Delaware Fighting to Against IRS Over Captive Insurers’ Trying to Search Legal Action in Supreme Court

The state of Delaware is going to the action with Supreme Court in its fight with the Internal Revenue Service (IRS) over the release of information on captive insurers.

This fight has placed Delaware’s state regulation of insurance and its authority to protect corporate privacy up against the power of the IRS to enforce federal tax laws.

The IRS wants the Delaware Department of Insurance to give it data on two captive insurers for an investigation it is conducting into potential tax avoidance by micro-captives. The IRS has been warning about alleged “abusive micro-captive insurance” transactions for years, even placing them on an annual “Dirty Dozen” list of tax scams. The IRS insists it is entitled to the information under federal tax laws.

But Delaware has a corporate privacy law that the insurance department says bars it from disclosing certain information about captive insurance companies to anyone, including the federal government, without the companies’ consent. However, the law does allow disclosure to the federal government if it agrees in writing to keep the disclosed information confidential. The IRS would not agree to do that and instead petitioned the District Court to enforce its summons against the insurance regulator.

The Department of Insurance argues that, under the federal McCarran-Ferguson Act, which established state regulation of the business of insurance, Delaware law overrides the IRS’s statutory authority, and it should not have to provide the information to the IRS.

The District Court backed the IRS. While the McCarran-Ferguson Act does protect state insurance laws from federal intrusion in certain situations, the District Court concluded that, before any such reverse- preemption occurs, precedent requires that the conduct at issue – in this case, the refusal to produce summonsed documents – must constitute the “business of insurance” within the meaning of the federal McCarran-Ferguson law. The District Court held that this threshold requirement was not met.

In late April the Third Circuit Court of Appeals affirmed the lower court’s ruling and it has now mandated that the Delaware insurance commissioner comply with the summons for information.

The Department of Insurance is asking Supreme Court Justice Samuel Alito to issue an emergency order pausing the Third Circuit’s mandatory order pending consideration of its appeal of the ruling to the full Supreme Court.

The state calls the lower courts’ rulings a “misapplication” of “reverse-preemption” under McCarran-Ferguson. These courts found that a state insurance regulatory statute did not reverse-preempt a federal statute that is not about insurance regulation. But the insurance department maintains this is an error because its protection of the captive insurance data falls under the meaning of the “business of insurance” under McCarran-Ferguson.

The department claims that this is a matter of the “business of insurance” because the confidentiality provision at issue deals with materials submitted in connection with the licensure and examinations of captive insurers “for the purpose of determining the solvency and safety of insurers, and for the protection of its policyholders.”

But the Third Circuit asserted in upholding the lower courts that the department’s “refusal to provide documents and testimony responsive to” the IRS request “is not the ‘business of insurance,’” adding that it is plainly not the “core of the ‘business of insurance.’”

The court added that after complying with the IRS requests, the department will be no less entitled to the information it currently receives to license captive insurance companies than it has previously been.

In petitioning for the emergency order from the high court, Delaware argued that the mandate would require the state insurance commissioner to violate the insurance laws of his own state, “an outcome that upends Congress’ stated purpose in enacting the McCarran-Ferguson Act.”