                                               RENT-A-CENTER, INC. AND AFFILIATED SUBSIDIARIES,
                                                  PETITIONERS v. COMMISSIONER OF INTERNAL
                                                           REVENUE, RESPONDENT
                                                Docket Nos.      8320–09, 6909–10,                 Filed January 14, 2014.
                                                                21627–10.

                                                   P, a domestic corporation, is the parent of numerous wholly
                                                owned subsidiaries including L, a Bermudian corporation. P
                                                conducted its business through stores owned and operated by
                                                its subsidiaries. The other subsidiaries and L entered into
                                                contracts pursuant to which each subsidiary paid L an
                                                amount, determined by actuarial calculations and an alloca-
                                                tion formula, relating to workers’ compensation, automobile,
                                                and general liability risks, and, in turn, L reimbursed a por-
                                                tion of each subsidiary’s claims relating to these risks. P’s
                                                subsidiaries deducted, as insurance expenses, the payments to
                                                L. In notices of deficiency issued to P, R determined that the
                                                payments were not deductible. Held: P’s subsidiaries’ pay-
                                                ments to L are deductible, pursuant to I.R.C. sec. 162, as
                                                insurance expenses.

                                           Val J. Albright and Brent C. Gardner, Jr., for petitioners.
                                           R. Scott Shieldes and Daniel L. Timmons, for respondent.
                                       FOLEY, Judge: Respondent determined deficiencies of
                                     $14,931,159, $13,409,628, $7,461,039, $5,095,222, and
                                     $2,828,861 relating, respectively, to Rent-A-Center, Inc.
                                     (RAC), and its subsidiaries’ 2003, 1 2004, 2005, 2006, and
                                     2007 (years in issue) consolidated Federal income tax
                                     returns. The issue for decision is whether payments to
                                     Legacy Insurance Co., Ltd. (Legacy), were deductible, pursu-
                                     ant to section 162, 2 as insurance expenses.

                                                                           FINDINGS OF FACT

                                       RAC, a publicly traded Delaware corporation, is the parent
                                     of a group of approximately 15 affiliated subsidiaries (collec-
                                           1 Respondent,
                                                      in his amended answer, asserted an additional $2,603,193
                                     deficiency relating to 2003.
                                       2 Unless otherwise indicated, all section references are to the Internal

                                     Revenue Code (Code) in effect for the years in issue, and all Rule ref-
                                     erences are to the Tax Court Rules of Practice and Procedure.

                                                                                                                                      1




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                                     2                   142 UNITED STATES TAX COURT REPORTS                                        (1)


                                     tively, petitioner). During the years in issue, petitioner was
                                     the largest domestic rent-to-own company. Through stores
                                     owned and operated by RAC’s subsidiaries, petitioner rented,
                                     sold, and delivered home electronics, furniture, and appli-
                                     ances. The stores were in all 50 States, the District of
                                     Columbia, Puerto Rico, and Canada. From 1993 through
                                     2002, petitioner’s company-owned stores increased from 27 to
                                     2,623. During the years in issue, RAC’s subsidiaries owned
                                     between 2,623 and 3,081 stores; had between 14,300 and
                                     19,740 employees; and operated between 7,143 and 8,027
                                     insured vehicles.
                                     I. Petitioner’s Insurance Program
                                        In 2001, American Insurance Group (AIG), in response to
                                     a claim against RAC’s directors and officers (D&O), withdrew
                                     a previous offer to renew RAC’s D&O insurance policy. To
                                     address this problem, RAC engaged Aon Risk Consultants,
                                     Inc. (Aon), which convinced AIG to renew the policy.
                                     Impressed with Aon’s insurance expertise and concerned
                                     about its growing insurance costs, petitioner engaged Aon to
                                     analyze risk management practices and to broker workers’
                                     compensation, automobile, and general liability insurance.
                                     With Aon’s assistance, petitioner developed a risk manage-
                                     ment department and improved its loss prevention program.
                                        Prior to August 2002, Travelers Insurance Co. (Travelers)
                                     provided petitioner’s workers’ compensation, automobile, and
                                     general liability coverage through bundled policies. Pursuant
                                     to a bundled policy, an insurer provides coverage and con-
                                     trols the claims administration process (i.e., investigating,
                                     evaluating, and paying claims). Travelers paid claims as they
                                     arose and withdrew amounts from petitioner’s bank account
                                     to reimburse itself for any claims less than or equal to peti-
                                     tioner’s deductible (i.e., a portion of an insured claim for
                                     which the insured is responsible). Pursuant to a predeter-
                                     mined formula, each store was allocated, and was responsible
                                     for paying, a portion of Travelers’ premium costs.
                                        In 2001, after receiving a $3 million invoice from Travelers
                                     for ‘‘claim handling fees’’, petitioner became dissatisfied with
                                     the cost and inefficiency associated with its bundled policies.
                                     On August 5, 2002, petitioner, with the assistance of Aon,
                                     obtained unbundled workers’ compensation, automobile, and




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                                     (1)                  RENT-A-CENTER, INC. v. COMMISSIONER                                        3


                                     general liability policies from Discover Re. Pursuant to an
                                     unbundled policy, an insurer provides coverage and a third-
                                     party administrator manages the claims administration
                                     process. Discover Re underwrote the policies; multiple
                                     insurers provided coverage; 3 and Specialty Risk Services,
                                     Inc. (SRS), 4 a third-party administrator, evaluated and paid
                                     claims. Petitioner and its staff of licensed adjusters had
                                     access to SRS’ claims management system and monitored
                                     SRS to ensure the proper handling of claims. This arrange-
                                     ment gave petitioner greater control over the claims adminis-
                                     tration process.
                                        Petitioner, pursuant to the Discover Re policies’
                                     deductibles, was liable for a specific amount of each claim
                                     against its workers’ compensation, automobile, and general
                                     liability policies (e.g., pursuant to its 2002 workers’ com-
                                     pensation policy, petitioner was liable for the first $350,000
                                     of each claim). Petitioner’s retention of a portion of the risk
                                     resulted in lower premiums.
                                     II. Legacy’s Inception
                                        Between 1993 and 2002, petitioner rapidly expanded and
                                     became increasingly concerned about its growing risk
                                     management costs. In 2002, after analyzing petitioner’s
                                     insurance program, Aon suggested that petitioner form a
                                     wholly owned insurance company (i.e., a captive). Aon rep-
                                     resentatives informed David Glasgow, petitioner’s director of
                                     risk management, about the financial and nonfinancial bene-
                                     fits of forming a captive. Aon convincingly explained that a
                                     captive could help petitioner reduce its costs, improve effi-
                                     ciency, obtain otherwise unavailable coverage, and provide
                                     accountability and transparency. Mr. Glasgow presented the
                                     proposal to petitioner’s senior management, who concurred
                                     with Mr. Glasgow’s recommendation to further explore the
                                     formation of a captive. Petitioner’s senior management
                                     directed Aon to conduct a feasibility study (i.e., relying on
                                     petitioner’s workers’ compensation, automobile, and general
                                       3 The following insurers provided coverage: U.S. Fidelity & Guarantee

                                     Co., Fidelity & Guaranty Insurance Co., Discover Property and Casualty
                                     Insurance Co., St. Paul Fire & Marine Co. of Canada, and Fidelity Guar-
                                     anty Insurance Underwriters Inc.
                                       4 SRS was affiliated with the Hartford Insurance Co., a well-established

                                     insurer, and did not have a contract with Discover Re.




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                                     4                   142 UNITED STATES TAX COURT REPORTS                                        (1)


                                     liability loss data) and to prepare loss forecasts and actuarial
                                     studies. Petitioner engaged KPMG to analyze the feasibility
                                     study, review tax considerations, and prepare financial
                                     projections.
                                        Aon, in the feasibility study, recommended that the captive
                                     be capitalized with no less than $8.8 million. Before deciding
                                     where to incorporate the captive, RAC analyzed projected
                                     financial data and reviewed multiple locations. On December
                                     11, 2002, RAC incorporated, and capitalized with $9.9 mil-
                                     lion, 5 Legacy, a wholly owned Bermudian subsidiary. 6
                                     Legacy opened an account with Bank of N.T. Butterfield and
                                     Son, Ltd., and, on December 20, 2002, filed a class 1 insur-
                                     ance company registration application with the Bermuda
                                     Monetary Authority (BMA), which regulated Bermuda’s
                                     financial services sector. A class 1 insurer may insure only
                                     the risk of its shareholders and affiliates; must be capitalized
                                     with at least $120,000; and must meet a minimum solvency
                                     margin calculated by reference to the insurer’s net pre-
                                     miums, general business assets, 7 and general business liabil-
                                     ities. See Insurance Act, 1978, secs. 4B, 6, Appleby (2008)
                                     (Berm.); Insurance Returns and Solvency Regulations, 1980,
                                     Appleby, Reg. 10(1), Schedule I, Figure B (Berm.). During the
                                     years in issue, the BMA had the authority to modify pre-
                                     scribed requirements through both prospective and retro-
                                     active directives for special allowances. See Insurance Act,
                                     1978, sec. 56.
                                        Legacy planned to insure petitioner’s liabilities for the
                                     period beginning in 2002 and ending December 31, 2003 (pro-
                                     posed period). Aon informed petitioner that coverage pro-
                                        5 RAC contributed $9.9 million of cash and received 120,000 shares of

                                     Legacy capital stock with a par value of $1.
                                        6 Legacy elected, pursuant to sec. 953(d), to be treated as a domestic cor-

                                     poration for Federal income tax purposes. In addition, Legacy engaged Aon
                                     Insurance Managers (Bermuda), Ltd., to monitor Legacy’s compliance with
                                     Bermudian regulations and to provide management, financial, and admin-
                                     istrative services.
                                        7 The Bermuda Insurance Act, the Insurance Accounts Regulations, and

                                     the Insurance Returns and Solvency Regulations reference ‘‘general busi-
                                     ness’’, ‘‘admitted’’, and ‘‘relevant’’ assets. See Insurance Act, 1978, sec. 1,
                                     Appleby (2008) (Berm.); Insurance Accounts Regulations, 1980, Appleby,
                                     Schedule III, Pt. 1, 13 (Berm.); Insurance Returns and Solvency Regula-
                                     tions, 1980, Appleby, Reg. 10(3), 11(4) (Berm.). For purposes of this Opin-
                                     ion, there is no significant difference among these terms.




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                                     (1)                  RENT-A-CENTER, INC. v. COMMISSIONER                                        5


                                     vided by unrelated insurers would be more costly than Aon’s
                                     estimate of Legacy’s premiums and that some insurers would
                                     not be willing to offer coverage. In response to a quote
                                     request, Discover Re stated that it was not in the market to
                                     provide the coverage Legacy contemplated. Discover Re esti-
                                     mated, however, that its premium (i.e., if it were to write one
                                     relating to the proposed period) would be approximately $3
                                     million more than Legacy’s.
                                     III. Petitioner’s Policies
                                        During the years in issue, petitioner obtained unbundled
                                     workers’ compensation, automobile, and general liability poli-
                                     cies from Discover Re. Pursuant to these policies, Discover
                                     Re provided petitioner with coverage above a predetermined
                                     threshold relating to each line of coverage. In addition,
                                     Legacy wrote policies that covered petitioner’s workers’ com-
                                     pensation, automobile, and general liability claims below the
                                     Discover Re threshold. Petitioner, depending on the amount
                                     of a covered loss, could seek payment from Legacy, Discover
                                     Re, or both companies.
                                        The annual premium Legacy charged petitioner was
                                     actuarially determined using Aon loss forecasts and was allo-
                                     cated to each RAC subsidiary that owned covered stores.
                                     RAC was a listed policyholder pursuant to the Legacy poli-
                                     cies. No premium was attributable to RAC, however, because
                                     it did not own stores, have employees, or operate vehicles.
                                     RAC paid the premiums relating to each policy, 8 estimated
                                     petitioner’s total insurance costs (i.e., Legacy policies, Dis-
                                     cover Re policies, third-party administrator fees, overhead,
                                     etc.), and established a monthly rate relating to each store’s
                                     portion of these costs. The monthly rate was based on three
                                     factors: each store’s payroll, each store’s number of vehicles,
                                     and the total number of stores. At the end of each year, RAC
                                     adjusted the allocations to ensure that its subsidiaries recog-
                                     nized their actual insurance costs. SRS administered all
                                     claims relating to petitioner’s workers’ compensation, auto-
                                           8 From
                                               December 31, 2002, through September 12, 2003, Legacy incurred
                                     a $4,861,828 liability relating to claim reimbursements due petitioner. This
                                     amount was netted against petitioner’s September 12, 2003, premium pay-
                                     ment (i.e., petitioner paid a net premium of $37,938,472 rather than the
                                     $42,800,300 gross premium).




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                                     6                    142 UNITED STATES TAX COURT REPORTS                                        (1)


                                     mobile, and general liability coverage. During the years in
                                     issue, the terms of Legacy’s coverage varied, Legacy progres-
                                     sively covered greater amounts of petitioner’s risk, and
                                     Legacy did not receive premiums from any unrelated entity.
                                     From December 31, 2002, through December 30, 2007,
                                     Legacy earned net underwriting income of $28,761,402. See
                                     infra p. 10.
                                           A. Legacy’s Deferred Tax Assets
                                        Pursuant to the Legacy policies, coverage began on
                                     December 31 of each year. Because petitioner was a calendar
                                     year accrual method taxpayer, these policies created tem-
                                     porary timing differences between income recognized for tax
                                     purposes and income recognized for financial accounting
                                     (book) purposes. 9 For example, on December 31, 2002, when
                                     Legacy’s second policy became effective, Legacy recognized,
                                     for tax purposes, the full amount of the premium (i.e.,
                                     $42,800,300) relating to the taxable year ending December
                                     31, 2002. See sec. 832(b)(4). For book purposes, however,
                                     Legacy in 2002 recognized only 1/365 of the premium (i.e.,
                                     $117,261), and the remaining $42,683,039 constituted a
                                     reserve. This timing difference created a deferred tax asset
                                     (DTA) because in 2002 Legacy ‘‘prepaid’’ its tax liability
                                     relating to income it recognized, for book purposes, in 2003.
                                     Each day Legacy recognized a portion of its premium income
                                     (i.e., $117,261) for book purposes and reduced its reserve by
                                     the same amount. On December 30, 2003, the reserve was
                                     fully depleted. Upon the issuance of a new policy on
                                     December 31, 2003, a new DTA was created because Legacy
                                     recognized, for tax purposes, in 2003 the full amount of the
                                     premium; a corresponding tax liability was incurred; the pre-
                                     mium reserve increased; and most of the premium income
                                     attributable to the 2003 policy was recognizable, for book
                                     purposes, in 2004.
                                           9 Each
                                              premium was generally paid in September of the year following
                                     the year in which the policy became effective. Use of the recurring item
                                     exception allowed petitioner to claim a premium deduction relating to the
                                     year in which the policy became effective, rather than the following year
                                     when the premium was actually paid. See sec. 461(h)(3)(A)(iii). On August
                                     28, 2007, petitioner filed Form 3115, Application for Change in Accounting
                                     Method, requesting permission to revoke its use of the recurring item ex-
                                     ception.




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                                     (1)                   RENT-A-CENTER, INC. v. COMMISSIONER                                        7


                                           1. Bermuda’s Minimum Solvency Margin Requirement
                                       Pursuant to the Bermuda Insurance Act, an insurance
                                     company must maintain a minimum solvency margin. See
                                     Insurance Act, 1978, sec. 6. More specifically, a class 1
                                     insurer’s general business assets must exceed its general
                                     business liabilities by the greatest of : $120,000; 10% of the
                                     insurer’s loss and loss expense provisions plus other insur-
                                     ance reserves; or 20% of the first $6 million of net premiums
                                     plus 10% of the net premiums which exceed $6 million. See
                                     Insurance Returns and Solvency Regulations, 1980, Appleby,
                                     Reg. 10(1), Schedule I, Figure B. DTAs generally may be
                                     treated as general business assets only with the BMA’s
                                     permission.

                                           2. Legacy Receives Permission To Treat DTAs as General
                                              Business Assets Through 2003
                                        In the minimum solvency margin calculation set forth in
                                     its insurance company registration application, Legacy
                                     treated DTAs as general business assets. On March 11, 2003,
                                     Legacy petitioned the BMA for the requisite permission to do
                                     so. The following letter from RAC accompanied the request:
                                           We write to confirm to you that Rent-A-Center, Inc., * * * will guar-
                                           antee the payment to Legacy Insurance Company, Ltd. (the ‘‘Company’’),
                                           * * * of all amounts reflected on the projected balance sheets of the
                                           Company previously delivered to you as deferred tax assets arising from
                                           timing differences in the amounts of taxes payable for tax and financial
                                           accounting purposes. This guaranty of payment will take effect in the
                                           event of any change in tax laws that would require recognition of an
                                           impairment of the deferred tax asset, and will be effective to the extent
                                           of the amount of the impairment.

                                       On March 13, 2003, the BMA granted Legacy permission
                                     to treat DTAs as general business assets on its statutory bal-
                                     ance sheet through December 31, 2003. 10 The BMA also
                                     informed Legacy that from December 31, 2002, through
                                     March 13, 2003, it ‘‘wrote insurance business without being
                                     in receipt of its Certificate of Registration and was therefore
                                     in violation of the [Bermuda Insurance] Act as it engaged in
                                     insurance business without a license.’’ Despite this violation,
                                     the BMA registered Legacy as a class 1 insurer effective
                                           10 See   infra pp. 9–10.




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                                     8                    142 UNITED STATES TAX COURT REPORTS                                        (1)


                                     December 20, 2002 (i.e., the date Legacy filed its insurance
                                     registration request and before it issued policies relating to
                                     the years in issue).
                                           3. The Parental Guaranty: Facilitating the Treatment of
                                              DTAs as General Business Assets Through 2006
                                       In response to the recurring DTA issue, Legacy requested
                                     that RAC guarantee DTAs relating to subsequent years. On
                                     September 17, 2003, RAC’s board of directors authorized the
                                     execution of a guaranty of ‘‘the obligations of Legacy to
                                     comply with the laws of Bermuda.’’ On the same day, RAC’s
                                     chairman and chief executive officer executed a parental
                                     guaranty and sent it to Legacy’s board of directors. The
                                     parental guaranty provided:
                                           The undersigned, Rent-A-Center, Inc. a Delaware corporation (‘‘Rent-A-
                                           Center’’) is sole owner of 100% of the issued and outstanding shares in
                                           your share capital and as such DOES HEREBY GUARANTEE financial
                                           support for you, Legacy Insurance Co., Ltd., * * * and for your business,
                                           as more particularly set out below, which is to say:
                                           Under the [Bermuda] Insurance Act * * * and related Regulations (the
                                           ‘‘Act’’), Legacy Insurance Co., Ltd., must maintain certain solvency and
                                           liquidity margins and, in order to ensure continued compliance with the
                                           Act, it is necessary to support Legacy Insurance Co., Ltd. with a guar-
                                           antee of its liabilities under the Act (the ‘‘Liabilities’’) not to exceed
                                           Twenty-Five Million US dollars (US $25,000,000).
                                           Accordingly, Rent-A-Center DOES HEREBY GUARANTEE to you the
                                           payment in full of the Liabilities of Legacy Insurance Co., Ltd. and fur-
                                           ther to indemnify and hold harmless Legacy Insurance Co., Ltd. from
                                           the Liabilities up to the maximum dollar amount [$25,000,000] indicated
                                           in the foregoing paragraph.

                                     Seeking regulatory approval to treat DTAs as general busi-
                                     ness assets in subsequent years, Legacy, on October 30,
                                     2003, petitioned the BMA and attached the parental guar-
                                     anty.
                                        On November 12, 2003, the BMA issued a directive which
                                     ‘‘approved the Parental Guarantee from Rent-A-Center, Inc.
                                     dated 17th September, 2003 up to an aggregate amount of
                                     $25,000,000 for utilization as part of * * * [Legacy]’s capital-
                                     ization’’. This approval was granted for the years ending
                                     December 31, 2003, 2004, 2005, and 2006. Legacy used the
                                     parental guaranty only to meet the minimum solvency




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                                     (1)                   RENT-A-CENTER, INC. v. COMMISSIONER                                        9


                                     margin (i.e., to treat DTAs as general business assets). 11 On
                                     December 30, 2006, RAC unilaterally canceled the parental
                                     guaranty because Legacy met the minimum solvency margin
                                     without it.

                                           B. Legacy’s Ownership of RAC Treasury Shares
                                        Legacy purchased RAC treasury shares during 2004, 2005,
                                     and 2006. The BMA approved the purchases and allowed
                                     Legacy to treat the shares as general business assets for pur-
                                     poses of calculating its liquidity ratio (i.e., its ratio of general
                                     business assets to liabilities). Pursuant to Bermuda solvency
                                     regulations, an insurer fails to meet the liquidity ratio if the
                                     value of its general business assets is less than 75% of its
                                     liabilities. See Insurance Returns and Solvency Regulations,
                                     1980, Appleby, Reg. 11(2). During the years in issue, Legacy
                                     met its liquidity ratio and did not resell the shares.
                                           C. Legacy’s Financial Reports
                                       For each policy period, Legacy’s auditor, Arthur Morris &
                                     Co. (Arthur Morris), prepared, and provided to RAC and the
                                     BMA, reports and financial statements. In these reports and
                                     statements, Arthur Morris calculated Legacy’s DTAs, 12 min-
                                     imum solvency margin, 13 premium-to-surplus ratio, 14 and
                                     net underwriting income. 15 During each of the years in
                                     issue, Legacy’s total statutory capital and surplus equaled or
                                     exceeded the BMA minimum solvency margin. In calculating
                                     total statutory capital and surplus, Arthur Morris took into
                                     account the following four components: contributed surplus,
                                     statutory surplus, capital stock, and other fixed capital (i.e.,
                                     assets deemed to be general business assets). During 2003,
                                     2004, and 2005, Legacy included portions of the parental
                                     guaranty as general business assets. During the years in
                                           11 See
                                              infra pp. 9–10.
                                           12 See
                                              supra p. 6.
                                       13 See supra p. 7.
                                       14 Premium-to-surplus ratio is one measure of an insurer’s economic per-

                                     formance. On Legacy’s reports and statements, Arthur Morris referred to
                                     Legacy’s premium-to-surplus ratio as the ‘‘premium to statutory capital &
                                     surplus ratio’’. For purposes of this Opinion, there is no significant dif-
                                     ference between these terms.
                                       15 Net underwriting income equals gross premiums earned minus under-

                                     writing expenses.




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                                     10                   142 UNITED STATES TAX COURT REPORTS                                                  (1)


                                     issue, the amounts of Legacy’s DTAs exceeded the portions of
                                     Legacy’s parental guaranty treated as general business
                                     assets. See table infra. Arthur Morris calculated Legacy’s
                                     statutory surplus by adding statutory surplus at the begin-
                                     ning of the year and income for the year, subtracting divi-
                                     dends paid and payable, and making other adjustments
                                     relating to changes in assets.
                                       The following table summarizes key details relating to Leg-
                                     acy’s policies:
                                                                         Parental                          Minimum                          Net
                                     Policy                              guaranty      Total statutory     solvency     Premium-to-     underwriting
                                     period     Premium       DTAs         asset      capital & surplus     margin      surplus ratio     income

                                      2003    $42,800,300   $5,840,613   $4,805,764      $5,898,192        $5,898,192     8.983:1       $1,587,542
                                      2004     50,639,000    6,275,326    4,243,823       7,036,573         7,036,572     7.695:1         (982,000)
                                      2005     54,148,912    7,659,009    3,987,916       8,379,436         8,379,435     6.369:1        8,411,912
                                      2006     53,365,926    8,742,425       -0-         10,014,206         9,284,601     6.326:1        8,810,926
                                      2007     63,345,022    9,689,714       -0-         12,428,663        10,888,698     5.221:1       10,933,022
                                      2008     64,884,392    9,607,661       -0-         23,712,022        11,278,359     2.538:1       18,391,392



                                     IV. Procedural History
                                        Respondent sent petitioner, on January 7, 2008, a notice of
                                     deficiency relating to 2003; on December 22, 2009, a notice
                                     of deficiency relating to 2004 and 2005; and on August 5,
                                     2010, a notice of deficiency relating to 2006 and 2007 (collec-
                                     tively, notices). In these notices, respondent determined that
                                     petitioner’s payments to Legacy were not deductible pursuant
                                     to section 162. On April 6, 2009, March 22, 2010, and Sep-
                                     tember 29, 2010, respectively, petitioner, whose principal
                                     place of business was Plano, Texas, timely filed petitions
                                     with the Court seeking redeterminations of the deficiencies
                                     set forth in the notices. After concessions, the remaining
                                     issue for decision is whether payments to Legacy were
                                     deductible.

                                                                                    OPINION

                                       In determining whether payments to Legacy were deduct-
                                     ible, our initial inquiry is whether Legacy was a bona fide
                                     insurance company. See Harper Grp. v. Commissioner, 96
                                     T.C. 45, 59 (1991), aff ’d, 979 F.2d 1341 (9th Cir. 1992);
                                     AMERCO v. Commissioner, 96 T.C. 18, 40–41 (1991), aff ’d,
                                     979 F.2d 162 (9th Cir. 1992). We respect the separate taxable
                                     treatment of a captive unless there is a finding of sham or
                                     lack of business purpose. See Moline Props., Inc. v. Commis-
                                     sioner, 319 U.S. 436, 439 (1943); Harper Grp. v. Commis-




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                                     (1)                  RENT-A-CENTER, INC. v. COMMISSIONER                                       11


                                     sioner, 96 T.C. at 57–59. Respondent contends that Legacy
                                     was a sham entity created primarily to generate Federal
                                     income tax savings.
                                     I. Legacy Was Not a Sham.
                                           A. Legacy Was Created for Significant and Legitimate
                                             Nontax Reasons.
                                       After successfully resolving petitioner’s D&O insurance
                                     problem, Aon evaluated petitioner’s risk management depart-
                                     ment. Petitioner, with Aon’s assistance, improved risk
                                     management practices, switched from bundled to unbundled
                                     policies, and hired SRS as a third-party administrator. Aon
                                     proposed that petitioner form a captive, and petitioner deter-
                                     mined that a captive would allow it to reduce its insurance
                                     costs, obtain otherwise unavailable insurance coverage, for-
                                     malize and more efficiently manage its insurance program,
                                     and provide accountability and transparency relating to
                                     insurance costs. Petitioner engaged KPMG to prepare finan-
                                     cial projections and evaluate tax considerations referenced in
                                     the feasibility study. Federal income tax consequences were
                                     considered, but the formation of Legacy was not a tax-driven
                                     transaction. See Moline Props., Inc. v. Commissioner, 319
                                     U.S. at 439; Britt v. United States, 431 F.2d 227, 235–236
                                     (5th Cir. 1970); Bass v. Commissioner, 50 T.C. 595, 600
                                     (1968). To the contrary, in forming Legacy, petitioner made
                                     a business decision premised on a myriad of significant and
                                     legitimate nontax considerations. See Jones v. Commissioner,
                                     64 T.C. 1066, 1076 (1975) (‘‘A corporation is not a ‘sham’ if
                                     it was organized for legitimate business purposes or if it
                                     engages in a substantial business activity.’’); Bass v. Commis-
                                     sioner, 50 T.C. at 600.
                                           B. There Was No Impermissible Circular Flow of Funds.
                                       Respondent further contends that Legacy was ‘‘not an inde-
                                     pendent fund, but an accounting device’’. In support of this
                                     contention, respondent cites a purported ‘‘circular flow of
                                     funds’’ through Legacy, RAC, and RAC’s subsidiaries.
                                     Respondent’s expert, however, readily acknowledged that he
                                     found no evidence of a circular flow of funds, nor have we.
                                     Legacy, with the approval of the BMA, purchased RAC
                                     treasury shares but did not resell them. Furthermore, peti-




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                                     12                  142 UNITED STATES TAX COURT REPORTS                                        (1)


                                     tioner established that there was nothing unusual about the
                                     manner in which premiums and claims were paid. Finally,
                                     respondent contends that the netting of premiums owed to
                                     Legacy during 2003 is evidence that Legacy was a sham. We
                                     disagree. This netting was simply a bookkeeping measure
                                     performed as an administrative convenience.
                                           C. The Premium-to-Surplus Ratios Do Not Indicate That
                                             Legacy Was a Sham.
                                        Respondent emphasizes that, during the years in issue,
                                     Legacy’s premium-to-surplus ratios were above the ratios of
                                     U.S. property and casualty insurance companies and Ber-
                                     muda class 4 insurers 16 (collectively, commercial insurance
                                     companies). On cross-examination, however, respondent’s
                                     expert admitted that his analysis of commercial insurance
                                     companies contained erroneous numbers. Furthermore, he
                                     failed to properly explain the profitability data he cited and
                                     did not include relevant data relating to Legacy. Moreover,
                                     his comparison, of Legacy’s premium-to-surplus ratios with
                                     the ratios of commercial insurance companies, was not
                                     instructive. Commercial insurance companies have lower pre-
                                     mium-to-surplus ratios because they face competition and, as
                                     a result, typically price their premiums to have significant
                                     underwriting losses. They compensate for underwriting
                                     losses by retaining sufficient assets (i.e., more assets per
                                     dollar of premium resulting in lower premium-to-surplus
                                     ratios) to earn ample amounts of investment income. Cap-
                                     tives in Bermuda, however, have fewer assets per dollar of
                                     premium (i.e., higher premium-to-surplus ratios) but gen-
                                     erate significant underwriting profits because their pre-
                                     miums reflect the full dollar value, rather than the present
                                     value, of expected losses. Simply put, the premium-to-surplus
                                     ratios do not indicate that Legacy was a sham.
                                           D. Legacy Was a Bona Fide Insurance Company.
                                       Petitioner presented convincing, and essentially uncontra-
                                     dicted, evidence that Legacy was a bona fide insurance com-
                                     pany. As respondent concedes, petitioner faced actual and
                                       16 A class 4 insurance company may carry on insurance business, includ-

                                     ing excess liability business or property catastrophe reinsurance business.
                                     See Insurance Act, 1978, sec. 4E.




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                                     (1)                  RENT-A-CENTER, INC. v. COMMISSIONER                                       13


                                     insurable risk. Comparable coverage with other insurance
                                     companies would have been more expensive, and some insur-
                                     ance companies (e.g., Discover Re) would not underwrite the
                                     coverage provided by Legacy. In addition, RAC established
                                     Legacy for legitimate business reasons, including: increasing
                                     the accountability and transparency of its insurance oper-
                                     ations, accessing new insurance markets, and reducing risk
                                     management costs. Furthermore, Legacy entered into bona
                                     fide arm’s-length contracts with petitioner; charged actuari-
                                     ally determined premiums; was subject to the BMA’s regu-
                                     latory control; met Bermuda’s minimum statutory require-
                                     ments; paid claims from its separately maintained account;
                                     and, as respondent’s expert readily admitted, was adequately
                                     capitalized. See Humana Inc. & Subs. v. Commissioner, 881
                                     F.2d 247, 253 (6th Cir. 1989), aff ’g in part, rev’g in part and
                                     remanding 88 T.C. 197, 206 (1987); Harper Grp. v. Commis-
                                     sioner, 96 T.C. at 59. Moreover, the validity of claims Legacy
                                     paid was established by SRS, an independent third-party
                                     administrator, which also determined the validity of claims
                                     pursuant to the Discover Re policies. See Harper Grp. v.
                                     Commissioner, 96 T.C. at 59. Finally, RAC’s subsidiaries did
                                     not own stock in, or contribute capital to, Legacy.
                                     II. The Payments to Legacy Were Deductible Insurance
                                         Expenses.
                                       The Code does not define insurance. The Supreme Court,
                                     however, has established two necessary criteria: risk shifting
                                     and risk distribution. See Helvering v. Le Gierse, 312 U.S.
                                     531, 539 (1941). In addition, the arrangement must involve
                                     insurance risk and meet commonly accepted notions of insur-
                                     ance. See Harper Grp. v. Commissioner, 96 T.C. at 58;
                                     AMERCO v. Commissioner, 96 T.C. at 38. These four criteria
                                     are not independent or exclusive, but establish a framework
                                     for determining ‘‘the existence of insurance for Federal tax
                                     purposes.’’ See AMERCO v. Commissioner, 96 T.C. at 38.
                                     Insurance premiums may be deductible. A taxpayer may not,
                                     however, deduct amounts set aside in its own possession to
                                     compensate itself for perils which are generally the subject
                                     of insurance. See Clougherty Packing Co. v. Commissioner, 84
                                     T.C. 948, 958 (1985), aff ’d, 811 F.2d 1297 (9th Cir. 1987). We
                                     consider all of the facts and circumstances to determine




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                                     14                  142 UNITED STATES TAX COURT REPORTS                                        (1)


                                     whether an arrangement qualifies as insurance. See Harper
                                     Grp. v. Commissioner, 96 T.C. at 57. Respondent contends
                                     that payments to Legacy represent amounts petitioner set
                                     aside to self-insure its risks.
                                           A. The Policies at Issue Involved Insurance Risk.
                                       Respondent concedes that petitioner faced insurable risk
                                     relating to all three types of risk: workers’ compensation,
                                     automobile, and general liability. Petitioner entered into con-
                                     tracts with Legacy and Discover Re to address these three
                                     types of risk. Thus, insurance risk was present in the
                                     arrangement between petitioner and Legacy.
                                           B. Risk Shifting
                                       We must now determine whether the policies at issue
                                     shifted risk between RAC’s subsidiaries and Legacy. This
                                     requires a review of our cases relating to captive insurance
                                     arrangements.
                                           1. Precedent Relating to Parent-Subsidiary Arrangements
                                       In 1978, we analyzed parent-subsidiary captive arrange-
                                     ments for the first time. See Carnation Co. v. Commissioner,
                                     71 T.C. 400 (1978), aff ’d, 640 F.2d 1010 (9th Cir. 1981). In
                                     Carnation, the parties entered into two insurance contracts:
                                     an agreement between Carnation and an unrelated insurer,
                                     and a reinsurance agreement between the captive and the
                                     unrelated insurer. Id. at 402–404. The unrelated insurer
                                     expressed concern to Carnation about the captive’s financial
                                     stability and requested a letter of credit or other guaranty.
                                     Id. at 404. Carnation refused to issue a letter of credit or
                                     other guaranty but did execute an agreement to provide,
                                     upon demand, $2,880,000 of additional capital to the captive.
                                     Id. at 402–404. We held, relying on Le Gierse, that the
                                     parent-subsidiary arrangement was not insurance because
                                     the three agreements (i.e., the two insurance contracts and
                                     the agreement to further capitalize the captive), when consid-
                                     ered together, were void of insurance risk. Id. at 409. The
                                     Court of Appeals for the Ninth Circuit affirmed and con-
                                     cluded that our application of Le Gierse was appropriate
                                     given the interdependence of the three agreements. See
                                     Carnation Co. v. Commissioner, 640 F.2d at 1013. Further-
                                     more, the Court of Appeals held that ‘‘[t]he key was that




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                                     (1)                   RENT-A-CENTER, INC. v. COMMISSIONER                                       15


                                     * * * [the unrelated insurer] refused to enter into the
                                     reinsurance contract with * * * [the captive] unless Carna-
                                     tion’’ executed the capitalization agreement. See id.
                                        In Clougherty, our next opportunity to analyze a parent-
                                     subsidiary captive arrangement, the parties entered into two
                                     insurance contracts: an agreement between Clougherty and
                                     an unrelated insurer, and a reinsurance agreement between
                                     the captive and the unrelated insurer. Clougherty Packing
                                     Co. v. Commissioner, 84 T.C. at 952. We concluded that ‘‘the
                                     operative facts [17] in the instant case * * * [were] indistin-
                                     guishable from the facts in Carnation’’, analyzed Clougherty’s
                                     balance sheet, and held that risk did not shift to the captive:
                                             We found in Carnation, as we find here, that to the extent the risk
                                           was not shifted, insurance does not exist and the payments to that
                                           extent are not insurance premiums. The measure of the risk shifted is
                                           the percentage of the premium not ceded. This is nothing more than a
                                           recharacterization of the payments which petitioner seeks to deduct as
                                           insurance premiums. [Id. at 956, 958–959.]

                                     The Commissioner urged us to adopt his economic family
                                     theory, which posits that
                                           the insuring parent corporation and its domestic subsidiaries, and the
                                           wholly owned ‘‘insurance’’ subsidiary, though separate corporate entities,
                                           represent one economic family with the result that those who bear the
                                           ultimate economic burden of loss are the same persons who suffer the
                                           loss. To the extent that the risks of loss are not retained in their entirety
                                           by * * * or reinsured with * * * insurance companies that are unre-
                                           lated to the economic family of insureds, there is no risk-shifting or risk-
                                           distributing, and no insurance, the premiums for which are deductible
                                           under section 162 of the Code. [Rev. Rul. 77–316, 1977–2 C.B. 53, 54.]

                                     In rejecting the Commissioner’s economic family theory, we
                                     emphasized that ‘‘[w]e have done nothing more in Carnation
                                     and here but to reclassify, as nondeductible, portions of the
                                     payments which the taxpayers deducted as insurance pre-
                                     miums but which were received by the taxpayer’s captive
                                     insurance subsidiaries.’’ See Clougherty Packing Co. v.
                                     Commissioner, 84 T.C. at 960.
                                           17 Our
                                               Opinion emphasized that the ‘‘operative’’ facts related to the
                                     ‘‘interdependence of all of the agreements’’ as confirmed by the ‘‘execution
                                     dates’’. See Clougherty Packing Co. v. Commissioner, 84 T.C. 948, 957
                                     (1985), aff ’d, 811 F.2d 1297 (9th Cir. 1987).




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                                     16                   142 UNITED STATES TAX COURT REPORTS                                        (1)


                                       The Court of Appeals for the Ninth Circuit affirmed our
                                     decision in Clougherty and applied a balance sheet and net
                                     worth analysis, pursuant to which a determination of
                                     whether risk has shifted depends on whether a covered loss
                                     affects the balance sheet and net worth of the insured. See
                                     Clougherty Packing Co. v. Commissioner, 811 F.2d at 1305.
                                     In defining insurance, the Court of Appeals stated that ‘‘a
                                     true insurance agreement must remove the risk of loss from
                                     the insured party.’’ Id. at 1306. The Court of Appeals elabo-
                                     rated:
                                           [W]e examine the economic consequences of the captive insurance
                                           arrangement to the ‘‘insured’’ party to see if that party has, in fact,
                                           shifted the risk. In doing so, we look only to the insured’s assets, i.e.,
                                           those of Clougherty, to determine whether it has divested itself of the
                                           adverse economic consequences of a covered workers’ compensation
                                           claim. Viewing only Clougherty’s assets and considering only the effect
                                           of a claim on those assets, it is clear that the risk of loss has not been
                                           shifted from Clougherty. [Id. at 1305.]

                                     Furthermore, the Court of Appeals explained that the bal-
                                     ance sheet and net worth analysis does not ignore separate
                                     corporate existence:
                                           Moline Properties requires that related corporate entities be afforded
                                           separate tax status and treatment. It does not require that the Commis-
                                           sioner, in determining whether a corporation has shifted its risk of loss,
                                           ignore the effect of a loss upon one of the corporation’s assets merely
                                           because that asset happens to be stock in a subsidiary. Because we only
                                           consider the effect of a covered claim on Clougherty’s assets, our analysis
                                           in no way contravenes Moline Properties. [Id. at 1307.]

                                     Finally, the Court of Appeals concluded that ‘‘[t]he parent of
                                     a captive insurer retains an economic stake in whether a cov-
                                     ered loss occurs. Accordingly, an insurance agreement
                                     between parent and captive does not shift the parent’s risk
                                     of loss and is not an agreement for ‘insurance.’ ’’ Id.
                                           2. Precedent Relating to Brother-Sister Arrangements,
                                       In Humana Inc. & Subs. v. Commissioner, 88 T.C. at 206,
                                     we were faced with two distinct issues: the deductibility of
                                     premiums paid by a parent to a captive (parent-subsidiary
                                     arrangement) and the deductibility of premiums paid by
                                     affiliated subsidiaries to a captive (brother-sister arrange-
                                     ment). Humana, Inc. (Humana), operated a hospital network
                                     and, in 1976, was unable to renew its existing policies




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                                     (1)                   RENT-A-CENTER, INC. v. COMMISSIONER                                       17


                                     relating to workers’ compensation, malpractice, and general
                                     liability. Id. at 200. Humana’s insurance broker could not
                                     obtain comparable coverage and recommended that Humana
                                     establish a captive insurance company. Id. Humana subse-
                                     quently incorporated, and capitalized with $1 million, a Colo-
                                     rado captive. Id. at 201–202. The captive provided coverage
                                     relating to Humana and its subsidiaries’ workers’ compensa-
                                     tion, malpractice, and general liability. Id. at 202–204.
                                     Humana paid the captive a monthly premium which was
                                     allocated among itself and each operating subsidiary. Id. at
                                     203.
                                        We held that the parent-subsidiary premiums were not
                                     deductible because Humana did not shift risk to the captive.
                                     See id. at 206–207. The brother-sister arrangement, however,
                                     presented an issue of first impression. See id. at 208. We
                                     rejected the Commissioner’s economic family theory and held
                                     ‘‘that it is more appropriate to examine all of the facts to
                                     decide whether or to what extent there has been a shifting
                                     of the risk from one entity to the captive insurance com-
                                     pany.’’ See id. at 214. We extended our rationale from Carna-
                                     tion and Clougherty (i.e., recharacterizing a captive insurance
                                     arrangement as self-insurance) to brother-sister arrange-
                                     ments and stated that declining to do so ‘‘would exalt form
                                     over substance and permit a taxpayer to circumvent our
                                     holdings by simple corporate structural changes.’’ See id. at
                                     213. The report on which we relied, prepared by Irving
                                     Plotkin, stated: ‘‘ ‘A firm placing its risks in a captive insur-
                                     ance company in which it holds a sole or predominant owner-
                                     ship position, is not relieving itself of financial uncertainty.’ ’’
                                     Id. at 210 (fn. ref. omitted). In addition, the report stated:
                                             ‘‘True insurance relieves the firm’s balance sheet of any potential
                                           impact of the financial consequences of the insured peril. For the price
                                           of the premiums, the insured rids itself of any economic stake in
                                           whether or not the loss occurs. * * * [However] as long as the firm deals
                                           with its captive, its balance sheet cannot be protected from the financial
                                           vicissitudes of the insured peril.’’ [Id. at 211–212; alteration in original;
                                           fn. ref. omitted.]

                                     After quoting extensively from the report and analyzing the
                                     facts, ‘‘[w]e conclude[d] that there was not the necessary
                                     shifting of risk from the operating subsidiaries of Humana
                                     Inc. to * * * [the captive] and, therefore, the amounts




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                                     18                   142 UNITED STATES TAX COURT REPORTS                                        (1)


                                     charged by Humana Inc. to its subsidiaries did not constitute
                                     insurance.’’ See id. at 214.
                                        Seven Judges concurred with the opinion of the Court’s
                                     parent-subsidiary holding but disagreed with the brother-
                                     sister holding. See Humana Inc. & Subs. v. Commissioner, 88
                                     T.C. at 219 (Ko¨rner, J., concurring and dissenting). They
                                     found the opinion of the Court’s rationale ‘‘disingenuous and
                                     entirely unconvincing’’ and asserted that the opinion of the
                                     Court had implicitly adopted the Commissioner’s ‘‘economic
                                     family’’ theory. Id. at 223. After emphasizing that the
                                     subsidiaries had no ownership interest in the captive, paid
                                     premiums for their own insurance, and would not be affected
                                     (i.e., their balance sheets and net worth) by the payment of
                                     an insured claim, the dissent further stated:
                                           The theory of Helvering v. Le Gierse, 312 U.S. 531 (1941), may have been
                                           adequate to sustain the holdings in Carnation and Clougherty, where
                                           only a parent and its insurance subsidiary were involved. It cannot be
                                           stretched to cover the instant brother-sister situation, where there was
                                           nothing—equity ownership or otherwise—to offset the shifting of risk
                                           from the hospital subsidiaries to * * * [the captive]. If the majority is
                                           to accomplish the fell deed here, ‘‘a decent respect to the opinions of
                                           mankind requires that they should declare the causes which impel them’’
                                           to such a result. [Id. at 224; fn. ref. omitted.]

                                       The Court of Appeals for the Sixth Circuit affirmed our
                                     decision relating to the parent-subsidiary arrangement, but
                                     reversed our decision relating to the brother-sister arrange-
                                     ment. 18 See Humana Inc. & Subs. v. Commissioner, 881 F.2d
                                     at 251–252. The Court of Appeals for the Sixth Circuit
                                     adopted the Court of Appeals for the Ninth Circuit’s balance
                                     sheet and net worth analysis and held that the subsidiaries’
                                     payments to the captive were deductible. Id. at 252 (‘‘[W]e
                                     look solely to the insured’s assets, * * * and consider only
                                     the effect of a claim on those assets[.]’’ (citing Clougherty
                                     Packing Co. v. Commissioner, 811 F.2d at 1305)). In rejecting
                                     our holding relating to the brother-sister arrangement, the
                                     Court of Appeals stated that ‘‘the tax court incorrectly
                                     extended the rationale of Carnation and Clougherty in
                                     holding that the premiums paid by the subsidiaries of
                                           18 We
                                              need not defer to the Court of Appeals for the Sixth Circuit’s hold-
                                     ing because this matter is appealable to the Court of Appeals for the Fifth
                                     Circuit, which has not addressed this issue. See Golsen v. Commissioner,
                                     54 T.C. 742, 757 (1970), aff ’d, 445 F.2d 985 (10th Cir. 1971).




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                                     (1)                   RENT-A-CENTER, INC. v. COMMISSIONER                                       19


                                     Humana Inc. to * * * [the captive], as charged to them by
                                     Humana Inc., did not constitute valid insurance agreements’’
                                     and concluded that ‘‘[n]either Carnation nor Clougherty
                                     * * * provide[s] a basis for denying the deductions in the
                                     brother-sister * * * [arrangement].’’ Id. at 252–253. In
                                     response to our rationalization that ‘‘[i]f we decline to extend
                                     our holdings in Carnation and Clougherty to the brother-
                                     sister factual pattern, we would exalt form over substance
                                     and permit a taxpayer to circumvent our holdings by simple
                                     corporate structural changes’’, the Court of Appeals stated:
                                           Such an argument provides no legal justification for denying the deduc-
                                           tion in the brother-sister context. The legal test is whether there has
                                           been risk distribution and risk shifting, not whether Humana Inc. is a
                                           common parent or whether its affiliates are in a brother-sister relation-
                                           ship to * * * [the captive]. We do not focus on the relationship of the
                                           parties per se or the particular structure of the corporation involved. We
                                           look to the assets of the insured. * * * If Humana changes its corporate
                                           structure and that change involves risk shifting and risk distribution,
                                           and that change is for a legitimate business purpose and is not a sham
                                           to avoid the payment of taxes, then it is irrelevant whether the changed
                                           corporate structure has the side effect of also permitting Humana Inc.’s
                                           affiliates to take advantage of the Internal Revenue Code § 162(a) (1954)
                                           and deduct payments to a captive insurance company under the control
                                           of the Humana parent as insurance premiums. [Id. at 255–256.]

                                        The Court of Appeals held that ‘‘[t]he test to determine
                                     whether a transaction under the Internal Revenue Code
                                     § 162(a) * * * is legitimate or illegitimate is not a vague and
                                     broad ‘economic reality’ test. The test is whether there is risk
                                     shifting and risk distribution.’’ Id. at 255. The Court of
                                     Appeals further addressed our analysis and stated:
                                              The tax court cannot avoid direct confrontation with the separate cor-
                                           porate existence doctrine of Moline Properties by claiming that its deci-
                                           sion does not rest on ‘‘economic family’’ principles because it is merely
                                           reclassifying or recharacterizing the transaction as nondeductible addi-
                                           tions to a reserve for losses. The tax court argues in its opinion that such
                                           ‘‘recharacterization’’ does not disregard the separate corporate status of
                                           the entities involved, but merely disregards the particular transactions
                                           between the entities in order to take into account substance over form
                                           and the ‘‘economic reality’’ of the transaction that no risk has shifted.
                                              The tax court misapplies this substance over form argument. The sub-
                                           stance over form or economic reality argument is not a broad legal doc-
                                           trine designed to distinguish between legitimate and illegitimate trans-
                                           actions and employed at the discretion of the tax court whenever it feels
                                           that a taxpayer is taking advantage of the tax laws to produce a favor-
                                           able result for the taxpayer. * * * The substance over form analysis,




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                                     20                   142 UNITED STATES TAX COURT REPORTS                                        (1)


                                           rather, is a distinct and limited exception to the general rule under
                                           Moline Properties that separate entities must be respected as such for
                                           tax purposes. The substance over form doctrine applies to disregard the
                                           separate corporate entity where ‘‘Congress has evinced an intent to the
                                           contrary’’ * * *
                                             [Humana Inc. & Subs v. Commissioner, 881 F.2d at 254.]

                                     In short, we do not look to the parent to determine whether
                                     premiums paid by the subsidiaries to the captive are deduct-
                                     ible. Id. at 252. The policies shifted risk because claims paid
                                     by the captive did not affect the net worth of Humana’s
                                     subsidiaries. See id. at 252–253.
                                           3. Brother-Sister Arrangements May Shift Risk.
                                       We find persuasive the Court of Appeals for the Sixth Cir-
                                     cuit’s critique of our analysis of the brother-sister arrange-
                                     ment in Humana. First, our extension of Carnation and
                                     Clougherty to brother-sister arrangements was improper. As
                                     the Court of Appeals correctly concluded: ‘‘Carnation dealt
                                     solely with the parent-subsidiary issue, not the brother-sister
                                     issue. Likewise, Clougherty dealt only with the parent-sub-
                                     sidiary issue and not the brother-sister issue. Nothing in
                                     either Carnation or Clougherty lends support for denying the
                                     deductibility of the payments in the brother-sister context.’’
                                     Id. at 253–254.
                                       Second, the opinion of the Court’s extensive reliance on
                                     Plotkin’s report to analyze the brother-sister arrangement
                                     was inappropriate. The report in Humana addressed parent-
                                     subsidiary, rather than brother-sister, arrangements. See
                                     Humana Inc. & Subs. v. Commissioner, 88 T.C. at 209; see
                                     also supra pp. 16–20. In the instant cases, Plotkin explicitly
                                     addressed brother-sister arrangements and stated:
                                              Even though the brother, the captive, and the parent are in the same
                                           economic family, to the extent that a brother has no ownership interest
                                           in the captive, the results of the parent-captive analysis do not apply.
                                           It is not the presence or absence of unrelated business, nor the number
                                           of other insureds (be they affiliates or non-affiliates), but it is the
                                           absence of ownership, the captive’s capital, and the number of statis-
                                           tically independent risks (regardless of who owns them) that enables the
                                           captive to provide the brother with true insurance as a matter of
                                           economics and finance.

                                     We agree. Humana’s subsidiaries had no ownership interest
                                     in the captive. See Humana Inc. & Subs. v. Commissioner, 88




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                                     (1)                  RENT-A-CENTER, INC. v. COMMISSIONER                                       21


                                     T.C. at 201–202. Thus, the parent-subsidiary analysis
                                     employed by the opinion of the Court was incorrect.
                                       Third, we did not properly analyze the facts and cir-
                                     cumstances. See id. at 214. The balance sheet and net worth
                                     analysis provides the proper analytical framework to deter-
                                     mine risk shifting in brother-sister arrangements. See
                                     Humana Inc. & Subs. v. Commissioner, 881 F.2d at 252;
                                     Clougherty Packing Co. v. Commissioner, 811 F.2d at 1305.
                                     Instead, we implicitly employed a substance-over-form
                                     rationale to recharacterize Humana’s subsidiaries’ payments
                                     as amounts set aside for self-insurance and referenced, but
                                     did not apply, the balance sheet and net worth analysis.
                                     Indeed, we did not ‘‘examine the economic consequences of
                                     the captive insurance arrangement to the ‘insured’ party to
                                     see if that party * * * [had], in fact, shifted the risk.’’ See
                                     Clougherty Packing Co. v. Commissioner, 811 F.2d at 1305.
                                           4. The Legacy Policies Shifted Risk.
                                         In determining whether Legacy’s policies shifted risk, we
                                     narrow our scrutiny to the arrangement’s economic impact on
                                     RAC’s subsidiaries (i.e., the insured entities). See Humana
                                     Inc. & Subs. v. Commissioner, 881 F.2d at 252–253;
                                     Clougherty Packing Co. v. Commissioner, 811 F.2d at 1305
                                     (‘‘[W]e examine the economic consequences of the captive
                                     insurance arrangement to the ‘insured’ party to see if that
                                     party has, in fact, shifted the risk. In doing so, we look only
                                     to the insured’s assets[.]’’). In direct testimony respondent’s
                                     expert, however, emphasized that petitioner’s ‘‘captive pro-
                                     gram * * * [did] not involve risk shifting that * * * [was]
                                     comparable to that provided by a commercial insurance pro-
                                     gram.’’ We decline his invitation to premise our holding on
                                     a specious comparability analysis. Simply put, the risk either
                                     was, or was not, shifted.
                                         The policies at issue shifted risk from RAC’s insured
                                     subsidiaries to Legacy, which was formed for a valid business
                                     purpose; was a separate, independent, and viable entity; was
                                     financially capable of meeting its obligations; and reimbursed
                                     RAC’s subsidiaries when they suffered an insurable loss. See
                                     Sears, Roebuck & Co. v. Commissioner, 96 T.C. 61, 100–101
                                     (1991), aff ’d in part, rev’d in part, 972 F.2d 858 (7th Cir.
                                     1992); AMERCO v. Commissioner, 96 T.C. at 41. Moreover,
                                     a payment from Legacy to RAC’s subsidiaries did not reduce




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                                     the net worth of RAC’s subsidiaries because, unlike RAC, the
                                     subsidiaries did not own stock in Legacy. Indeed, on cross-
                                     examination, respondent’s expert conceded that the balance
                                     sheets and net worth of RAC’s subsidiaries were not affected
                                     by a covered loss and that the policies shifted risk:
                                             [Petitioner’s counsel]: But if the loss gets paid, whose balance sheet
                                           gets affected in that case?
                                             [Respondent’s expert]: What’s hanging me up is that I don’t know
                                           whether—I guess you’re right, because * * * [RAC’s subsidiary] will
                                           treat the payment from—the payment that it expects from Legacy as an
                                           asset, so the loss would hit Legacy’s [balance sheet].
                                             [Petitioner’s counsel]: But it wouldn’t hit * * * [RAC’s subsidiary’s]
                                           balance sheet.
                                             [Respondent’s expert]: I would think that’s right. * * *
                                             [Petitioner’s counsel]: Why is that not risk-shifting?
                                             [Respondent’s expert]: That’s an—why is that not risk-shifting?
                                             [Petitioner’s counsel]: Yes. Why is that not risk-shifting? Why hasn’t
                                           [RAC’s subsidiary] shifted its risk to Legacy? Its insurance risk—why
                                           hasn’t it shifted to Legacy in that scenario?
                                             [Respondent’s expert]: I mean, I would say from an accounting
                                           perspective, it has managed to have—is it—if we’re going to respect all
                                           these [corporate] forms, then it will have shifted that risk.

                                           5. The Parental Guaranty Did Not Vitiate Risk Shifting.
                                       Legacy, in March 2003, petitioned the BMA and received
                                     approval, through December 31, 2003, to treat DTAs as gen-
                                     eral business assets. On September 17, 2003, RAC issued the
                                     parental guaranty to Legacy, which petitioned, and received
                                     permission from, the BMA to treat DTAs as general business
                                     assets through December 31, 2006. Respondent contends that
                                     the parental guaranty abrogated risk shifting between
                                     Legacy and RAC’s subsidiaries. We disagree. First, and most
                                     importantly, the parental guaranty did not affect the balance
                                     sheets or net worth of the subsidiaries insured by Legacy.
                                     Petitioner’s expert, in response to a question the Court posed
                                     during cross-examination, convincingly countered respond-
                                     ent’s contention:
                                             [The Court]: * * * [W]hat impact does the corporate structure have on
                                           the effect of the parental guarantee?
                                             [Petitioner’s expert]: I think it has a great impact on it. None of the
                                           subs, as I understand it, are entering in or [are] a part of that guar-
                                           antee. Only the subs are effectively insureds under the policy. They are
                                           the only ones who produce risks that could be covered. The guarantee
                                           in no way vitiates the completeness of the transfer of their uncertainty,
                                           their risk, to the insuring subsidiary.




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                                             Even if one assumes that the guarantee increases the capital that the
                                           captive could use to pay losses, none of those payments would go to the
                                           detriment of the sub as a separate legal entity.

                                        Second, the cases upon which respondent relies are distin-
                                     guishable. Respondent cites Malone & Hyde, Inc. v. Commis-
                                     sioner, 62 F.3d 835, 841 (6th Cir. 1995) (holding that a
                                     reinsurance arrangement was not bona fide because the cap-
                                     tive was undercapitalized and the parent guaranteed the
                                     captive’s obligations to an unrelated insurer), rev’g T.C.
                                     Memo. 1993–585; Carnation Co. v. Commissioner, 71 T.C. at
                                     404, 409 (holding that a reinsurance arrangement lacked
                                     insurance risk where the captive was undercapitalized and,
                                     at the insistence of an unrelated primary insurer, the parent
                                     agreed to provide additional capital); and Kidde Indus., Inc.
                                     v. United States, 40 Fed. Cl. 42, 49–50 (1997) (holding that
                                     a reinsurance arrangement lacked risk shifting because the
                                     parent indemnified the captive’s obligation to pay an unre-
                                     lated primary insurer). Unlike the agreements in these cases,
                                     the parental guaranty did not shift the ultimate risk of loss;
                                     did not involve an undercapitalized captive; and was not
                                     issued to, or requested by, an unrelated insurer. Cf. Malone
                                     & Hyde, Inc. v. Commissioner, 62 F.3d at 841–843; Carnation
                                     Co. v. Commissioner, 71 T.C. at 404, 409; Kidde Indus., Inc.,
                                     40 Fed. Cl. at 49–50.
                                        Third, RAC guaranteed Legacy’s ‘‘liabilities under the Act
                                     [i.e., the Bermuda Insurance Act and related regulations]’’,
                                     pursuant to which Legacy was required to maintain ‘‘certain
                                     solvency and liquidity margins’’. RAC did not pay any money
                                     pursuant to the parental guaranty and Legacy’s ‘‘liabilities
                                     under the Act’’ did not include Legacy’s contractual obliga-
                                     tions to RAC’s affiliates or obligations to unrelated insurers.
                                     For purposes of calculating the minimum solvency margin,
                                     Legacy treated a portion of the parental guaranty as a gen-
                                     eral business asset. See supra pp. 9–10. In sum, by providing
                                     the parental guaranty to the BMA, Legacy received permis-
                                     sion to treat DTAs as general business assets and ensured its
                                     continued compliance with the BMA’s solvency require-
                                     ments. 19 The parental guaranty served no other purpose and
                                           19 Legacy
                                                 used a portion of the parental guaranty as a general business
                                     asset. See supra pp. 9–10. Legacy’s DTAs always exceeded the amount of
                                                                                                       Continued




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                                     was unilaterally revoked by RAC, in 2006, when Legacy met
                                     the BMA’s solvency requirements without reference to DTAs.
                                           C. The Legacy Policies Distributed Risk.
                                        Risk distribution occurs when an insurer pools a large
                                     enough collection of unrelated risks (i.e., risks that are gen-
                                     erally unaffected by the same event or circumstance). See
                                     Humana Inc. & Subs. v. Commissioner, 881 F.2d at 257. ‘‘By
                                     assuming numerous relatively small, independent risks that
                                     occur randomly over time, the insurer smoothes out losses to
                                     match more closely its receipt of premiums.’’ Clougherty
                                     Packing Co. v. Commissioner, 811 F.2d at 1300. This dis-
                                     tribution also allows the insurer to more accurately predict
                                     expected future losses. In analyzing risk distribution, we look
                                     at the actions of the insurer because it is the insurer’s, not
                                     the insured’s, risk that is reduced by risk distribution. See
                                     Harper Grp. v. Commissioner, 96 T.C. at 57. A captive may
                                     achieve adequate risk distribution by insuring only subsidi-
                                     aries within its affiliated group. See Humana Inc. & Subs. v.
                                     Commissioner, 881 F.2d at 257; Rev. Rul. 2002–90, 2002–2
                                     C.B. 985.
                                        Legacy insured three types of risk: workers’ compensation,
                                     automobile, and general liability. During the years in issue,
                                     RAC’s subsidiaries owned between 2,623 and 3,081 stores;
                                     had between 14,300 and 19,740 employees; and operated
                                     between 7,143 and 8,027 insured vehicles. RAC’s subsidiaries
                                     operated stores in all 50 States, the District of Columbia,
                                     Puerto Rico, and Canada. RAC’s subsidiaries had a sufficient
                                     number of statistically independent risks. Thus, by insuring
                                     RAC’s subsidiaries, Legacy achieved adequate risk distribu-
                                     tion. See Humana Inc. & Subs. v. Commissioner, 881 F.2d at
                                     257.
                                           D. The Arrangement Constituted Insurance in the Com-
                                              monly Accepted Sense.
                                       Legacy was adequately capitalized, regulated by the BMA,
                                     and organized and operated as an insurance company. Fur-
                                     thermore, Legacy issued valid and binding policies, charged
                                     and received actuarially determined premiums, and paid

                                     the parental guaranty treated as a general business asset. See supra pp.
                                     9–10.




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                                     (1)                  RENT-A-CENTER, INC. v. COMMISSIONER                                       25


                                     claims. In short, the arrangement between RAC’s subsidi-
                                     aries and Legacy constituted insurance in the commonly
                                     accepted sense. See Harper Grp. v. Commissioner, 96 T.C. at
                                     60.

                                                                                Conclusion
                                       The payments by RAC’s subsidiaries to Legacy are, pursu-
                                     ant to section 162, deductible as insurance expenses.
                                       Contentions we have not addressed are irrelevant, moot, or
                                     meritless.
                                       To reflect the foregoing,
                                                                        Decisions will be entered under Rule 155.
                                       Reviewed by the Court.
                                       THORNTON, VASQUEZ, WHERRY, HOLMES, BUCH, and NEGA,
                                     JJ., agree with this opinion of the Court.
                                       GOEKE, J., did not participate in the consideration of this
                                     opinion.



                                        BUCH, J., concurring: To the extent respondent is arguing
                                     that a captive insurance arrangement between brother-sister
                                     corporations cannot be insurance as a matter of law, we need
                                     not reach that issue. In Rev. Rul. 2001–31, 2001–1 C.B. 1348,
                                     1348, the Internal Revenue Service stated that it would ‘‘no
                                     longer invoke the economic family theory with respect to cap-
                                     tive insurance transactions.’’ And in Rauenhorst v. Commis-
                                     sioner, 119 T.C. 157, 173 (2002), we held that we may treat
                                     as a concession a position taken by the IRS in a revenue
                                     ruling that has not been revoked. Because Rev. Rul. 2001–
                                     31 has not been revoked, we could treat the economic family
                                     argument as conceded.
                                        At the same time the IRS abandoned the economic family
                                     theory, it made clear that it would ‘‘continue to challenge cer-
                                     tain captive insurance transactions based on the facts and
                                     circumstances of each case.’’ Rev. Rul. 2001–31, 2001–1 C.B.
                                     at 1348. Then, in a series of revenue rulings, the IRS shed
                                     light on the facts and circumstances it deemed relevant. See
                                     Rev. Rul. 2005–40, 2005–2 C.B. 4; Rev. Rul. 2002–91, 2002–
                                     2 C.B. 991; Rev. Rul. 2002–90, 2002–2 C.B. 985; Rev. Rul.
                                     2002–89, 2002–2 C.B. 984.




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                                     26                  142 UNITED STATES TAX COURT REPORTS                                        (1)


                                       The concise opinion of the Court sets forth facts and cir-
                                     cumstances supporting its conclusion. I write separately to
                                     respond to points made in Judge Lauber’s dissent.
                                     I. Legacy’s Policies
                                       Taking into account the nature of risks that Legacy
                                     insured, Legacy was sufficiently capitalized.
                                           A. Long-Tail Coverage
                                        During each of the years in issue Legacy insured three
                                     types of risk: workers’ compensation, automobile, and general
                                     liability. Policies relating to these risks are generally referred
                                     to as long-tail coverage because ‘‘claims may involve damages
                                     that are not readily observable or injuries that are difficult
                                     to ascertain.’’ See Acuity v. Commissioner, T.C. Memo. 2013–
                                     209, at *8–*9. Workers’ compensation insurance, which gen-
                                     erated between 66% and 73% of Legacy’s premiums 1 during
                                     the years in issue, ‘‘is generally long tail coverage because of
                                     the inherent uncertainty in determining the extent of an
                                     injured worker’s need for medical treatment and loss of
                                     wages for time off work.’’ Id. An insurer pays out claims
                                     relating to long-tail coverage over an extended period.
                                           B. Rent-A-Center’s Insurance Program
                                       Rent-A-Center did not obtain insurance solely from Legacy;
                                     Rent-A-Center also obtained insurance from multiple unre-
                                     lated third parties. Legacy was responsible for only a portion
                                     of each claim (e.g., the first $350,000 of each workers’ com-
                                     pensation claim during 2003). To the extent that a claim
                                     exceeded Legacy’s coverage, a third-party insurer was
                                     responsible for paying the excess amount. Rent-A-Center
                                     obtained coverage from unrelated third-party insurers for
                                     claims of up to approximately $75 million. Therefore, extraor-
                                     dinary losses would not affect Legacy’s ability to pay claims
                                     because they would be covered by unrelated third parties.



                                       1 Legacy’s premiums attributable to workers’ compensation liability were

                                     $28,586,597 in 2003; $35,392,000 in 2004; $36,463,579 in 2005;
                                     $39,086,374 in 2006; and $45,425,032 in 2007.




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                                     (1)                  RENT-A-CENTER, INC. v. COMMISSIONER                                       27


                                           C. Allocation Formula
                                        Premiums were actuarially determined. At trial respondent
                                     conceded that Aon ‘‘produced reliable and professionally pro-
                                     duced and competent actuarial studies.’’ Legacy relied on
                                     these studies to set premiums. Once Legacy determined the
                                     premium, Rent-A-Center allocated it to each operating sub-
                                     sidiary in the same manner that it allocated premiums
                                     relating to unrelated insurers. In a captive arrangement, a
                                     parent may allocate a premium among its subsidiaries. See
                                     Humana Inc. & Subs. v. Commissioner, 881 F.2d 247, 248
                                     (6th Cir. 1989) (‘‘Humana Inc. allocated and charged to the
                                     subsidiaries portions of the amounts paid representing the
                                     share each bore for the hospitals each operated.’’), aff ’g in
                                     part, rev’g in part and remanding 88 T.C. 197 (1987); Kidde
                                     Indus., Inc. v. United States, 40 Fed. Cl. 42, 45 (1997)
                                     (‘‘National determined the premiums that it charged Kidde
                                     based in part on underwriting data supplied by Kidde’s divi-
                                     sions and subsidiaries * * * Kidde used these same data to
                                     allocate the total premiums among its divisions and subsidi-
                                     aries.’’).
                                     II. The Parental Guaranty
                                        Citing a footnote in Humana, see Lauber op. p. 39, Judge
                                     Lauber’s dissenting opinion asserts that the existence of a
                                     parental guaranty is enough to justify disregarding the cap-
                                     tive insurance arrangement. That footnote, however,
                                     addresses only situations in which there is both inadequate
                                     capitalization and a parental guaranty, concluding: ‘‘These
                                     weaknesses alone provided a sufficient basis from which to
                                     find no risk shifting and to decide the cases in favor of the
                                     Commissioner.’’ Humana Inc. & Subs. v. Commissioner, 881
                                     F.2d at 254 n.2 (emphasis added). Here, the fact finder did
                                     not find inadequate capitalization. And the mere existence of
                                     a parental guaranty is not enough for us to disregard the
                                     captive insurer; we must look to the substance of that guar-
                                     anty.
                                        As the opinion of the Court finds, the parental guaranty
                                     was created to convert deferred tax assets into general busi-
                                     ness assets for regulatory purposes. See op. Ct. p. 22. The cir-
                                     cumstances relating to its issuance, including that the
                                     parental guaranty was issued to Legacy and that it was lim-




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                                     28                  142 UNITED STATES TAX COURT REPORTS                                        (1)


                                     ited to $25 million—or, less than 10% of the total premiums
                                     paid to Legacy—support the conclusion that it was created
                                     solely to encourage the Bermuda Monetary Authority to
                                     allow Legacy to treat DTAs as general business assets.
                                        In contrast, the cases that have found that a parental
                                     guaranty eliminates any risk shifting involved either a
                                     blanket indemnity or a capitalization agreement that
                                     resulted in a capital infusion in excess of premiums received.
                                     And even then, the indemnity or capitalization agreement
                                     was coupled with an undercapitalized captive. Accordingly,
                                     those cases are distinguishable from the situation presented
                                     here.
                                        Malone & Hyde, Inc. v. Commissioner, 62 F.3d 835 (6th
                                     Cir. 1995), rev’g T.C. Memo. 1993–585, involved an insurance
                                     subsidiary established to provide reinsurance for the parent
                                     and its subsidiaries. After incorporating the captive, Malone
                                     & Hyde entered into an agreement with a third-party insurer
                                     to insure both its own and its subsidiaries’ risks. Id. at 836.
                                     The third-party insurer then reinsured the first $150,000 of
                                     coverage per claim with the captive. Id. Because the captive
                                     was thinly capitalized—it had no assets other than $120,000
                                     of paid-in capital—Malone & Hyde executed ‘‘hold harmless’’
                                     agreements in favor of the third-party insurer. Id. These
                                     agreements provided that if the captive defaulted on its
                                     obligations as reinsurer, then Malone & Hyde would com-
                                     pletely shield the third-party insurer from liability. Id. In
                                     deciding whether the risk had shifted, the court held that
                                     ‘‘[w]hen the entire scheme involves either undercapitalization
                                     or indemnification of the primary insurer by the taxpayer
                                     claiming the deduction, or both, these facts alone disqualify
                                     the premium payments from being treated as ordinary and
                                     necessary business expenses to the extent such payments are
                                     ceded by the primary insurer to the captive insurance sub-
                                     sidiary.’’ Id. at 842–843. In short, Malone & Hyde, Inc. had
                                     a thinly capitalized captive insurer and a blanket indemnity.
                                     Here, neither of those facts is present.
                                        The facts in Kidde Indus., Inc. are quite similar to those
                                     in Malone & Hyde, Inc. Kidde incorporated a captive and
                                     entered into an insurance agreement with a third-party
                                     insurer who in turn entered into a reinsurance agreement
                                     with the captive. Kidde Indus., Inc., 40 Fed. Cl. at 45. As in
                                     Malone & Hyde, Inc., the captive was significantly under-




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                                     (1)                  RENT-A-CENTER, INC. v. COMMISSIONER                                       29


                                     capitalized, and Kidde executed an indemnification agree-
                                     ment to provide the third-party insurer with the ‘‘level of
                                     comfort’’ needed before it would issue the policies. Id. at 48.
                                     Again, the court held that Kidde retained the risk of loss and
                                     could not deduct the premiums. Id.
                                        Carnation Co. v. Commissioner, 71 T.C. 400 (1978), aff ’d,
                                     640 F.2d 1010 (9th Cir. 1981), involved slightly different
                                     facts. A captive reinsured 90% of the third-party insurer’s
                                     liabilities under Carnation’s policy. Id. at 403. As part of this
                                     arrangement, the third-party insurer ceded 90% of the pre-
                                     miums to the captive and the captive paid the third-party
                                     insurer a 5% commission based on the net premiums ceded.
                                     Id. Carnation provided $3 million of capital to the captive—
                                     an amount that was well in excess of the total annual pre-
                                     miums paid to the captive—because the third-party insurer
                                     had concerns about the captive’s capitalization. Id. at 404.
                                     The Court held that the reinsurance agreement and the
                                     agreement to provide additional capital counteracted each
                                     other and voided any insurance risk. Id. at 409. In affirming
                                     the Tax Court, the Court of Appeals for the Ninth Circuit
                                     held that, in considering whether the risk had shifted, the
                                     key was that the third-party insurer would not have issued
                                     the policies without the capitalization agreement. Carnation
                                     Co. v. Commissioner, 640 F.2d at 1013.
                                        Those cases are distinguishable because they all involved
                                     undercapitalized captives. As explained previously, the
                                     opinion of the Court found that Legacy was adequately
                                     capitalized. Further, in each of the three cases above, the
                                     parent provided either indemnification or additional capital-
                                     ization in order to persuade a third-policy insurer to issue
                                     insurance policies. Here, Discover Re provided insurance
                                     before Legacy’s inception and continued providing coverage
                                     after Legacy was formed. The parental guaranty was issued
                                     to Legacy for the singular purpose of allowing Legacy to treat
                                     the DTAs as general business assets. Additionally, the guar-
                                     anty amounted to only $25 million. This small fraction of the
                                     $264 million in premiums for policies written by Legacy
                                     during the years in issue does not rise to the level of protec-
                                     tion provided by the total indemnities in Malone & Hyde,
                                     Inc. and Kidde Indus., Inc.
                                        When we consider the totality of the facts, the parental
                                     guaranty appears to have been immaterial. This conclusion




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                                     30                  142 UNITED STATES TAX COURT REPORTS                                        (1)


                                     is bolstered by the facts that the parental guaranty was uni-
                                     laterally withdrawn by Rent-A-Center in 2006 and that Rent-
                                     A-Center never contributed any funds to Legacy pursuant to
                                     that parental guaranty.
                                     III. Consolidated Groups
                                        Judge Lauber’s dissent refers to a hodgepodge of facts
                                     about how Rent-A-Center operated its consolidated group as
                                     evidence that Legacy’s status as a separate entity should be
                                     disregarded. Examples of the facts cited in that dissent are
                                     that Legacy had no employees and that payments between it
                                     and other members of the Rent-A-Center consolidated group
                                     were handled through journal entries. See Lauber op. p. 44.
                                        In the real world of large corporations, these practices are
                                     commonplace. For ease of operations, including running pay-
                                     roll, companies create a staff leasing subsidiary and lease
                                     employees companywide. Or they hire outside consultants to
                                     handle the operations of a specialty business such as a cap-
                                     tive insurer. Legacy, like Humana, hired an outside manage-
                                     ment company to handle its business operations. Compare
                                     op. Ct. note 6 (Legacy engaged Aon to provide management
                                     services) with Humana Inc. & Subs. v. Commissioner, 88
                                     T.C. at 205 (Humana engaged Marsh & McLennan to provide
                                     management services). And it is unrealistic to expect mem-
                                     bers of a consolidated group to cut checks to each other.
                                     Rent-A-Center and Legacy did what is commonplace—they
                                     kept track of the flow of funds through journal entries. So
                                     long as complete and accurate records are maintained, the
                                     commingling of funds is not enough to require the dis-
                                     regarding of a separate business. See, e.g., Kahle v. Commis-
                                     sioner, T.C. Memo. 1991–203 (finding that the taxpayer
                                     ‘‘maintained complete and accurate records’’ notwithstanding
                                     the commingling of business and personal funds).
                                        Corporations filing consolidated returns are to be treated
                                     as separate entities, unless otherwise mandated. Gottesman
                                     & Co. v. Commissioner, 77 T.C. 1149, 1156 (1981). It may be
                                     advantageous for a corporation to operate through various
                                     subsidiaries for a multitude of reasons. These reasons may
                                     include State law implications, creditor demands, or simply
                                     convenience, but ‘‘so long as that purpose is the equivalent
                                     of business activity or is followed by the carrying on of busi-




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                                     (1)                  RENT-A-CENTER, INC. v. COMMISSIONER                                       31


                                     ness by the corporation, the corporation remains a separate
                                     taxable entity.’’ Moline Props., Inc. v. Commissioner, 319 U.S.
                                     436, 438–439 (1943). Even the consolidated return regula-
                                     tions make clear that an insurance company that is part of
                                     a consolidated group is treated separately. See sec. 1.1502–
                                     13(e)(2)(ii)(A), Income Tax Regs. (‘‘If a member provides
                                     insurance to another member in an intercompany trans-
                                     action, the transaction is taken into account by both mem-
                                     bers on a separate entity basis.’’). Thus, if a corporation gives
                                     due regard to the separate corporate structure, we should do
                                     the same.
                                     IV. Conclusion
                                        The issue presented in these cases is ultimately a matter
                                     of when, not whether, Rent-A-Center is entitled to a deduc-
                                     tion relating to workers’ compensation, automobile, and gen-
                                     eral liability losses. 2 Because the IRS has conceded in its
                                     rulings that insurance premiums paid between brother-sister
                                     corporations may be insurance and the Court determined
                                     that, under the facts and circumstances of these cases as
                                     found by the Judge who presided at trial, the policies at issue
                                     are insurance, Rent-A-Center is entitled to deduct the pre-
                                     miums as reported on its returns. See op. Ct. pp. 13–25.
                                        FOLEY, GUSTAFSON, PARIS, and KERRIGAN, JJ., agree with
                                     this concurring opinion.



                                       HALPERN, J., dissenting:
                                       ‘‘‘The principle of judicial parsimony’ (L. Hand, J., in
                                     Pressed Steel Car Co. v. Union Pacific Railroad Co., * * *
                                     [240 F. 135, 137 (S.D.N.Y. 1917)]), if nothing more, condemns
                                     a useless remedy.’’ Sinclair Ref. Co. v. Jenkins Petroleum
                                     Process Co., 289 U.S. 689, 694 (1933). While usually invoked
                                     by a court to justify a stay in discovery on other issues when
                                     one issue is dispositive of a case, 8A Charles Allen Wright,
                                       2 If the Court had determined that the policies were not insurance, then

                                     Rent-A-Center would nevertheless have been entitled to deduct the losses
                                     as they were paid or incurred. See sec. 162. By forming Legacy and giving
                                     due regard to its separate structure, Rent-A-Center achieved some accel-
                                     eration of deductions relating to losses that would otherwise be deductible,
                                     along with other nontax benefits. See op. Ct. p. 11.




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                                     32                  142 UNITED STATES TAX COURT REPORTS                                        (1)


                                     Arthur R. Miller & Richard L. Marcus, Federal Practice and
                                     Procedure, sec. 2040, at 198 n.7 (3d ed. 2010), I think the
                                     principle should guide us in declining to overrule Humana
                                     Inc. & Subs. v. Commissioner, 88 T.C. 197 (1987), aff ’d in
                                     part, rev’d in part and remanded, 881 F.2d 247 (6th Cir.
                                     1989), to the extent that it holds that a captive insurance
                                     arrangement between brother-sister corporations cannot be
                                     insurance as a matter of law.
                                        These cases are before the Court Conference for review, see
                                     sec. 7460(b), because we perceive that Judge Foley’s report is
                                     in part overruling Humana, although Judge Foley does not
                                     in so many words say so. He says: ‘‘We find persuasive the
                                     Court of Appeals for the Sixth Circuit’s critique of our anal-
                                     ysis the brother-sister arrangement in Humana.’’ See op. Ct.
                                     p. 20. The Court of Appeals said: ‘‘We reverse the tax court
                                     on * * * the brother-sister issue.’’ Humana Inc. & Subs. v.
                                     Commissioner, 881 F.2d at 257. Under our Conference proce-
                                     dures, the Conference may not adopt a report overruling a
                                     prior report of the Court absent the affirmative vote of a
                                     majority of the Judges entitled to vote on the case. Six of the
                                     sixteen Judges entitled to vote on these cases join Judge
                                     Foley, for a total of seven clearly affirmative votes. Six
                                     Judges voted ‘‘no’’. Three Judges voted ‘‘concur in result’’, and
                                     those votes, under our procedures, are counted as affirmative
                                     votes. Whether the Court has in fact overruled a portion of
                                     Humana undoubtedly will be unclear to many readers of this
                                     report. The resulting confusion is unnecessary. Moreover, by
                                     putting his report overruling Humana before the Conference,
                                     Judge Foley has put before the Conference his subsidiary
                                     findings of fact and his ultimate finding that the brother-
                                     sister payments were correctly characterized as insurance
                                     premiums. That has attracted two side opinions, one
                                     characterizing Judge Foley’s opinion as ‘‘concise’’ (Judge
                                     Buch), see concurring op. p. 26, and emphasizing evidence in
                                     the record that supports his findings and the other character-
                                     izing his ultimate findings as ‘‘conclusory’’ (Judge Lauber) see
                                     Lauber op. p. 38, and contending ‘‘the undisputed facts of the
                                     entire record warrant the opposite conclusion * * *, [that]
                                     the Rent-A-Center arrangements do not constitute ‘insurance’
                                     for Federal income tax purposes.’’ Whether I describe Judge
                                     Foley’s analysis as concise or as conclusory, simply put, there
                                     is insufficient depth to it to persuade me to join his findings




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                                     (1)                  RENT-A-CENTER, INC. v. COMMISSIONER                                       33


                                     (i.e., that there is risk shifting, that there is risk distribution,
                                     and, in general, that there is a bona fide insurance arrange-
                                     ment). I do agree with Judge Lauber that ‘‘[w]hether the
                                     facts and circumstances, evaluated in the aggregate, give rise
                                     to ‘insurance’ presents a question of proper characterization.
                                     It is thus a mixed question of fact and law.’’ See Lauber op.
                                     p. 38. Nevertheless, had Judge Foley steered clear of
                                     Humana, I believe that we could have avoided Conference
                                     consideration and have left it to the appellate process (if
                                     invoked) to determine whether Judge Foley’s findings are
                                     persuasive.
                                        And I believe that Judge Foley could have steered clear of
                                     Humana. As both Judges Buch and Lauber point out, the
                                     Commissioner has given up on arguing that captive insur-
                                     ance arrangement between brother-sister corporations cannot
                                     be insurance as a matter of law. See, e.g., Rev. Rul. 2001–
                                     31, 2001–C.B. 1348. Judge Foley ignores that ruling and its
                                     progeny when, pursuant to Rauenhorst v. Commissioner, 119
                                     T.C. 157, 173 (2002), he could have relied on the Commis-
                                     sioner’s concessions to steer clear of revisiting Humana. I
                                     agree with Judge Foley that Humana is not dispositive of the
                                     brother-sister insurance question in these cases, but not
                                     because I would overrule Humana on that issue; rather, I see
                                     no reason to address Humana in the light of the Commis-
                                     sioner’s present administrative position. While I agree with
                                     Judge Foley that the facts and circumstances test provides
                                     the proper analytical framework, I otherwise dissent from his
                                     opinion.
                                        LAUBER, J., agrees with this dissent.



                                        LAUBER, J., dissenting: These cases, like Humana Inc. &
                                     Subs. v. Commissioner, 88 T.C. 197 (1987), aff ’d in part,
                                     rev’d in part and remanded, 881 F.2d 247 (6th Cir. 1989),
                                     involve what I will refer to as a ‘‘classic’’ captive insurance
                                     company. In these cases, as in Humana, the captive has no
                                     outside owners and insures no outside risks. Rather, it is
                                     wholly owned by the parent of the affiliated group and it
                                     ‘‘insures’’ risks only of the parent and the operating subsidi-
                                     aries, which stand in a brother-sister relationship to it.




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                                     34                  142 UNITED STATES TAX COURT REPORTS                                        (1)


                                       In Humana we held that purported ‘‘insurance’’ premiums
                                     paid to a captive by other members of its affiliated group—
                                     whether by the parent or by the sister corporations—were
                                     not deductible for Federal income tax purposes. An essential
                                     requirement of ‘‘insurance’’ is the shifting of risk from
                                     insured to insurer. Helvering v. Le Gierse, 312 U.S. 531, 539
                                     (1941). We held in Humana that ‘‘there was not the nec-
                                     essary shifting of risk’’ from the operating subsidiaries to the
                                     captive, and hence that none of the purported ‘‘premiums’’
                                     constituted amounts paid for ‘‘insurance.’’ 88 T.C. at 214. The
                                     Court of Appeals for the Sixth Circuit affirmed as to amounts
                                     paid to the captive by the parent, but reversed as to amounts
                                     paid to the captive by the sister corporations. 881 F.2d at
                                     257.
                                       The opinion of the Court (majority) adopts the reasoning
                                     and result of the Sixth Circuit, overrules Humana in part,
                                     and holds that amounts charged to the captive’s sister cor-
                                     porations constitute deductible ‘‘insurance premiums.’’ I dis-
                                     sent both from the majority’s decision to overrule Humana
                                     and from its holding that amounts charged to the sister cor-
                                     porations constituted payments for ‘‘insurance’’ under the
                                     totality of the facts and circumstances.
                                     I. Background
                                        The captive insurance issue has a rich history to which the
                                     majority refers only episodically. It has been clear from the
                                     outset of our tax law that taxpayers (other than insurance
                                     companies) cannot deduct contributions to an insurance
                                     reserve. Steere Tank Lines, Inc. v. United States, 577 F.2d
                                     279, 280 (5th Cir. 1978); Spring Canyon Coal Co. v. Commis-
                                     sioner, 43 F.2d 78, 80 (10th Cir. 1930). Thus, if a unitary
                                     operating company maintains a reserve for self-insurance,
                                     amounts it places in that reserve are not deductible as
                                     ‘‘insurance premiums.’’
                                        One strategy by which taxpayers sought to avoid this non-
                                     deductibility rule was to place their self-insurance reserve
                                     into a captive insurance company. In cases involving ‘‘classic’’
                                     captives—i.e., captives that have no outside owners and
                                     insure no outside risks—the courts have uniformly held that
                                     this strategy does not work. Employing various legal theo-
                                     ries, every court to consider the question has held that




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                                     (1)                   RENT-A-CENTER, INC. v. COMMISSIONER                                       35


                                     amounts paid by a parent to a classic captive do not con-
                                     stitute ‘‘insurance premiums.’’ 1
                                        Insurance and tax advisers soon devised an alternative
                                     strategy for avoiding the bar against deduction of contribu-
                                     tions to a self-insurance reserve—namely, adoption of or
                                     conversion to a holding company structure. In essence, an
                                     operating company would drop its self-insurance reserve into
                                     a captive; drop its operations into one or more operating
                                     subsidiaries; and have the purported ‘‘premiums’’ paid to the
                                     captive by the sister companies instead of by the parent. In
                                     Humana, we held that this strategy did not work either, rea-
                                     soning that ‘‘we would exalt form over substance and permit
                                     a taxpayer to circumvent our holdings [involving parent-cap-
                                     tive payments] by simple corporate structural changes.’’ 88
                                     T.C. at 213. In effect, we concluded in Humana that conver-
                                     sion to a holding-company structure—without more—should
                                     not enable a taxpayer to accomplish indirectly what it cannot
                                     accomplish directly, achieving a radically different and more
                                     beneficial tax result when there has been absolutely no
                                     change in the underlying economic reality.
                                        While the Commissioner had success litigating the parent-
                                     captive pattern, he had surprisingly poor luck litigating the
                                     brother-sister scenario. The Tenth Circuit, like our Court,
                                     agreed that brother-sister payments to a classic captive are
                                     not deductible as ‘‘insurance premiums.’’ 2 By contrast, the
                                           1 See
                                              Beech Aircraft Corp. v. United States, 797 F.2d 920 (10th Cir.
                                     1986); Stearns-Roger Corp. v. United States, 774 F.2d 414, 415–416 (10th
                                     Cir. 1985); Humana Inc. & Subs. v. Commissioner, 88 T.C. 197, 207 (1987),
                                     aff ’d in part, rev’d in part and remanded, 881 F.2d 247 (6th Cir. 1989);
                                     Clougherty Packing Co. v. Commissioner, 84 T.C. 948 (1985), aff ’d, 811
                                     F.2d 1297, 1307 (9th Cir. 1987); Carnation Co. v. Commissioner, 71 T.C.
                                     400 (1978), aff ’d, 640 F.2d 1010, 1013 (9th Cir. 1981). On the other hand,
                                     the courts have held that parent-captive payments may constitute ‘‘insur-
                                     ance premiums’’ where the captive has a sufficient percentage of outside
                                     owners or insures a sufficient percentage of outside risks. See, e.g., Sears,
                                     Roebuck & Co. v. Commissioner, 96 T.C. 61 (1991) (approximately 99.75%
                                     of insured risks were outside risks), supplemented by 96 T.C. 671 (1991),
                                     aff ’d in part and rev’d in part, 972 F.2d 858 (7th Cir. 1992); Harper Grp.
                                     v. Commissioner, 96 T.C. 45 (1991) (approximately 30% of insured risks
                                     were outside risks), aff ’d, 979 F.2d 1341 (9th Cir. 1992); AMERCO v. Com-
                                     missioner, 96 T.C. 18 (1991) (between 52% and 74% of insured risks were
                                     outside risks), aff ’d, 979 F.2d 162 (9th Cir. 1992).
                                       2 See Beech Aircraft Corp., 797 F.2d at 922; Stearns-Roger Corp., 774
                                                                                                       Continued




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                                     36                  142 UNITED STATES TAX COURT REPORTS                                        (1)


                                     Sixth Circuit in Humana reversed our holding to this effect.
                                     And after some initial ambivalence, the Court of Federal
                                     Claims appears to have concluded that brother-sister ‘‘pre-
                                     mium’’ payments are deductible. 3
                                        The Commissioner had even less success persuading courts
                                     to adopt the ‘‘single economic family’’ theory enunciated in
                                     Rev. Rul. 77–316, 1977–2 C.B. 53, upon which his litigating
                                     position was initially based. That theory was approved by the
                                     Tenth Circuit 4 and found some favor in the Ninth Circuit. 5
                                     But it was rejected by our Court 6 as well as by the Sixth and
                                     Federal Circuits. 7
                                        Assessing this track record, the Commissioner made a
                                     strategic retreat. In 2001 the IRS announced that it ‘‘will no
                                     longer invoke the economic family theory with respect to cap-
                                     tive insurance transactions.’’ Rev. Rul. 2001–31, 2001–1 C.B.
                                     1348, 1348. In 2002 the IRS likewise abandoned its position
                                     that there is a per se rule against the deductibility of

                                     F.2d at 415–416.
                                         3 Compare Mobil Oil Corp. v. United States, 8 Cl. Ct. 555, 566 (1985)

                                     (‘‘[B]y deducting the premiums on its tax returns, * * * [the affiliated
                                     group] achieved indirectly that which it could not do directly. It is well set-
                                     tled that tax consequences must turn upon the economic substance of a
                                     transaction[.]’’), with Kidde Indus., Inc. v. United States, 40 Fed. Cl. 42
                                     (1997) (brother-sister payments deductible for years for which parent did
                                     not provide indemnity agreement). See generally Ocean Drilling & Explo-
                                     ration Co. v. United States, 988 F.2d 1135, 1153 (Fed. Cir. 1993) (brother-
                                     sister payments deductible where captive insured significant outside risks).
                                         4 See Beech Aircraft Corp., 797 F.2d 920; Stearns-Roger Corp., 774 F.2d

                                     at 415–416. See generally Humana, 881 F.2d at 251 (‘‘Stearns-Roger, Mobil
                                     Oil, and Beech Aircraft * * * each explicitly or implicitly adopted the eco-
                                     nomic family concept.’’).
                                         5 See Clougherty Packing, 811 F.2d at 1304 (‘‘[W]e seriously doubt that

                                     the use of an economic family concept in defining insurance runs afoul of
                                     the Supreme Court’s holding in Moline Properties.’’); id. at 1305 (finding
                                     ‘‘considerable merit in the Commissioner’s [economic family] argument’’
                                     but finding it unnecessary to rely on that theory); Carnation Co., 640 F.2d
                                     at 1013.
                                         6 See Humana, 88 T.C. at 214 (rejecting the Commissioner’s ‘‘economic

                                     family’’ concept); Clougherty Packing, 84 T.C. at 956 (same); Carnation Co.,
                                     71 T.C. at 413 (same).
                                         7 See Malone & Hyde, Inc. v. Commissioner, 62 F.3d 835 (6th Cir. 1995)

                                     (rejecting ‘‘economic family’’ theory but ruling against deductibility of pay-
                                     ments to captive based on facts and circumstances), rev’g T.C. Memo.
                                     1993–585; Ocean Drilling & Exploration Co., 988 F.2d at 1150–1151;
                                     Humana, 881 F.2d at 251.




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                                     (1)                  RENT-A-CENTER, INC. v. COMMISSIONER                                       37


                                     brother-sister ‘‘premiums,’’ concluding that the characteriza-
                                     tion of such payments as ‘‘insurance premiums’’ should be
                                     governed, not by a per se rule, but by the facts and cir-
                                     cumstances of the particular case. Rev. Rul. 2002–90, 2002–
                                     2 C.B. 985; accord Rev. Rul. 2001–31, 2001–1 C.B. at 1348
                                     (‘‘The Service may * * * continue to challenge certain cap-
                                     tive insurance transactions based on the facts and cir-
                                     cumstances of each case.’’).
                                     II. Overruling Humana
                                        We decided Humana against a legal backdrop very dif-
                                     ferent from that which we confront today. The Commissioner
                                     in Humana urged a per se rule, predicated on his ‘‘single eco-
                                     nomic family’’ theory, against the deductibility of brother-
                                     sister ‘‘insurance premiums.’’ The Commissioner has long
                                     since abandoned both that per se rule and the theory on
                                     which it was based. Given this change in the legal environ-
                                     ment, I see no need for the Court to reconsider Humana,
                                     which in a practical sense may be water under the bridge.
                                        Respondent’s position in the instant cases is consistent
                                     with the ruling position the IRS has maintained for the past
                                     12 years—namely, that characterization of intragroup pay-
                                     ments as ‘‘insurance premiums’’ should be determined on the
                                     basis of the facts and circumstances of the particular case.
                                     See Rev. Rul. 2001–31, 2001–1 C.B. at 1348. The majority
                                     adopts this approach as the framework for its legal analysis.
                                     See op. Ct. pp. 13-14 (‘‘We consider all of the facts and cir-
                                     cumstances to determine whether an arrangement qualifies
                                     as insurance.’’). The Court need not overrule Humana to
                                     decide (erroneously in my view) that respondent should lose
                                     under the facts-and-circumstances approach that respondent
                                     is now advancing. In Humana, ‘‘we emphasize[d] that our
                                     holding * * * [was] based upon the factual pattern presented
                                     in * * * [that] case,’’ noting that in other cases ‘‘factual pat-
                                     terns may differ.’’ 88 T.C. at 208. That being so, the Court
                                     today could rule for petitioners on the basis of what the
                                     majority believes to be the controlling ‘‘facts and cir-
                                     cumstances,’’ distinguishing Humana rather than overruling
                                     it. Principles of judicial restraint counsel that courts should
                                     decide cases on the narrowest possible ground.




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                                     38                   142 UNITED STATES TAX COURT REPORTS                                        (1)


                                     III. The ‘‘Facts and Circumstances’’ Approach
                                       Although I do not believe it necessary or proper to overrule
                                     Humana, the continuing vitality of that precedent does not
                                     control the outcome. These cases can and should be decided
                                     in respondent’s favor under the ‘‘facts and circumstances’’
                                     approach that he is currently advancing. In Rev. Rul. 2002–
                                     90, 2002–2 C.B. at 985, the IRS concluded that brother-sister
                                     payments were correctly characterized as ‘‘insurance pre-
                                     miums’’ where the assumed facts included the following (P =
                                     parent and S = captive):
                                           P provides S adequate capital * * *. S charges the 12 [operating]
                                           subsidiaries arms-length premiums, which are established according to
                                           customary industry rating formulas. * * * There are no parental (or
                                           other related party) guarantees of any kind made in favor of S. * * *
                                           In all respects, the parties conduct themselves in a manner consistent
                                           with the standards applicable to an insurance arrangement between
                                           unrelated parties.

                                       The facts of the instant cases, concerning both ‘‘risk
                                     shifting’’ and conformity to arm’s-length insurance standards,
                                     differ substantially from the facts assumed in Rev. Rul.
                                     2002–90, supra. The instant facts also differ substantially
                                     from the facts determined in judicial precedents that have
                                     characterized intragroup payments as ‘‘insurance premiums.’’
                                     Whether the facts and circumstances, evaluated in the aggre-
                                     gate, give rise to ‘‘insurance’’ presents a question of proper
                                     characterization. It is thus a mixed question of fact and law.
                                       The majority makes certain findings of basic fact, which I
                                     accept for purposes of this dissenting opinion. In many
                                     instances, however, the majority makes no findings of basic
                                     fact to support its conclusory findings of ultimate fact. In
                                     other instances, the majority does not mention facts that
                                     tend to undermine its ultimate conclusions. In my view, the
                                     undisputed facts of the entire record warrant the opposite
                                     conclusion from that reached by the majority and justify a
                                     ruling that the Rent-A-Center arrangements do not con-
                                     stitute ‘‘insurance’’ for Federal income tax purposes.
                                           A. Risk Shifting
                                           1. Parental Guaranty
                                       Rent-A-Center, the parent, issued two types of guaranties
                                     to Legacy, its captive. First, it guaranteed the multi-million-




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                                     (1)                  RENT-A-CENTER, INC. v. COMMISSIONER                                       39


                                     dollar ‘‘deferred tax asset’’ (DTA) on Legacy’s balance sheet,
                                     which arose from timing differences between the captive’s
                                     fiscal year and the parent’s calendar year. Normally, a DTA
                                     cannot be counted as an ‘‘asset’’ for purposes of the (rather
                                     modest) minimum solvency requirements of Bermuda insur-
                                     ance law. The parent’s guaranty was essential in order for
                                     Legacy to secure an exception from this rule.
                                        Second, the parent subsequently issued an all-purpose
                                     guaranty by which it agreed to hold Legacy harmless for its
                                     liabilities under the Bermuda Insurance Act up to $25 mil-
                                     lion. These liabilities necessarily included Legacy’s liabilities
                                     to pay loss claims of its sister corporations. This all-purpose
                                     $25 million guaranty was eliminated at yearend 2006, but it
                                     was in existence for the first three tax years at issue.
                                        When approving the brother-sister premiums in Rev. Rul.
                                     2002–90, 2002–2 C.B. at 985, the IRS explicitly excluded
                                     from the hypothesized facts the existence of any parental or
                                     related-party guaranty executed in favor of the captive.
                                     Numerous courts have likewise ruled that the existence of a
                                     parental guaranty, indemnification agreement, or similar
                                     instrument may negate the existence of ‘‘insurance’’ purport-
                                     edly supplied by a captive. See, e.g., Malone & Hyde, Inc. v.
                                     Commissioner, 62 F.3d 835, 842–843 (6th Cir. 1995) (finding
                                     no ‘‘insurance’’ where parent guaranteed captive’s liabilities),
                                     rev’g T.C. Memo. 1993–585; Humana, 881 F.2d at 254 n.2
                                     (presence of parental indemnification or recapitalization
                                     agreement may provide a sufficient basis on which to find no
                                     ‘‘risk shifting’’); Carnation Co. v. Commissioner, 71 T.C. 400,
                                     402, 409 (1978) (finding no ‘‘insurance’’ where parent agreed
                                     to supply captive with additional capital), aff ’d, 640 F.2d
                                     1010 (9th Cir. 1981); Kidde Indus., Inc. v. United States, 40
                                     Fed. Cl. 42, 50 (1997) (finding no ‘‘insurance’’ where parent
                                     issued indemnification letter).
                                        By guaranteeing Legacy’s liabilities, Rent-A-Center agreed
                                     to step into Legacy’s shoes to pay its affiliates’ loss claims.
                                     In effect, the parent thus became an ‘‘insurer’’ of its subsidi-
                                     aries’ risks. The majority cites no authority, and I know of
                                     none, for the proposition that a holding company can ‘‘insure’’
                                     the risks of its wholly owned subsidiaries. The presence of
                                     this parental guaranty argues strongly against the existence
                                     of ‘‘risk shifting’’ here.




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                                     40                  142 UNITED STATES TAX COURT REPORTS                                        (1)


                                         The majority asserts that Rent-A-Center’s parental guar-
                                     anty ‘‘did not vitiate risk shifting’’ and offers three rationales
                                     for this conclusion. See op. Ct. pp. 22–24. None of these
                                     rationales is convincing. The majority notes that the parent
                                     ‘‘did not pay any money pursuant to the parental guaranty’’
                                     and suggests that the guaranty was really designed only to
                                     make sure that Legacy’s DTAs were counted in calculating
                                     its Bermuda minimum solvency margin. See id. p. 23. The
                                     fact that the parent was never required to pay on the guar-
                                     anty is irrelevant; it is the existence of a parental guaranty
                                     that matters in determining whether a captive is truly pro-
                                     viding ‘‘insurance.’’ And whatever may have prompted the
                                     issuance of the guaranty, the fact is that it literally covers
                                     all of Legacy’s liabilities up to $25 million. The DTAs never
                                     got above $9 million during 2003–06. See id. p. 10. Legacy’s
                                     ‘‘liabilities’’ obviously included Legacy’s liability to pay the
                                     insurance claims of its sister companies.
                                         The majority contends that the judicial precedents cited
                                     above ‘‘are distinguishable’’ because the guaranty issued by
                                     Rent-A-Center ‘‘did not shift the ultimate risk of loss; did not
                                     involve an undercapitalized captive; and was not issued to,
                                     or requested by, an unrelated insurer.’’ See id. p. 23. The
                                     majority’s first asserted distinction begs the question because
                                     it assumes that risk has been shifted to Legacy, which is the
                                     proposition that must be proved. The majority’s second
                                     asserted distinction is a play on words. While Legacy for
                                     most of the period at issue was not ‘‘undercapitalized’’ from
                                     the standpoint of Bermuda’s (modest) minimum solvency
                                     rules, it was very poorly capitalized in comparison with real
                                     insurance companies. See infra pp. 41–43. Moreover, the
                                     Court of Appeals for the Sixth Circuit in Humana indicated
                                     that a parental guaranty alone, without regard to the cap-
                                     tive’s capitalization, can ‘‘provide[] a sufficient basis from
                                     which to find no risk shifting.’’ 881 F.2d at 245 n.2. The
                                     majority’s third asserted distinction is a distinction without
                                     a difference. While Rent-A-Center’s guaranty was not
                                     requested by ‘‘an unrelated insurer,’’ it was demanded by
                                     Legacy’s nominal insurance regulator as a condition of
                                     meeting Bermuda’s minimum solvency requirements.
                                         As the ‘‘most important[ ]’’ ground for deeming the guar-
                                     anty irrelevant, the majority asserts that the parental guar-
                                     anty ‘‘did not affect the balance sheets or net worth of the




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                                     (1)                  RENT-A-CENTER, INC. v. COMMISSIONER                                       41


                                     subsidiaries insured by Legacy.’’ See op. Ct. p. 22. The
                                     majority here reprises its argument that the ‘‘net worth and
                                     balance sheet analysis’’ must be conducted at the level of the
                                     operating subsidiaries. See id. pp. 15-16, 21. Whatever the
                                     merit of that argument generally, as applied to the guaranty
                                     it clearly proves too much. A parental guaranty of a captive’s
                                     liabilities will never affect the balance sheet or net worth of
                                     the sister company that is allegedly ‘‘insured.’’ But the Sixth
                                     Circuit, the Federal Circuit, and this Court have all held that
                                     the existence of a parental guaranty may negate the exist-
                                     ence of ‘‘insurance’’ within an affiliated group.
                                           2. Inadequate Capitalization
                                        When blessing the brother-sister premium payments in
                                     Rev. Rul. 2002–90, supra, the Commissioner hypothesized
                                     that the parent had supplied the captive with ‘‘adequate cap-
                                     ital.’’ Numerous judicial opinions have likewise held that risk
                                     cannot be ‘‘shifted’’ to a captive unless the captive is suffi-
                                     ciently capitalized to absorb the risk. See, e.g., Beech Aircraft,
                                     797 F.2d at 922 n.1 (no ‘‘insurance’’ where captive was
                                     undercapitalized); Carnation Co., 71 T.C. at 409 (same).
                                        The majority bases its conclusion that Legacy was ‘‘ade-
                                     quately capitalized’’ on the fact that Legacy ‘‘met Bermuda’s
                                     minimum statutory requirements’’ once the parental guar-
                                     anty of the DTA is counted. See op. Ct. p. 13. The fact that
                                     a captive meets the minimum capital requirements of an off-
                                     shore financial center is not dispositive as to whether the
                                     arrangements constitute ‘‘insurance’’ for Federal income tax
                                     purposes. Indeed, the Sixth Circuit in Malone & Hyde held
                                     that intragroup payments were not ‘‘insurance premiums’’
                                     even though the captive met ‘‘the extremely thin minimum
                                     capitalization required by Bermuda law.’’ 62 F.3d at 841.
                                        In fact, Legacy’s capital structure was extremely question-
                                     able during 2003–06. The only way that Legacy was able to
                                     meet Bermuda’s extremely thin minimum capitalization
                                     requirement was by counting as general business assets its
                                     DTAs, and those DTAs could be counted only after Rent-A-
                                     Center issued its parental guaranty. The DTAs were essen-
                                     tially a bookkeeping entry. Without treating that book-
                                     keeping entry as an ‘‘asset,’’ Legacy would have been under-
                                     capitalized even by Bermuda’s lax standards.




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                                     42                  142 UNITED STATES TAX COURT REPORTS                                        (1)


                                        The extent of Legacy’s undercapitalization is evidenced by
                                     its premium-to-surplus ratio, which was wildly out of line
                                     with the ratios of real insurance companies. The premium-to-
                                     surplus ratio provides a good benchmark of an insurer’s
                                     ability to absorb risk by drawing on its surplus to pay
                                     incurred losses. In this ratio, ‘‘premiums written’’ serves as
                                     a proxy for the losses to which the insurer is exposed. Expert
                                     testimony in these cases indicated that U.S. property/cas-
                                     ualty insurance companies, on average, have something like
                                     a 1:1 premium-to-surplus ratio. In other words, their surplus
                                     roughly equals the annual premiums for policies they write.
                                     By contrast, Legacy’s premium-to-surplus ratio—ignoring the
                                     parental guaranty of its DTA—was 48:1 in 2003, 19:1 in
                                     2004, 11:1 in 2005, and in excess of 5:1 in 2006 and 2007.
                                     In other words, Legacy’s surplus covered only 2% of pre-
                                     miums for policies written in 2003 and only 5% of premiums
                                     for policies written in 2004, whereas commercial insurance
                                     companies have surplus coverage in the range of 100%. Even
                                     if we allow the parental guaranty to count toward Legacy’s
                                     surplus, its premium-to-surplus ratio was never better than
                                     5:1.
                                        Legacy’s assets were undiversified and modest. It had a
                                     money market fund into which it placed the supposed ‘‘pre-
                                     miums’’ received from its parent. This fund was in no sense
                                     ‘‘surplus’’; it was a mere holding tank for cash used to pay
                                     ‘‘claims.’’ Apart from this money market fund, Legacy
                                     appears to have had no assets during the tax years at issue
                                     except the following: (a) the guaranties issued by its parent;
                                     (b) the DTA reflected on its balance sheet; and (c) Rent-A-
                                     Center treasury stock that Legacy purchased from its parent.
                                     For Federal tax purposes, the parental guaranties cannot
                                     count as ‘‘assets’’ in determining whether Legacy was ade-
                                     quately capitalized. They point in the precisely opposite
                                     direction.
                                        The DTA and treasury stock have in common several fea-
                                     tures that make them poor forms of insurance capital. First,
                                     neither yields income. The DTA was an accounting entry
                                     that by definition cannot yield income, and the Rent-A-
                                     Center treasury stock paid no dividends. No true insurance
                                     company would invest 100% of its ‘‘reserves’’ in non-income-
                                     producing assets. With no potential to earn income, the
                                     ‘‘reserves’’ could not grow to afford a cushion against risk.




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                                     (1)                   RENT-A-CENTER, INC. v. COMMISSIONER                                       43


                                        Moreover, neither the DTA nor the treasury stock was
                                     readily convertible into cash. The DTA had no cash value.
                                     The treasury stock by its terms could not be sold or alien-
                                     ated, although the parent agreed to buy it back at its issue
                                     price. In effect, Legacy relied on the availability of cash from
                                     its parent, via repurchase of treasury shares, to pay claims
                                     in the event of voluminous losses. 8
                                        Finally, Legacy’s assets were, to a large degree, negatively
                                     correlated with its insurance risks. During 2004–06, Legacy
                                     purchased $108 million of Rent-A-Center treasury stock,
                                     while ‘‘insuring’’ solely Rent-A-Center risks. Thus, if outsized
                                     losses occurred, those losses would simultaneously increase
                                     Legacy’s liabilities and reduce the value of the Rent-A-Center
                                     stock that was Legacy’s principal asset. No true insurance
                                     company invests its reserves in assets that are both
                                     undiversified and negatively correlated to the risks that it is
                                     insuring.
                                        In sum, when one combines the existence of the parental
                                     guaranty, Legacy’s extremely weak premium-to-surplus ratio,
                                     the speculative nature and poor quality of the assets in Leg-
                                     acy’s ‘‘insurance reserves,’’ and the fact that Legacy without
                                     the parental guaranty would not even have met ‘‘the
                                     extremely thin minimum capitalization required by Bermuda
                                     law,’’ Malone & Hyde, 62 F.3d at 841, the absence of ‘‘risk
                                     shifting’’ seems clear. Under the totality of the facts and cir-
                                     cumstances, I conclude that there has been no transfer of
                                     risk to the captive and hence that the Rent-A-Center
                                     arrangements do not constitute ‘‘insurance’’ for Federal
                                     income tax purposes.
                                           B. Conformity to Insurance Industry Standards
                                       When blessing the brother-sister premiums in Rev. Rul.
                                     2002–90, supra, the IRS hypothesized that ‘‘the parties [had]
                                     conduct[ed] themselves in a manner consistent with the
                                     standards applicable to an insurance arrangement between
                                     unrelated parties.’’ Our Court has similarly ruled that trans-
                                     actions in a captive-insurance context must comport with
                                           8 Because
                                                  Legacy ‘‘insured’’ losses only below a defined threshold, there
                                     was a cap on the size of any individual loss that it might have to pay. See
                                     op. Ct. p. 5. However, the number of individual loss events within that
                                     tranche could exceed expectations.




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                                     44                  142 UNITED STATES TAX COURT REPORTS                                        (1)


                                     ‘‘commonly accepted notions of insurance.’’ Harper Grp. v.
                                     Commissioner, 96 T.C. 45, 58 (1991), aff ’d, 979 F.2d 1341
                                     (9th Cir. 1992). Because risk shifting is essential to ‘‘insur-
                                     ance,’’ Helvering v. Le Gierse, 312 U.S. at 539, the absence
                                     of risk shifting alone would dictate that the Rent-A-Center
                                     payments are not deductible as ‘‘insurance premiums.’’ How-
                                     ever, there are a number of respects in which Rent-A-Center,
                                     its captive, and the allegedly ‘‘insured’’ subsidiaries did not
                                     conduct themselves in a manner consistent with accepted
                                     insurance industry norms. These facts provide additional
                                     support for concluding that these arrangements did not con-
                                     stitute ‘‘insurance.’’
                                        Several facts discussed above in connection with ‘‘risk
                                     shifting’’ show that the Rent-A-Center arrangements do not
                                     comport with normal insurance industry practice. These
                                     include the facts that Legacy was poorly capitalized; that its
                                     premium-to-surplus ratio was way out of line with the ratios
                                     of true insurance companies; and that is ‘‘reserves’’ consisted
                                     of assets that were non-income-producing, illiquid,
                                     undiversified, and negatively correlated to the risks it was
                                     supposedly ‘‘insuring.’’ No true insurance company would act
                                     this way.
                                        It appears that Legacy had no actual employees during the
                                     tax years at issue. It had no outside directors, and it had no
                                     officers apart from people who were also officers of Rent-A-
                                     Center, its parent. Legacy’s ‘‘operations’’ appear to have been
                                     conducted by David Glasgow, an employee of Rent-A-Center,
                                     its parent. ‘‘Premium payments’’ and ‘‘loss reimbursements’’
                                     were effected through bookkeeping entries made by account-
                                     ants at Rent-A-Center’s corporate headquarters. Legacy was
                                     in practical effect an incorporated pocketbook that served as
                                     a repository for what had been, until 2003, Rent-A-Center’s
                                     self-insurance reserve.
                                        Legacy issued its first two ‘‘insurance policies’’ before
                                     receiving a certificate of registration from Bermuda insur-
                                     ance authorities. According to those authorities, Legacy was
                                     therefore in violation of Bermuda law and ‘‘engaged in the
                                     insurance business without a license.’’ (Bermuda evidently
                                     agreed to let petitioners fix this problem retroactively.)
                                        For the first three months of its existence, Legacy was in
                                     violation of Bermuda’s minimum capital rules because the
                                     DTA was not cognizable in determining capital adequacy.




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                                     (1)                  RENT-A-CENTER, INC. v. COMMISSIONER                                       45


                                     Only upon the issuance of the parental guaranty in March
                                     2003, and the acceptance of this guaranty by Bermuda
                                     authorities, was Legacy able to pass Bermuda’s capital ade-
                                     quacy test.
                                        There was no actuarial determination of the premium pay-
                                     able to Legacy by each operating subsidiary based on the
                                     specific subsidiary’s risk profile. Rather, an outside insurance
                                     adviser estimated the future loss exposure of the affiliated
                                     group, and Rent-A-Center, the parent, determined an aggre-
                                     gate ‘‘premium’’ using that estimate. The parent paid this
                                     ‘‘premium’’ annually to Legacy. The parent’s accounting
                                     department subsequently charged portions of this ‘‘premium’’
                                     to each subsidiary, in the same manner as self-insurance
                                     costs had been charged to those subsidiaries before Legacy
                                     was created. In other words, in contrast to the facts assumed
                                     in Rev. Rul. 2002–90, supra, there was in these cases no
                                     determination of ‘‘arms-length premiums * * * established
                                     according to customary industry rating formulas.’’ To the
                                     contrary, the entire arrangement was orchestrated exactly as
                                     it had been orchestrated before 2003, when the Rent-A-
                                     Center group maintained a self-insurance reserve for the
                                     tranche of risks purportedly ‘‘insured’’ by Legacy.
                                        From Legacy’s inception in December 2002 through May
                                     2004, Legacy did not actually pay ‘‘loss claims’’ submitted by
                                     the supposed ‘‘insureds.’’ Rather, the parent’s accounting
                                     department netted ‘‘loss reimbursements’’ due to the subsidi-
                                     aries from Legacy against ‘‘premium payments’’ due to
                                     Legacy from the parent. Beginning in July 2004, the parent
                                     withdrew a fixed, preset amount of cash via weekly bank
                                     wire from Legacy’s money market account. These weekly
                                     withdrawals depleted Legacy’s money market account to near
                                     zero just before the next annual ‘‘premium’’ was due. This
                                     modus operandi shows that Rent-A-Center regarded Legacy
                                     not as an insurer operating at arm’s length but as a bank
                                     account into which it made deposits and from which it made
                                     withdrawals.
                                        These facts, considered in their totality, lead me to dis-
                                     agree with the majority’s conclusory assertions that ‘‘Legacy
                                     entered into bona fide arm’s length contracts with * * *
                                     [Rent-A-Center]’’; that Legacy ‘‘charged actuarially deter-
                                     mined premiums’’; that Legacy ‘‘paid claims from its sepa-
                                     rately maintained account’’; and that Legacy ‘‘was adequately




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                                     46                  142 UNITED STATES TAX COURT REPORTS                                        (1)


                                     capitalized.’’ See op. Ct. p. 13. In my view, the totality of the
                                     facts and circumstances could warrant the conclusion that
                                     Legacy was a sham. At the very least, the totality of the facts
                                     and circumstances makes clear that the arrangements here
                                     did not comport with ‘‘commonly accepted notions of insur-
                                     ance,’’ Harper Grp., 96 T.C. at 58, and that the Rent-A-
                                     Center group of companies did not ‘‘conduct themselves in a
                                     manner consistent with the standards applicable to an insur-
                                     ance arrangement between unrelated parties,’’ Rev. Rul.
                                     2002–90, 2001–2 C.B. at 985. The departures from accepted
                                     insurance industry practice, combined with the absence of
                                     risk shifting to the captive from the alleged ‘‘insureds,’’ con-
                                     firms that these arrangements did not constitute ‘‘insurance’’
                                     for Federal income tax purposes.
                                        COLVIN, GALE, KROUPA, and MORRISON, JJ., agree with
                                     this dissent.

                                                                               f




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