Opinion
10704-19
04-05-2022
Robertino Presta & Antonella Presta, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER
Mark V. Holmes Judge
This is one of two related cases that have been assigned to this division of the Court. There has been extensive pretrial preparation, and trial is set to begin on May 31, 2022. Petitioners moved on March 11, 2022 to amend their petition in this case; respondent opposed the motion on March 22, 2022.
Background
The most important background fact in this case is that it is one of the Commissioner's many challenges to the validity of microcaptive insurance arrangements. These arrangements seem to have proliferated mightily in the last decade. See Avrahami v. Commissioner, 149 T.C. 144 (2017); Caylor v. Commissioner, T.C. Memo. 2021-30, 121 T.C.M. (CCH) 1205 (2021); Syzygy Ins. Co. v. Commissioner, T.C. Memo. 2019-34, 117 T.C.M. (CCH) 1165 (2019); Rsrv. Mech. Corp. v. Commissioner, T.C. Memo. 2018-86, 115 T.C.M. (CCH) 1475 (2018); see generally I.R.S. News Release IR-2019-47 (Mar. 19, 2019) (reporting before the pandemic that there were more than 500 docketed microcaptive cases pending before the Court).
If such an arrangement works, it generates immediate deductions for the payment of insurance. This premium income can then be excluded by the microcaptive under IRC § 831. One of the Commissioner's complaints in such cases is that the premiums are set wildly too high, creating inflated deductions. Another is that microcaptives sometimes don't pay out very much in the way of claims, making them look not very much like insurance as it's traditionally understood.
With this motion to amend their pleading, the Prestas want to hedge their bet that the trial will show that their microcaptive works. If they lose that bet, they argue, they should at least be allowed to show that some of the losses that their microcaptive paid out as claimed would otherwise have been deductible. They argue that they didn't take deductions for these expenses on their returns because they were accounted for as losses reimbursed by insurance. But if they lose their primary argument and their insurance-expense deductions have to be added back into income, they now argue that the microcaptive must be the equivalent of a loss reserve, which would mean that the claims paid could just be recharacterized as ordinary business losses that were deductible as not reimbursed by insurance.
There is intuitive plausibility in this argument.
But can they amend their petition now, so close to trial, to put it in play?
Discussion
Tax Court Rule 41(a) provides that when more than 30 days have passed after an answer has been served, "a party may amend a pleading only by leave of Court or by written consent of the adverse party, and leave shall be give freely when justice so requires."
Whether a party may amend its answer lies within our sound discretion. Quick v. Commissioner, 110 T.C. 172, 178 (1998) (citation omitted). In determining the justice of allowing a proposed amendment, we must examine the particular circumstances of the case, and consider, among other factors: (a) whether an excuse for the delay exists; and (b) whether the opposing party would suffer unfair surprise, disadvantage, or prejudice. Estate of Ravetti v. Commissioner, 64 T.C.M. (CCH) 1476, 1478 (1992).
A. Delay
Petitioners first argue that they didn't really delay, because in the petition that they filed back in 2019 they warned respondent "that they may be entitled to additional deductions, credits or other adjustments that were not claimed or allowed on their original filed income tax returns." Rule 31(a) requires "fair notice of the matters in controversy." The quoted language does not give respondent notice of anything like the argument in the alternative that petitioners now raise-it's much too general to do that.
B. Prejudice
We nevertheless often exercise our discretion to overlook delay if allowing an amendment would be in the interests of justice and wouldn't prejudice the nonmoving party. Petitioners argue that respondent wouldn't be prejudiced in this case because the parties have engaged in an extensive and mostly cooperative exchange of records. They argue in particular that they provided all of the microcaptive's claim files to respondent and earlier this year informally answered respondent's questions about how they accounted for claims made and paid for both book and tax accounting purposes.
Respondent acknowledges that petitioners were forthcoming in producing their accounting records, but observe that this isn't the same as making clear how petitioners accounted for these claims for tax purposes. We don't see prejudice here because it is the rare taxpayer who makes alternative arguments on his returns, and petitioners stress this is an alernative litigating position.
But respondent also argues that petitioners are not just trying to plead a new argument, but rather are raising a new issue. We do distinguish between new theories or arguments, and new matters or issues-"we have held that for respondent to change the section of the Code on which he relies does not cause the assertion of the new theory to be new matter if the section relied on is consistent with the determination made in the deficiency notice relying on another section of the Code." Barton v. Commissioner, 63 T.C.M. (CCH) 2202, 2207 (1992) (citing Estate of Emerson v. Commissioner, 67 T.C. 612, 620 (1977)), aff'd, 993 F.2d 233 (11th Cir. 1993).
The key distinction is whether proof of the new argument would reasonably alter the evidence presented. A new theory or new argument is just about the existing evidence. A new issue is one that would reasonably require consideration of new evidence, and the prejudice to the nonmoving party is typically an inability to gather that new evidence in time for trial. See Hurst v. Commissioner, 124 T.C. 16, 30 (2005).
This is an argument that we find convincing. Petitioners' microcaptive may well have to be either an insurance company or the equivalent of a loss reserve. But paying claims from a loss reserve is not sufficient proof of their deductibility. That proof must show that the claimed loss or expense was ordinary and necessary to the business and not nondeductible or chargeable to capital or limited by the Code in some other way.
With trial rapidly approaching and discovery at an end, letting petitioners amend their petition to raise the issue that claims made were also deductible would be prejudicial to respondent. It is therefore
ORDERED that petitioners' unopposed April 1, 2022 motion for leave to file a reply to respondent's response is granted. The Reply to Response to Motion for Leave to File Out of Time First Amendment to Petition lodged with the motion shall be filed as of the date of this Order. It is also
ORDERED that petitioners' March 11, 2022 motion for leave to file out of time first amendment to petition is denied.