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United States v. Owensboro Dermatology Associates, P.S.C.

United States District Court, W.D. Kentucky, Owensboro Division

July 6, 2017

UNITED STATES OF AMERICA PETITIONER
v.
OWENSBORO DERMATOLOGY ASSOCIATES, P.S.C. RESPONDENT UNITED STATES OF AMERICA PETITIONER
v.
DERMATOLOGY PROPERTY MANAGEMENT, LLC RESPONDENT UNITED STATES OF AMERICA PETITIONER
v.
BEVELED EDGE INSURANCE COMPANY RESPONDENT

          JOSEPH H. MCKINLEY, JR. CHIEF JUDGE

          MEMORANDUM OPINION AND ORDER

          H. Brent Brennenstuhl United States Magistrate Judge

         BACKGROUND

         Before the Court are the United States' motions to compel production, and in the alternative, motions for in camera review of all communications identified in Respondents' revised privilege logs (4:16-mc-00003, DN 15; 4:16-mc-00004, DN 15; 4:16-mc-00005, DN 15). Respondents, Owensboro Dermatology Associates, PSC, Dermatology Property Management, LLC, and Beveled Edge Insurance Company (collectively “Respondents”), have filed objections to the motions (4:16-mc-00003, DN 16; 4:16-mc-00004, DN 16; 4:16-mc-00005, DN 16). The United States has filed replies to each objection (4:16-mc-00003, DN 19; 4:16-mc-00004, DN 20; 4:16-mc-00005, DN 20).

         After completing a thorough review of the parties' memoranda, the revised privilege logs, and applicable law, the undersigned concluded that an in camera review must be conducted of all the emails identified in the revised privilege logs to determine whether the attorney-client privilege applies to each of the withheld emails (4:16-mc-00003, DN 21; 4:16-mc-00004, DN 21; 4:16-mc-00005, DN 21). Pursuant to the order entered June 14, 2017, Respondents submitted directly to the undersigned's Bowling Green chambers for in camera review all of the emails identified in their revised privilege logs (Id.). The undersigned has completed the in camera review of the emails. This matter is ripe for determination.

         FINDINGS OF FACT

         Dr. Michael J. Crowe and Dr. Artis P. Truett are equal shareholders in Owensboro Dermatology Associates, PSC, a Kentucky professional services corporation (“Owensboro”) (4:16-mc-00003, DN 7-1 PageID # 45). Owensboro is a dermatological medical practice specializing in the treatment of skin cancer, moles, eczema, acne, etc. (Id.). Drs. Crowe and Truett are equal partners in Dermatology Property Management LLC, a real estate investment company (“Dermatology Property”) (Owensboro and Dermatology Property will be collectively referred to as the “Insured Entities”) (Id. PageID # 45-46).

         On December 2, 2008, Drs. Crowe and Truett incorporated Beveled Edge, a C corporation organized under the laws of the state of Kentucky (Id. PageID # 46). “Beveled edge timely elected to be taxed under Internal Revenue Code (‘IRC') Section 831(b) as a captive insurance company providing direct property and casualty insurance policies to the Insured Entities to cover risks of the businesses supplemental to those covered by their commercial policies until such time as its surplus grows to a point the Insured Entities could begin to replace their commercial policies with policies issued by Beveled Edge” (Id.). After jointly operating Beveled Edge from 2008 through the 2011 policy period, Drs. Crowe and Truett made the business decision to dissolve it and each establish his own captive insurance company to insure his portion of the risks of the Insured Entities (Id.).

         In November 2012, Dr. Crowe formed Micro Cap KY Insurance Company, Inc., and Dr. Truett formed Cavallo Nero Insurance, Inc.[1] (Id. PageID # 46-47). Micro Cap and Cavallo Nero provide direct property and casualty insurance policies to the Insured Entities (Id.).

         The law firm of Moore Ingram Johnson & Steele, LLP (“MIJS”) has provided ongoing captive and non-captive legal advice to Drs. Crowe and Truett personally as well as regarding the Insured Entities since 2006 (Id. PageID # 59-60). On March 20, 2009, Doctors Crowe and Truett entered into a captive management agreement with MIJS to provide captive management services regarding Beveled Edge (Id. PageID # 60). The captive management agreement was issued on MIJS law firm letterhead (Id.). Doctors Crowe and Truett also entered into an engagement agreement with MIJS to provide captive management services regarding Micro Cap and Cavallo Nero on December 11, 2012 and December 10, 2012 respectively (Id.).

         MIJS Captive Management, LLC managed Beveled Edge and currently manages Mirco Cap and Cavallo Nero under the terms of Captive Management Agreements (Id. PageID # 59). MIJS Captive Management “is a wholly owned subsidiary of the law firm of MIJS and has no assets, no employees and no income or losses” (Id.). MIJS Captive Management “does not even have a bank account as all revenue generated by captive management services flows directly to MIJS” (Id.). MIJS Captive Management does not have letterhead as its “existence is purely for optical purposes” (Id.). “[T] he insurance attorneys providing captive management services do so through MIJS” (Id.).

         In October 2014, the Internal Revenue Service began auditing Beveled Edge and the Insured Entities (Id. PageID # 47-48). As part of this inquiry, the IRS issued summonses on April 25, 2016, requiring each of them to produce several categories of documents for examination (4:16-mc-00003, DN 15-2 PageID # 222-29; 4:16-mc-00004, DN 15-2 PageID # 208-15; 4:16-mc-00005, DN 15-2 PageID # 192-99). On May 9, 2016, Beveled Edge and the Insured Entities produced all documents identified in the summonses, except for a series of email communications between MIJS attorneys and Dr. Crowe, Dr. Truett, Angie Grant (assistant to Dr. Crowe regarding Beveled Edge and the Insured Entities), Sara Burden (assistant to Dr. Truett regarding Beveled Edge and the Insured Entities), and Brenda Clayton (an agent of Beveled Edge providing accounting and advisory services to Beveled Edge and the Insured Entities) (4:16-mc-00003, DN 7-1 PageID # 60 and DN 16-3 Affidavit of Dr. Crowe PageID # 498). Beveled edge and the Insured Entities assert that the withheld email communications were made in furtherance of MIJS' providing legal advice pertaining to their participation in the captive insurance program (Id.).

         On June 8, 2016, the IRS issued notices of deficiency to Michael J. Crowe and Julie W. Crowe and to Artis P. Truett and Allison H. Truett (collectively “the Crowes and Truetts”) for taxable years 2012, 2013, and 2014 determining, in part, that $1, 114, 916, $740, 029, and $881, 392 in insurance expenses claimed by Owensboro for taxable years 2012, 2013, in 2014, respectively, should be disallowed because the purported insurance and/or reinsurance transactions lack economic substance, the substance of the transactions do not comport with their form, the various steps involved in the transactions were engaged in for no purpose other than to avoid or evade tax, the expenses were not ordinary and necessary to Owensboro's business, and the amounts were not paid to an insurance company and were not paid for insurance (4:16-mc-00003, DN 15 PageID # 197-98). Additionally, the notices of deficiency determined that the Crowes and Truetts are liable for the I.R.C. § 6662(i) penalty and, in the alternative, the I.R.C. § 6662(h) penalty (Id.).

         Also on June 8, 2016, the IRS issued notices of deficiency to the Crowes and Truetts for taxable years 2012, 2013, and 2014 determining, in part, that $76, 896, $76, 896, and $127, 008 in insurance expenses claimed by Dermatology Property for the taxable years 2012, 2013, and 2014, respectively should be disallowed because the purported insurance and/or reinsurance transactions lack economic substance, the substance of the transactions do not comport with their form, the various steps involved in the transactions were engaged in for no purpose other than to avoid or evade tax, the expenses were not ordinary and necessary to Dermatology Property's business, and the amounts were not paid to an insurance company and were not paid for insurance (4:16-mc-00004, DN 15 PageID # 183-84). Additionally, the notices of deficiency determined that the Crowes and Truetts are liable for the I.R.C. § 6662(i) penalty and, in the alternative, the I.R.C. § 6662(h) penalty (Id.).

         Additionally, on June 8, 2016, the IRS issued a notice of deficiency for Beveled Edge's 2012 tax year determining that the transactions were not insurance transactions within the meaning of federal tax law, that Beveled Edge was not an insurance company for purposes of section 831(b), that Beveled Edge was not eligible for tax treatment under section 831(b), that the amounts Beveled Edge was entitled to, and/or received, under a purported captive insurance program were included in Beveled Edge's ...


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