Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board

(1979).
The Service’s position is that a taxpayer has not bought insurance when it pays premiums to an
entity it owns either directly or indirectly (or with whom it shares a parent) and is, therefore, not
entitled to a deduction under IRC section 162. This position is set forth in Rev. Rul. 77-316,
1977-2 C.B. 53, amplified and clarified, Rev. Rul. 88-72, 1988-2 C.B. 31, clarified, Rev. Rul.
89-61, 1989-1 C.B. 75, Rev. Rul. 78-338, 1978-2 C.B. 107, Rev. Rul. 88-72, 1988-2 C.B. 31 and
Rev. Rul. 89-61, 1989-1 C.B. 75.
In Rev. Rul. 77-316 the Service determined that there is no shifting of the risk from the parent
and its subsidiaries to the captive to the extent of the risk retained by the captive because the
premiums paid remain within the same"economic family," under the practical control of the parent
and its affiliates. In addition, they are not expenses "paid or incurred" within the meaning of IRC
section 162. Therefore, the amounts paid to and retained by the captive in the factual scenarios
set forth in the revenue ruling are not deductible.
Until recently the Service had been successful in denying taxpayers a deduction for premiums paid
to their wholly-owned subsidiaries on the theory that the parent has not truly shifted the risk of
loss. See Gulf Oil Corporation v. Commissioner, 914 F.2d 396 (3d Cir. 1990), aff’g 89 T.C.
1010 (1987); Clougherty Packing Co. v. Commissioner, 811 F.2d 1297 (9th Cir. 1987), aff’g 84
T.C. 948 (1985); Beech Aircraft Corp. v. United States, 797 F.2d 920 (10th Cir. 1986), aff’g
1984-2 U.S.T.C. Para. 9803 (Kan. 1984); Stearns-Roger Corporation v. United States, 774 F.2d
414 (10th Cir. 1985), aff’g 577 F.Supp. 833; Mobil Oil Corporation v. United States, 8 Cl. Ct.
555 (1985). In each of these cases the courts concluded that a premium payment to a subsidiary
is the functional equivalent of setting up a reserve for losses, and therefore not deductible. The
one exception is Crawford Fitting Company v. United States, 606 F.Supp. 136 (N.D.OH.1985),
in which the district court held that insurance premiums paid to a captive insurance company were
deductible as ordinary and necessary business expenses because the taxpayer and the other
shareholders of the captive were not so economically related that their separate financial
transactions had to be aggregated and treated as the transactions of a single taxpayer. The
Crawford Companies were not a parent-subsidiary group but were a group of separate
corporations that were owned and controlled by a group of related individuals.
Although the Government has been mostly successful in arguing for disallowance, not all of the
theories advanced by the Government have been embraced by the courts. In particular, the Tax
Court has rejected the "economic family" theory though the economic family theory had been
accepted by certain appellate courts. See Stearns-Roger Corporation, above, Beech Aircraft,
above, Carnation v. Commissioner, 640 F.2d 1010 (9th Cir. 1981), aff’g 71 T.C. 400 (1978),
cert. denied, 454 U.S. 965 (1981); and Clougherty Packing Company. In Carnation, the Ninth
Circuit agreed with the conclusion set forth in Rev. Rul. 77-316 that there could be no shifting or
distribution of risk where a parent enters what purports to be an insurance arrangement with a
wholly-owned subsidiary. Similarly, in Clougherty Packing, the Ninth Circuit stated that Rev.
Rul. 77-316 does not conflict with the recognition of the separate entity status of corporations
doctrine set forth in Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943).
Although the Tax Court has not embraced the economic family theory, the court has established a
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