The U.S. Court of Federal Claims has declined to end a tax dispute before trial, allowing the Internal Revenue Service to continue challenging $239,773 in premium deductions claimed by a Texas-based captive insurance manager. The September 25 ruling in Capstone Associated Services v. United States means the case will proceed to a full hearing, with the parties required to propose a schedule by October 16, 2026.
At issue are payments made by Capstone to two affiliated insurers domiciled in Anguilla, British West Indies: FinServ Casualty Corporation and PoolRe Insurance Corporation. Capstone paid $147,595 in premiums to FinServ across ten policies and $92,178 to PoolRe for stop-loss coverage on nine of those policies. The arrangement allocated losses above a threshold between the two entities, with FinServ covering 20% and PoolRe 80%. PoolRe then ceded its share to a quota-share pool comprising 79 insurance companies, including FinServ itself.
The tax benefit stems from Internal Revenue Code Section 831(b), which allows small insurers to exclude up to $1.2 million in premiums from taxable income. The Supreme Court has previously noted that such captive arrangements carry a “potential for tax evasion,” a point cited in the opinion. Judge Kathryn C. Davis found that unresolved factual questions precluded summary judgment, rejecting Capstone’s motion to dismiss the IRS’s challenge.
Capstone relied on a controller’s declaration to prove that premiums were actually paid, but the government’s expert interpreted the underlying ledger differently. The court noted that a memorandum establishing the premium allocation was drafted during litigation, not at the time of the transactions, and the controller conceded that the original allocations were “determined prior to his being there.” This discrepancy undermined Capstone’s claim that the payments were genuine insurance premiums.
Claims handling also drew scrutiny. Capstone pointed to written procedures, but those documents were drafted by Capstone itself in its role as captive insurance manager. A government expert described the processing as “flawed and inconsistent” with the firm’s own policies, raising questions about whether the entities operated as bona fide insurers.
The most significant issue was PoolRe’s independence. Although a third party formally owned PoolRe, its own conflict-of-interest policy described it as “a wholly owned subsidiary of Capstone.” A services agreement gave Capstone the power to dissolve PoolRe, and one director testified that he provided overlapping consulting services to both companies and could not recall PoolRe ever paying a claim before 2016. These facts, the court said, could support a finding that the arrangement was a sham.
The case highlights ongoing IRS scrutiny of micro-captive insurance arrangements, which have been a focus of enforcement efforts. Advisors should note that the outcome could have implications for clients using similar structures. For more on regulatory developments, see the Sixth Circuit’s recent FINRA ruling and Treasury’s proposed tax-exempt changes.
While the IRS has often prevailed in such cases, the court’s decision to deny summary judgment suggests that the facts here are not one-sided. The trial will allow both sides to present expert testimony and documentary evidence. Until then, the $239,773 in deductions and the 20% accuracy-related penalties remain in dispute.
