We now join the microcaptive case of Patel v. CIR already in progress. The previous episode was related in my article, Another Taxpayer Microcaptive Blowout Loss In Patel (Apr. 6, 2024). This article described one of the most poorly designed and shoddily managed of the captive insurance company structures ever to be described by the U.S. Tax Court. In the end, the Tax Court found that the transactions involving the two captives (Magellan and Plymouth) and their risk pool (Capstone Re) did not constitute insurance for tax purposes and were thus not deductible by their owner’s operating businesses.
At that time, the Tax Court deferred its decision on penalties until later, and that later has now arrived in the form of the opinion in Patel v. CIR, 165 T.C. 10 (Nov. 12, 2025), which you can read here.
The Tax Court started its opinion, as all sequels do, with a recap of its earlier opinion. A physician in Texas, Dr. Patel, through self-study decided that he needed to start a captive insurance company. Dr. Patel was put into contact with a financial advisor who performed an analysis of Dr. Patel’s situation, and then put Dr. Patel in contact with Sean King of captive manager CIC Services, LLC. The financial advisor recalled that Dr. Patel stated that his medical practice was paying $2.5 million in income taxes and that he desired the formation of two microcaptives. The e-mail evidence between Dr. Patel and King “during the tax years at issue contain similar suggestions that the purpose of forming a captive was tax avoidance, not insurance protection.” There also didn’t appear to be much if any discussion as to whether Dr. Patel even needed a captive for insurance purposes.
CIC Services advised Dr. Patel that it could form and manage a captive for Dr. Patel “without conduct any studies related to the need to form a captive.” But Dr. Patel didn’t want just one captive, he wanted two.
In the meantime, Dr. Patel hired a tax attorney by the name of Coomes to help with the creation of the captive. Coomes apparently did not have any experience with insurance, much less captive insurance, and was self-taught through books and articles. Nonetheless, Coomes assisted Dr. Patel in 2011 to complete the application s to form a captive insurance company. Coomes then “forwarded the applications to an actuary, Allen Rosenbach of ACR Solutions Group, to purportedly price the premiums for the policies.” This led to the development of the policies that were to be sold by Dr. Patel’s new captive (Magellan Insurance Company) to his medical practice.
Coomes also created a business plan for Magellan which outlined the insurance coverages that it would offer and that Dr. Patel’s practice would pay about $1.145 million for the captive’s insurance policies. As the Tax Court opinion noted:
“The record establishes that the business plan was created to serve as justification to form a captive—after the decision had already been made—not to analyze whether a captive was necessary. [] No person associated with Magellan completed a feasibility study to determine the costs and merits of a captive arrangement for Dr. Patel’s businesses. [] Moreover, neither Dr. Patel nor his advisers explored the cost and availability of the same policies on the commercial market.”
But of course Dr. Patel had wanted two captives and not just one. Coincidentally, Dr. Patel’s nephew was a tax attorney. In 2015, this nephew sent Dr. Patel a copy of an article which warned that Congress and the IRS were looking into microcaptives and that they would “likely be coming under heightened review/scrutiny.” This apparently didn’t phase Dr. Patel and so in 2016, he told his financial adviser that he wanted to form a second captive. According to the Tax Court’s opinion: “The record demonstrates that Dr. Patel’s decision to form a new captive was motivated by his desire to retain increased limits on income tax deductibility.”
By e-mail, the financial adviser told Sean King at CIC Services that Dr. Patel wanted a second captive for that tax year. Ominously, the same e-mail noted that the IRS had contacted Dr. Patel’s accountant about Magellan and that other microcaptives formed by Coomes were being examined. Despite this, Dr. Patel went forward with his new captive, called Plymouth Insurance Company and formed in 2016. Dr. Patel also increased the total amounts paid for captive insurance premiums.
It was worth noting by the Tax Court that Dr. Patel kept purchasing his insurance policies from commercial insurers just as before. This included Dr. Patel’s malpractice insurance, liability and umbrella insurance, workers compensation, and the like. The total premiums for this insurance ran from $68,000 to $106,000 per year.
What did Dr. Patel’s two captives insure? The Tax Court observed that the two captives often duplicated the coverage issued by the commercial carriers, as well as covered some dubious risks, for just over $4.5 million. It was also observed that Dr. Patel never consulted his insurance broker to determine whether the captive’s coverage was commercially available (as noted above, it was) or whether the commercial coverage was cheaper (it also was, and much so). Moreover, although Dr. Patel claimed that a purpose of the captive was his trust of captive insurance over commercial carriers, Dr. Patel never used his captives to insure his biggest liability, that of medical malpractice.
Tax attorney Coomes, the one who was self-taught in insurance, had formed a risk pool called Capstone Reinsurance Co. Ltd., for use of his clients’ microcaptives. Magellan and Plymouth participated in the risk pool such that 51% of their premiums appeared ― at least on paper ― to be mixed with premiums with unrelated captives to cover common risks. But that was on paper, and the Tax Court remarked that Capstone Re provided little more than a “circular flow of funds” which did not distribute risk in any meaningful sense.
All that brought that Tax Court to the issue of premium pricing, which was “developed to facilitate favorable income tax treatment for the Patels, not for business purposes.” The actuary involved, Rosenberg, was hired to determine premium pricing but instead was “flexible” in setting premiums “when requested to do so.” Instead, Dr. Patel determined the amount of premiums that he wanted to pay and Rosenbach apparently just backfilled the premiums until those premiums got close to the maximum limits allowing in particular years by the tax laws.
In the end, the Tax Court determined that:
“The foregoing facts demonstrate that the purpose of issuing policies through the microcaptives was to drive up premium prices to take advantage of the deductibility of premiums paid to the microcaptives. [] The record does not support a finding that the purpose of these transactions was to provide legitimate insurance coverage needs.”
Needless to say, the IRS took a dim view of Dr. Patel’s captive arrangements and disallowed the deductions from tax years 2013 to 2016 for the premiums paid to the captive. As related in my previous article, the Tax Court ruled against Dr. Patel (and his wife) and in favor of the IRS in what could only be described as a total blowout opinion. But that ruling left the penalties to be addressed.
In an earlier opinion, the Tax Court had granted in part the Patels’ motion for summary judgment as to part of their penalties on the grounds that the involved IRS agent had failed to follow the correct procedures to obtain supervisor approval. But that still left for the Tax Court the issue of whether the Patels were subject to the 20% accuracy-related penalties for tax years 2013 through 2016. The Tax Court now took up the issue of those accuracy-related penalties.
After a lengthy ― and excellent ― discussion of the history of the economic substance doctrine, the Tax Court noted that Congress had set forth a two-part test to determine whether economic substance was present in a transaction: (1) the transaction causes a material change to the taxpayer’s economic position, other than the tax benefits; and (2) the taxpayer had a substantial purpose for entering into the transaction, other than the tax benefits.
Applying this test to the Patel captives, they were an obvious flop. The insurance premiums circulated between Magellan, Plymouth and Capstone were simply circular transactions which did not change the Patels’ economic position. “Further, Dr. Patel paid unreasonable and excessive premiums, up to the amount allowed by section 831(b), while maintaining his commercial insurance coverage.” There was also an obvious disconnect between the price of the premiums paid by Dr. Patel to his captives (totaling over $4.5 million) against his cost for commercial insurance ($68,000 to $106,000 depending on the year).
Moreover, the record evidence indicated that Dr. Patel had entered into his captive transactions for the very purpose of trying to avoid taxes and without true regard to the insurance effect of these transactions:
“How do we know? Mr. Rosenbach did not provide actuarially determined policy premiums. [] To the contrary, he changed the premium amounts when requested to do so. [] We further note that Dr. Patel provided target premiums he wanted to pay, focusing on the maximum amounts he could pay into the captive. [] Those maximums coincided with the relevant limit provided by section 831(b), and Mr. Rosenbach was aware of the ceiling.”
In other words, Rosenbach was not applying actuarial principles to set premiums, but was instead simply following the desires of Dr. Patel that those premiums be as high as possibly within the limits of Tax Code § 831(b). This resulted in the “oddity of a purported customer seeking to maximize his expense”. The Tax Court also noted that Dr. Patel was effectively on both sides of the transaction, since he could set the very high premiums charged by the captives that he owned, and then cause his medical practice to pay those absurd premiums.
The Tax Court also could not let pass that Dr. Patel insisted on forming his second captive, Plymouth, even though he was by then aware that his first captive, Magellan, was under IRS examination and that other captives formed by tax attorney Coomes were also under examination.
Further, Dr. Patel’s responses for the financial feasibility study did not address the primary purpose of such studies: To determine if there is an insurance need for a captive. The Magellan business plan was created after Dr. Patel had already decided to form his captive, and numerous e-mails suggested that the purpose of Magellan was to reduce Dr. Patel’s income tax, not to increase his insurance protection. When Magellan did issue insurance policies, those often overlapped in coverage the insurance that Dr. Patel was already purchasing from his commercial carriers. It was also telling that Dr. Patel did not use his captives to insure his biggest real risk, being malpractice liability, but left that exclusively to the commercial carriers.
The bottom line was that the Tax Court affirmed the IRS’s assessment of the 20% accuracy-related penalties against Dr. Patel for tax years 2014-2016. But wait, it gets worse.
Section 6662(i) of the Internal Revenue Code allows for an increased penalty, from 20% to 40%, for an underpayment of tax that results from “nondisclosed noneconomic substance transactions”. This requires an analysis of whether a taxpayer has made an “adequate disclosure” of the transaction in the tax returns or an addendum to the tax return. The Tax Court found that the Patels had failed to make such adequate disclosure for the years 2014 and 2015.
There was also the question as to whether the Patels were liable for accuracy-related penalties for negligence and substantial understatements of income tax. In this context, “negligence is strongly indicated where a taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction, credit, or exclusion on a return that would seem ‘too good to be true’ under the circumstances.”
The Tax Court effectively found that Dr. Patel should have known better. He held multiple professional degrees and described himself as a “savvy financial person”. Dr. Patel’s desire to form a captive came from his own self-study. Yet, Dr. Patel failed to investigate whether he could properly use a captive insurance structure to reduce his tax liability. “This is exactly the type of “too good to be true” transaction that should cause taxpayers to seek out competent advice from independent advisers.” Moreover, Dr. Patel’s own nephew had warned him that the IRS was investigating these exact sorts of captive arrangements before Dr. Patel went forward with forming the second captive, Plymouth.
This brought the Tax Court to the issue of whether Dr. Patel had engaged in his captive transactions under something known as substantial authority. There can be no penalty assessed for understatement of taxes if the position of the taxpayer was supported by substantial authority. “Substantial authority for the treatment of an item exists only if the weight of the authorities supporting the treatment of the item is substantial in relation to the weight of authorities supporting contrary treatment.” This is determined in relation to the particular facts and circumstances of the transactions under examination.
The Patels here argued that the captive transactions were supported by substantial authority because of the so-called “safe harbors” created by IRS Revenue Rulings and prior court opinions related to captives. The problem with this argument was that it had already been rejected by the Tax Court in its earlier decision regarding the Patels’ captives. Further, “no prior captive cases supported the allowance of deductions as insurance expenses for payments that were not made for insurance.” Since the Patels’ transactions had already been held not to be insurance for tax purposes, this argument was a dead end.
To counter this, the Patels argued that the favorable case law which applied to much larger captives should support their microcaptive transactions. However, “nothing in these cases permitted Dr. Patel to form a captive without any business rationale and for the sole purpose of obtaining tax benefits.” Thus, the Tax Court decided that there was no substantial authority supporting the Patels’ captive transactions.
Nor had the transaction acted with reasonable cause or in good faith. While the Patels argued that Dr. Patel had relied upon the advice of professionals in deciding to form Magellan and Plymouth, the Patels did not identify these professionals. The Tax Court thus assumed that the Patels meant Coomes, King and Fay. But each of these persons had problems.
Taxpayers cannot rely upon the promoter of a tax transaction to demonstrate good faith. Coomes and Sean King could thus not be relied upon because they were promoters for this purpose. As to Coomes, he had structured Dr. Patel’s captives, drafted the policies, designed and set up the risk pool program, and sold these microcaptive deals to these clients to generate fees. As to King, he had provided captive management services to Magellan and Plymouth for fees and also profited from the pooling arrangement. Thus, they were promoters in relation to Dr. Patel and he could not reasonably rely upon their advice.
That left Fay, but Dr. Patel himself testified that he did not seek advice from Fay in determining whether to form a captive. Dr. Patel also testified that he knew that Fay was unfamiliar with captives and only wanted Fay to put him in contact with somebody who did. Thus, without determining whether Fay was also a promoter, the Tax Court determined that Dr. Patel could not rely upon his advice in good faith.
Further, the fact that Dr. Patel considered himself to be “financially savvy” came back to haunt him as the Tax Court noted that he should have seen that the tax benefits of his captive arrangements were “too good to be true”.
This concluded the Tax Court’s opinion, which held that Dr. Patel should pay the 40% penalty for tax years 2014 and 2015, and the 20% penalty for tax year 2016.
ANALYSIS
The really crazy thing is that this opinion exists at all, because Dr. Patel made a bizarre decision to take this case to the U.S. Tax Court. For these tax years, the IRS had been routinely settling similar microcaptive cases for only the 20% penalty. But even if Dr. Patel had paid the full amount with the 40% penalties, he would still have been ahead over litigation when one considers the likely hundreds of thousands of dollars spent on case. There was just no way that Dr. Patel was going to be ahead by litigating his captives as opposed to simply settling with the IRS as the vast majority of microcaptive owners had done before and since.
A cynic might suggest that those who urge their clients to take these very bad facts microcaptive cases to Tax Court are scamming their clients out of legal fees to try hopeless cases.
There can be little doubt that Dr. Patel’s microcaptive case was nothing less than Dead On Arrival at the Tax Court. Of all the microcaptive cases that have resulted in Tax Court opinions, the facts of Dr. Patel’s captives were by a good measure the worst. From start to finish, Dr. Patel’s captives were very poorly conceived and then very poorly operated. Almost nothing was done right with Dr. Patel’s captives. Thus, there was just no reason whatsoever to believe under these facts that Dr. Patel was going to notch the first win for a microcaptive before the Tax Court. In my opinion, if somebody convinced Dr. Patel to take this case to Tax Court, they sold him a bill of goods. On the other hand, Dr. Patel may have convinced himself that he was right (always a dangerous thing) and set out to prove that. If so, he proved the precise opposite.
Dr. Patel is not the only person who comes out of this mess looking like a fool. Some of the folks who assisted Dr. Patel with his captive also come out looking negligent if not outright incompetent. What were these professionals paid for other than to get Dr. Patel’s captives right? Somehow, Dr. Patel had stumbled into the amateur hour for captives and he paid the price. But there is a lesson there too in choosing one’s professional advisors ― and in seeking an independent second opinions. One might suggest based on these facts, however, that the last thing Dr. Patel probably wanted was an independent second opinion that told him the truth: The tax benefits he sought were unavailable to him. And that’s the thing with tax shelters, which is that once somebody has set their mind on the tax savings there will always be somebody willing to take their money to try to get them to that result, even if the result is ultimately beyond their reach.
What a good captive advisor would have told Dr. Patel was the truth: A captive was never going to work for him in his situation. But, again, the self-described “financially savvy” Dr. Patel through his own self-study had set his mind upon a captive, looking at only the potential tax benefits while ignoring the impossibly high hurdles that had to be cleared (and ultimately which were not cleared). Then, Dr. Patel relied upon the microcaptive promoters to shield him from penalties, although those promoters were exactly the folks that he was not allowed to rely upon.
Otherwise, this opinion is a great read for the technical requirements of how penalties are to be considered in general and specifically for microcaptives. This opinion is also instructional in that tax deals cannot be approached on a “shoot first, aim later” basis. To avoid penalties, any deal that will have significant tax benefits must be deeply analyzed in advance of implementation, non-tax benefits must be substantial and bona fide, and an independent tax attorney should review the proposed arrangement and sign off on it being legitimate and defensible.
None of which was done here.