On November 1, the Internal Revenue Service (IRS) issued Notice 2016-66, which impacts the small captive insurance company sector – specifically those captives that have made an election under section 831(b). The Notice listed some, but by no means all, 831(b) captives as “transactions of interest.” Prior to this Notice, the IRS had identified certain small captives as among its list of “Dirty Dozen Tax Scams,” and as such has been actively examining captives and their owners and litigating cases in the U.S. Tax Court. This new “transaction of interest” designation put some small captive insurance company transactions into a tax-reporting regime that can potentially lead to significant penalties and IRS income tax and promoter examinations.
Under Section 831(b), insurance companies earning no more than $1.2 million ($2.2 million beginning in 2017) in annual written premiums can opt not to pay taxes on those premiums and be taxed only on their investment income. In addition, the premiums are deducted by the insured as a business expense. To successfully utilize the 831(b) election, the captive must be first and foremost a risk management tool with legitimate risks and properly priced premiums with real insurance contracts negotiated at arm’s length.
Generally, small captives under Notice 2016-66 that constitute 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 Notice also requires persons who are engaged in abusive section 831(b) captives to make “Material Advisor” filings and to be aware that they are subject to tax shelter promoter penalties if they continue to market such captives.
Caitlin Morgan 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. Just give us a call at (855) 975-4949.