If a microcaptive arrangement lacks real economic substance and the taxpayer fails to disclose it clearly, a 40% penalty may apply.
Holding
The Tax Court upheld a 40% accuracy-related penalty under §6662(i) because the taxpayer’s microcaptive insurance arrangement did not have economic substance and was not properly disclosed.
Why It Matters
Not a new rule. Strong application. Courts have been rejecting microcaptives for years. This case reinforces that trend and extends it to the enhanced penalty.
Disclosure is doing real work now. Simply listing “insurance expense” is not disclosure. You need enough detail to flag the issue for the IRS.
Economic substance still dominates. §7701(o) remains the central filter. If the transaction fails, penalties follow automatically.
Penalty risk escalates quickly. Once a transaction is deemed to lack economic substance, the jump from 20% to 40% depends almost entirely on disclosure.
Key Facts
The taxpayers set up a microcaptive insurance arrangement that invo…
