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Revenue Ruling 2001-31 IRS Abandons Economic Family Theory

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Revenue Ruling 2001-31 IRS Abandons Economic Family Theory

Postby Riser Adkisson LLP » Thu Nov 27, 2008 9:51 am

Revenue Ruling 2001-31, 2001-26 I.R.B. 1348 (6/25/2001)

Amplified by Rev. Rul. 2002-89

Amplified by Rev. Rul. 2002-90

Section 162 - Trade or Business Expenses

26 CFR 1.162-1: Business Expenses

(Also sections 118, 165, 301, 801, 831; 1.118-1, 1.165-1, 1.301-1)

This ruling explains that the Service will no longer raise the "economic family theory" set forth in Rev. Rul. 77-316 (1977-2 C.B. 53), in addressing whether captive insurance transactions constitute valid insurance. Rather, the Service will address captive insurance transactions on a case-by-case basis.

Rev. Rul. 2001-31

Recent abuses of IRC §501(c)(15) companies have compelled the IRS to issue multiple Revenue Rulings, Procedures, Notices and Bulletins addressing various issues associated with the use of closely-held insurance companies. In addition, the IRS is closely scrutinizing companies organized pursuant to IRC §501(c)(15). Recently issued IRS publications include:

In Rev. Rul. 77-316, 1977-2 C.B. 53, three situations were presented in which a taxpayer attempted to seek insurance coverage for itself and its operating subsidiaries through the taxpayer's wholly-owned captive insurance subsidiary. The ruling explained that the taxpayer, its non-insurance subsidiaries, and its captive insurance subsidiary represented one "economic family" for purposes of analyzing whether transactions involved sufficient risk shifting and risk distribution to constitute insurance for federal income tax purposes. See Helvering v. Le Gierse, 312 U.S. 531 (1941). The ruling concluded that the transactions were not insurance to the extent that risk was retained within that economic family. Therefore, the premiums paid by the taxpayer and its non-insurance subsidiaries to the captive insurer were not deductible..

No court, in addressing a captive insurance transaction, has fully accepted the economic family theory set forth in Rev. Rul. 77-316. See, e.g., Humana, Inc. v. Commissioner, 881 F.2d 247 (6th Cir. 1989); Clougherty Packing Co. v. Commissioner, 811 F.2d 1297 (9th Cir. 1987) (employing a balance sheet test, rather than the economic family theory, to conclude that transaction between parent and subsidiary was not insurance); Kidde Industries, Inc. v. United States, 40 Fed. Cl. 42 (1997). Accordingly, the Internal Revenue Service will no longer invoke the economic family theory with respect to captive insurance transactions.

The Service may, however, continue to challenge certain captive insurance transactions based on the facts and circumstances of each case. See, e.g., Malone & Hyde v. Commissioner, 62 F.3d 835 (6th Cir. 1995) (concluding that brother-sister transactions were not insurance because the taxpayer guaranteed the captive's performance and the captive was thinly capitalized and loosely regulated); Clougherty Packing Co. v. Commissioner (concluding that a transaction between parent and subsidiary was not insurance).


Rev. Rul. 77-316, 1977-2 C.B. 53; Rev. Rul. 78-277, 1978-2 C.B. 268; Rev. Rul. 88-72, 1988-2 C.B. 31; and Rev. Rul. 89-61, 1989-1 C.B. 75, are obsoleted.

Rev. Rul. 78-338, 1978-2 C.B. 107; Rev. Rul. 80-120, 1980-1 C.B. 41; Rev. Rul. 92-93, 1992-2 C.B. 45; and Rev. Proc. 2000-3, 2000-1 I.R.B. 103, are modified.


The principal author of this revenue ruling is Robert A. Martin of the Office of Associate Chief Counsel (Financial Institutions & Products). For further information regarding this revenue ruling, contact Mr. Martin at (202) 622-3970 (not a toll-free call).
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Re: Revenue Ruling 2001-31 IRS Abandons Economic Family Theory

Postby elodiex » Thu Apr 30, 2009 5:03 am

Dentist and the malpractice insurance they are required to carry. What is lawsuit protocol?
I am in medical malpractice settlement negotiations with a dentist. Her insurance company was handling the negotiations, then the dentist license expired and the insurance company dropped the dentist. The dentist obtained a new policy from a new insurance company. Now the original insurance company has dropped out of negotiations. Is it possible that the original insurance company wants me to file suit against the dentist, and then the new insurance company will have to defend the dentist? Or, because the first insurance company received the initial settlement letter with notice of intent to sue, they will have to carry on and defend the dentist even though they no longer have the dentist as a client. Please clarify the typical procedure in this type of situation. Thanks a million! N.
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