rr-01-31.pdf

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Part I
Section 162.–Trade or Business Expenses
26 CFR 1.162-1: Business Expenses
(Also §§ 118, 165, 301, 801, 831; 1.118-1, 1.165-1, 1.301-1)
Rev. Rul. 2001-31
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 (6
th
Cir. 1989); Clougherty Packing Co. v. Commissioner,
811 F.2d 1297 (9
th
Cir. 1987) (employing a balance sheet test, rather than the
economic

2
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 (6
th
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).
EFFECT ON OTHER DOCUMENTS
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.
DRAFTING INFORMATION
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).