Recently, a New York State tax appeals administrative law judge ruled that the premiums of a captive insurer of a pharmacy chain registered in New York are not eligible for tax deduction.

        The company, named Stewart, and its New York-registered Black Ridge Insurance Company were established in 2003. Captive tax experts from McDermott Will & Emery, representing the company, applied to the court for a redetermination and a refund of US$10-11 million in corporate business taxes paid during 2006-2009. The captive was dissolved in 2010.
        New York State tax appeals administrative law judge Barbara Russo ruled that because the pharmacy chain's pure captive was operated and managed entirely by its parent company, although its premiums met the requirements for captive insurer qualification and the recognition of captive premiums under Article 33 of the Tax Law and New York insurance regulation, the arrangement did not achieve the necessary risk transfer and risk distribution. The captive must therefore pay US$211,266 in tax incurred during the period.

        Under current US tax law, "insurance" whose premiums qualify for deduction must have at least the following attributes: first, risk transfer, meaning risk is shifted from one company to another, unrelated company; second, risk distribution, meaning risk is spread among a sufficient number of parties. On this theory, captive insurers that only underwrite the risks of enterprises within a group do not qualify for tax deduction, because the risk remains within the group and lacks the attributes of risk transfer and risk distribution. Only when a captive underwrites the business of sister companies within the group or third-party business exceeding 30% can it enjoy the tax deduction.