In 1986, the Internal Revenue Service (IRS) added 831(b) captives to the Internal Revenue Code for the purpose of creating a more uniform tax code for mutual and stock property casualty insurance companies. Prior to the enactment of this Internal Revenue Code, three layers of taxation existed for insurance companies depending on the amount of annual gross receipts. However, this did not include property and casualty insurance providers.
Potential Abuses of 831(b) Captives
This IRS legislation subjected small insurance companies not offering life insurance to premium limitation amounts as well as an alternative tax amount based on only the taxable portion of investment income. By using this alternative tax structure, an insurance company does not need to pay federal income tax on underwriting profits. Unfortunately, some insurance companies not eligible to pay taxes under the 831(b) captives structure committed fraudulent acts to help the company qualify for it. Some also engaged in cybercrimes for the same reason,
The IRS tends to look suspiciously on an insurance company that files few or no claims during a year. However, this is more often a sign of a business run well than a company trying to take advantage of tax codes it does not qualify for to lower its own federal tax liability. Venture Capital feels that a business should receive financial rewards if it is able to manage its captives well.
Anti-Abuse Measures Passed by Congress
Because some business chose to commit fraud to qualify for 831(b) captives, the federal government has started to crack down on the types of business that can legitimately claim it. For taxable years occurring after December 31, 2016, companies claiming this tax structure must meet each of the following criteria:
- Operate as an insurance company
- Receive no more than $2.2 million dollars in the course of a year in net premiums
- Meet the diversification requirements we describe below
- Have or make a current election to pay taxes through the section 831(b) tax code
Congress added diversification requirements as part of its anti-abuse measures to address the evasion of gift taxes and estate taxes. To meet this requirement, an insurance company cannot receive more than 20 percent of its net annual written premiums or direct written premiums if that amount is greater from a single client. The law treats all policyholders related by blood or who are members of a single controlled group as one policyholder when applying the 20 percent rule.
The ownership test is another diversification requirement under 831(b) captives. This rule states that ownership of an insurance company by special holders under 831(b) cannot be more than two percent greater than the company’s insured assets or typical ownership. Special holders include spouses or direct descendant of a person who holds a direct or indirect interest in the items covered by an insurance policy.
Several Other New Laws Pertain to 831(b) Captives
The above represent just some of the changes Congress has made in the qualification and reporting of income under this tax structure. Although it can get very complex, IRS law does not allow you to use ignorance as a reason for not abiding by tax laws. We encourage you to schedule an appointment with Venture Captive today to learn more about how these changes affect you.