Last month we alerted you to the Internal Revenue Service (IRS) disclosure-reporting deadline on “transactions of interests” for 831(b) captives initially scheduled to take effect on January 31st. The deadline has now been extended to May 1, 2017 under IRS Notice 2017-08 after the agency received several requests that more time was needed for such reporting.
Under Section 831(b) of the tax code, any small property/casualty insurer with annual premiums under $2.2 million (this amount increased as of this year) may choose to be taxed on its net investment income as opposed to its premium income. To successfully utilize the 831(b) election, the small captives or micro-captives as they are known must be first and foremost be a risk management tool with legitimate risks and properly priced premiums with real insurance contracts negotiated at arm’s length.
Now, as of May 1, 2017, the IRS is requiring a detailed information disclosure on IRS Form 8886, “Reportable Transaction Disclosure Statement,” by participants in transactions with certain 831(b) captives, and requires that “material advisors” to any affected 831(b) captive must disclose certain information on IRS Form 8918, “Material Advisor Disclosure Statement.” If not filed in time, there will be significant penalties incurred. Note that not all 831(b) captives are “transactions of interest” requiring reporting.
831(b) captives considered a “transaction of interest” are those that (1) have liabilities for covered losses and expenses in an amount less than 70% of the total premiums earned; (2) whether any loan or other financing arrangement has occurred between the captive and related parties; (3) the captive’s jurisdiction; (4) a description of the types of coverage(s); (5) how the premium(s) was/were determined, including the names and contact information for any actuary or underwriter involved; (6) a description of the claims paid; and (7) a description of the captive’s assets.
The purpose of the Notice is to stem the marketing of abusive 831(b) captives formed to obtain favorable tax treatment (deductions and rate arbitrage) rather than for risk management. For example, the IRS is looking for cases where the insured business is covered by commercial insurance, but nonetheless purchases duplicative coverage from its captive, again, because the premium paid to the captive is deductible to the insured and excluded from the captive’s income. The IRS is also concerned about policies that are vaguely drafted, which makes it difficult to determine objectively what risks are covered by the policy, making the captive’s decision to pay a claim practically discretionary. The Notice also makes clear that the IRS is very concerned about premiums that far exceed those for a roughly comparable commercially available insurance policy.
We will continue to keep you updated on the IRS and its notices regarding 831(b) captives. Caitlin Morgan Captive Services specializes in providing alternative risk solutions and captive insurance solutions – from Deductible Reimbursement Policies (DRPs) to Buy-Backs, Single-Parent Captives, Group Captives, Association Captives, Risk Retention Groups (RRGs), Protected Cell Companies and Agency Captives. We can help you determine whether a captive is right for your organization or client. Just give us a call at (855) 975-4949.