The Internal Revenue Service last week announced it had withdrawn a proposed regulation that, if enacted, could have driven captive insurance formations offshore, self-insurance experts had warned.

The action followed intense lobbying of Treasury Department officials and members of Congress, as well as an onslaught of taxpayer comments sought by the IRS by Dec. 27, 2007.

The regulation--1.1502-13(e), proposed on Sept. 28, 2007--would have eliminated the tax deduction for reserves established by captive insurers for insurance sold to affiliates, if the insureds and insurer file in the same consolidated return.

However, while acknowledging the influence of comments received from interested parties in deciding to withdraw the proposed change, the agency did not close the door permanently on the debate.

"The IRS and the Treasury Department continue to study whether revisions to the rules for intercompany transactions are necessary to clearly reflect the taxable income of consolidated groups," the agency said in its notice.

For the moment, however, a potential crisis for the domestic captive industry has been averted, officials said.

"This is great news for the industry and it's the right answer," said Charles J. "Chaz" Lavelle, an attorney with Greenebaum Doll & McDonald PLLC, in Louisville, Ky., and a member of the Tax Advisory Committee for the Captive Insurance Companies Association and the Vermont Captive Insurance Association.

"It's the right answer because the income of the consolidated group is best reflected by allowing the insurance company to be treated in the same manner as any other insurance company," he said.

Mr. Lavelle added that another positive aspect is that "it also does not have the collateral effect of pushing people offshore and overruling 20 years of captive litigation."

The Coalition for Fairness to Captive Insurers, CICA and VCIA issued a statement to express their satisfaction with the decision.

"We are thrilled that the IRS and Treasury Department have chosen to withdraw the portion of the proposed regulation involving captive insurance companies," said Dennis Harwick, co-chair of the Coalition and president of CICA.

Molly Lambert, co-chair of the Coalition and VCIA president, said the decision "removes the uncertainty that has hung over the captive industry since the IRS regulation was proposed last fall."

Tomas M. Jones, a partner with McDermott Will & Emery in Chicago, a law firm that represented the Coalition, told National Underwriter that the news is "gratifying--a once-in-a-career event, maybe." He added that "apparently, they took the [industry's] comments seriously."

Mr. Jones said the "combination of the technical arguments, policy arguments and political efforts that were made resulted in success."

Regarding the potential loss of captive business to offshore domiciles had the proposal been enacted, he said, "Let's say that the playing field should stay level now."

Dick Goff, president of the Self-Insurance Institute of America Inc., called the IRS decision "a big win for SIIA and the industry." SIIA officials and professional lobbyists presented the industry's case to members of Congress, congressional staff and high-level officials from the Treasury Department and IRS.

The industry's response included comments based on arcane tax principles applicable to consolidations, underlying tax policy, the impact on offshore incentives, economics and insurance regulation.

Responses came from trade associations, service providers, state captive regulators and even the National Governors Association.

The IRS also issued a notice that it had cancelled a public hearing on the proposal, scheduled for Feb. 29 in Washington, D.C.

Special Reports /

IRS Drops Proposed Change In Captive Tax

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