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831(b) captive taxation

The IRS is cracking down on abusive use of 831(b) election by small captive insurance companies that are formed and operated primarily for income and estate tax reduction objectives. New tax law changes effective January 1, 2017 target some of these abuses, making it more difficult to realize the intended tax incentives afforded small insurance companies. See the key disclaimers following this cash flow impact summary chart, including the major disclaimer that the tax benefits of making the 831(b) election cannot be the primary reason for forming a captive or you will be in violation of the Economic Substance Test discussed more below. Risk management objectives must be the primary and driving force behind creation and operation of closely held captive insurance companies.
 

Key Disclaimer:
Tax incentives should be of interest - they are important. However non-tax reasons must drive all captive formation decisions. The Economic Substance Test now part of the US Internal Revenue Code (and long established case law and other IRS rules) emphasize that non-tax business and economic reasons for structuring transactions must be the primary reasons for business decisions, not tax benefits. Also designing a captive takes expertise most people lack. Risk identification, assessment and policy coverage design and pricing require careful consideration if deductibility of premiums paid your captive is important to you.

Making sure a business has substantial and primary non-tax reasons to form an affiliated captive can be a tough concept to navigate as many transactions would never be entertained but for tax incentives, such as funding retirement plans. Moreover nearly every tax incentive was created specifically to encourage taxpayer behavior. So the government is being bi-polar on this issue; they want you to do certain things to protect or enhance your business and financial interests, but they may get angry if you do.

Do not feel alone if this confuses you - most people are confused due to mixed messages and conflicting initiatives coming from Washington on many issues not to mention a tax code that has long been overly complex and confusing due to a multitude of tax policy and special interest provisions preventing reforming the tax code into an efficient and fair revenue raising system that promotes capital retention and accumulation in the US to drive domestic investment and job creation.

Select your captive design, formation and management "partner" based on their experience, ethics and depth and range of competency. These are attributes well worth paying extra for.

Key Assumptions to above chart:
  • The chart above over-simplifies the tax impact of properly designed and operated qualifying 831(b) captives. 
  • It is for discussion purposes only. 
  • The deduction of premiums is a complex matter not necessarily related to the captive operations at all. 
  • To be deductible premiums must be reasonable and necessary business expenses.
  • Losses are not reflected, but should be expected - losses impact both scenarios equally and must be paid whether you have a captive or not.
  • $65,000 in total annual operating expenses are assumed (click here to learn more about the range and detail of captive formation and operating costs).
  • State imposed self procurement taxes possibly applicable are not reflected.
  • Taxes due on captive distributions or wind-up are not reflected.
  • Gift and estate tax implications that can be minimized when a captive design incorporates multi-generational asset protection and estate planning are also not reflected. When possible, integrating asset protection and estate planning ownership structures should be considered as the additional benefits are well worth the extra start up costs and complexity (the ownership structure can impact other considerations too including investment control and flexibility).
While tax incentives are always attractive, there are a myriad of compelling non-tax business, economic and competitive reasons to own your own 831(b) captive when designed and operated correctly. These non-tax risk management reasons must drive the business decisions to form your own captive insurance company. Significant risk analysis and insurance policy design and underwriting expertise is required to do this correctly.  

While 831(b) was enacted in 1986 during a severely hard insurance market period where businesses across the US faced commercial insurance cancellations, non-renewals and skyrocketing premiums, 831(b) captives only became attractive since 2002 after the IRS issued revenue ruling guidance and abandoned the economic family theory doctrine challenge to captive arrangements. Read more in our taxation summary.

More Related Information:
  • Click here for our detailed general discussion of important captive taxation questions and rules.
  • Click here for more 831(b) captive taxation and planning articles.
Captives formed by privately held businesses and professionals could be integrated with asset protection and estate plans even though the IRS is troubled by such advanced applications of captive ownership structures which consider and achieve objectives beyond a traditionally narrow view of  risk management.

For detailed information on the range of captive asset investment opportunities and the interplay with financing business expansion, privately placed annuities and life insurance, family foundations and other advanced wealth management techniques, contact us.

Click here for a good article about increased IRS scrutiny of 831(b) captives published in Forbes online March 2014. Also consider if you chose to form your captive offshore, that the consequences can be expensive if it is proven to not qualify as an insurance company and its election under 953(d) to be taxed as a US insurance company disallowed. See the March 12, 2014 IRS memo on this issue by clicking here

ALERT: Information on this website and in linked articles and books may be dated. No assurances can or are given that information herein will be updated. It is for informational purposes only.



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