For years, the IRS has attacked the tax treatment of insurance of captive insurance and their affiliates to preclude captive insurance companies from deducting payments to captive insurance companies as premiums and instead treat them as capital contributions.  From 1977 through 2001, the IRS argued that a parent corporation and its captive insurance company did not shift loss or distribute risk because the same economic family bore the loss.  Since there was no shift or distribution of risk, the transfer did not involve insurance and the payments to the captive companies did not qualify as premiums.  No court accepted this approach.

From 2002 through the present, captive insurance companies and their affiliates have relied on a trio of revenue rulings that set forth when payments to a captive insurance are premiums that are deferred and earned as income over the course of the policy and when they are capital contributions.  These bright line revenue rulings have reduced the business risk in determining when a captive insurance can deduct premiums.

Not content to leave well enough alone, however, on September 27, the IRS proposed new regulations for public comment that modify the intercompany obligation regulations; if a captive insurer receives just 5% of its total premiums from affiliates on the same consolidated tax return, the transaction must recognize the premium income up front but will not be able to take a deduction until the loss is paid, not when it is accrued.

The public comment period for these proposed regulations ends on December 27, 2007.  If the IRS moves forward, the proposed regulations could take effect in 2008.