Forming a captive insurance company to mitigate risk and increase profits is, in many cases, an excellent choice for many business owners.
There is a lot of information out there on captive insurance companies and the terms that surround the concept. 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.
What is 831(b) Insurance?
An 831(b) captive is a captive insurance company that is taxed under Internal Revenue Code § 831(b). This provides that a captive 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 captives.
831(b) Insurance and the IRS
If you do a search for “831(b) captive 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 the fact that these captives were writing policies that they really had no chance of having a claim on. 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 the risk that they have. Essentially, the IRS said that charging five-hundred thousand dollars for a policy in a captive 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 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. 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 call 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 manager and tell them that you want to cover this risk that could never happen in your business, a reputable captive 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.
What are your thoughts on 831(b) insurance companies, captive insurance structure, and the advantages of strategic risk management solutions? Tell us what you think in the comments below.
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