the Patels’ commercial coverages. See Keating, T.C. Memo.
2024-2, at *61 (finding a rate-on-line that was ten times higher than
commercial insurance policies “patently unreasonable”). A higher rate-
on-line means the insurance coverage is more expensive per dollar of
coverage, thus leading to a greater deduction for premiums. See Syzygy
Ins. Co., T.C. Memo. 2019-34, at *31–34. For example, Mr. Rosenbach
priced premiums for the legal expense policy at $14,000 for $20,000 of
coverage. As noted by Ms. Garland, this would be the equivalent of
purchasing collision coverage for a $20,000 car and paying a $14,000
premium for that policy. This is further evidence that the premiums
were unreasonable.
We also give little credit to Mr. Rosenbach’s expert reports, which
were prepared for the purpose of litigation and appear aimed at
providing justification for the high premiums. This Court has already
determined that Mr. Rosenbach’s calculations under very similar
circumstances were utterly unreasonable. See Avrahami, 149 T.C.
at 194–95; Swift, T.C. Memo. 2024-13, at *42–43. Mr. Rosenbach
admitted that he was later sued for his premium calculations in
Avrahami. Mr. Rosenbach’s bias weighs against his credibility. See
Dunn v. Sears, Roebuck & Co., 639 F.2d 1171, 1174 (5th Cir.), opinion
corrected, 645 F.2d 511 (5th Cir. 1981) (observing that an expert’s
“potential bias may be explored on cross-examination”); Nagle v.
Gusman, No. 12-cv-1910, 2016 WL 9411379, at *1 (E.D. La. Mar. 3,
2016) (finding that evidence regarding an expert’s “experience in a prior
50
[*50] lawsuit is relevant to his potential bias and credibility as an expert
witness” in current lawsuit); Butler v. Rigsby, No. 96-cv-2453, 1998 WL
164857, at *3 (E.D. La. Apr. 7, 1998) (“[A]n expert witness’ experiences
in prior lawsuits is relevant to demonstrate possible biases.”). We give
Mr. Rosenbach’s testimony little weight.
Finally, we once again note that Mr. Coomes could not recall
whether he ever told Mr. Rosenbach to increase or decrease a premium
amount. We found Mr. Coomes’s testimony on this point to lack
credibility, particularly in light of Magellan’s and Plymouth’s high
premiums that were closely related to Dr. Patel’s requested amounts.
We conclude that Mr. Rosenbach’s calculations were aimed not at
actuarially sound decision-making but at justifying total premiums as
close as possible to $1.2 (or $2.2) million, without going over, to satisfy
section 831(b). See, e.g., Avrahami, 149 T.C. at 196.
In short, we find that Magellan’s and Plymouth’s premiums were
unreasonable and aimed at maximizing tax deductions, not at
incorporating actuarily sound principles. “The voluminous record before
us leaves the firm impression that premium amounts were engineered
to suit the tax needs of the moment, not to account for any risk.” Swift,
T.C. Memo. 2024-13, at *40. This factor weighs heavily against the
Patels.
5. Payment of Claims
Finally, we look at whether Magellan and Plymouth paid any
claims. No claims were filed under Magellan’s or Plymouth’s direct
written policies during the tax years at issue. As noted above, the
majority of Capstone claims were submitted after the IRS began
examining the Capstone captives. Magellan paid only $138,205 during
the same period for its share of claims from Capstone. During that same
period, Magellan collected millions in premiums.
Further, although we have received into evidence the Fourth
Stipulation and accompanying exhibits, we find that this evidence is
only marginally helpful in deciding the issues before the Court for the
tax years at issue. As noted by respondent, changes were made to the
Capstone pooling arrangement after the IRS began examining the
captives formed by Mr. Coomes. Thus, subsequent claims activity—
made after changes to Capstone—has little bearing on our analysis of
the outcome here.
51
[*51] In short, the relatively small payments made by Dr. Patel’s
captives might weigh slightly in favor of the Patels. But “we do not
regard this as overwhelming evidence that the arrangement constituted
insurance in the commonly accepted sense.” Syzygy Ins. Co., T.C. Memo.
2019-34, at *45; see also Swift, T.C. Memo. 2024-13, at *44.
6. Conclusion Regarding Insurance in the Commonly
Accepted Sense
Although the Patels’ captives displayed some attributes of
insurance companies, the Patels have not proven that the payments that
they seek to deduct as insurance expenses were for insurance in the
commonly accepted sense. See Keating, T.C. Memo. 2024-2, at *53. The
Patels have therefore failed to prove that the payments were for
insurance for federal income tax purposes. 21
C. Conclusion Regarding Magellan and Plymouth
Transactions
Because we find that Magellan and Plymouth failed to distribute
risk and were not selling insurance in the commonly accepted sense, we
need not decide whether their transactions involved insurance risk or
risk shifting. Caylor Land & Dev., T.C. Memo. 2021-30, at *48 (citing
Clougherty, 811 F.2d at 1300 n.5). The premiums paid to Magellan and
Plymouth and deducted by the Patels did not constitute “insurance” for
federal tax purposes. Id. at *48–49. Accordingly, we find that Magellan’s
and Plymouth’s purported captive transactions did not constitute
insurance because they failed to distribute risk and, in the alternative,
did not act as an insurer commonly would.
IV. Effect on Petitioners
Next, we examine the effect of these conclusions on the Patels.
After initial briefing, the Court ordered additional briefing on the tax
consequences if the transactions at issue are not insurance. See Docket
No. 24344-17, Order (Doc. 359). In response, the Patels assert that, if
21 In reaching our conclusions, we have considered that although states have
the power to regulate insurance companies, states do not have the authority to
determine whether payments made to purported insurance companies are for
“insurance” within the meaning of the Code and for federal income tax purposes. See,
e.g., AMERCO & Subs., 96 T.C. at 42. Accordingly, the Patels’ repeated argument that
the Court must defer to state agencies to determine whether the transactions are
“insurance” is without merit.
52
[*52] the transactions are not insurance, then they should be considered
indemnity contracts and analyzed as such. We have considered this
argument and find no evidence in the voluminous record to support the
Patels’ new argument.
As noted by respondent, Magellan and Plymouth are not parties
to this action, and therefore the tax consequences for those entities are
beyond the scope of this Memorandum Opinion. Accordingly, we need
not examine the consequences to Magellan and Plymouth.
But having determined that the Magellan and Plymouth
arrangements did not constitute insurance, we will now discuss the legal
effect of that conclusion on the Patels for the tax years at issue. Because
the payments at issue were not for insurance, “then they are not
ordinary and necessary business expenses” paid or incurred in
connection with a trade or business and may not be deducted under
section 162(a). See Swift, T.C. Memo. 2024-13, at *44–45 (quoting
Avrahami, 149 T.C. at 199). We therefore sustain the Commissioner’s
determination to adjust the Patels’ income by disallowing these
deductions.
V. Conclusion
Based on the foregoing, we sustain the Commissioner’s deficiency
determinations as set forth herein. In reaching our conclusions, we have
considered all arguments made by the parties, and to the extent not
mentioned or addressed, they are irrelevant or without merit.
To reflect the foregoing,
An appropriate order will be issued.