IRS Adds 831(b) Microcaptives to its Dirty Dozen List of “Tax Scams”

The IRS has been aware of the aggressive use of section 831(b) companies for some time: Reports in the trade press indicate that numerous audits of section 831(b) companies are ongoing.

Tax law allows businesses to create “captive” insurance companies to enable those businesses to protect against certain risks. The insured claims deductions under the tax code for premiums paid for the insurance policies while the premiums end up with the captive insurance company owned by same owners of the insured or family members. The captive insurance company, in turn, can elect under a separate section of the tax code [section 831(b)] to be taxed only on the investment income from the pool of premiums, excluding taxable income of up to $1.2 million per year in net written premiums.

In February, the Senate Finance Committee considered a legislative proposal that would increase the limitation on premiums from $1,200,000 to $2,200,000, but that would have significantly restricted the uses of section 831(b) companies by limiting to 20 percent the percentage of premiums that could be received from any one policyholder (or group of related policyholders), as well as prohibiting section 831(b) companies from assuming reinsurance. However, the restrictive provisions were met with opposition and did not survive a voice vote of the Committee.

Subsequently, on April 14, 2015, Senator Orrin Hatch introduced S.905, a bill that would, as did the earlier proposal, increase the premium limitation for section 831(b) companies from $1,200,000 to $2,200,000, with an inflation adjustment for future years. S.905 does not directly address the restrictive provisions in the earlier proposal, however; rather, it would direct the Secretary of the Treasury to submit to the Senate Finance Committee a report on the abuse of captive insurance companies for estate planning purposes “so Congress can better understand the scope of this problem and whether legislation is necessary to address it.” This report, which would be due no later than February 11, 2016, is to contain legislative recommendations for addressing abuses.

Over in the US House of Representatives, Representative Erik Paulsen, Minnesota (R), and Representative Ron Kind, Wisconsin (D), are cosponsoring H.R. 1788, also increasing the allowable maximum premium to $2.2 million for 831(b) captives.