Captive Insurance Arrangements Are on the IRS Radar
Internal Revenue Service scrutiny of captive insurance arrangements is increasing, and much of it is aimed at small captives utilizing the 831(b) tax election, say many in the captive industry.
Large or small, captives must be formed for the right reasons, their premiums must be appropriate and their business plans must involve genuine insurance, captive experts say.
But some “minicaptive” or “microcaptive” formations under Section 831 (b) of the Internal Revenue Code lack a genuine insurance purpose and instead provide tax shelters for their owners, experts say. IRS scrutiny drawn by improper use of captives threatens to cast a bad light on the entire captive industry, many fear.
“Supposedly, the word is out of the general counsel's office that the IRS in the last year or so has taken an increased interest in captives,” said Jay Adkisson, a partner at Riser Adkisson L.L.P. in Newport Beach, Calif., and chairman of the American Bar Association's committee on captive insurance. “There are more cases against captives than ever before.”
Some people “have their own motivations for getting clients into captives that don't necessarily involve risk management, let’s just call them what they are: They're tax shelters.
If the IRS wanted to make a lot of money, they could go out and audit every one of the 831(b) captives that's doing terrorism coverage,” he said. Terrorism coverage “tends to be a hallmark of the tax shelter captives. They're coming up with these terrorism covers and the pricing bears utterly no relationship to any kind of reality.”
Under Section 831(b), property/casualty captives earning less than $1.2 million in annual premium may elect to pay U.S. taxes only on their investment income.
The provision, part of the Tax Reform Act of 1986, was meant to encourage formation of insurance companies and simplify business for small companies. The rapid growth of small captives taking advantage of the 831(b) election has driven similar rapid growth of several newer captive domiciles such as Utah, Montana and Kentucky as it has added to many captive managers' rosters of captive clients.
If you set up a captive we suggest you file under IRS 6707A to reduce fines if you do get audited.
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.