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Today the Treasury Department and the IRS issued guidance on the qualification of arrangements as “insurance” for federal income tax purposes.

Today’s ruling does not call into question the vast majority of insurance contracts, which are issued by commercial insurance companies in the ordinary course of business. Instead, it reminds taxpayers who are parties to smaller one-on-one arrangements that the requirement of risk distribution must be met for the arrangements to qualify as insurance. The ruling was accompanied by a notice soliciting comments from the public on other insurance-related topics.

Since the Supreme Court’s 1941 decision in Helvering v. LeGierse, both risk shifting and risk distribution have been required for an arrangement to constitute insurance for Federal income tax purposes. Revenue Ruling 2005-40 concludes that an arrangement with an entity that “insures” the risks of only one policyholder does not qualify as insurance for tax purposes because the risks are not distributed among other policyholders. The ruling also explains how this conclusion applies to single-member limited liability companies, which in some cases are treated as entities separate from their owners and in other cases are disregarded.

Qualification of an arrangement as insurance may effect whether the issuer is taxed as an insurance company and whether or when amounts paid under the arrangement may be deductible. If an arrangement does not qualify as insurance, it may instead be characterized as a deposit, a loan, a contribution to capital, or an indemnity arrangement other than an insurance contract.

Source: Dept of Treasury