November 15, 2020

Why 831(b) Insurance Companies are Still Viable

5 min read

R. Wesley Sierk, III ; Managing Director, Risk Management Advisors

Why 831(b) Insurance Companies are Still Viable

For many business owners, forming a captive insurance company to mitigate risk and increase profits is an excellent choice. There is a lot of information on captive insurance companies and the concept's terms. However, some of it can be a little confusing. One such term is “831(b).”What exactly is 831(b), and why are these insurance companies still viable? Let’s take a look.

Basics of 831(b) Insurance

An 831(b) captive insurance company is a captive insurance company taxed under the Internal Revenue Code § 831(b). This provides that a captive insurance company that qualifies to be taxed as a U.S. insurance company only needs to pay investment income tax in the year where its written premium is below or just at the threshold for the applicable tax year. These are also known as micro-captive insurance companies.

IRS Oversight

If you search for “831(b) captive insurance structure” or “captive insurance law,” you will likely find a lot of information that discusses the IRS crackdown on 831(b)s. While a lot of that information is true, it’s full of a lot of misinformation as well. Let’s start by explaining why the IRS is cracking down on some 831(b)s. Captive insurance arrangements are typically deductible. 831(b) Insurance companies only pay taxes on their investment earnings.

What gained the IRS’s attention was that these captive insurance companies were writing policies they had no chance of having a claim. It wasn’t that different than getting tsunami coverage for a business in Phoenix, Arizona. Simply put, the policies were ridiculous. As a result, the IRS came to many of these businesses and established that this was invalid coverage under Section 162. They said that the premium amounts do not equate to their risk. Essentially, the IRS noted that charging five hundred thousand dollars for a policy in a captive insurance company that could be purchased in a traditional market for five thousand dollars was not valid nor reasonable. I’m sure we can agree this is right.

When the IRS went after captive insurance companies, they went after certain captive insurance management partners and actuarial partners as promoters of tax shelters because they were the ones that were doing these practices the most egregiously. The IRS and the Tax Court noted that the business owner bought policies, but they had claims in their business that they never submitted over to their captive insurance company. So, they just went wholesale and just disallowed these.

Currently, there are anywhere between 750 and 1,500 cases for 831(b) being filed in Tax Court. Since 2015, the IRS has only heard five of these cases and only three verdicts have been found, all of which were against the taxpayer. Anybody in the captive insurance industry knows that when the Tax Court went through the cases, it was likely that the verdict would come out against the taxpayer. That is because these were done incorrectly and inappropriately, and they were covering risk or priced in certain ways that were not valid and reasonable.

So, are 831(b) insurance companies really that bad?

831(b) Insurance Companies Are Still Viable

During these notorious Tax Court rulings, the IRS explicitly said that they don’t think 831(b)s are bad. They think that they’re valid and reasonable for the right businesses. Bad 831(b)s are simply bad, but there are good ones out there that could be excellent private insurance solutions. It all comes down to use cases and whether or not such coverage actually works for your business. If you have workers’ comp or general liability, or if you’re a trucking company and you have commercial auto insurance, you know those are very valid insurance policies. Now, using the argument that we used before about tsunami coverage in Arizona: If you go to any reputable captive insurance manager and tell them that you want to cover this risk that could never happen in your business, a reputable captive insurance manager will say “no.” They will also say that if you have a good amount of premiums, your claims are lower than your industry peers. From there, you can go and get reinsurance. It’s all about captive insurance best practices and finding what works for your business without fraudulent activities. There’s no reason not to consider a captive insurance company because it’s quite valid and reasonable. It’s also approved by Congress and the IRS when done the right way.

Want to know if a captive insurance company is the right fit for your business?

Take the assessment to find out:

https://www.riskmgmtadvisors.com/captive-insurance-fit-assessment

The contents of this article are for general informational purposes only and Risk Strategies Company makes no representation or warranty of any kind, express or implied, regarding the accuracy or completeness of any information contained herein. Any recommendations contained herein are intended to provide insight based on currently available information for consideration and should be vetted against applicable legal and business needs before application to a specific client.

R. Wesley Sierk, III ; Managing Director, Risk Management Advisors

Wesley Sierk is a recognized authority in the realm of captive insurance company design and management. As Managing Director and Lead Strategist for Risk Management Advisors, Inc., he possesses an unmatched track record that spans nearly 30 years, with a focus on empowering profitable, closely held businesses. Wesley's expertise isn't just limited to consultation; he's profoundly adept at strategic implementation. He has partnered with leading homebuilders, real estate developers, manufacturing enterprises, and professionals in sports and entertainment, providing them with unparalleled insights and solutions. A hallmark of Wesley's career has been his unwavering commitment to his education. He holds esteemed designations like the Chartered Financial Consultant (ChFC) and Chartered Life Underwriter, both awarded by the American College since 1996. Further amplifying his credentials is the CRIS (Construction Risk and Insurance Specialist) recognition, secured in 2006. Notably, he's among the rare individuals globally to have earned the Associate in Captive Insurance (ACI) designation, a testament to his profound understanding of the subject. Beyond his direct work with clients, Wesley takes immense pride in working hand-in-hand with other professionals, including CPAs, Attorneys, and Financial Advisors. This collaborative approach ensures thorough due diligence and optimal plan design implementation. An accomplished author, Wesley has penned critical works like Taken Captive: The Secret to Capturing Your Piece of America's Multi-Billion Dollar Insurance Industry and You Can Make It, But Can You Keep It?. The latter serves as a guiding light for the affluent, teaching them strategies to preserve their hard-earned assets. In the realm of speaking engagements, Wesley is a coveted name. Whether it's insurance industry gatherings or legal and accounting symposiums, he's regularly called upon to demystify the intricate dance between traditional insurance markets and the potential of captive insurance entities. Under Wesley's leadership, Risk Management Advisors remains a beacon of innovation, committed to elevating clients' financial well-being and mitigating risks in an ever-evolving landscape. He is married to Leslie and has two 'not so young' children. Their son is attending the University of Tennessee studying entrepreneurship and risk management. While their daughter finishes up her high school years. They love to travel, golf, cook and hike with their two huge dogs.