United States Tax Court

Agency decision

Ask Donna

What actually matters in this document.

Text

T.C. Memo. 2024-34

SUNIL S. PATEL AND LAURIE MCANALLY PATEL, ET AL., 1

Petitioners

COMMISSIONER OF INTERNAL REVENUE,

Respondent

—————

Docket Nos. 24344-17, 11352-18,

25268-18.

Filed March 26, 2024.

—————

Ps claimed deductions under I.R.C. § 162 on their

2013, 2014, 2015, and 2016 tax returns for amounts paid to

purported captive insurance companies A and B and to

entity C, which purported to reinsure a portion of its risk

with A and B. R denied the deductions and determined that

A’s and B’s elections under I.R.C. § 831(b) were invalid,

because the amounts paid did not qualify as insurance

premiums for federal income tax purposes.

Held: Amounts paid to A and B are not insurance

premiums for federal income tax purposes and are not

deductible under I.R.C. § 162.

—————

David D. Aughtry and Patrick J. McCann, Jr., for petitioners.

Sebastian Voth and Emerald G. Smith, for respondent.

1 Cases of the following petitioners have been consolidated herewith for

purposes of trial, briefing, and disposition: Sunil S. Patel and Laurie M. McAnallyPatel, Docket Nos. 11352-18 and 25268-18.

Served 03/26/24

[*2]

MEMORANDUM FINDINGS OF FACT AND OPINION

JONES, Judge: Sunil S. Patel, M.D. (Dr. Patel) and Laurie M.

McAnally-Patel, M.D. (Dr. McAnally-Patel) 2 seek redetermination of

deficiencies in federal income tax determined by the Internal Revenue

Service (IRS) for taxable years 2013, 2014, 2015, and 2016 (tax years at

issue).

Dr. Patel is the co-founder of an eye surgery center and the

founder of two research centers in the West Texas area. Beginning in

2011, Dr. Patel’s businesses supplemented their commercial insurance

coverage by purchasing assorted policies from purported microcaptive3

insurance companies—Magellan Insurance Company (Magellan) and

Plymouth Insurance Company (Plymouth)—that Dr. Patel also

controlled. The premiums paid to the microcaptives were substantially

more than the premiums paid to Dr. Patel’s commercial insurers,

creating substantial tax benefits for the Patels.

The IRS examined the purported insurance arrangements for

each of the tax years at issue and concluded that the purported

insurance premiums paid to Magellan and Plymouth could not be

treated or taxed under section 831(b). 4 Thus, it issued notices of

2 We sometimes refer to Dr. Patel and Dr. McAnally-Patel as the Patels.

3 “A ‘captive insurance company’ is a corporation whose stock is owned by one

or a small number of companies and which handles all or a part of the insurance needs

of its shareholders or their affiliates.” Caylor Land & Dev., Inc. v. Commissioner, T.C.

Memo. 2021-30, at *8 n.4; see also Harper Grp. v. Commissioner, 96 T.C. 45, 46 n.3

(1991), aff’d, 979 F.2d 1341 (9th Cir. 1992). In our prior cases, we have adopted the

term “microcaptive” to refer to “a small captive insurance company,” i.e., one that takes

in less than $1.2 or $2.2 million (adjusted for inflation) in premiums depending on the

tax year at issue. See Caylor Land & Dev., T.C. Memo. 2021-30, at *8 n.4; see also

Avrahami v. Commissioner, 149 T.C. 144, 179 (2017); Swift v. Commissioner, T.C.

Memo. 2024-13, at *2 n.1; Keating v. Commissioner, T.C. Memo. 2024-2, at *50 n.52

(explaining that amendments to section 831(b) increased the premium ceiling). The

Patels take issue with the term “microcaptive,” apparently viewing the word as

“diminutive” and asserting that “some [Court] opinions reflect that subtle, insidious,

inaccurate prejudice.” See Docket No. 24344-17, Pet’rs’ Reply Br. at 52 (Doc. 354). We

disagree. We do not view the word “microcaptive” as pejorative and will continue to

use the term consistent with our prior cases.

4 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C. (Code), in effect at all relevant times, regulatory references are

to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times,

and Rule references are to the Tax Court Rules of Practice and Procedure. All monetary

amounts are rounded to the nearest dollar.

[*3] deficiency that disallowed the claimed deductions and determined

accuracy-related penalties. 5

The issue for decision is whether the transactions involving

Magellan and Plymouth constituted insurance for federal income tax

purposes pursuant to section 831(b).

For the reasons set forth herein, we will sustain the

Commissioner’s determinations that the transactions at issue did not

constitute insurance for federal income tax purposes.

FINDINGS OF FACT

This case was tried during a special trial session in Washington,

D.C. The parties filed three stipulations of fact with accompanying

exhibits. We incorporate by this reference the stipulations of settled

issues and facts, the stipulated exhibits, and any exhibits admitted at

trial, except to the extent set forth herein.

The parties also filed a Fourth Stipulation of Facts (Fourth

Stipulation) and accompanying exhibits, subject to respondent’s

objections. After receiving the parties’ arguments at trial, the Court took

the Fourth Stipulation under advisement and allowed the parties to

make additional arguments in posttrial briefing. Having now considered

the parties’ arguments, the Court overrules respondent’s objections and

receives the Fourth Stipulation and accompanying exhibits into

evidence.

In our Findings of Fact, we use the terms “insurance,”

“reinsurance,” “risk,” “pooling,” “coverage,” “policy,” and similar terms

to describe the forms of the transactions at issue in these cases. But our

use of those terms does not reflect any ruling as a matter of fact or law

with respect to insurance or insurance companies within the meaning of

the Code. See Rsrv. Mech. Corp. v. Commissioner, T.C. Memo. 2018-86,

at *3, aff’d, 34 F.4th 881 (10th Cir. 2022).

Court.

The Patels resided in Texas when they timely petitioned this

5 We will address the IRS’s penalty determinations in a separate opinion.

[*4] I.

The Patels and Their Businesses

Dr. Patel’s Early Life and Education

Dr. Patel was born in India and immigrated to the United States

as a child. Although he did not speak English when he started school at

the age of nine, he ultimately graduated from high school in the top five

percent of his class. He earned a bachelor of science degree in physics

from the University of California, Los Angeles in 1983. In 1989, he

earned a doctor of philosophy degree in immunology, and in 1991 he

earned a doctor of medicine degree, both from the University of Texas

Southwest. After completing a residency and fellowships in California,

Dr. Patel returned to Texas in 1997 to practice medicine.

Dr. McAnally-Patel’s Education and Career

During his quest for higher education, Dr. Patel met Dr.

McAnally-Patel; 6 they married in 1989. Dr. McAnally-Patel also

completed medical school and was licensed to practice medicine in Texas

from November 22, 1997, until May 5, 2015. However, she no longer

maintains an active medical license.

In 2009, Dr. McAnally-Patel obtained a certificate to teach high

school science. She now teaches physics at a high school in Abilene,

Texas.

Ophthalmology Specialists of Texas, Integrated Clinical

Research, and Strategic Clinical Research Group

In August 2000, Dr. Patel formed his own eye surgery practice,

Ophthalmology Specialists of Texas 7 (OST) doing business as West

Texas Retina Consultants. OST specializes in the evaluation and

management of eye-related medical conditions involving the retina,

vitreous, and macula. Providers at OST operate on eyeballs, including

conducting pneumatic retinopexy, retina laser surgery, biopsies of

ocular infections, and intraocular injections.

6 The record does not reflect that Dr. McAnally-Patel had any involvement in

the purported microcaptive transactions. Nonetheless, our decisions today will affect

her joint federal income tax returns. See infra Opinion Part IV.

7 OST was initially formed as a Texas professional association in August 2000,

but it was converted to a Texas professional limited liability company in November

2011.

[*5] In addition to his work with OST, Dr. Patel conducts clinical

research trials on experimental drugs for retina diseases through two

companies he established: Integrated Clinical Research, LLC (ICR) and

Strategic Clinical Research Group, LLC (SCR). OST refers 98 percent of

the ICR and SCR patients.

The same type of work is performed at ICR and SCR, but at

different locations. That is, they enter into contracts and clinical trial

protocols with pharmaceutical companies to test experimental drugs.

Human volunteers are tested to determine whether the drugs are safe.

The two companies also enter into agreements with the U.S. Food and

Drug Administration (FDA). The pharmaceutical companies may use

the data to obtain FDA approval of the drugs.

During the tax years at issue, the balance of OST, ICR, and SCR

procedures consisted of conducting surgeries and laser procedures as

well as inserting injections into eyeballs. Procedures involve a range of

potential patient risks, including pain, infection, inflammation,

bleeding, loss of vision, loss of an eyeball, and death.

All three entities face regulatory oversight from federal and state

authorities. Dr. Patel views this regulatory oversight as a “massive

burden.” He also believes that, as a retina specialist, he has a target

placed on his back by the government. During the tax years at issue, the

three entities had between seven and eight offices, five doctors, and

fewer than 100 employees. Several of the employees and physicians

overlap among the three entities. Further, the ICR and OST offices are

located at the same address.

II.

The Patels’ Lawsuits and Introduction to Captive Insurance

In 2002, Dr. McAnally-Patel was sued by a patient for care she

provided at a regional hospital’s clinic for indigent patients. As a result,

in approximately 2003, the Patels consulted with an attorney to discuss

asset protection, including captive insurance. They ultimately opted not

to form a captive insurance company after the meeting. Instead, they

opted to form two separate family partnerships for asset protection.

In 2003, Dr. Patel and other physicians decided to form a hospital,

in part so that Dr. Patel would not have to wait for operating rooms for

his patients. Dr. Patel’s family, friends, and fellow physicians invested

with him to form the new hospital. In connection with this endeavor, Dr.

[*6] Patel formed two separate entities: (1) West Texas Hospital, Ltd. 8

(West Texas Hospital), to operate the new hospital; and (2) Hospital

Properties Management, LLP (Hospital Properties), to build and own

the hospital. In February 2004, Hospital Properties purchased land

across the street from OST and then built a hospital.

In 2005, West Texas Hospital opened as a 14-bed surgical hospital

in Abilene, Texas. Less than two years later, in January 2007, a patient

at West Texas Hospital suffered complications following spinal surgery

performed by a different doctor. The patient was transferred to another

hospital and ultimately died.

After the death, West Texas Hospital received negative publicity.

As a result, politicians and regulatory agencies began investigating

West Texas Hospital. Ultimately, just over two months after the

patient’s death, West Texas Hospital lost its Medicare provider contract,

thus losing 60 to 70 percent of its total revenue.

West Texas Hospital ceased operations after its Medicare

contract was officially terminated. Drs. Patel and McAnally-Patel, along

with West Texas Hospital and others affiliated with West Texas

Hospital, were sued by the estate of the deceased patient. That case

continued through September 28, 2015.

West Texas Hospital was not profitable during the time it

operated. Between personal money and personally guaranteed debt, Dr.

Patel and his family invested $3.1 million to open and fund West Texas

Hospital. Approximately two-thirds of the Patels’ total loss was related

to the commercial real estate purchased by Hospital Properties,

and one-third was related to West Texas Hospital. The commercial real

estate owned by Hospital Properties faced foreclosure in February 2008.

III.

Formation of the Captives

Introduction to Christopher Fay and CIC Services

In May 2007, just a few months after the death of the West Texas

Hospital patient, Dr. Patel purchased a book about asset protection,

which included a chapter on captive insurance. At that time, Dr. Patel

considered forming a captive, but he ultimately did not do so. Four years

later, in May 2011, Dr. Patel purchased another copy of the same asset

8 Initially, Dr. Patel formed West Texas Specialty Hospital, Ltd., on March 26,

2003, but he changed the name to West Texas Hospital, Ltd., on July 18, 2003.

[*7] protection book he had purchased in 2007. In addition, he

purchased two books on captive insurance. 9

Around that same time, in approximately May 2011, Dr. Patel’s

business partner, Dr. Young Lee, introduced Dr. Patel to a financial

planner, Christopher Fay, to discuss financial and insurance products.

During Dr. Patel’s introductory call with Mr. Fay, Dr. Patel expressed

his interest in forming a captive insurance company. Dr. Patel already

knew he wanted to form a captive when he called Mr. Fay. The purpose

of his call with Mr. Fay was to identify someone to help him form a

captive, not to advise him about whether a captive was the right

decision.

Mr. Fay did not know much about captive insurance, so he

recommended that Dr. Patel meet with Sean King 10 of CIC Services,

LLC (CIC Services) to discuss forming a captive. In an email sent to

facilitate a meeting between Dr. Patel and Mr. Sean King, Mr. Fay

stated that Dr. Patel was the “MD paying almost 2.5M in income taxes

and did his own research on [captive insurance companies]. He wants to

talk with Sean about doing potentially 2 CIC[s].”

In addition to introducing Dr. Patel to Mr. Sean King, Mr. Fay

asked Dr. Patel to complete a feasibility study. According to Dr. Patel,

Mr. Fay emailed the feasibility study several times. At trial, Dr. Patel

disclaimed any interest in financial products offered by Mr. Fay.

According to Dr. Patel, he is a “savvy financial person” and he did not

want any advice. Rather, he knew that he wanted to form a captive

insurance company.

Eventually, Dr. Patel completed the feasibility study, although

the exact timing of when he completed it is a matter of dispute and not

entirely clear. At trial, Dr. Patel stated that he completed the study in

9 The names of the books are (1) Asset Protection: Concepts and Strategies for

Protecting Your Wealth by Jay Adkisson and Chris Riser; (2) Taken Captive: The Secret

to Capturing Your Piece of America’s Multi-Billion Dollar Insurance Industry by R.

Wesley Sierk, III; and (3) Adkisson’s Captive Insurance Companies: An Introduction to

Captives, Closely-Held Insurance Companies, and Risk Retention Groups by Jay

Adkisson.

10 Thomas King of CIC Services is Sean King’s father. Because both individuals

are discussed throughout this Opinion, we refer to them as Mr. Sean King and Mr.

Thomas King for clarity.

[*8] 2012 out of an apparent sense of obligation and “politeness” because

he would be working with Mr. Fay on and off.

However, at his deposition, Dr. Patel gave conflicting answers,

stating that he completed the feasibility study in 2011 because “we were

looking at possibly starting a captive insurance company” and later,

after several breaks and through questions posed by his own attorney,

changing his answer and stating that the feasibility study related to

financial services and not forming a captive. In any event, the feasibility

study he completed focused exclusively on wealth and estate planning.

It did not mention or discuss captive insurance. On the form, Dr. Patel

stated that his goals were aggressive growth and wealth accumulation.

In June 2011, Dr. Patel met with Mr. Sean King and Mr. Fay to

discuss forming a captive insurance company. At this juncture, Dr. Patel

had already determined that he wanted to form one. He was not seeking

advice about whether to form a captive. Rather, he was seeking advice

about structuring the captive and how to move forward.

Mr. Sean King advised that CIC Services could handle

management responsibilities for a captive insurance company. However,

he recommended attorneys Dr. Patel could contact to form a captive.

Although Mr. Sean King recommended several attorneys, he “really

liked” James Coomes.

In July 2011, without conducting any studies related to the need

to form a captive, Dr. Patel emailed Mr. Fay and stated that he wanted

to move forward with forming two captive insurance companies. In

response, Mr. Sean King suggested that they schedule a phone call that

included Mr. Coomes.

James Coomes and Capstone Reinsurance Co.

Background

Mr. Coomes has been an attorney since 1999. After obtaining a

master of laws degree in taxation at New York University, Mr. Coomes

joined a law firm where he spent roughly half of his practice focusing on

estate planning. Mr. Coomes also taught estate planning at the

University of Alabama Law School from approximately 2005 through

2011.

In 2011, Mr. Coomes formed his own practice, specializing in

captive insurance companies, business corporate work, and estate

[*9] planning. In connection with his work representing captive

insurance companies, Mr. Coomes drafted insurance policies. Mr.

Coomes does not have formal training in captive insurance or writing

insurance policies. Rather, he learned to write insurance policies by

reviewing commercial insurance policies, reading articles, and studying

books.

Formation of Capstone Reinsurance Company, Ltd.

In November 2012, Mr. Coomes formed Capstone Reinsurance

Company, Ltd. (Capstone), in the Turks and Caicos Islands. Capstone

operates as a reinsurance company, purportedly providing risk sharing

among captive insurance companies. Mr. Coomes and his wife served as

the officers and directors of Capstone during the tax years at issue. Mr.

Coomes served as the president, and Capstone had no other employees.

The details of the Capstone reinsurance program are discussed more

fully infra Findings of Fact Part III.F.

Beginning in 2014, Jennifer Stalvey of the Tennessee Department

of Commerce & Insurance (TDCI) examined Capstone as a reinsurance

pool. Based on its examination, TDCI approved Capstone Reinsurance

as a risk-distribution reinsurance pool for Tennessee captive insurance

companies. Similarly, TDCI approved CIC Services as a Tennessee

Captive Manager.

Magellan Insurance Co.

Formation of Magellan

In August 2011, Mr. Sean King and Mr. Coomes held a telephone

conference with Dr. Patel to discuss forming a captive. Ultimately, Dr.

Patel retained Mr. Coomes to handle the formation and operation of a

captive insurance program.

After engaging Mr. Coomes, Dr. Patel and his assistant, Lindsay

Guerrero, completed applications for captive insurance for OST and ICR

in November 2011. The applications included requests for information

regarding the size and nature of the business operations, the number of

business locations, the number of employees, their key customers and

suppliers, the coverages provided by their commercial carriers, and their

commercial loss history.

After receiving the applications, Mr. Coomes forwarded them to

an actuary, Allen Rosenbach of ACR Solutions Group, to price the

[*10] premiums for the policies. On one occasion, Mr. Coomes and Mr.

Rosenbach interviewed Dr. Patel about the applications. Mr. Coomes

and Mr. Rosenbach identified coverages for the insureds, including OST

and ICR.

Further, Mr. Coomes created a Business Plan for the proposed

insurance company, Magellan, outlining proposed insurance coverages

through the captive. The Business Plan set forth the business rationale

for forming the captive:

(i) obtaining the ability to insure risks which are otherwise

unavailable in the traditional commercial marketplace and

to design custom insurance policies, (ii) retaining profits

that would otherwise have to be paid to commercial

insurers in the form of premiums in excess of the amounts

repaid to cover losses, (iii) achieving flexibility in choosing

investments into which the premiums of [Magellan] may

be made, and (iv) obtaining access to the re-insurance

market if desired.

Pursuant to the Business Plan, Magellan intended to participate

in a risk pool “with other captive insurance companies” that “cover[s]

business risks relating to terrorist attacks.” In the first year, premiums

charged were expected to be in the range of $1,145,000. Further, the

Business Plan called for Magellan to file an election under section 953(d)

to enable it to be taxed as an insurance company in the United States.

The Business Plan also noted that “[i]t is also intended that [Magellan]

will limit its insurance activity to levels where its premiums are not in

excess of US $1,200,000 per annum.”

Through Mr. Coomes, and consistent with the Business Plan, Dr.

Patel submitted an application for Magellan to carry on as an insurance

business with the Federation of St. Christopher and Nevis (St. Kitts)

Financial Services Regulatory Commission (FSRC) on November 22,

2011. Magellan was incorporated in St. Kitts on December 8, 2011.

Additionally, that same day, Magellan filed its Memorandum and

Articles of Association with the FSRC, indicating that Magellan would

be engaged in “Group Captive Insurance, primarily, property and

casualty insurance.” Further, the Statutory Statement identified

Corporate Solutions, Ltd. and Heritor Management, Ltd. as Directors of

Magellan. Magellan’s application to carry on an insurance business was

approved, and on December 22, 2011, Magellan received its insurance

license from St. Kitts FSRC.

[*11] Although Mr. Coomes completed the Business Plan, neither he

nor anyone associated with Magellan completed a feasibility study to

determine the costs and merits of a captive arrangement for Dr. Patel’s

businesses. Respondent’s expert, Roberta Garland, explained that a

feasibility study “is an important aspect of setting up a captive” and a

proper feasibility study would explore the various alternatives and

perform a cost-benefit analysis of a captive before moving forward.

Moreover, neither Dr. Patel nor his advisers explored the cost and

availability of the same policies on the commercial market. The

feasibility study completed by Dr. Patel, at the request of Mr. Fay, did

not discuss captive insurance.

Ownership of Magellan and Investment of Assets

Magellan is owned by Odyssey Properties, LLC (Odyssey), a

limited liability company formed under the laws of Wyoming on

November 9, 2011. Initially, Odyssey was owned by Dr. Patel

(35 percent), Dr. McAnally-Patel (35 percent), and the Patel Business

Trust (30 percent).

Magellan’s substantial premiums, coupled with modest expenses

and claims history, meant that it had significant resources on hand. In

January 2012, Dr. Patel met with Mr. Sean King and Mr. Fay to discuss

investment of Magellan’s assets. On January 16, 2012, Dr. Patel signed

an application for a separate legal entity that had yet to be created,

Magellan Investments, LLC (Magellan Investments), to acquire an

“Eclipse Indexed Life” insurance plan. Ten days later, on January 26,

2012, Mr. Coomes filed articles of organization for Magellan

Investments, as a single-member limited liability company under the

laws of Wyoming. Magellan Investments is wholly owned by Magellan.

In April 2012, Magellan Investments completed the purchase of a

life insurance policy from Minnesota Life Insurance Company

(Minnesota Life), insuring the life of Dr. Patel, with planned annual

premiums of $1,150,000 and a death benefit of $43,348,241. The

Minnesota Life policy is Magellan Investments’ primary asset.

In 2016, the Patels transferred another thirty percent interest to

the Patel Business Trust. Thus, the Patels now each have a 20 percent

interest in Magellan through Odyssey. The Patel Business Trust now

owns 60 percent of Magellan through Odyssey. The Patel Business Trust

names the Patels’ three children as beneficiaries, meaning the Patels’

children own 60 percent of Magellan. The Patels decided to make this

[*12] change, in part, because of the increasing value of their

businesses. In August 2016, Mr. Fay sent an email to Mr. Coomes,

inquiring whether, now that Magellan was owned by a 60 percent trust

for the Patels’ children, “we assume that 60% of death proceeds are out

of Patel’s estate and not subject to taxes?” Mr. Coomes responded: “That

is a reasonable assumption.”

Plymouth Insurance Co.

In February 2016, Dr. Patel informed Mr. Fay that he wanted to

form a new captive. Dr. Patel claims that he decided to form the second

captive because of statutory changes enacted in 2015 that changed

ownership requirements for small captive insurance companies.

Contemporaneous records reveal a more complicated picture. It is true

that Dr. Patel and his advisers sought ways to comply with new

ownership requirements for small captives. However, as discussed in

more detail below, correspondence with Dr. Patel’s advisers reveals that

they were concerned about Dr. Patel’s ability to meet ownership

guidelines to retain favorable tax treatment (including increased limits

on deductibility) and reduce his potential estate tax exposure.

Decision to Form Plymouth

In February 2016, Mr. Fay emailed Mr. Sean King, informing him

that Dr. Patel “wants to get his estate planning in order and then move

forward with his new captive this year.” In that same email, Mr. Fay

stated that Dr. Patel’s accountant had been contacted by the IRS about

Dr. Patel’s captive. According to the email, several captives formed by

Mr. Coomes were being examined by the IRS.

The next day, Mr. Thomas King of CIC Services emailed Mr. Fay

to make sure he was aware of “the process of a captive of ours being

audited.” Mr. Thomas King advised that once a client receives notice of

their captive being audited, they should contact him by telephone and

then Mr. Coomes, who would take over and respond to any IRS requests.

Two days later, Mr. Thomas King emailed Mr. Fay and Mr. Sean

King, copying Bryan Ridgway of CIC Services and Mr. Coomes. He

stated that he informed Dr. Patel of the “audit situation” and that Dr.

Patel was “fine” with it and “really wants to start another captive.” Mr.

Thomas King also asked Mr. Fay whether he could “do the captive first

and then build the estate planning around it.”

[*13] In response, Mr. Sean King stated that “[t]he only estate planning

question with regard to the captive would be who should own it. If we

can firm that up, then proceeding with it shouldn’t impact the estate

planning too much.” Subsequent emails over the next several months

also discussed the ownership structure of Magellan and Dr. Patel’s

anticipated second captive, all for the purpose of determining the new

captive’s impact on Dr. Patel’s estate planning and income tax benefits.

In October 2016—after months of discussing the structure of a

new captive—Dr. Patel entered into a formal agreement with Mr.

Coomes and CIC Services to handle the formation and management of

a new captive. Dr. Patel decided to move forward despite being on notice

that the IRS was examining the captives formed by Mr. Coomes.

And this was not the first time Dr. Patel was made aware of

concerns regarding certain captives. In February 2015, Dr. Patel’s

nephew—a tax attorney—emailed him an article about captive

insurance companies being a “topic of conversation” for Congress and

the IRS, and the nephew noted that they will “likely be coming under

heightened review/scrutiny.”

On November 15, 2016, Mr. Fay sent an email to schedule a

conference call with Mr. Sean King, Mr. Coomes, and Norm Lofgren

(referred to by Mr. Fay as “Sunil’s tax attorney”) to discuss “ownership

of the new captive,” and he noted that Mr. Lofgren was included to

“explore all potential options to minimize future estate taxes.” Two days

later, on November 17, 2016, Mr. Fay sent an email to Ms. Guerrero and

asked her to inform Dr. Patel that he would be having a conference call

the following week with Mr. Coomes, Mr. Sean King, and Mr. Lofgren to

discuss “ownership for the captive and options to reduce future estate

taxes.”

Formation and Ownership of Plymouth

On November 27, 2016, Mr. Ridgway submitted a proposed

charter and bylaws for Plymouth to the TDCI. That charter was

approved on December 5, 2016, and on December 8, 2016, Dr. Patel

officially formed Plymouth as a licensed captive insurance company in

Tennessee.

Dr. Patel placed 100 percent ownership of Plymouth in Linus

Capital, LLC (Linus Capital), a Texas limited liability company. In turn,

Linus Capital is owned by the Sunil Patel 2016 Irrevocable Trust,

created on December 19, 2016.

[*14] In 2016, Plymouth was capitalized with $25,000 in cash and a

$225,000 Irrevocable Letter of Credit from Dr. Patel. On December 15,

2016, Mr. Fay inquired in an email whether the $25,000 was a loan or

capital. He noted that Dr. Patel would likely increase his contribution to

Plymouth “to approx[imately] $1 million while adding $1.1 million to

[the] other captive to meet the 2017 2.1-2.2 million increase” in tax

benefits for microcaptives. In response, Mr. Lofgren stated that Dr.

Patel’s “funds to the LLC will be in the form of a loan since we do not

want him to own any part of the underlying captive for federal estate

tax purposes.”

In 2017—after the tax years at issue—Plymouth purchased a

Flexible Premium Adjustable and Index-Linked Universal Life

Insurance policy with planned premiums of $348,179 and a death

benefit of $10 million. Mr. Thomas King believed the entire death

benefit of the life insurance policy would pass through Plymouth to Dr.

Patel’s family.

Policies Issued by Magellan and Plymouth

During the tax years at issue, Magellan—and Plymouth in 2016—

issued direct written policies to OST and ICR, and SCR. 11 Each year,

Mr. Coomes sent a Master Application and Supplemental Applications

to Dr. Patel and Ms. Guerrero. Mr. Coomes transmitted those

applications to Mr. Rosenbach, who then purportedly priced the

insurance premiums as discussed more fully infra Findings of Fact

Part III.H. Mr. Coomes drafted the policies that Magellan and Plymouth

issued to OST, ICR, and SCR.

The tables below outline the policies issued by Magellan and

Plymouth from 2013 through 2016. They include premium amounts,

occurrence limits, and aggregate limits for each policy.

Magellan (OST – 2013)

Policy

Premium

Administrative Actions

$86,000

Computer Operations and Data

45,300

Commercial Crime

19,400

Employment Practices

33,300

Litigation Defense Expense

70,300

Tax Indemnity

59,200

11 Direct written policies to SCR began in 2015.

Occ. Limit

$1,000,000

1,000,000

Agg. Limit

$2,000,000

2,000,000

1,000,000

[*15] Business Interruption (Loss of Key

Employee)/Extra Expense (EE)

Business Interruption (Competitors)/EE

Business Interruption (Reputational

Damage)/EE

Business Interruption (Reg. and Leg.

Change)/EE

Legal Expense

Special Catastrophic Risk

100,800

1,000,000

59,200

1,000,000

3,000,000

102,700

1,000,000

3,000,000

177,600

1,000,000

3,000,000

14,000

69,400

20,000

1,000,000

20,000

1,000,000

Occ. Limit

$500,000

500,000

Agg. Limit

$500,000

500,000

20,000

500,000

20,000

500,000

Occ. Limit

$1,000,000

1,000,000

Agg. Limit

$2,000,000

2,000,000

1,000,000

3,000,000

1,000,000

3,000,000

1,000,000

3,000,000

20,000

1,000,000

20,000

1,000,000

Occ. Limit

$500,000

500,000

Agg. Limit

$500,000

500,000

Magellan (ICR – 2013)

Policy

Premium

Administrative Actions

$38,800

Computer Operations and Data

23,100

Commercial Crime

11,100

Employment Practices

15,700

Litigation Defense Expense

30,500

Tax Indemnity

27,700

Business Interruption (Loss of Key

44,400

Employee)/EE

Business Interruption (Contract

57,300

Cancellation)/EE

Legal Expense

14,000

Special Catastrophic Risk

35,100

Magellan (OST – 2014)

Policy

Premium

Administrative Actions

$68,400

Computer Operations and Data

41,600

Commercial Crime

15,700

Employment Practices

30,500

Litigation Defense Expense

60,100

Tax Indemnity

62,900

Business Interruption (Loss of Key

96,200

Employee)/EE

Business Interruption (Competitors)/EE

56,400

Business Interruption (Reputational

97,100

Damage)/EE

Business Interruption (Reg. and Leg.

170,200

Change)/EE

Legal Expense

14,000

Special Catastrophic Risk

64,700

Magellan (ICR – 2014)

Policy

Premium

Administrative Actions

$28,700

Computer Operations and Data

26,800

Commercial Crime

8,300

[*16] Business Interruption (Loss of Key

Employee)/EE

Business Interruption (Contract

Cancellation)/EE

Special Catastrophic Risk

Legal Expense

Tax Indemnity

Litigation Defense Expense

Employment Practices Liability Insurance

49,900

500,000

72,100

500,000

32,400

14,000

31,400

25,900

12,000

500,000

20,000

500,000

20,000

500,000

Occ. Limit

$1,000,000

1,000,000

Agg. Limit

$2,000,000

1,000,000

2,000,000

1,000,000

2,000,000

1,000,000

2,000,000

20,000

1,000,000

20,000

1,000,000

Occ. Limit

$500,000

500,000

Agg. Limit

$500,000

500,000

20,000

500,000

20,000

500,000

Occ. Limit

$500,000

500,000

Agg. Limit

$500,000

500,000

Magellan (OST – 2015)

Policy

Premium

Administrative Actions

$74,000

Computer Operations and Data

35,100

Commercial Crime

14,800

Employment Practices

20,300

Litigation Defense Expense

43,500

Tax Indemnity

59,200

Business Interruption (Loss of Key

115,600

Employee)/EE

Business Interruption (Reputational

103,600

Damage)/EE

Business Interruption (Reg. and Leg.

181,300

Change)/EE

Legal Expense

14,000

Special Catastrophic Risk

55,500

Magellan (ICR – 2015)

Policy

Premium

Administrative Actions

$22,200

Computer Operations and Data

26,800

Commercial Crime

8,300

Employment Practices

8,300

Litigation Defense Expense

12,000

Tax Indemnity

29,600

Business Interruption (Loss of Key

66,600

Employee)/EE

Business Interruption (Contract

65,700

Cancellation)/EE

Legal Expense

14,000

Special Catastrophic Risk

27,700

Magellan (SCR – 2015)

Policy

Premium

Administrative Actions

10,200

Computer Operations

9,200

Business Interruption (Contract

23,100

Cancellation)/EE

[*17] Commercial Crime

Employment Practices

Litigation Defense Expense

Tax Indemnity

Business Interruption (Loss of Key

Employee)/EE

Legal Expense

Special Catastrophic Risk

7,400

5,500

4,600

17,600

500,000

16,600

500,000

14,000

27,700

20,000

500,000

20,000

500,000

Occ. Limit

$500,000

500,000

Agg. Limit

$500,000

500,000

20,000

500,000

100,000

20,000

500,000

100,000

Occ. Limit

$500,000

500,000

Agg. Limit

$500,000

500,000

20,000

500,000

100,000

20,000

500,000

100,000

Occ. Limit

$1,000,000

1,000,000

Agg. Limit

$2,000,000

1,000,000

2,000,000

Magellan (ICR – 2016)

Policy

Premium

Administrative Actions

$24,000

Computer Operations and Data

26,800

Commercial Crime

8,300

Employment Practices

9,200

Litigation Defense Expense

13,900

Tax Indemnity

29,600

Business Interruption (Loss of Key

59,200

Employee)/EE

Business Interruption (Contract

96,200

Cancellation)/EE

Legal Expense

14,000

Special Catastrophic Risk

27,700

5,000

Crisis Coach

Magellan (SCR – 2016)

Policy

Premium

Administrative Actions

$11,100

Computer Operations and Data

9,200

Business Interruption (Contract

32,400

Cancellation)/EE

Commercial Crime

7,400

Employment Practices

5,500

Litigation Defense Expense

5,500

Tax Indemnity

17,600

Business Interruption (Loss of Key

13,900

Employee)/EE

Legal Expense

14,000

Special Catastrophic Risk

27,700

5,000

Crisis Coach

Plymouth (OST – 2016)

Policy

Premium

Administrative Actions

$78,600

Computer Operations and Data

35,100

Commercial Crime

14,800

Employment Practices

20,300

Litigation Defense Expense

41,600

[*18] Tax Indemnity

Business Interruption (Loss of Key

Employee)/EE

Business Interruption (Reputational

Damage)/EE

Business Interruption (Reg. and Leg.

Change)/EE

Legal Expense

Special Catastrophic Risk

Bus. Interruption (Natural Perils)/EE

Crisis Coach

Bus. Interruption (Property Damage)/EE

62,900

1,000,000

131,300

1,000,000

117,500

1,000,000

2,000,000

62,000

1,000,000

2,000,000

14,000

55,500

32,400

20,000

1,000,000

20,000

1,000,000

2,000,000

5,000

100,000

44,400

1,000,000

2,000,000

To summarize, the captive policies fell into the following

categories of coverage:

10.

11.

12.

13.

14.

15.

16.

Administrative Actions

Business Interruption (Natural Peril)

Business Interruption (Broad Form Property Damage)

Business Interruption (Competitors)

Business Interruption (Customer Contract Cancellation)

Business Interruption (Loss of Key Employees)

Business Interruption (Regulatory & Legislative Change)

Business Interruption (Reputational Damage)

Commercial Crime

Computer Operations and Data

Crisis Coach

Employment Practices

Legal Expense

Litigation Defense Expense

Tax Indemnity

Special Catastrophic Risk

Summaries of the coverage for each of the policies are generally

contained in Coverage Summary forms. The following list describes, in

simplified terms, the coverages for Magellan for the tax years at issue.

Administrative Actions: “This covers losses (i.e., legal

expenses, fines and assessments) from investigations,

audits and proceedings brought against the Insured by

governmental bodies. Tax related administrative actions

are excluded.”

[*19] Business Interruption (also referred to as Business

Income) (Natural Perils) and Extra Expense

Insurance: This “covers loss of profits and extra expenses

resulting from the temporary suspension of the Insured’s

operations due to inclement weather conditions or a

natural disaster, including but not limited to, a flood,

earthquake or tornado.”

Business Interruption (also referred to as Business

Income) (Broad Form Property Damage) and Extra

Expense Insurance: This “covers loss of profits and extra

expenses resulting from the interruption of the Insured’s

operations due to (i) damage or breakdown of the Insured’s

property (including tangible and intangible personal

property and real property), (ii) utility service

interruptions including, but not limited to, interruptions of

the Insured’s telecommunications systems and (iii) loss of

access to the Insured’s premises by the Insured, its

employees, suppliers or customers.”

Business Interruption (also referred to as Business

Income) (Entrance by Competitors) and Extra

Expense Insurance: “This covers loss of profits resulting

from the entrance by a competitor in the Insured’s

business.”

Business Interruption (also referred to as Business

Income) (Customer Contract Cancellation) and

Extra Expense Insurance: This “covers loss of income

and extra expenses resulting from the cancellation of one

or more key contracts by a customer of the Insured or from

the bankruptcy or liquidation of any key customer who is a

party to such key contract.”

Business Interruption (also referred to as Business

Income) (Loss of Key Employee) and Extra Expense

Insurance: “This covers loss of profits resulting from the

retirement or voluntary departure of a key employee of the

Insured.

Business Interruption (also referred to as Business

Income) (Regulatory and Legislative Changes) and

Extra Expense Insurance: This “covers loss of profits

[*20] and extra expenses resulting from legislative, regulatory,

administrative and governmental changes adversely

affecting the Insured’s operations.”

Business Interruption (also referred to as Business

Income) (Reputational Damage) and Extra Expense

Insurance: This “covers loss of profits and extra expenses

resulting from negative publicity that cause damage to the

Insured’s reputation in the marketplace.”

Commercial Crime: This “covers losses resulting from or

related to theft or dishonesty committed by employees of

the Insured or by third parties including, but not limited

to, investigative expenses incurred by the Insured.”

Computer Operations and Data: This “covers losses (i.e.

expenses incurred and lost income) resulting from attacks,

breakdowns, and malfunctions and security breaches of the

Insured’s computers, computer programs and servers (and

related peripheral equipment) including but not limited to,

the cost to replace or restore data and computer programs,

the cost of data entry, the cost of reprogramming and

computer consultation service, public relations expenses

incurred to protect or restore your reputation, monetary

payments, fees, fines and penalties imposed against the

Insured by credit card associations and expenses related to

extortion threats that caused an interruption of the

Insured’s operations.”

Crisis Coach Insurance: “This covers crisis management

expenses resulting from a crisis event involving the Named

Insured.”

Employment Practices Insurance: “This covers losses

resulting from claims made by employees, former

employees, or potential employees of the Insured for

wrongful termination of employment, sexual harassment

and other employment-related allegations and certain

claims made by third parties for wrongful discrimination.”

Legal Expense Insurance: “This covers legal expenses

incurred by the Insured (or an employee, officer or director

of the Insured) for defending claims against the Insured (or

an employee, officer o[r] director of the Insured) or for the

[*21] consultation thereof, for prosecuting any claims by the

Insured against third parties and for the consultation

thereof, and for the Insured’s participation in any

arbitration, mediation or other alternative dispute

[resolution] proceeding.”

Litigation Defense Expense Insurance: “This covers

litigation expenses incurred by the Insured for defending

claims that fall outside certain specified commercial

liability policies of the Insured or for defending claims that

are in excess of the limits of such existing liability policies.

This Policy also covers the deductible(s) on such liability

policies. This insurance policy only applies to such

litigation expenses after the limits of the Legal Expense

Insurance Policy have been exhausted.”

Tax Indemnity Insurance: “This covers losses from tax

payments, including interest and penalties, and tax

assessments, including associated expenses (i.e. legal,

consulting and accounting expenses) which arise out of an

audit of any foreign, federal, state or local tax return of the

Insured.”

Special Catastrophic Risk Insurance: “This covers loss

of profits and property resulting from the accidental or

intentional disruption of critical infrastructure such as

transportation systems, electrical power systems, gas and

oil storage and transportation systems, banking and

finance, transportation systems and water supply

systems.”

Plymouth provided substantially similar insurance coverage beginning

in 2016.

The parties’ experts agree that the Magellan and Plymouth

policies generally contain terms one would typically see in insurance

policies. For example, David Russell, an expert offered by respondent,

observed that certain coverages are generally available in the

marketplace, including crime, employment practices, and computer

data. The Patels’ expert, Michael Angelina, also agrees that the policies

issued by Magellan and Plymouth contain terms that are similar to

those contained in commercial insurance policies, including policy forms

containing declarations, the insuring agreement, and other provisions.

[*22] However, the policies also contain atypical provisions. For

example, the policies operate under “claims made and reported” terms,

requiring the insured to report the loss before the expiration of the

policy. In the insurance industry, such provisions are considered

unfavorable to insureds. 12 The policies also contain a provision stating

that all policies provide excess insurance to other coverage, such as Dr.

Patel’s commercial insurance. However, high premiums are typically

indicative of primary insurance coverage. Another atypical provision is

that the policies cannot be canceled, and premiums are considered fully

earned at inception, meaning that no refund is due to the insured.

Capstone’s Reinsurance Program

From the beginning, Mr. Coomes recognized that a captive

insurance company is “required to ‘distribute risk’ in order to be treated

as an insurance company for tax purposes.” In a memorandum to

potential members of the Capstone reinsurance arrangement, Mr.

Coomes emphasized the need for a microcaptive to obtain risk

distribution and noted that the IRS considers the risk distribution

requirement satisfied if the “risk borne by your [microcaptive] is spread

among one or more insureds that are unrelated” to the captive. Further,

he stated that, according to caselaw, “30% of the total premiums

received by an insurance company from unrelated insureds represents

a significant portion of its risk.” He also stated that “safe harbor

provisions of the Revenue Ruling 2002-89 take a more strict position

requiring more than 50% of the total premiums received by an insurance

company to be received from unrelated insureds.”

Applying his analysis, Mr. Coomes sought to create a pooling

arrangement through Capstone to distribute risk among the captives he

formed. Captives participating in the pooling arrangement did so via two

instruments: (1) a Reinsurance Agreement; and (2) an accompanying

Quota Share Retrocession Agreement.

Under the Reinsurance Agreements for each year, Capstone

agreed to reinsure 51 percent of the Ultimate Net Loss of each Covered

Policy. Ultimate Net Loss is defined under the agreements as “the actual

loss paid or payable by [Magellan or Plymouth] from the settlement or

compromise of claims . . . arising from one or more Covered Policies.” In

other words, as part of the Reinsurance Agreements, Magellan and

12 In contrast, a typical claims-made policy permits an insured to report claims

for a certain period after the expiration of the policy.

[*23] Plymouth—and other captives—paid fifty-one percent of the

premiums they received from their insured customers—for example,

OST, ICR, and SCR—to Capstone.

Mr. Coomes billed Magellan and Plymouth yearly, and the

invoices represented 51 percent of the total premiums plus a “risk

distribution” ceding fee of $5,000 charged by Capstone. The Reinsurance

Agreements also provided that in the event of insolvency of the

reinsured, the maximum amount recoverable by the reinsured is the

amount of reinsurance premiums paid to Capstone.

As participants in the Capstone program, Magellan and

Plymouth were also parties to the Quota Share Retrocession Agreement.

Under that agreement, members of Capstone agreed to collectively

assume 100 percent of the losses Capstone incurred under the various

Reinsurance Agreements it entered with the participating captives in

the pool. According to the agreement, the captives participating in the

Capstone pooling arrangement were purportedly not liable for any

losses on policies they directly wrote to their own insureds. Presumably,

this provision was added to the Quota Share Retrocession Agreement

because of Mr. Coomes’s concern that the captives would not otherwise

appear to achieve risk distribution.

In exchange for their agreement to reinsure a quota share of

Capstone losses, Capstone paid its members a Quota Share Reinsurance

Premium. Within days, and no later than December 31 of the year,

Capstone returned half of the money paid by Magellan and Plymouth.

The remaining half was paid into the Capstone Trust, and within six to

seven months, Capstone returned 70 percent of the money held in the

trust. Thus, within six to eight months, approximately 85 percent of

money was returned to Magellan and Plymouth during the tax years at

issue. The remaining 15 percent was left in the trust until all claims

were paid. Thus, although only 15 percent remained to pay claims,

50 percent of exposure remained.

In other words, as participants in the Capstone arrangement,

Magellan and Plymouth paid 51 percent of their premiums into the

pooling arrangement. And in less than a year, they received a large

percentage of funds back as part of the quota share agreement. The

quota share that Magellan and Plymouth assumed under the quota

share agreement for each tax year at issue was calculated so that these

entities received payments from Capstone that were roughly equal to

[*24] the premiums Capstone was entitled to receive from Magellan and

Plymouth as part of the reinsurance agreement.

This flow of funds is best represented by the following figures

prepared by Mr. Russell. Figure A 13 represents the steps in the flow of

funds from OST, ICR, and SCR to Magellan (or Plymouth) to Capstone

and back again.

Further, as noted by Mr. Russell, accounting statements for

Capstone illustrate the flow of premiums between Magellan and

Capstone. For example, in 2013, Magellan ceded $578,799 in premiums

to Capstone for 2013 reinsurance coverage and assumed the exact same

amount for a quota share retrocession with Capstone. After a relatively

small amount in losses was ultimately assumed, Magellan received a

total of $551,284.89 back from Capstone, or over 95 percent of

premiums.

This pattern of a circular flow of funds is illustrated in Figure B,

prepared by Mr. Russell:

13 Figure A contains a typographical error original to Mr. Russell’s report. In

the “Steps in the Flow of Funds” box, the word “retocedes” should be “retrocedes.” In

addition, a “retrocessionaire” in Figure A refers to a reinsurer of Capstone. Magellan

and Plymouth are reinsurers, or retrocessionaires, of Capstone.

[*25]

At the time Dr. Patel’s entities joined the Capstone pooling

arrangement, he did not know anything about the other pool members,

including their risks, industries, ability to fulfill their quota share

claims, or captive insurance policies.

Dr. Patel’s Commercial Insurance Coverage

Despite obtaining numerous policies through his captives, Dr.

Patel also purchased insurance coverage with third-party commercial

insurers throughout the tax years at issue for each of his entities. OST

and ICR maintained commercial insurance policies that covered

regulatory, malpractice, worker’s compensation, automobile, and

umbrella risks and included a general business owners’ package.

Mr. Russell provided a general assessment of the commercial

insurance policies in place during the tax years at issue. The following

list is a summary he prepared that contains a nonexhaustive general

overview of the commercial policies:

Businessowners Package Policy (BOP): This policy

provides a package of several property and liability

coverages needed by a small business. The property

coverages include: 1) coverage for losses to a building

owned by the insured; 2) coverage for losses to the business

personal property (e.g. furnishings and equipment) owned

[*26] by the business; 3) coverage for lost profits and extra

expenses during an interruption to business from a covered

loss; and 4) several other smaller coverages including glass,

accounts receivable coverage (for records that have been

damaged or destroyed), fine art and other coverage

extensions. The liability protections include general

liability [GL] and medical payments coverage; these cover

losses and legal defense brought by third parties, not

including medical malpractice.

Business Auto Policy (Auto): This policy provides

liability and property protection to the insured against

claims brought by third parties as well as property damage

to the insured’s vehicles. This policy also provides

protection against injuries caused by uninsured and

underinsured motorists as well as personal injury

protection for injuries suffered by the insured and

passengers in the insured’s vehicles.

Umbrella Policy (Umbrella): This policy provides

additional liability coverage if the applicable coverage

limits of business auto or general liability coverages are

exhausted.

Workers Compensation and Employers Liability

(WC/EL): This policy provides the insured with protection

against employee injury obligations, including medical

expenses, lost wages and claims brought by third parties

as the result of worker injuries.

e-MD Network Security and Privacy/Broad

Regulatory Protection Plus (eMD/Regulatory+): This

policy provides a medical facility or office with a package of

coverages for losses and expenses that result from events

including breaches of digital privacy, Cyber Liability,

Cyber Terrorism, Cyber Extortion, Network Assets and

Breach Coverage. In addition, the policy includes coverage

(if permitted by law) for regulatory proceedings costs, fines

and penalties, shadow audit expenses and other claims

expenses for wrongful acts, errors and omissions.

[*27] The tables below present general summaries of the insurance

coverage the Patels maintained through commercial insurers for the tax

years at issue:

Prem.

Occ.

Limit

Agg. Limit

Auto

$8,831

$1,000,000

Travelers

Lloyds

BOP/GL

11,791

1,000,000

2,000,000

OST +

ICR

Travelers

Lloyds

BOP Prop.

2,794,480

2012

OST +

ICR

Travelers

Lloyds

BOP Bus. Pers.

Prop.

3,075,791

2012

OST

Lloyds/

NAS

eMD/Regulatory

4,091

1,000,000

3,000,000

2012

OST +

ICR

Travelers

Indem.

Umbrella

2,123

2,000,000

2012

OST

Texas

Mutual

WC/EL

11,829

1,000,000

2012

OST

OMIC

Med. Mal./Prof.

Liability

30,253

1,000,000

3,000,000

Year

Insured

Insurer

Coverage

Prem.

Occ.

Limit

Agg. Limit

2013

OST +

ICR

Travelers

Casualty

Auto

$11,119

$1,000,000

2013

OST +

ICR

Travelers

Lloyds

BOP/GL

14,620

1,000,000

2,000,000

2013

OST +

ICR

Travelers

Lloyds

BOP Prop.

2,906,259

2013

OST +

ICR

Travelers

Lloyds

BOP Bus. Pers.

Prop.

3,193,821

2013

OST

Lloyds/

NAS

eMD/Regulatory

6,609

1,000,000

5,000,000

2013

OST +

ICR

Travelers

Indem.

Umbrella

2,478

2,000,000

2013

OST

Texas

Mutual

WC/EL

14,290

1,000,000

2013

OST

OMIC

Med. Mal./Prof.

Liability

36,559

1,000,000

3,000,000

Year

Insured

Insurer

2012

OST +

ICR

Travelers

Casualty

2012

OST +

ICR

2012

Coverage

[*28]

Prem.

Occ.

Limit

Agg. Limit

Auto

$11,336

$1,000,000

Travelers

Indem.

BOP/GL

19,708

1,000,000

2,000,000

OST +

ICR

Travelers

Indem.

BOP Prop.

5,053,446

2014

OST +

ICR

Travelers

Indem.

BOP Bus. Pers.

Prop.

3,564,668

2014

OST

Lloyds/

NAS

eMD/Regulatory

6,609

1,000,000

5,000,000

2014

OST +

ICR

Travelers

Indem.

Umbrella

2,825

2,000,000

2014

OST

Texas

Mutual

WC/EL

16,031

1,000,000

2014

OST

OMIC

Med. Mal./Prof.

Liability

43,365

1,000,000

3,000,000

Year

Insured

Insurer

Coverage

Prem.

Occ.

Limit

Agg. Limit

2015

OST +

ICR

Travelers

Casualty

Auto

$11,238

$1,000,000

2015

OST +

ICR

Travelers

Indem.

BOP/GL

22,442

1,000,000

2,000,000

2015

OST +

ICR

Travelers

Indem.

BOP Prop.

5,255,583

2015

OST

Travelers

Indem.

BOP Bus. Pers.

Prop.

3,702,253

2015

OST

Lloyds/

NAS

eMD/Regulatory

2,678

1,000,000

4,000,000

2015

OST +

ICR

Travelers

Indem.

Umbrella

2,994

2,000,000

2015

OST

Texas

Mutual

WC/EL

15,456

1,000,000

2015

OST

OMIC

Med. Mal./Prof.

Liability

40,112

1,000,000

3,000,000

Year

Insured

Insurer

2014

OST +

ICR

Travelers

Casualty

2014

OST +

ICR

2014

Coverage

[*29]

Prem.

Occ.

Limit

Agg. Limit

Auto

$13,576

$1,000,000

Travelers

Indem.

BOP/GL

36,787

1,000,000

2,000,000

OST +

ICR

Travelers

Indem.

BOP Prop.

6,000,000

2016

OST +

ICR

Travelers

Indem.

BOP Bus. Pers.

Prop.

6,832,912

6,862,912

2016

OST

Lloyds/

NAS

eMD/Regulatory

3,249

1,000,000

3,000,000

2016

OST +

ICR

Travelers

Indem.

Umbrella

3,446

2,000,000

2016

OST

Texas

Mutual

WC/EL

14,499

1,000,000

2016

OST

OMIC

Med. Mal./Prof.

Liability

28,199

1,000,000

3,000,000

Year

Insured

Insurer

2016

OST +

ICR

Travelers

Casualty

2016

OST +

ICR

2016

Coverage

The combined commercial premiums for the tax years at issue

totaled $462,704 and ranged between approximately $68,000 and

$106,000 per year for the three entities. In contrast, during the same tax

years at issue, Dr. Patel’s businesses paid premiums to Dr. Patel’s

captives totaling just over $4.5 million.

The Patels maintained this commercial insurance coverage

despite Dr. Patel stating that he has an inherent distrust of commercial

insurance. Further, Dr. Patel did not place his medical malpractice

insurance coverage with his captives, despite also professing that one

purpose of forming the microcaptives stemmed from a medical

malpractice incident. Nor did he ever consult with his longtime

commercial insurance agent about forming a microcaptive, including

whether he could obtain comparable—or even cheaper—coverage

through his commercial carriers.

Premium Pricing

The parties’ experts agree that an insurance premium is typically

determined by an actuary who uses actuarially sound methodologies.

Here, there is evidence that premium pricing was determined in two

ways. First, Mr. Coomes hired Mr. Rosenbach to develop policy

[*30] premiums for Magellan and Plymouth. But there is also evidence

in the record indicating that Dr. Patel and his employee directed

premium amounts. We will address each in turn.

Mr. Rosenbach’s Captive Pricing

From the start, Mr. Rosenbach proved himself flexible in

preparing premium pricing. For each policy period, he prepared pricing

reports. According to the reports, he was hired to “[d]evelop reasonable

premium estimates for insurance policies expected to be issued” by

Magellan. In broad terms, Mr. Rosenbach’s reports state that “[w]here

comparable coverages were identified, the base rates and rating factors

developed in this report were based on a survey of rating plans obtained

from regulatory filings submitted by commercial insurance carriers” in

the United States. He also stated that “commercial rates and rating

factors selected represent a reasonable basis from which to develop

premium estimates for comparable coverages” provided by Magellan.

Where comparable coverages were not available, Mr. Rosenbach

used stock language in his pricing reports for each policy 14 and stated

that he used “professional judgment to develop reasonable rating

guidelines to reflect the expected loss potentials.” Finally, he stated that

base rates were created using “historical consistency and rate-on-line

ranges.” Despite these statements in the reports—which were created

contemporaneously at the time policies were issued by Magellan and

Plymouth—Mr. Rosenbach did not otherwise credibly or adequately

explain the basis for his premium amounts. Rather, the Premium

Development reports contain little to no explanation for how he arrived

at the amounts he ultimately recommended.

But in connection with this litigation, Mr. Rosenbach created an

expert report attempting to explain his premium calculations. According

to Mr. Rosenbach, his pricing process involved determining a base

premium for each policy and then adjusting that base by various factors.

He also claimed that he determined a base rate by using comparable

coverages, typically from public filings from Chubb, a large insurance

company, where available, and then applied additional factors to reach

the premium amounts for the captives.

14 The language Mr. Rosenbach used in his pricing reports in these cases

appears to be identical to language he used in such reports in Swift v. Commissioner,

T.C. Memo. 2024-13, at *16.

[*31] However, Mr. Rosenbach’s calculations and additional factors

resulted in premium amounts far removed from the Chubb premium

pricing. He used factors that are not typically used by actuaries, nor are

these factors defined in actuarial literature. Further, the additional

factors are undocumented and, as noted by Ms. Garland, so large that

they bear no relation to the commercial rates that he starts with.

Despite having several years’ worth of insurance data, he did not adjust

the pricing of the policies with the additional information that became

available over time, though his reports stated that he would do so.

The premium amounts Mr. Rosenbach calculated were

significantly higher than the commercial premium amounts for the

same or similar types of coverage. For example, the rate-on-line—a

measure of the cost of insurance—was up to 12 times higher for the

Patels’ captive insurance compared to their commercial insurance.

During the tax years at issue, the average rate-on-line for the captives’

policies ranged from over 4 percent to over 7 percent, depending on the

calculation method used. In contrast, the average rate-on-line for the

commercial policies was typically below 1 percent, depending on the

calculation method used.

As an example of the excessively high premium amounts for the

microcaptive policies, the limit of liability for legal expense policies

issued by Magellan and Plymouth for the tax years at issue is only

$20,000, but the premium is $14,000 a year, which amounts to a rateon-line of 70 percent. In contrast, Dr. Patel’s BOP commercial coverage

for the 2013 through 2014 period charged a similar premium amount

($16,981), but it covered property up to a limit of $4 million and

liability—including legal expense—up to a limit of $2 million. The BOP

policy has a rate-on-line of less than one percent.

In addition, Mr. Rosenbach stated that he developed the premium

pricing with the expectation that the coverages would be “high severity

and low frequency,” meaning that the insured entities would be loss free

for many years. Yet, contemporaneous records do not support Mr.

Rosenbach’s post hoc justification for high premiums. Records reveal

that Mr. Rosenbach anticipated loss ratios for Magellan between 56 and

57.1 percent. Relatedly, records reveal that Mr. Rosenbach expected

Plymouth to experience loss ratios of 40 percent to 70 percent. These

numbers are not consistent with Mr. Rosenbach’s assertion that he

expected Magellan to be loss free for many years.

[*32] Moreover, the high premium amounts are not consistent with Mr.

Rosenbach’s contention that the rates were developed for “low

frequency” lines of business. As noted by Ms. Garland, for a single

insured, “low frequency” would suggest a claim every 10 to 20 years.

However, a premium of nearly $1 million is consistent with a claim every

year in the range of $500,000 to $700,000. Neither Magellan nor

Plymouth had claim history supporting a claim every year. Yet the

Patels paid Magellan and Plymouth more than $1 million in policy

premiums each year.

Further, Mr. Coomes could not recall whether he ever instructed

Mr. Rosenbach to (1) increase or decrease a premium amount; (2) target

a certain premium level; or (3) increase or decrease premium amounts

based on a request from a client. But Mr. Rosenbach was aware of the

$1.2 million limit on exclusion from taxability under section 831(b),

which was later increased to $2.2 million. He also testified that he

believed the final pricing reports he prepared for Mr. Coomes’s clients

from 2011 to 2016 always totaled less than $1.2 million in premiums.

Further, in 2014, Mr. Coomes sought advice from another

attorney who handled captive insurance companies and asked him

whether there was a standard test “when speaking with prospective

clients in terms of the maximum amount of premiums that are

reasonable based upon the gross or net income of the business? The

question of course presumes that all premiums can be justified from an

actuarial standpoint.”

Dr. Patel’s Involvement in Premium Pricing

Although Mr. Coomes claimed that Mr. Rosenbach developed

premium pricing for Dr. Patel’s captives, the record reveals that Dr.

Patel and his employee provided Mr. Coomes with a target to be hit for

the Patel captives’ premiums. Contemporaneous emails during the tax

years at issue also reveal that Dr. Patel had input regarding the

insurance premiums he wanted to pay his captives, including asking for

higher premiums. For example, in December 2012, Mr. Ridgway emailed

Dr. Patel, inquiring about the amount of total casualty insurance

premiums that Dr. Patel would pay for that year. In response, Ms.

Guerrero responded that same day: “We are not positive on the amount

that should go in the box below. Dr. Patel is thinking the amt is

$1,150,000.00. Is this the amount that you are expecting. Please advise.”

Mr. Ridgway responded: “Yes, that’s around the amount we were

expecting.” Ms. Guerrero responded again that “Dr. Patel wanted to

[*33] know what the max is that we can pay into the captive,” to which

Mr. Ridgway responded “$1,200,000.”

Similarly, in 2014, Ms. Guerrero emailed Mr. Coomes and asked

why policy premiums were less than the year before because “Dr. Patel

was expecting a little closer to 1.2 million for the both.” Mr. Coomes

replied that he “simply renewed the same policies at the same limits as

last year,” premiums had dropped in the commercial market, and they

should look at adding other coverages or increasing limits the following

year, apparently to increase the total amount of insurance premiums

Dr. Patel was paying to the captive. In response, Dr. Patel informed Ms.

Guerrero that he wanted to add SCR as an insured in 2015. Thus, in

2015, Magellan began issuing policies to SCR. In August 2015, Ms.

Guerrero emailed Mr. Coomes and stated that “Dr. Patel would like to

add another company to the captive” and asked where to start.

Reinsurance Premium Pricing

With respect to Capstone’s premium pricing structure, Mr.

Coomes stated that an actuary developed the 51 percent reinsurance

premium for each captive. But there is no credible evidence to support

Mr. Coomes’s statement. There is no documentation demonstrating that

an actuary—whether Mr. Rosenbach or another person—determined

the reasonableness of the reinsurance premiums for each captive.

Claims Activity

CIC Services handled certain clerical functions for captives in the

Capstone pool, including for Magellan and Plymouth. In particular,

during the tax years at issue, CIC Services was responsible for reviewing

a portion of claims submitted by captives participating in Capstone.

Once claims were approved, CIC Services notified Capstone.

In 2013, the Reinsurance Agreement provided that the parties

agreed to be bound by the decision of a third-party claims adjuster for

any claims exceeding $20,000. However, claims that did not exceed

$20,000 would be submitted to the captive manager or a third-party

claims adjuster at the discretion of Capstone. From 2014 through 2016,

the Reinsurance Agreement provided that Capstone had the discretion

to submit all claims to the captive manager.

During the tax years at issue, Mr. Sean King, Mr. Ridgway, and

Mr. Thomas King—all with CIC Services—had ownership interests in a

captive insurance company that participated in the Capstone pool, while

[*34] at the same time they also approved claims for the Capstone pool.

In October 2014, Mr. Coomes raised concerns about employees of CIC

Services approving claims when they owned a captive in the same

pooling arrangement.

Further, for the 2015 policy period, approximately 14 percent of

all approved claims submitted to Capstone related to one claim for

$605,669 by Mr. Thomas King. The claim was for Thomas King’s loss of

income because Minnesota Life Insurance no longer offered life

insurance policies to captive insurance companies. Notably, the claim

was submitted in 2017, after the policy period was over and after Mr.

Thomas King sent an email informing Dr. Patel that the IRS was

examining his captives.

During the tax years at issue, Magellan and Plymouth did not pay

any claims for the direct policies they issued to OST, ICR, or SCR. They

did pay a share of Capstone pool claims, but those claims represent an

average loss ratio 15 of less than five percent for Magellan and three

percent for Plymouth. By contrast, commercial insurance carriers in the

property and casualty industry had an average loss ratio of

approximately 70 percent during the same period.

Finally, Capstone claims increased significantly after the IRS

began examining Capstone captives, including in subsequent years not

at issue here. Most of the claim activity for the 2015 reinsurance pool—

which represents the majority of claims activity during the years at

issue—occurred after the IRS began examining captives formed by Mr.

Coomes.

IV.

The Patels’ Returns and IRS Examination

The IRS conducted examinations of the Patels’ joint federal

income tax returns for each of the tax years at issue and issued notices

of deficiency to them. For each tax year at issue, respondent determined

that neither Magellan nor Plymouth could be treated or taxed as a small

insurance company under section 831(b). As a result, the IRS disallowed

the amounts deducted as insurance premiums and determined the

following deficiencies for the tax years at issue:

15 The insurance industry uses a measure called the “loss ratio” to compare

losses and adjustment expenses with premiums earned. As explained by Ms. Garland,

a loss ratio of 60 percent means that 60 cents of each premium dollar earned is used to

pay claims and associated expenses.

[*35]

Year

Deficiency

2013

2014

2015

2016

$247,892

484,420

475,186

529,949

OPINION

Burden of Proof

The determinations in a notice of deficiency bear a presumption

of correctness, see Welch v. Helvering, 290 U.S. 111, 115 (1933), and the

taxpayer generally bears the burden of proving them erroneous in

proceedings in this Court, see Rule 142(a)(1). 16 The taxpayer bears the

burden of proving entitlement to any deduction claimed. INDOPCO, Inc.

v. Commissioner, 503 U.S. 79, 84 (1992). Thus, a taxpayer claiming a

deduction on a federal income tax return must demonstrate that the

deduction is provided for by statute and must maintain records

sufficient to enable the Commissioner to determine the correct tax

liability. See § 6001; Hradesky v. Commissioner, 65 T.C. 87, 89–90

(1975), aff’d per curiam, 540 F.2d 821 (5th Cir. 1976); Treas. Reg.

§ 1.6001-1(a).

If, in any court proceeding, the taxpayer puts forth credible

evidence with respect to any factual issue relevant to ascertaining the

liability of the taxpayer and meets certain other requirements, the

burden of proof shifts to the Commissioner. § 7491(a)(1) and (2). 17 When

each party has satisfied its burden of production, then the party

supported by the weight of the evidence will prevail; and thus a shift in

the burden of proof has real significance only in the event of an

evidentiary tie. See Knudsen v. Commissioner, 131 T.C. 185, 189 (2008),

supplementing T.C. Memo. 2007-340.

The Patels once again ask the Court to shift the burden of proof to

respondent. The Court has already considered and denied petitioners’ pre-trial motion

requesting the same relief (see Docket No. 24344-17, Order, Doc. 217), and we decline

to reconsider their renewed motion.

17 The U.S. Court of Appeals for the Fifth Circuit, to which an appeal in these

cases would presumptively lie, see § 7482(b)(1), has also held that if an “assessment is

arbitrary and erroneous, the burden shifts to the government to prove the correct

amount of any taxes owed,” Portillo v. Commissioner, 932 F.2d 1128, 1133 (5th Cir.

1991), aff’g in part, rev’g and remanding in part T.C. Memo. 1990-68.

[*36] We do not perceive an evidentiary tie in these cases and are able

to decide the issues on the preponderance of the evidence. See, e.g.,

Swift, T.C. Memo. 2024-13, at *26; Bordelon v. Commissioner, T.C.

Memo. 2020-26, at *11.

II.

Evaluation of Evidence

In deciding whether a taxpayer has carried his burden of proof,

witness credibility is an important consideration. Ishizaki v.

Commissioner, T.C. Memo. 2001-318, 2001 WL 1658189, at *7. “[T]he

distillation of truth from falsehood . . . is the daily grist of judicial life.”

Diaz v. Commissioner, 58 T.C. 560, 564 (1972). “As a trier of fact, it is

our duty to listen to the testimony, observe the demeanor of the

witnesses, weigh the evidence, and determine what we believe.” Kropp

v. Commissioner, T.C. Memo. 2000-148, 2000 WL 472840, at *3.

Both parties presented experts to support their respective

positions. See Fed. R. Evid. 702; Crimi v. Commissioner, T.C. Memo.

2013-51, at *40 (“An expert witness may be allowed to testify in a

proceeding before this Court when his or her scientific, technical, or

other specialized knowledge might help us to understand the evidence

or decide a fact in issue.”). Although experts are helpful, we are not

bound by any particular expert opinion. Hunt & Sons, Inc. v.

Commissioner, T.C. Memo. 2002-65, 2002 WL 398703, at *9. In addition,

we are free to accept only a portion of an expert’s opinion. Estate of

Jackson v. Commissioner, T.C. Memo. 2021-48, at *64; see also Parker v.

Commissioner, 86 T.C. 547, 562 (1986). We focus our analysis on the

degree to which an expert’s opinions are supported by the evidence in

the record. See Helvering v. Nat’l Grocery Co., 304 U.S. 282, 295 (1938);

Estate of Davis v. Commissioner, 110 T.C. 530, 538 (1998).

With this framework in mind, we determine the credibility of

witnesses, resolve evidentiary conflicts, and draw inferences from the

voluminous record developed by the parties. Keating, T.C. Memo.

2024-2, at *50.

III.

Taxation of Insurance

We begin our discussion by briefly explaining the taxation and

deductibility of microcaptive insurance payments. Insurance

companies—other than life insurance companies—are generally taxed

on their income in the same manner as other corporations. See §§ 11,

831(a). However, section 831(b) provides an alternative taxing structure

for certain small insurance companies. During the tax years at issue, an

[*37] insurance company with net written premiums (or, if greater,

direct written premiums) that did not exceed $1.2 million (or $2.2

million beginning in 2016) for the year could elect to be taxed under

section 831(b). See § 831(b)(2). A microcaptive that makes a valid section

831(b) election is subject to tax only on its investment income.

Further, amounts paid for insurance are deductible under section

162(a) as ordinary and necessary expenses paid or incurred in

connection with a trade or business. See Treas. Reg. § 1.162-1(a). Section

162(a) does not prohibit deductions for microcaptive insurance

premiums. But an inherent requirement for a company to make a valid

section 831(b) election is that it must transact in insurance. See

Avrahami, 149 T.C. at 175–76. Likewise, the deductibility of insurance

premiums depends on whether the premiums were truly payments for

insurance. Syzygy Ins. Co. v. Commissioner, T.C. Memo. 2019-34, at *28.

These rules are even more complicated when the insurer and the

insureds are related. Avrahami, 149 T.C. at 176. Although insurance

premiums may be deductible, amounts set aside in a loss reserve as a

form of self-insurance are not. See, e.g., Caylor Land & Dev., T.C. Memo.

2021-30, at *31.

Thus, these cases hinge on whether the Patels’ microcaptive

insurance arrangement meets the definition of insurance. But neither

the Code nor the regulations define “insurance.” Id. Thus, we are guided

by caselaw in determining whether a particular transaction constitutes

insurance for federal income tax purposes. See Helvering v. Le Gierse,

312 U.S. 531, 539–40 (1941); Estate of Chew v. Commissioner, 148 F.2d

76, 78 (5th Cir. 1945), aff’g 3 T.C. 940 (1944); Avrahami, 149 T.C. at 177.

Courts have examined four criteria in deciding whether an

arrangement constitutes insurance for federal income tax purposes:

(1) the insurer distributes the risk among its policy holders; (2) the

arrangement is insurance in the commonly accepted sense; (3) the

arrangement shifts the risk of loss to the insurer; and (4) the

arrangement involves insurable risks. Helvering v. Le Gierse, 312 U.S.

at 539–40; Avrahami, 149 T.C. at 177 (first citing Rent-A-Center, Inc. v.

Commissioner, 142 T.C. 1, 13 (2014); then citing R.V.I. Guar. Co. &

Subs. v. Commissioner, 145 T.C. 209, 225 (2015); then citing Harper

Grp., 96 T.C. at 58; and then citing AMERCO & Subs. v. Commissioner,

96 T.C. 18, 38 (1991), aff’d, 979 F.2d 162 (9th Cir. 1992)).

“These four nonexclusive criteria establish a framework for

determining the existence of insurance for Federal income tax

[*38] purposes.” Rsrv. Mech. Corp., T.C. Memo. 2018-86, at *33. We will

first look at risk distribution.

Risk Distribution

Risk distribution is one of the common characteristics of

insurance identified by the Supreme Court. See Helvering v. Le Gierse,

312 U.S. at 539. It occurs when the insurer pools a large enough

collection of unrelated risks. Rent-A-Center, 142 T.C. at 24; see also

Caylor Land & Dev., T.C. Memo. 2021-30, at *33. This concept is based

on the law of large numbers—“a statistical concept that theorizes that

the average of a large number of independent losses will be close to the

expected loss.” Avrahami, 149 T.C. at 181. “By assuming numerous

relatively small, independent risks that occur randomly over time, the

insurer smoothes out losses to match more closely its receipt of

premiums.” Clougherty Packing Co. v. Commissioner, 811 F.2d 1297,

1300 (9th Cir. 1987), aff’g 84 T.C. 948 (1985).

In prior captive insurance cases, taxpayers have attempted to

show risk distribution in two ways: (1) participating in a pooling

arrangement whereby the pool performs the functions 18 of an insurance

company; or (2) issuing direct written policies to affiliate entities with a

large enough pool of unrelated risks. Swift, T.C. Memo. 2024-13, at *29.

On both points, Magellan and Plymouth fail to demonstrate risk

distribution.

The Pooling Arrangement

To decide whether Magellan and Plymouth distributed risk by

participating in a captive insurance pool, we must determine whether

Capstone performed the functions of an insurance company. See

Avrahami, 149 T.C. at 185 (citing Rent-A-Center, Inc., 142 T.C. at 10).

18 As noted by respondent, our prior opinions have examined reinsurance

pooling arrangements by determining whether the arrangement operated as a bona

fide insurance company. Avrahami, 149 T.C. at 192; Syzygy Ins. Co., T.C. Memo. 201934, at *29–30; Rsrv. Mech. Corp., T.C. Memo. 2018-86, at *38. The U.S. Court of

Appeals for the Tenth Circuit’s opinion affirming Reserve Mechanical noted that this

Court did not invalidate a quota share arrangement on the ground that it failed to

meet the formal definition of an insurance company. Rsrv. Mech. Corp. v.

Commissioner, 34 F.4th at 912. Rather, this Court invalidated the quota share

arrangement on the ground that, as a matter of substance, the pooling arrangement

did not perform the functions of an insurance company. Id. Regardless of the label, our

analysis focuses on whether Capstone performed the functions of an insurance

company.

[*39] To determine whether an entity is performing the functions of an

insurance company, we have considered a number of factors, including:

(1) whether it was created for legitimate nontax reasons;

(2) whether there was a circular flow of funds;

(3) whether the entity faced actual and insurable risk;

(4) whether the policies were arm’s-length contracts;

(5) whether the entity charged actuarially determined premiums;

(6) whether comparable coverage was more expensive or even

available;

(7) whether it was subject to regulatory control and met minimum

statutory requirements;

(8) whether it was adequately capitalized; and

(9) whether it paid claims from a separately maintained account.

Id. at 185; Syzygy Ins. Co., T.C. Memo. 2019-34, at *29–30. We will

address the most relevant factors in our analysis. See Rsrv. Mech. Corp.,

T.C. Memo. 2018-86, at *38–39.

Circular Flow of Funds

Under the arrangement with Capstone, each pool member paid

51 percent of its written premiums to Capstone in exchange for

purported reinsurance. But within a few days, Capstone returned half

the reinsurance premium to each pool member. Capstone returned

another 35 percent within 7 or 8 months. For the tax years at issue,

Magellan and Plymouth received payments from Capstone that were

roughly equal to the premiums Capstone was entitled to receive from

Magellan and Plymouth as part of the reinsurance agreement.

Further, although some claims were paid in the pool during the

tax years at issue, the amounts were minimal, resulting in Magellan and

Plymouth receiving nearly all of their premiums back as reinsurance

premiums during the tax years at issue. In considering similar

circumstances, we have determined that “[w]hile not quite a complete

loop, this arrangement looks suspiciously like a circular flow of funds.”

Syzygy Ins. Co., T.C. Memo. 2019-34, at *30–31 (quoting Avrahami, 149

[*40] T.C. at 186); see also Swift, T.C. Memo. 2024-13, at *33; Rsrv.

Mech. Corp., T.C. Memo. 2018-86, at *41.

Arm’s-Length Contracts

There is no evidence of any arm’s-length negotiations in

determining the premiums paid to Capstone. As noted above, there is no

actuarial determination of the reasonableness of the 51 percent of

premiums ceded to Capstone. Magellan’s and Plymouth’s captive

arrangement’s rate-on-line was 12 times higher than the premiums for

the commercial policies. Dr. Patel accepted these amounts despite not

attempting to determine whether commercial insurance policies would

offer the same or similar coverage for less.

As noted by the Court when discussing the lack of arm’s-length

contracts for a similar reinsurance pool:

It is fair to assume that a purchaser of insurance would

want the most coverage for the lowest premiums. In an

arm’s-length negotiation, an insurance purchaser would

want to negotiate lower premiums instead of higher

premiums. Seemingly, the main advantage of paying

higher premiums is to increase deductions.

Syzygy Ins. Co., T.C. Memo. 2019-34, at *33–34. Similarly here, the lack

of negotiation regarding premium prices—and Dr. Patel’s desire to pay

higher premiums to maximize his deductions and the amount flowing

through the captives—demonstrate a lack of arm’s-length transactions.

Moreover, Dr. Patel entered the reinsurance pool with other

members without performing due diligence regarding the other pool

members, including their risks, industries, ability to fulfill quota share

claims, or captive insurance policies. This lack of due diligence is

indicative of a lack of arm’s-length negotiations.

Actuarially Determined Premiums

We also look at whether the entity charged actuarially

determined premiums. Avrahami, 149 T.C. at 186. We have previously

held that premiums were actuarially determined when the company

relied upon an outside consultant’s “‘reliable and professionally

produced and competent actuarial studies’ to set premiums.” Syzygy Ins.

Co., T.C. Memo. 2019-34, at *34 (quoting Rent-a-Center, 142 T.C. at 27

(Buch, J., concurring)). In contrast, “[w]e have held that premiums were

[*41] not actuarially determined when there has been no evidence to

support the calculation of premiums and when the purpose of premium

pricing has been to fit squarely within the limits of section 831(b).” Id.

Here, Capstone charged its pool members a reinsurance premium

of exactly 51 percent of their captive premium amounts, without

accounting for the different risks of pool members, the types of

businesses of pool members, or the geographical location of pool

members. As in our prior cases, we are concerned with a one-size-fits-all

approach to pricing. See Avrahami, 149 T.C. at 186–87; Syzygy Ins. Co.,

T.C. Memo. 2019-34, at *36; Rsrv. Mech. Corp., T.C. Memo. 2018-86,

at *43. As noted by Ms. Garland—whom we found credible—there is no

evidence that the 51 percent of premium ceded to Capstone was

actuarially determined. In contrast, Mr. Coomes’s memorandum to

captive owners implies that the amount was arbitrarily selected to

comply with caselaw and a perceived safe harbor for risk distribution.

Furthermore, although Mr. Coomes testified that an “actuary”

determined premium amounts and the 51 percent reinsurance

premium, we found that his testimony lacked credibility.

Approval by the TDCI

Finally, the Patels argue that because the TDCI determined that

Capstone is a reinsurer, the Court should show deference to that state

regulatory agency. We disagree. Although the TDCI regulates insurance

companies, it does not have the authority to determine whether an

entity operates as an insurance company within the meaning of the

Code. See, e.g., Grp. Life & Health Ins. Co. v. United States, 434 F.2d

115, 120 (5th Cir. 1970); Cuesta Title Guar. Co. v. Commissioner, 71 T.C.

278, 285 (1978), aff’d, 639 F.2d 787 (9th Cir. 1981) (unpublished table

decision). We recognize that Congress has delegated to the states the

authority to regulate the business of insurance. See AMERCO & Subs.,

96 T.C. at 42. But our focus is on whether Capstone was operated as an

insurance—or reinsurance—company for federal tax purposes, looking

beyond the formalities and considering the realities of the transactions.

See Syzygy Ins. Co., T.C. Memo. 2019-34, at *38. Here, although

Capstone was organized and regulated as a reinsurance company under

[*42] state and international law, 19 these insurance-like traits cannot

overcome its other failings. See id.

Conclusion

Based on the foregoing, we find that the facts surrounding the

Capstone pooling agreement indicate that Capstone did not perform the

functions of an insurance company. 20 See Rsrv. Mech. Corp. v.

Commissioner, 34 F.4th at 912. Accordingly, Magellan and Plymouth

have not achieved sufficient risk distribution via the Capstone pooling

arrangement.

Direct Written Policies

Sufficient risk distribution may also be achieved by issuing

policies to the Patels’ affiliated entities. See Avrahami, 149 T.C. at 182.

As noted by Ms. Garland, risk distribution “is achieved by insuring risks

that are spread out and independent of each other, either by

geographical region, type of exposure, line of business, or other criteria.”

The Patels’ expert, Mr. Angelina, agrees that with the law of large

numbers, the goal is to get an exposure base of statistically independent

risks.

In Rent-A-Center, 142 T.C. at 24, we concluded that the captive

assumed and pooled premiums for “a sufficient number of statistically

independent risks” and achieved risk distribution because it issued

policies for its affiliates that covered more than 14,000 employees, 7,100

vehicles, and 2,600 stores in all 50 states. We found that the captive in

As set forth supra Findings of Fact Part III.B.2, Capstone was initially

formed under the laws of the Turks and Caicos Islands. However, the Patels do not

argue that the Court should show deference to the Turks and Caicos regulators.

20 The Patels urge the Court to find that Capstone mirrors the Green Island

Insurance Treaty, a reinsurance pool that both parties’ experts consider to be one of

the best reinsurance pools for captive insurance. However, there are obvious,

significant differences between Capstone and Green Island. In the Green Island pool,

(1) premiums are tailored to establish rates based on an individual participant’s

unique risk profile and loss experience; (2) the pool members are very large publicly

traded companies with many independent exposures; (3) there are financial standards

for both the captive and the parent; (4) Green Island is managed by a worldwide firm,

not the same individual who also formed the captives; (5) premiums are tailored and

revised annually based on historical losses; and (6) a participants’ committee vets each

company that wants to join the pool and requires the approval of a supermajority of 75

percent of committee members for a new company to join the pool. The record reflects

that Capstone does not have any of these characteristics.

[*43] Securitas Holdings, Inc. & Subs. v. Commissioner, T.C. Memo.

2014-225, at *26–27, distributed risk effectively, for a number of

reasons, including that it provided worker’s compensation coverage for

more than 200,000 employees, automobile coverage for more than 2,200

vehicles, and other coverages for more than 25 separate entities.

By contrast, in Avrahami, 149 T.C. at 181, we found that the

captive’s issuance of seven types of direct policies covering exposures for

four related entities was insufficient to distribute risk. In Rsrv. Mech.

Corp., T.C. Memo. 2018-86, at *35–36, we found that the captive’s

issuance of eleven and thirteen types of policies for three insureds was

insufficient to achieve risk distribution. Similarly, in Caylor Land &

Dev., T.C. Memo. 2021-30, at *35, we found that having zero risks from

an unrelated party, with all risks in the same geographic area, was

insufficient for risk distribution. We determined that there was no risk

distribution where the taxpayer’s captive insured, at most, two to three

entities with six to nine lines of coverage. Swift, T.C. Memo. 2024-13,

at *29.

We reach the same conclusion here. Magellan and Plymouth

issued policies to only three (or fewer) related entities during the tax

years at issue. From 2013 through 2014, Magellan directly insured only

two related entities—OST and ICR. In 2015, Magellan directly insured

only three related entities—OST, ICR, and SCR. In 2016, Magellan

insured two related entities: ICR and SCR, and Plymouth insured just

one entity: OST. Thus, Magellan’s and Plymouth’s issuance of policies

to, at most, one to three entities is insufficient to achieve risk

distribution.

The Patels would have us focus on the number of patient visits

and procedures at each entity, not the number of insured entities. They

argue that there were between 27,442 and 34,443 patient visits and

between 6,621 and 9,084 procedures, creating over 88,200 points of

exposure for OST across multiple offices and surgical locations for one

year. We disagree. As noted by Ms. Garland, the number of patient visits

is not relevant to most of the coverages insured by Magellan and

Plymouth. Rather, the number of visits or patients is an indicator of risk

for Dr. Patel’s professional liability and general liability policies—the

commercial policies he maintained despite forming Magellan and

Plymouth. Similarly, a larger number of employees would increase the

workers compensation exposure and medical professional liability

exposure. But, again, these are coverages Dr. Patel maintained through

his commercial insurance coverage, not the microcaptives.

[*44] Moreover, as we found, the standard in the industry is to look at

the number of doctors when evaluating risk, see Swift, T.C. Memo.

2024-13, at *30, and “using the doctor-patient interaction as the

appropriate unit of measurement for risk exposure would be tantamount

to treating as the correct unit of measurement for risk exposure in the

automobile insurance context every time a car is put into gear,” id. n.13.

And we do not think the number of physicians at Dr. Patel’s entities

sufficient for risk distribution. See id. at *30. At most, the entities had

five physicians. We do not believe that this is an adequate number of

risk exposures, concentrated in one line of insurance, for the operation

of the law of large numbers. In short, the captives “face[d] a number of

independent risks that are at least a couple orders of magnitude smaller

than the captives in cases where we’ve found sufficient distribution of

risk.” Caylor Land & Dev., T.C. Memo. 2021-30, at *37.

Regardless, when determining whether an arrangement

distributes risk, we also analyze the number of independent risk

exposures, Avrahami, 149 T.C. at 183, and the Patels’ captives did not

face independent risks. As noted above, we found independent risks in

R.V.I., 145 T.C. at 228–29, when an insurance company issued 951

policies covering more than 750,000 vehicles, 2,000 real estate

properties, and 1.3 million equipment assets in 7 different geographic

regions. The captive in Rent-A-Center, 142 T.C. at 24, had sufficient

independent risk exposures when it provided workers compensation,

automobile, and general liability policies that covered more than 14,000

employees, 7,100 vehicles, and 2,600 stores in all 50 states. Independent

risk exposure was achieved in Securitas Holdings, T.C. Memo. 2014-225,

at *26–27, when the captive provided workers compensation coverage

for more than 200,000 employees, automobile coverage for

approximately 2,200 vehicles, and other coverages for more than 25

separate entities.

In considering whether Magellan’s and Plymouth’s risk exposures

were independent, we find that they fall well short of the situations

described above. Magellan and Plymouth issued 22 to 36 policies to 3

health care entities owned by Dr. Patel during the tax years at issue.

The insureds were all OST, ICR, and SCR: medical entities in the same

geographic area of West Texas with fewer than 100 employees and 5

surgeons, some of which overlap, all operating in the same “well-defined

slices of the medical field.” See Swift, T.C. Memo. 2024-13, at *31. Thus,

the lack of independent exposures is readily apparent and another

reason the captives failed to achieve risk distribution. See id.

[*45]

Revenue Rulings

Finally, the Patels claim that the IRS provides risk distribution

“safe-harbors” via Revenue Ruling 2002-89, 2002-2 C.B. 984, and

Revenue Ruling 2002-90, 2002-2 C.B. 985. The Commissioner is

required to follow his revenue rulings, and we have treated revenue

rulings as concessions by the Commissioner where those rulings are

relevant to the disposition of a case. Rauenhorst v. Commissioner, 119

T.C. 157, 171–73 (2002). But for a taxpayer to rely on a revenue ruling,

the facts of the taxpayer’s transaction must be substantially the same

as those in the ruling. Barnes Grp., Inc. v. Commissioner, T.C. Memo.

2013-109, at *37–38, aff’d, 593 F. App’x 7 (2d Cir. 2014).

Both rulings addressed situations involving parties who

“conduct[ed] themselves consistently with the standards applicable to

an insurance arrangement between unrelated parties.” Rev. Rul.

2002-89, 2002-2 C.B. at 984; see also Rev. Rul. 2002-90. However, the

rulings do not have facts substantially similar to those present here.

For example, both revenue rulings require risk distribution. See

Rev. Rul. 2002-89; Rev. Rul. 2002-90. For the reasons discussed supra

Opinion Part III.A.1 and 2, we find that risk distribution is not present

here. Further, in Revenue Ruling 2002-89, premiums were established

via customary industry rating formulas, which also are not present here.

See supra Opinion Part III.A.1.c, B.4. In Revenue Ruling 2002-90, the

premiums were the result of arm’s-length transactions, which also did

not occur here. See supra Opinion Part III.A.1.b. Accordingly, the Patels

cannot rely on the revenue rulings to deduct the purported premiums.

See Syzygy Ins. Co., T.C. Memo. 2019-34, at *48.

Conclusion Regarding Risk Distribution

We conclude that Magellan and Plymouth did not achieve risk

distribution, either through Capstone or through its affiliated entities.

Risk distribution is a necessary component of insurance, and its absence

here leads us to conclude that Magellan’s and Plymouth’s transactions

during the tax years at issue were not insurance transactions. See

Avrahami, 149 T.C. at 190.

Insurance in the Commonly Accepted Sense

The absence of risk distribution is enough for us to conclude that

the Magellan and Plymouth transactions were not insurance

transactions. See Avrahami, 149 T.C. at 190; Swift, T.C. Memo. 2024-13,

[*46] at *37. But as an alternative ground, we also look at whether the

transactions constitute insurance in the commonly accepted sense.

Caylor Land & Dev., T.C. Memo. 2021-30, at *39. In making this

determination, we examine a number of factors, including:

(1) whether the company was organized, operated, and regulated

as an insurance company;

(2) whether it was adequately capitalized;

(3) whether the policies were valid and binding;

(4) whether premiums were reasonable and the result of arm’slength transactions;

(5) whether claims were paid;

(6) whether policies covered typical insurance risks; and

(7) whether there was a legitimate business reason for acquiring

insurance from the captive.

Avrahami, 149 T.C. at 191; see also Syzygy Ins. Co., T.C. Memo. 2019-34,

at *37. Below, we examine the most salient factors to our analysis.

Organization, Operation, and Regulation

First, we consider whether Magellan and Plymouth were

organized, operated, and regulated as insurance companies. In

considering whether Magellan and Plymouth operated as insurance

companies, we “look beyond the formalities and consider the realities of

the purported insurance transactions.” See Avrahami, 149 T.C. at 192

(quoting Hosp. Corp. of Am. v. Commissioner, T.C. Memo. 1997-482,

1997 WL 663283, at *24). There is no dispute that Magellan was

incorporated and regulated as a captive insurance company in St. Kitts.

Further, Plymouth was incorporated and regulated in Tennessee.

However, aside from these organizational formalities, the facts

demonstrate that Magellan and Plymouth were not operated as

insurance companies. See Swift, T.C. Memo. 2024-13, at *37; Keating,

T.C. Memo. 2024-2, at *53. Magellan’s and Plymouth’s planning,

incorporation, and operations during the tax years at issue were

managed almost entirely by Capstone and Mr. Coomes. Magellan and

Plymouth had no employees of their own that performed services.

[*47] In the shadow of litigation, Dr. Patel paints a sympathetic and

compelling story about the downfall of the West Texas Hospital. We

believe Dr. Patel’s testimony about the end of the West Texas Hospital

and its impact on him and his family. But a close examination of the

evidence does not support his testimony that his experience with West

Texas Hospital was the reason he decided to form captive insurance

companies. Simply put, we did not find Dr. Patel’s testimony on this

point to be credible.

Further, there is no credible evidence that Dr. Patel’s

conversations about forming a captive centered around preventing a

future disaster. Indeed, Dr. Patel stated that he did not need advice

about forming a captive. Rather, he knew he was ready to proceed after

studying books about asset protection and “the secret to capturing . . .

[a] piece of America’s multi-billion dollar industry.” This is particularly

poignant given that Dr. Patel maintained all of his regular commercial

insurance coverage, including malpractice insurance, during the tax

years at issue.

Moreover, other than Dr. Patel’s self-study and the Business Plan

created for Magellan, there is no evidence that any feasibility study was

conducted to determine whether a captive was necessary and, if so, what

policies were required. There is also no evidence that due diligence was

conducted to determine whether a second captive was necessary. Rather,

it appears that a desire to take advantage of increased tax benefits came

first, and the justification to form a second captive came second.

Relatedly, there is no evidence that Dr. Patel performed any due

diligence with respect to the reinsurance or quota share agreements that

Magellan and Plymouth executed with Capstone. As we noted in Swift,

T.C. Memo. 2024-13, at *37, “[t]his omission would seem bizarre if these

were actual insurance companies.”

In reality, Capstone orchestrated Magellan’s and Plymouth’s

activities so that they appeared to be engaged in the business of issuing

insurance contracts. But the facts establish that they were not operated

as insurance companies in the commonly accepted sense. See Swift, T.C.

Memo. 2024-13, at *39; Rsrv. Mech. Corp., T.C. Memo. 2018-86, at *53.

This factor weighs against the Patels.

Capitalization

Next, we turn to capitalization. The parties agree that Magellan

met the minimum capitalization requirements of St. Kitts, and

[*48] Plymouth met the minimum capitalization requirements of

Tennessee. This is the same as adequate capitalization. See Swift, T.C.

Memo. 2024-13, at *39; Keating, T.C. Memo. 2024-2, at *56. This factor

favors the Patels.

Valid and Binding Policies

Next, we examine whether the policies were valid and binding.

The caselaw is not entirely clear on what makes a policy “valid and

binding.” We have held that policies were valid and binding when “[e]ach

insurance policy identified the insured, contained an effective period for

the policy, specified what was covered by the policy, stated the premium

amount, and was signed by an authorized representative of the

company.” Securitas Holdings, T.C. Memo. 2014-225, at *28. In R.V.I.,

145 T.C. at 231, we found that policies were valid and binding when the

insured filed claims for covered losses and the captive insurance

company paid them. We have also looked at factors beyond whether the

policies are simply binding such as conflicting policy terms. Avrahami,

149 T.C. at 194.

Generally, Magellan’s and Plymouth’s direct written policies

contained the necessary terms to make them valid and binding

insurance contracts. Nonetheless, the Magellan and Plymouth policies

also contain atypical provisions that are not common within the

insurance industry. Examples include (1) claims-made provisions that

are unfavorable to the insureds; (2) excess policy provisions despite high

premiums that are indicative of primary policies; and (3) an inability to

cancel the policies and receive refunds. Swift, T.C. Memo. 2024-13,

at *39 (noting that the policies at issue contained “questionable

draftsmanship, with several of the policies acting effectively as excess

coverage masquerading as primary”).

Given that evidence regarding the validity of Magellan’s and

Plymouth’s policies is mixed, we conclude that this factor is neutral for

the Patels. See id.; Rsrv. Mech. Corp., T.C. Memo. 2018-86, at *54–55.

Reasonableness of Premiums

Next, we examine whether Magellan’s and Plymouth’s premiums

were reasonable and the result of arm’s-length transactions. For the

reasons noted supra Opinion Part III.A.1.b and c, we find that

Magellan’s and Plymouth’s premiums were wholly unreasonable.

[*49] First, it is apparent that Dr. Patel targeted the monetary limit of

section 831(b) by telling his advisers how much he wanted to pay to the

captives. When Magellan premiums dropped as a result of a change in

the commercial insurance market, he chose to add SCR as an insured to

get the total of premiums closer to the $1.2 million target. “As a general

matter, we have serious reservations about the reasonableness of

premiums developed to hit a preordained target for tax purposes, as

here.” Swift, T.C. Memo. 2024-13, at *40.

Second, we give very little weight to Mr. Rosenbach’s premium

calculations. The record establishes that Mr. Rosenbach’s calculations

were aimed at targeting total premiums as close as possible to $1.2

million. Mr. Rosenbach used ill-defined factors to increase the premium

amounts to reach the $1.2 million limit. He was aware of the $1.2 million

limit and never priced premiums above that amount.

Relatedly, during the tax years at issue, the average rate-on-line

for the Patels’ captives’ policies was up to 12 times higher than the rateon-line for the Patels’ commercial coverages. See Keating, T.C. Memo.

2024-2, at *61 (finding a rate-on-line that was ten times higher than

commercial insurance policies “patently unreasonable”). A higher rateon-line means the insurance coverage is more expensive per dollar of

coverage, thus leading to a greater deduction for premiums. See Syzygy

Ins. Co., T.C. Memo. 2019-34, at *31–34. For example, Mr. Rosenbach

priced premiums for the legal expense policy at $14,000 for $20,000 of

coverage. As noted by Ms. Garland, this would be the equivalent of

purchasing collision coverage for a $20,000 car and paying a $14,000

premium for that policy. This is further evidence that the premiums

were unreasonable.

We also give little credit to Mr. Rosenbach’s expert reports, which

were prepared for the purpose of litigation and appear aimed at

providing justification for the high premiums. This Court has already

determined that Mr. Rosenbach’s calculations under very similar

circumstances were utterly unreasonable. See Avrahami, 149 T.C.

at 194–95; Swift, T.C. Memo. 2024-13, at *42–43. Mr. Rosenbach

admitted that he was later sued for his premium calculations in

Avrahami. Mr. Rosenbach’s bias weighs against his credibility. See

Dunn v. Sears, Roebuck & Co., 639 F.2d 1171, 1174 (5th Cir.), opinion

corrected, 645 F.2d 511 (5th Cir. 1981) (observing that an expert’s

“potential bias may be explored on cross-examination”); Nagle v.

Gusman, No. 12-cv-1910, 2016 WL 9411379, at *1 (E.D. La. Mar. 3,

2016) (finding that evidence regarding an expert’s “experience in a prior

[*50] lawsuit is relevant to his potential bias and credibility as an expert

witness” in current lawsuit); Butler v. Rigsby, No. 96-cv-2453, 1998 WL

164857, at *3 (E.D. La. Apr. 7, 1998) (“[A]n expert witness’ experiences

in prior lawsuits is relevant to demonstrate possible biases.”). We give

Mr. Rosenbach’s testimony little weight.

Finally, we once again note that Mr. Coomes could not recall

whether he ever told Mr. Rosenbach to increase or decrease a premium

amount. We found Mr. Coomes’s testimony on this point to lack

credibility, particularly in light of Magellan’s and Plymouth’s high

premiums that were closely related to Dr. Patel’s requested amounts.

We conclude that Mr. Rosenbach’s calculations were aimed not at

actuarially sound decision-making but at justifying total premiums as

close as possible to $1.2 (or $2.2) million, without going over, to satisfy

section 831(b). See, e.g., Avrahami, 149 T.C. at 196.

In short, we find that Magellan’s and Plymouth’s premiums were

unreasonable and aimed at maximizing tax deductions, not at

incorporating actuarily sound principles. “The voluminous record before

us leaves the firm impression that premium amounts were engineered

to suit the tax needs of the moment, not to account for any risk.” Swift,

T.C. Memo. 2024-13, at *40. This factor weighs heavily against the

Patels.

Payment of Claims

Finally, we look at whether Magellan and Plymouth paid any

claims. No claims were filed under Magellan’s or Plymouth’s direct

written policies during the tax years at issue. As noted above, the

majority of Capstone claims were submitted after the IRS began

examining the Capstone captives. Magellan paid only $138,205 during

the same period for its share of claims from Capstone. During that same

period, Magellan collected millions in premiums.

Further, although we have received into evidence the Fourth

Stipulation and accompanying exhibits, we find that this evidence is

only marginally helpful in deciding the issues before the Court for the

tax years at issue. As noted by respondent, changes were made to the

Capstone pooling arrangement after the IRS began examining the

captives formed by Mr. Coomes. Thus, subsequent claims activity—

made after changes to Capstone—has little bearing on our analysis of

the outcome here.

[*51] In short, the relatively small payments made by Dr. Patel’s

captives might weigh slightly in favor of the Patels. But “we do not

regard this as overwhelming evidence that the arrangement constituted

insurance in the commonly accepted sense.” Syzygy Ins. Co., T.C. Memo.

2019-34, at *45; see also Swift, T.C. Memo. 2024-13, at *44.

Conclusion Regarding Insurance in the Commonly

Accepted Sense

Although the Patels’ captives displayed some attributes of

insurance companies, the Patels have not proven that the payments that

they seek to deduct as insurance expenses were for insurance in the

commonly accepted sense. See Keating, T.C. Memo. 2024-2, at *53. The

Patels have therefore failed to prove that the payments were for

insurance for federal income tax purposes. 21

Conclusion

Regarding

Transactions

Magellan

and

Plymouth

Because we find that Magellan and Plymouth failed to distribute

risk and were not selling insurance in the commonly accepted sense, we

need not decide whether their transactions involved insurance risk or

risk shifting. Caylor Land & Dev., T.C. Memo. 2021-30, at *48 (citing

Clougherty, 811 F.2d at 1300 n.5). The premiums paid to Magellan and

Plymouth and deducted by the Patels did not constitute “insurance” for

federal tax purposes. Id. at *48–49. Accordingly, we find that Magellan’s

and Plymouth’s purported captive transactions did not constitute

insurance because they failed to distribute risk and, in the alternative,

did not act as an insurer commonly would.

IV.

Effect on Petitioners

Next, we examine the effect of these conclusions on the Patels.

After initial briefing, the Court ordered additional briefing on the tax

consequences if the transactions at issue are not insurance. See Docket

No. 24344-17, Order (Doc. 359). In response, the Patels assert that, if

21 In reaching our conclusions, we have considered that although states have

the power to regulate insurance companies, states do not have the authority to

determine whether payments made to purported insurance companies are for

“insurance” within the meaning of the Code and for federal income tax purposes. See,

e.g., AMERCO & Subs., 96 T.C. at 42. Accordingly, the Patels’ repeated argument that

the Court must defer to state agencies to determine whether the transactions are

“insurance” is without merit.

[*52] the transactions are not insurance, then they should be considered

indemnity contracts and analyzed as such. We have considered this

argument and find no evidence in the voluminous record to support the

Patels’ new argument.

As noted by respondent, Magellan and Plymouth are not parties

to this action, and therefore the tax consequences for those entities are

beyond the scope of this Memorandum Opinion. Accordingly, we need

not examine the consequences to Magellan and Plymouth.

But having determined that the Magellan and Plymouth

arrangements did not constitute insurance, we will now discuss the legal

effect of that conclusion on the Patels for the tax years at issue. Because

the payments at issue were not for insurance, “then they are not

ordinary and necessary business expenses” paid or incurred in

connection with a trade or business and may not be deducted under

section 162(a). See Swift, T.C. Memo. 2024-13, at *44–45 (quoting

Avrahami, 149 T.C. at 199). We therefore sustain the Commissioner’s

determination to adjust the Patels’ income by disallowing these

deductions.

Conclusion

Based on the foregoing, we sustain the Commissioner’s deficiency

determinations as set forth herein. In reaching our conclusions, we have

considered all arguments made by the parties, and to the extent not

mentioned or addressed, they are irrelevant or without merit.

To reflect the foregoing,

An appropriate order will be issued.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.