Terence and Janet Keating v. Comm., TCM 2024-2

Terence and Janet Keating were shareholders of Risk Management Strategies, Inc. (RMS), an S corporation whose business was being an employer for its clients, which were primarily banks administering special needs trusts. RMS assumed the employer liability resulting from the employment of caregivers who worked for special needs trusts, handled payroll, and generally carried out the responsibilities of being an employer to caregivers and other employees that would have otherwise fallen on its clients. For each year at issue, RMS reported incurring approximately $1.2 million of expenses for purported insurance coverage provided through an arrangement among its affiliated captive insurance company, Risk Retention, Ltd., an Anguillan corporation. Terence Keating and another RMS shareholder owned Risk Retention. Risk Retention paid dividends of $1 million in 2012 and again in 2014, consistently reporting those payments on Form 1099-DIV as qualified dividends.

Risk Retention made two elections: (1) a controlled foreign corporation that is an insurance company to be treated as a domestic corporation, and (2) to pay tax only on investment income under §831(b). Through complex reinsurance programs, Risk Retention was able to receive substantial portions of its reinsurance premiums back from companies that ostensibly assumed risks under policies written for RMS. Examination of the policies, practices, underwriting process, premium determination and payments, claims payments, and reasonableness of the premiums, lead the court to conclude that payments to Risk Retention were not for insurance.

Because the payments from RMS to Risk Retention were not for insurance, they were not allowed as deductions. With the determination that Risk Retention was not selling insurance, it no longer qualified as an insurance company and was not eligible to make an election to be treated as a domestic corporation. Without treatment as a domestic corporation, the issue of whether the dividends were qualified dividends or not had to be reviewed.

Qualified dividend income is defined as dividends received from either domestic corporations or qualified foreign corporations. Qualified foreign corporations, generally, are those that are incorporated in a possession of the United States  or are incorporated in a country with a comprehensive income tax treaty with the United States. Anguilla does not have a comprehensive income tax treaty with the United States. The Tax Court ruled that the dividends paid by Risk Retention were ordinary income.