1. Implications to Producer and Dealership Retained Risk Programs From Recent Tax Court Decisions and IRS Rulings and Regulations by Mark E. Anderson

2. Topics 1.Service Maintenance Agreements 2.Lifetime Warranty Products 3.Micro Captives 4.Rent-A-Center Tax Court Decision A.Securitas Holdings Inc 5.Series limited liability companies (LLCs) and Segregated Portfolio Companies (“SPC) aka Cell Companies 2

3. Service Maintenance Agreements 1.What’s in a word? A.Nothing and everything! 2.Insistence on using term “prepaid” 3.Service contracts are “prepaid” too, but not referred to as “Prepaid Service Contracts”. 4.Prepaid Maintenance Agreements carry an evil connotation with the IRS! A.Ruling from the 1980’s saying “not insurance” B.Properly structured, “Service Maintenance Agreements” can convey “insurance risk” for tax purposes C.Why muck up a properly structured Service Maintenance Agreement by using “prepaid” in description. 5.Bottom Line – Stop referring to Service Maintenance Agreements as “prepaid”. A.Be consistent and eradicating the term. B.Go through every agreement, marketing/promotional materials, contracts, treaties and expunge the term. 3

4. Lifetime Warranty Products 1.Form is very very important! 2.Devil is in the details, often micro details. 3.Branding tool for providing dealership, but to securitize the tax treatment, very critical that all the pieces match. 4.Typically form of program is not “dealership obligor”, but administrator obligor”. 5.Critical to: A.Make sure all program agreement, contracts, etc clearly define who is the obligor. (it is not the dealership) B.Dealership accounting is important; Balance Sheet only! 4

5. Micro Captives 1.Captive.com defines a Micro Captive as: A.A captive insurance company operating with annual written premium of less than $1.2 million. In the United States, such captives are taxed under Internal Revenue Code § 831(b), which provides that a captive qualifying to be taxed as a U.S. insurance company will pay tax only on investment income. 2.Why relevant to you? 3.Being “promoted” to dealer principals as a way to obtain a current tax deduction for risk exposures that are traditionally self insured. 5

6. Micro Captives - Continued Dealer Principal Dealership Micro Captive Insurance Premiums 6

7. Micro Captives - Continued Dealer Principal Dealership Micro Captive Insurance Premiums 7

8. Micro Captives - Continued 4.Some promoters greedy and oversell benefits without properly explaining the tax risks. 5.Have seen situations where insurance premiums are determined based upon how much of the $1.2 is attempting to be sheltered. 6.Documentation typically been very good. A.Risk pooling for 3 rd party risk B.Actuarial calculations C.Etc 8

9. Rent-A-Center Tax Court Decision 1.In a 2014 Tax Court upheld premium payments as properly deductible 2.First case since IRS issued a series of rulings for safe harbors. 3.Numerous factors cited by IRS as to not allow deductions, yet Tax Court in a Regular Decision upheld deductions. 4.Effect is to provide further incentive for Micro Captives to be promoted to dealer principals. 5.Introduction of 3 rd party producer risk still should be a motivator especially if dealer principal is profit participating through reinsurance. 9

10. Rent-A-Center Tax Court Decision - Cont Dealer Principal Dealership Micro Captive Insurance Premiums 10

11. Rent-A-Center Tax Court Decision - Cont 2.First case since IRS issued a series of rulings for safe harbors. 3.Numerous factors cited by IRS as to not allow deductions, yet Tax Court in a Regular Decision upheld deductions. 4.Effect is to provide further incentive for Micro Captives to be promoted to dealer principals. 5.Introduction of 3 rd party producer risk still should be a motivator especially if dealer principal is profit participating through reinsurance. 11

12. Securitas Holdings, Inc 1.Memorandum Decision by the Tax Court A.Implies that area of law is settled in eyes of the Tax Court 2.Allowed premium deduction by parent even though parent guaranteed claim payments of captive subsidiary 12

13. Securitas Holdings, Inc - Continued Dealer Principal Dealership Micro Captive Insurance Premiums Guarantee Claim Payments to 3 rd Parties 3 rd Parties 13

14. Securitas Holdings, Inc - Continued 1.Implications? 2.Further promotion of Micro Captive programs to dealer principals! 14

15. Series Limited Liability Companies (LLCs) and Segregated Portfolio Companies (“SPC”) aka Cell Companies 1.On November 8, 2010, the IRS released proposed regulations on the tax treatment of series limited liability companies (LLCs) and cell companies, proposing to treat the individual series or cells as separate entities for tax purposes (REG-119921-09). 2.Eight states and Puerto Rico have enacted series LLC statutes that allow an LLC to establish separate “series” within it. 3.The series are not separate legal entities, but each series has associated with it specified members of the LLC, as well as specified assets, rights, obligations, and investment objectives or business purposes. 4.Being associated with a series is thus comparable to direct ownership of the series. 5.Under series LLC statutes, the debts, liabilities, and obligations of one series are generally enforceable only against the assets of that series and not against assets of other series or of the series LLC. 15

16. LLC’s and SPC’s Continued 6.Some jurisdictions have established similar entities known variously as protected cell companies, segregated account companies or segregated portfolio companies (cell companies). 7.A cell company may establish multiple cells, each of which has its own name and is identified with a specific participant, but each cell is not treated under local law as a legal entity distinct from the cell company. 8.The assets of each cell are statutorily protected from the creditors of any other cell and from the creditors of the cell company. 16

17. LLC’s and SPC’s Continued 9.There has been little guidance on the federal tax treatment of series LLCs and similar entities, and in Notice 2008-19 the IRS asked for comments on series LLC issues in general and specifically on issues that arise when arrangements entered into by a cell constitute insurance for federal income tax purposes. 10.The comments the IRS received generally recommended that series and cells should be treated as separate entities for federal tax purposes, and the IRS in its proposed regulations has generally agreed to treat them that way. 17

18. LLC’s and SPC’s Continued 11.The proposed regulations provide that, for federal tax purposes, a domestic series will be treated as an entity formed under local law, whether or not local law treats the series as a separate legal entity. The tax treatment of the series will then be governed by the check-the-box regulations (Regs. Secs. 301.7701-1 through 301.7701-3). 18

19. LLC’s and SPC’s Continued 11.The IRS considered automatically treating series as disregarded entities because they are generally not considered separate entities for local law purposes. A.However, the IRS decided that the factors supporting separate entity status for series outweigh the factors in favor of disregarding series as entities separate from the series LLC and other series of the series LLC. B.They specifically looked at the fact that the rights, duties, and powers of members associated with a series are direct and specifically identified. C.They also noted that individual series may have separate business purposes and investment objectives. D.The IRS concluded that these factors are sufficient to treat domestic series as entities formed under local law. 19

20. LLC’s and SPC’s Continued 12.The proposed regulations do not address the entity status for federal tax purposes of the series LLC itself, just the series within it. 13.Specifically, the proposed regulations do not address whether a series LLC is recognized as a separate entity for federal tax purposes if it has no assets and engages in no activities independent of its series. 20