Drake Plastic Products Inc. is challenging new IRS regulations targeting “abusive” microcaptive insurance arrangements, claiming the rules unfairly ensnare legitimate business risk management strategies.
The lawsuit, filed with affiliate Drake Insurance Company and captive management firm Strategic Risk Alternatives LLC, seeks to block a rule finalized in January that labels certain microcaptives as transactions of interest requiring enhanced scrutiny.
The controversy centers on Section 831(b) of the tax code, which allows small captive insurers favorable tax treatment. Under the new rule, microcaptives face additional oversight if the insured company owns at least 20% of the captive and either maintains a loss ratio below 60% or hasn’t generated taxable income for fund recipients over five years.
Steven Quance, Drake Plastic’s president, established Drake Insurance in North Carolina to address coverage gaps his business faced. Despite nine IRS audits of Drake-related entities and Quance’s family – all concluding without finding irregularities – the agency disallowed the company’s 2020 captive insurance premium deduction, claiming the arrangement lacked “economic substance.”
“Drake Insurance is a cornerstone of our risk management strategy,” Quance said. “Despite extreme pressure and coercion by the IRS to close our captive, we saw no choice but to fight a tyrannical Goliath for justice.”
The case highlights growing tension between IRS efforts to combat tax avoidance and legitimate business risk management. Captive insurance companies – essentially in-house insurers covering parent company risks – have become popular among small businesses insuring hard-to-cover exposures.
The new regulations impose significant burdens, requiring detailed transaction reviews demanding substantial time and resources. Companies face potential fines, criminal liability for non-compliance, and increased state regulatory scrutiny.
The pressure forced Drake Plastic to revoke its captive’s Section 831(b) election in April, eliminating federal tax advantages. The company will only reinstate the election if courts block the new rule.
Quance frames the challenge as defending small business rights beyond his company’s situation, arguing the IRS approach threatens to undermine valuable risk management tools for businesses facing unique risks.
“This lawsuit is not just about correcting an unfair assessment against our company – it’s about defending the rights of honest businesses to use lawful risk management strategies without fear of arbitrary IRS action,” he said.
The outcome could significantly impact the captive insurance industry and set precedents for how the IRS regulates these arrangements.
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