STEP – US doctors succeed in attorney-client privilege claim over micro-captive insurance advice

Enjoy this article courtesy of STEP:

“In US v Micro Cap KY Ins. Co. Inc. (No. 5:16-cv-00278, 2017 WL 1132904), the US District Court (Eastern District of Kentucky) held, on March 27, 2017, that email communications between two doctors and the a law firm, which had advised them in the formation of captive insurance companies, should be protected by attorney-client privilege.

The IRS summons

Attorneys at Moore Ingram Johnson & Steele LLP (MIJS) helped the two doctors to each set up their own micro-captive insurance company (Micro Cap KY Insurance Company, Inc. and Cavallo Nero Insurance, Inc.) to insure their respective portions of risk of their joint dermatologist business.

The Internal Revenue Service (IRS) subsequently carried out an audit of the companies’ income tax liabilities for the tax years 2012-2014, and issued a summons asking that they produce documents for examination. The doctors complied by producing all the documents identified in the summons, but refused to hand over email exchanges with MIJS, claiming they were covered by attorney-client privilege. The IRS sought full compliance with the summons through an enforcement action.


Captive insurance transactions “are transactions of interest”

As reported in the November 9, 2016, edition of STEP’s North America News Digest, IRS Notice 2016-66, issued on November 1, 2016, identifies certain transactions relating to small captive insurance companies as “transactions of interest”. The IRS wishes to gather more information about why and how small captives, which have the potential for tax avoidance, are being formed and operated.

In Micro Cap, the US District Court upheld the doctors’ claim to attorney-client privilege, but law firm Mayer Brown says that: “To the extent the IRS’s actions in Micro Cap reflect the manner by which these [IRS] campaigns will be conducted, taxpayers with campaign issues should brace themselves for contentious examinations.”


Waiving attorney-client privilege

The District Court agreed with the Magistrate Judge of the Eastern District of Kentucky, who held that the doctors had properly invoked the principle of attorney-client privilege and had not, by filing a petition against the Commissioner of the Internal Revenue Service before the US Tax Court, waived their right to it. In that related Tax Court claim, the doctors had argued that relying on their lawyers’ advice protected them from the imposition of penalties under the “reasonable cause” defence.

The District Court found that the doctors’ communications with MIJS were covered by the principle of attorney-client privilege and did not need to be produced to the IRS.


“The district court’s opinion in Micro Cap bolsters the attorney-client privilege…and should provide some relief to tax planners and taxpayers who rely on attorney advice and tax opinions in structuring their business transactions”, says Mayer Brown. “While the District Court’s opinion is arguably of limited precedential value, it should serve as a persuasive predicate for future court decisions.” – “