The line between legitimate tax planning and unsuccessful tax avoidance is indistinct. Courts routinely grapple with whether a taxpayer has crossed the line from legitimate tax planning to unsuccessful tax avoidance. Legislated exemptions, such as the one provided under section 501(c)(15) for some insurance companies, are a public and open invitation to tax planning.
This kind of tax planning runs the risk, however, of being considered unsuccessful tax avoidance in circumstances in which the taxpayer has a weak or nonexistent business purpose for an insurance arrangement. In examining the bona fides of an insurance arrangement, courts will look behind the formal structure and scrutinize its reasonableness and business purpose to determine if the taxpayer has met the requirements for the insurance exemption.
It can be difficult to predict how courts will proceed when they engage in this examination, particularly because common law tests involve several criteria and ultimately rely on the exercise of judicial discretion. Still, it is now possible to use machine-learning models to gain insight into how courts have approached insurance arrangements based on the totality of the case law. Leveraging insights from a systematic analysis of earlier decisions in the form of a machine-learning model allows researchers to make accurate predictions about how future cases are likely to be resolved. Indeed, Blue J Tax achieves 94 percent accuracy in modeling how insurance arrangement cases will be resolved by the courts.
In this month’s installment of Blue J Predicts, our focus is on the taxpayer’s appeal of the Tax Court’s decision in Reserve Mechanical.1 We examine the strength of Reserve’s appeal on the issue of whether it was exempt from tax as a valid insurance company under section 501(c)(15). The Tenth Circuit heard oral arguments on May 4, and its decision is pending. Based on the facts found by the Tax Court, Blue J predicts with 77 percent confidence that Reserve’s appeal will be dismissed.2
1Reserve Mechanical Corp. v. Commissioner, T.C. Memo. 2018-86.
2 To uncover the machine-learning insights detailed in this article, we assume for the purpose of analysis that Reserve will succeed on the issue of whether at least 30 percent of the premiums it received are from unrelated insureds. Additionally, we assume for the purpose of analysis that the Tenth Circuit will not determine the issue of whether Reserve is an insurance company solely on the bona fides of the reinsurer, PoolRe. As both these issues may be determinative of the outcome of whether Reserve is an insurance company, we assume for the sake of analysis that Reserve will satisfy these requirements in order to uncover the impact of other important factors for the purpose of analysis and to arrive at the 77 percent confidence prediction.
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