The United States Tax Court recently rendered a significant decision in CFM Insurance, Inc. v. Commissioner, T.C. Memo. 2025-83, a case that adds another layer to the complex landscape of microcaptive insurance arrangements. This article provides a comprehensive overview of the case, from its foundational facts to the Tax Court’s nuanced legal analysis and ultimate conclusions.

Background and Findings of Fact

The case concerns Robertino and Antonella Presta, owners of a chain of grocery stores in the Chicago area operating under the "Caputo’s" brand. The business grew from a single 3,750-square-foot store in Elmwood Park to multiple locations, with the Prestas expanding by acquiring and opening new stores, each set up as a separate Illinois corporation. By 2015, they owned and operated several Caputo’s New Farm Produce stores, alongside other related entities like LBR Importing & Distributing, Inc. (formed for direct dealing with sellers), LBR Construction, Inc. (general contractor for store remodeling), and R&A Real Estate Holding, LLC (a holding company for their real-estate ventures, jointly owned by the Prestas and their gift trusts). The average gross revenues for the holding company alone exceeded $6 million between 2012 and 2015, with Caputo’s stores generating tens of millions in gross revenue annually.

Facing inherent risks in their expanding operations, particularly concerns about product recall, food contamination, and food-borne illness liability, the Prestas sought commercial insurance. Their insurance broker, Steve Gabinski of Arthur J. Gallagher Risk Management Services, Inc. (Gallagher), suggested forming a captive insurance company to cover these gaps, as commercial coverage was limited and prohibitively expensive. In 2012, the Prestas formed CFM Insurance, Inc. (CFM) under Utah law, an onshore domicile with low capital requirements and favorable regulatory guidelines. Artex Risk Solutions, Inc. (Artex), a division of Gallagher, was retained to operate CFM. Robertino Presta and Antonella Presta each owned a 50-percent interest in CFM, and Robertino served as its president.

CFM, as a microcaptive insurer, collected premiums just shy of $1.2 million annually from the Caputo’s entities between 2012 and 2015. CFM elected to be treated as a small insurance company under Internal Revenue Code (I.R.C.) section 831(b) for these tax years. The various Caputo’s entities deducted these insurance premiums, allocating them based on their income.

CFM provided various types of policies, including Administrative Actions, Business Interruption Difference in Conditions (DIC), Collection Risk, Crisis Management/Reputation Risk, Employment Practices Liability, General Liability DIC, Legal/Litigation Expenses, Loss of Key Customer, Loss of Key Employee, Loss of Key Supplier, Mechanical Breakdown DIC, Product Recall, Network Security & Privacy Liability, and Regulatory Change. The policies were generally evergreen, automatically renewing each year, and covered not only Caputo’s New Farm Produce, Inc. but also the Prestas’ other companies (Caputo’s entities).

The payment of premiums and issuance of policies presented irregularities:

For 2012, CFM didn’t issue actual policies until January 2013, several weeks after the coverage period had ended. The $1,199,136 premium was paid in December 2012, despite no specific due date on the invoice.
For 2013, renewal endorsements were not issued until December 27, 2013, four days before the end of the coverage period, and the premium payment was made in December 2013.
For 2014, policies were rejiggered, and the binder was sent only in May. CFM issued renewal endorsements in July 2014, which included a new Business Interruption DIC policy. Premiums were invoiced in April and May 2014, with a partial payment in July 2014 and the remainder in December 2014, violating a quarterly payment requirement.
For 2015, CFM canceled existing policies and reissued new declarations in January 2016, with a purported effective date of January 2015. The premium payment was made in December 2015, just before the end of the policy year.

Claims handling was also noted as unusual. No claims were submitted for 2012 or 2013. Only two were submitted in 2014 and three in 2015. Artex, CFM’s third-party administrator for claims, had no written guidelines until late 2013 or early 2014 and no licensed claims adjusters until 2014. Some claims were paid before a notice-of-claim form was submitted or before CFM authorized payment. One notable claim, initially denied under the regulatory-change policy, was re-submitted under the business interruption DIC policy after the Prestas asserted it was a response to a cyberattack; Artex then approved it.

The Commissioner audited CFM and the Prestas, disallowing CFM’s section 831(b) election, arguing that the transaction was not an "insurance transaction within the meaning of federal tax law" and that premiums were taxable income under I.R.C. section 61. The Commissioner also disallowed the Prestas’ pass-through insurance deductions from the Caputo’s entities and a claimed net operating loss (NOL) deduction, asserting accuracy-related penalties under I.R.C. section 6662(a).

The Parties’ Arguments and Taxpayer Request for Relief

The Commissioner contended that CFM was an illegitimate microcaptive, similar to those found non-compliant in previous cases like Avrahami, Syzygy, and Reserve Mechanical. Consequently, he argued that CFM was not a true insurance company and that the premium payments were not deductible.

The Prestas countered with several arguments:

McCarran-Ferguson Act: They asserted that under federal law, Utah’s determination that CFM qualified as an insurance company should be conclusive. Since Utah had licensed and regulated CFM as an insurer, the federal courts should defer to this state-level determination.
Common-Law Definition: Even if the McCarran-Ferguson Act argument failed, the Prestas contended that CFM still met the common-law definition of insurance under federal tax law, satisfying the requirements of risk shifting, risk distribution, insurable risk, and the commonly accepted notion of insurance.
Unwinding the Transaction: If CFM was not deemed an insurance company, the Prestas requested that the transaction be unwound. They argued that the payments to CFM should be recharacterized as either contributions of capital or deposits to a loss reserve. If recharacterized as a loss reserve, the Caputo’s entities would not be entitled to deductions for premiums, but CFM would not be liable for tax on those payments, and the Prestas would be entitled to an adjustment for reimbursements reported as taxable income.

Court’s Analysis of the Law

The Tax Court began by reiterating the established definition of "insurance" for federal tax purposes, which, though not defined in the Code or regulations, requires a transaction to involve risk-shifting and risk-distribution, an actual "insurance risk", and meet the "commonly accepted notion of insurance". The Commissioner conceded that the transactions satisfied the insurable-risk and risk-shifting criteria, narrowing the Court’s focus to risk distribution and the commonly accepted notion of insurance.

McCarran-Ferguson Act

The Court addressed the Prestas’ novel argument concerning the McCarran-Ferguson Act. The Act provides that the "business of insurance...shall be subject to the laws of the several States which relate to the regulation or taxation of such business," and no Act of Congress "shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance" unless specifically related to insurance.

The Court rejected this argument, emphasizing the distinction between "insurance" and "the business of insurance" as clarified by the Supreme Court in SEC v. Nat’l Sec., Inc., 393 U.S. 453, 460 (1969). The Court stated that its interpretation and application of the Internal Revenue Code (I.R.C.) in no way regulates the relationship between CFM and Caputo’s Fresh Market; that function remains with Utah regulators. Furthermore, the Act’s prohibition is against invalidating, impairing, or superseding state law for the purpose of regulating the business of insurance, not against federal regulation of the "business of insurance" itself. Imposing tax consequences, even if it reduces the attractiveness of microcaptive insurance, does not invalidate or impair state law (Humana Inc. v. Forsyth, 525 U.S. 299, 301 (1999)). The Court concluded that the McCarran-Ferguson Act does not mandate deference to Utah’s determination of CFM as an insurance company.

Risk Distribution

Risk distribution is rooted in the law of large numbers, requiring a sufficiently large collection of independent risk exposures for the insurer to predict losses reasonably. The Court clarified that risk distribution is viewed from the perspective of the entire package of policies an insurer writes for an insured, not necessarily each individual policy.

The Court cited previous microcaptive cases where risk distribution was found lacking, often due to insufficient numbers of brother-sister entities or independent risk exposures. For example, Avrahami v. Commissioner, 149 T.C. 144 (2017), found seven types of policies for four entities insufficient, and Caylor v. Commissioner, 121 T.C.M. (CCH) 1205 (2021), noted that even with seven policies, independent exposures ranged only from 1 to 12. In contrast, large-captive cases like Harper Grp. v. Commissioner, 96 T.C. 45 (1991), had thousands of customers and shipments, and Rent-A-Center, Inc. v. Commissioner, 142 T.C. 1 (2014), involved 14,000 employees, 7,000 vehicles, and 2,600 stores. While there’s no "bright line" number, risk distribution in successful cases involved significantly higher numbers of independent risks.

The Court also discussed the "safe harbor" provision from Revenue Ruling 2002-90, 2002-52 I.R.B. 985, where risk distribution may be adequate if a captive insurer insures 12 or more related entities, none of which represents more than 15% of the total risk insured.

Commonly Accepted as Insurance

This criterion involves assessing whether a company operates like a normal insurance company. Factors typically examined include:

Formal organization and regulation: Whether the company is licensed and regulated as an insurer.
Premium calculations: Whether premiums are reasonably priced and determined using sound underwriting principles, not "backed into" a target amount or set without considering loss history.
Valid and binding policies: Whether policies are timely issued, clearly defined, and free from conflicting or ambiguous terms.
Claims handling: Whether claims are processed consistently, with proper procedures, and not handled in an "ad hoc" or overly accommodating manner for the insured.
Employees/Absentee owners: Whether the company has sufficient internal expertise and engaged owners, or if operations are entirely outsourced with a disengaged leadership.
Due diligence: Whether adequate feasibility studies and risk analyses are conducted before policy issuance.

Application of Law to Facts and Conclusions

McCarran-Ferguson Act

The Court applied its legal analysis directly, concluding that the McCarran-Ferguson Act did not compel deference to Utah’s state-level determination of CFM’s insurance status. This argument, while novel for a domestic captive, was found unpersuasive given the Act’s purpose and the nature of federal tax law.

Risk Distribution

The Prestas did not argue, nor provide evidence, that the Caputo’s entities met the 15% total risk threshold for the Revenue Ruling 2002-90 safe harbor, thus failing to dock there.

The Court then turned to independent risk exposures, examining various categories despite the Commissioner’s initial broad objection to the Prestas’ methodology. Critically, the Court highlighted that the Commissioner’s own experts often conceded the validity of the Prestas’ proposed exposure units and that risk distribution could be achieved by combining risks across policies.

Customer Transactions: The Court accepted customer transactions (averaging 4.5 million annually across stores) as an appropriate proxy for risk exposure units. This was a pivotal finding, heavily influenced by the testimony of both the Prestas’ and the Commissioner’s experts, who largely agreed that customer numbers were appropriate exposure units for certain policies.
Products Sold: The Court accepted the 50,000 different products sold at Caputo’s stores as risk exposures. It rejected the Commissioner’s argument that third-party coverage for recalls negated Caputo’s risk, noting that Caputo’s still bore costs for storage, handling, and potential recall expenses not covered by commercial policies.
Major Equipment: The Court did not accept the 2,000 pieces of major equipment as proven risk exposures due to insufficient corroborating evidence beyond Robertino Presta’s testimony and unitemized depreciation schedules.
Computer Logins: The Court rejected computer logins (1,300-1,500) as independent risk exposures, citing a lack of expert testimony supporting their use as such.
Employees: The Court accepted 1,023–2,183 employees as risk exposures, as the Commissioner offered no compelling counter-arguments.
Key Employees: The Court did not accept the 90 key employees as sufficiently proven risk exposures due to lack of detail and corroboration for the list provided.
Regulatory Changes: The Court rejected the concept of "unlimited" regulatory changes as an exposure unit, finding it implausible. Revenue was considered a more plausible proxy for this risk.
Store Location: The Court accepted 6-8 store locations as exposure units.
Suppliers: The Court accepted one key supplier for 2012 as a risk exposure but found no proof for 2013 due to lack of a written agreement.
Unrelated Tenants: The Court did not accept 91 unrelated tenants as proven risk exposures due to lack of corroboration.
Insured Entities and Policies: The Court accepted 17-19 insured entities and 11-14 captive policies as adequate exposure units.

Regarding the independence of risk exposures:

Number of Entities: The Commissioner argued for treating all Caputo’s stores as one entity due to shared corporate services and vendors. The Court rejected this argument, finding no legal basis to disregard the separate legal status, locations, employees, and customers of each Caputo’s store.
Geographic Diversity: The Court agreed with the Commissioner that the concentration of all entities in a single metropolitan area weighed against finding complete independent risk among different entities.
Diversity of Industry: The Commissioner’s attempt to silo all entities into the "grocery-store industry" was rejected. The Court distinguished this from Caylor, noting that while some entities were linked to grocery, real estate entities and others were not necessarily dependent solely on the grocery industry, thus exhibiting independent risk.
Revenue as a Proxy for Risk: The Court rejected the Commissioner’s argument to combine all Caputo’s stores’ revenue as a linchpin, adhering to the principle of examining individual entities. This approach did not indicate a lack of independence based on revenue.
Independence of Policies: The Court found the policies sufficiently independent. Despite the Commissioner’s hypotheticals of cascading losses, his own expert testified to numerous instances where risks between policies were uncorrelated, such as an employee’s liquor sale leading to a fine at one store versus a food poisoning incident at another.

Ultimately, the Court arrived at a total of 4,551,057–4,552,225 independent exposure units, largely driven by the accepted customer transactions. This number was "over 200 times the exposure units we have found sufficient in previous cases". The Court found that there were sufficient independent exposure units for the law of large numbers to apply, and thus the policies CFM issued sufficiently distributed risk. The Court specifically noted that this was a "startling conclusion" and that the unique record and the agreement of experts, particularly the Commissioner’s experts, heavily influenced this finding, cautioning that "Our factfinding from such peculiar records is unlikely to feed precedents in the future".

Commonly Accepted as Insurance

Despite the favorable finding on risk distribution, the Court’s analysis under the "commonly accepted notion of insurance" was less sanguine for the Prestas.

Formal Operation: CFM was formally organized, licensed, and regulated as an insurance company in Utah, meeting capitalization requirements and undergoing reviews. This factor weighed in the Prestas’ favor.
Premium Calculations:
- The premiums for CFM were consistently just under the $1.2 million threshold for I.R.C. section 831(b), suggesting they were determined within a specific budget rather than purely actuarially, which weighed against CFM operating as a normal insurer.
- CFM also failed to consult its own history of losses in setting premiums, another negative indicator.
- However, concerning the reasonableness of the premiums, the Court found them to be reasonable. Expert actuaries (Ekdom and Rhodes) presented calculations that were generally in line with CFM’s premiums. The Court heavily emphasized the Commissioner’s failure to provide his own expert calculations for reasonable premiums and the contradictory testimony from his experts on this point. The Court declined to substitute the Commissioner’s judgment for that of a credible expert.
- Despite the reasonableness of the premiums, the history of premium collection weighed against CFM. Premiums for 2012, 2013, and partially 2014 were paid untimely (often in December, near the end of the coverage period), and the allowance of payment at the very end of a coverage year was deemed "eccentric".
Valid and Binding Policies:
- Untimely issuance of policies (e.g., 2012 and 2015 policies issued after the coverage period ended, 2013 policies issued four days before period end) weighed heavily against CFM operating as a normal insurer. The Court referenced Utah’s 150-day binder validity law, noting that even the 2014 policies were issued beyond this timeframe.
- Ambiguity in policy terms (e.g., unclear "Named Insured," undefined material terms like "key supplier" or criteria for "reputation damaged," blanket exclusions contradicting coverage in the Business Interruption DIC policy) also weighed against CFM. The Court applies heightened scrutiny to related-party transactions.
Claims Handling:
- CFM’s procedures for claims processing were found to be informal, with no dedicated claims department or licensed adjusters until 2014. While the Court found Artex’s process "adequate" when compared to other insurers, the informal nature was neutral.
- However, CFM’s actual claims processing weighed heavily against it. There were no claims in 2012-2013. For the five claims in 2014-2015: three were paid before notice-of-claim forms were submitted, one was paid before the policy was even issued and with the policy limit changed, and for another, an underwriter inappropriately overruled a claims adjuster’s denial. This "haphazard handling" of every single claim with material defects indicated CFM was not operated like a normal insurance company.
Absentee Owners: Robertino Presta, a 50% owner and president, had "little knowledge of the operations" and even "forgot that he had appointed himself as CFM’s president". This disengagement, while outsourcing is permissible, weighed against CFM acting as a normal insurer.
Due Diligence: CFM did engage in adequate due diligence by having Artex perform a feasibility study before policies were issued, which weighed in its favor on this specific point.

Overall Conclusion on Commonly Accepted as Insurance: The Court found it a "much closer call than is usual in microcaptive cases". Despite CFM being formally organized and regulated, adequately capitalized, and charging reasonable premiums, these factors were outweighed by its failure to operate as a normal insurance company. Key deficiencies included not regularly issuing valid and binding policies, untimely premium collection, and particularly the haphazard handling of claims. Therefore, the Court concluded by a preponderance of the evidence that CFM was not offering something that would be commonly accepted as insurance.

This determination rendered CFM ineligible for the I.R.C. section 831(b) election, meaning the premiums received by CFM were taxable income under I.R.C. section 61. Consequently, the deductions claimed by the Caputo’s entities for these premium payments were not deductible.

Unwinding the Transaction

The Prestas sought to recharacterize the payments as capital contributions or contributions to a loss reserve.

Capital Contributions: The Court rejected this recharacterization, as the payments were intended to be insurance premiums, not capital contributions.
Loss Reserve: This recharacterization was also rejected. The Prestas failed to meet their burden of proving that the substance of the transaction did not match its form and that the form was not chosen for inconsistent tax benefits. Testimony indicated the Prestas were informed that captive insurance offered greater tax benefits than a mere loss reserve.

Penalties

The Commissioner asserted I.R.C. section 6662(a) accuracy-related penalties against the Prestas for substantial understatements of income tax. The Prestas asserted a defense of reasonable cause and good faith reliance on professional advice. The Court applied the three-factor test for this defense:

Competent Professional: Hamilton Kwon, the Prestas’ CPA, was found to be a competent professional with sufficient expertise. He had 18 years of public accounting experience, researched captive insurance, and consulted with colleagues.
Necessary and Accurate Information: Kwon reviewed the information provided to Artex, engagement letters, the feasibility study, and captive policies, and had direct access to Artex.
Actual Good Faith Reliance: Robertino Presta, with no education beyond high school and no tax or insurance industry experience, reasonably relied on Kwon’s advice and a reputable public accounting firm.

The Court concluded that the Prestas reasonably relied on Kwon’s advice, which alone was sufficient to prevent the accuracy-related penalties. Additionally, the Court noted that at the time CFM was formed and returns filed, "the validity of microcaptive insurance was an issue of first impression," and there was "no clear authority to guide taxpayers". This absence of clear guidance further supported the finding that the Prestas should not be liable for penalties.

Conclusion

In summary, the Tax Court in CFM Insurance, Inc. held that CFM did not qualify as an insurance company under federal tax law, primarily due to its operational deficiencies despite sufficient risk distribution. This means:

The deductions claimed by the Caputo’s entities for premiums paid to CFM were disallowed.
The premiums received by CFM were includible in its gross income under I.R.C. section 61, and the transaction could not be recharacterized as capital contributions or loss reserves.
However, the Prestas were not liable for accuracy-related penalties under I.R.C. section 6662(a) due to their reasonable cause and good faith reliance on competent professional advice, compounded by the lack of clear authority on microcaptive insurance at the time.

This decision serves as a critical reminder for tax professionals regarding the stringent operational requirements for captive insurance companies to be recognized as legitimate insurers for federal tax purposes. While satisfying risk distribution is essential, demonstrating operations consistent with the "commonly accepted notion of insurance" through timely policy issuance, proper premium collection, and rigorous claims handling remains paramount. The case also underscores the importance of well-documented, reasonable reliance on qualified tax advisors, which can be a vital defense against accuracy-related penalties.

Prepared with assistance from NotebookLM.