IRS Targets Micro-captives
Growth of the captive industry could be devastated if Congress moves ahead with a proposed law that would make it financially unfeasible for micro-captives to be formed.
In February, the Senate Finance Committee considered a preliminary bill that would add restrictive language to the regulation of 831(b) captives, or micro-captives, which are formed with less than $1.2 million in premium. The 831(b) tax election allows captives that qualify to be taxed on their investment income only.
“If you take 831(b)s out of the captive market,” said Dan Towle, director of financial services, Vermont Agency of Commerce and Community Development, “I don’t think there would be any growth in the marketplace. … All of the flash you have heard about huge growth [of captives] is all based on 831(b)s.”
He noted that 831(b) captives are “not a core market for Vermont.”
“Everyone is trying to fix a problem that no one can define,” he said. “We can’t put forth a solution if you can’t articulate the abuse you are seeing. — Dennis Harwick, president, Captive Insurance Cos. Association
On Feb. 10, the Senate Finance Committee briefly introduced the mark-up of a bill that would increase the 831(b) premium amount to $2.2 million, indexed for inflation, as well as add “very restrictive language” that would hamper the formation of micro-captives, said Dennis Harwick, president of the Captive Insurance Cos. Association, which held its international conference in Orlando, Fla., on March 10-11.
“It came from the IRS, which has this position that there is abuse going on,” he said, noting that the IRS has an “antipathy toward captives.”
On Feb. 3, the IRS listed captive insurance among its “abusive tax shelters” on the IRS “dirty dozen” list of tax scams. It cited “abuse involving a legitimate tax structure [involving] certain small or ‘micro’ captive insurance companies.”
The abuse comes in, it said, when “unscrupulous promoters persuade closely held entities to participate in this scheme,” which involves creating onshore or offshore captive insurance companies that should be used for insurance purposes but instead are used to shelter income for a wealthy entity by using “implausible risks for exorbitant ‘premiums,’ ” according to the IRS.
In the Senate Finance Committee, the restrictive language of the proposed bill was temporarily excised, pending more information about captive abuses from the Department of Treasury, but industry insiders are concerned the language will be reinserted. Sen. Chuck Grassley, R-Iowa, is the “moving force” behind the legislation, Harwick said.
“What they were trying to push through the legislature would kill the small captive industry entirely.” — David Snowball, captive director, State of Utah Insurance Department
David Snowball, captive director, State of Utah Insurance Department, said the proposed bill would require that no single owner have more than 20 percent of the premium, and that the captive can’t “assume” reinsurance or risk distribution pools.
“What they were trying to push through the legislature would kill the small captive industry entirely,” Snowball said.
Utah, he said, probably has more than 200 micro-captives, of the 417 captives domiciled in the state. He and others noted, however, that no one tracks the number of 831(b) captives, as it is a tax elective that is taken after the captive is formed.
“Most of the captives out there are legitimate captives,” Snowball said. “They are trying to take advantage of some tax opportunities but they fit within the guidelines the IRS has established for a good captive.”
States most likely to be affected by a change in IRS regulations would be Utah, Delaware, North Carolina, Tennessee and Nevada, among others.
Deca Penn, regulator for the British Virgin Islands, said the proposed change in the law is “a little concerning, but we are just monitoring because there is not much we can do. It’s difficult to say right now because the IRS has not put into place anything concrete.”
The majority of BVI captives are 831(b)s, said Alicia Green, marketing manager, BVI Finance.
“We would like them to leave the situation as it is right now,” Penn said, noting that proposals for captives domiciled in BVI have “to suggest there is a legitimate business.”
Harwick noted the National Association of Insurance Commissioners is trying to develop language for the legislation that would address IRS concerns about abusive captives and isolate offenders from captives formed for legitimate insurance purposes.
The process is difficult, he said.
“Everyone is trying to fix a problem that no one can define,” he said. “We can’t put forth a solution if you can’t articulate the abuse you are seeing. … It’s frustrating shadowboxing perceived abuses that no one has really defined.”
From CICA’s perspective, he said, all captives must be legitimate insurance companies, with valid underwriting, risk transfer, risk distribution and “arm’s length pricing.”
“If it’s really just to transfer wealth,” he said, “our industry is very uncomfortable with that because it’s being called insurance and it’s not. … A bad apple hurts everyone.”