IRS Revenue Ruling
2001-31

Code Secs. 162, 118, 165, 301, 801, 831

<<FULL TEXT>>

26 CFR 1.162-1: Business expenses.
(Also sections 118, 165, 301, 801, 831; 1.118-1, 1.165-1, 1.301-1,
1.801-3, 1.831-3.)

This ruling explains that the Service will no longer raise the
"economic family theory" set forth in Rev. Rul. 77-316 (1977-2 C.B. 53),
in addressing whether captive insurance transactions constitute valid
insurance. Rather, the Service will address captive insurance transactions
on a case-by-case basis.


REV. RUL. 2001-31

In Rev. Rul. 77-316 (1977-2 C.B. 53), three situations were presented
in which a taxpayer attempted to seek insurance coverage for itself and
its operating subsidiaries through the taxpayer's wholly-owned captive
insurance subsidiary. The ruling explained that the taxpayer, its
noninsurance subsidiaries, and its captive insurance subsidiary
represented one "economic family" for purposes of analyzing whether
transactions involved sufficient risk shifting and risk distribution to
constitute insurance for federal income tax purposes. See Helvering v. Le
Gierse, 312 U.S. 531 (1941). The ruling concluded that the transactions
were not insurance to the extent that risk was retained within that
economic family. Therefore, the premiums paid by the taxpayer and its
non-insurance subsidiaries to the captive insurer were not deductible.

No court, in addressing a captive insurance transaction, has fully
accepted the economic family theory set forth in Rev. Rul. 77-316. See,
e.g., Humana, Inc. v. Commissioner, 881 F.2d 247 (6th Cir. 1989);
Clougherty Packing Co. v. Commissioner, 811 F.2d 1297 (9th Cir. 1987)
(employing a balance sheet test, rather than the economic family theory,
to conclude that transaction between parent and subsidiary was not
insurance); Kidde Industries, Inc. v. United States, 40 Fed. Cl. 42
(1997). Accordingly, the Internal Revenue Service will no longer invoke
the economic family theory with respect to captive insurance transactions.

The Service may, however, continue to challenge certain captive
insurance transactions based on the facts and circumstances of each case.
See, e.g., Malone & Hyde v. Commissioner, 62 F.3d 835 (6th Cir. 1995)
(concluding that brother-sister transactions were not insurance because
the taxpayer guaranteed the captive's performance and the captive was
thinly capitalized and loosely regulated); Clougherty Packing Co. v.
Commissioner (concluding that a transaction between parent and subsidiary
was not insurance).


EFFECT ON OTHER DOCUMENTS

Rev. Rul. 77-316, 1977-2 C.B. 53; Rev. Rul. 78-277, 1978-2 C.B. 268;
Rev. Rul. 88-72, 1988-2 C.B. 31; and Rev. Rul. 89-61, 1989-1 C.B. 75, are
obsoleted.

Rev. Rul. 78-338, 1978-2 C.B. 107; Rev. Rul. 80-120, 1980-1 C.B. 41;
Rev. Rul. 92-93, 1992-2 C.B. 45; and Rev. Proc. 2000-3, 2000-1 I.R.B. 103,
are modified.


DRAFTING INFORMATION

The principal author of this revenue ruling is Robert A. Martin of the
Office of Associate Chief Counsel (Financial Institutions & Products). For
further information regarding this revenue ruling, contact Mr. Martin at
(202) 622-3970 (not a toll-free call).

<<END RULING>>
 

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