Navigating the 831(b) quagmire
Peter Dawson (pictured), chief executive of Dawson LLC and adviser to the 831(b) Institute, talks to Captive International about why the IRS has become so against 831(b) elections.
As regulatory scrutiny intensifies in the US, the once-obscure Section 831(b) of the Internal Revenue Code has emerged as a flashpoint in the ongoing battle between small to mid-sized businesses and the Internal Revenue Service (IRS).
At the heart of this clash is the role of “micro-captives” – a type of insurance company designed to help businesses manage risk while enjoying certain tax advantages. Speaking candidly ahead of an upcoming captive insurance summit, Peter Dawson, chief executive of Dawson LLC and adviser to the 831(b) Institute, gave Captive International an overview of where the US currently stands on this complex issue.
The ‘red-headed stepchild’ of captive insurance
Captive insurance companies, broadly speaking, are insurance entities created and owned by a parent firm to underwrite its own risks. Major corporations have leveraged captives for decades. However, micro-captives established under 831(b) elections – which allow certain small insurance companies to be taxed only on investment income rather than premiums – have long been treated as a marginal or problematic offshoot of the sector.
“The 831(b)s have been the red-headed stepchild of the insurance industry forever,” Dawson remarked. He acknowledges there have been abuses – captive structures that functioned primarily as tax shelters without any real risk management functions. The IRS, he claims, has latched onto these bad examples to justify a broader crackdown, effectively criminalising what Congress has repeatedly affirmed as legitimate business practices.
A bureaucratic tug of war
According to Dawson, the real issue lies not in the existence of 831(b) captives but in how the IRS has handled them. “They've cherry-picked horrible fact patterns,” he said, “but through it all, the silver lining is the IRS is finally acknowledging that 831(b)s can exist and are legitimate.”
Yet, that acknowledgement comes at a cost. Recent regulations have muddied the waters, creating contradictions and confusion. Dawson points to inconsistencies in new guidance – rules that seem to conflict with each other and ignore the fundamentals of insurance such as risk shifting, risk distribution and fortuitous events. “It’s clear they view this as a tax issue only,” he said. “They’re ignoring basic insurance principles.”
Worse, he argues, is the IRS’s heavy-handed governance structure – what he calls a “quasi-judicial” system in which the IRS acts as legislator, enforcer and judge. “It’s a grotesque concentration of power,” Dawson asserts. “You have an executive agency that’s effectively making up its own laws, enforcing them and then ruling on them as if they were a court.”
He cited recent Supreme Court pushback (For reference: Supreme Court of the United States. SEC v. Jarkesy. 27 June 2024; Supreme Court of the United States. Loper Bright Enterprises v. Raimondo. 28 June 2024) on these quasi-judicial practices as a turning point: “Finally, the court said, ‘Enough. You’re not all three branches of government rolled into one.’”
Taxpayer purgatory
Beyond the legal and philosophical arguments lies a practical nightmare for thousands of business owners. “We’ve got 1,000 active IRS reviews, not court cases, just in an endless tax limbo,” Dawson explained. “Taxpayer purgatory, I call it, in direct conflict with the Taxpayer Bill of Rights (Taxpayer Bill of Rights, Internal Revenue Service, https://www.irs.gov/taxpayer-bill-of-rights. Accessed 11 July 2024).”
These reviews often drag on for years without resolution, effectively paralysing businesses that depend on the legitimacy and operational functionality of their captive insurance vehicles. “A business owner can’t wait 20 years, let alone 20 months, to find out if they’re in compliance,” Dawson said.
While new lawsuits are now being filed to challenge recent regulations – by his estimate, a few dozen to date – this still leaves a vast number of companies caught in stasis, with no guidance and no recourse.
A recurring theme in Dawson’s critique is the lack of expertise at the IRS. “They don’t have the muscle to govern this properly,” he said, characterising the agency’s talent pool as underqualified for the complexity of the task. The real challenge is that this area is complex because it is at the conflux of tax, law, finance, insurance and actuarial science. “You’re not going to find highly skilled actuaries or experienced insurance attorneys working for $60,000 a year. Good talent has fled the IRS.”
He was blunt in his assessment: “Why would someone like me work for the IRS for $100,000 a year when I can earn quadruple that in the private sector?” For Dawson, the combination of regulatory overreach and bureaucratic incompetence is a recipe for disaster.
Towards a common-sense compromise?
Despite his harsh critique, Dawson is not an anti-regulation zealot. “I don’t hate regulation,” he said. “I hate unintelligent regulation. I want regulation that’s informed – where government and the industry work together.” What’s needed, he argues, is compromise: regulations that preserve the congressional intent of Section 831(b) while curbing real abuses.
He also sees an opportunity in the current US political climate. “This administration has been surprisingly receptive to small and medium-sized businesses,” Dawson noted. “If there’s ever a time to fix this, it’s now.”
A way forward?
But will it happen? Dawson is not optimistic about a swift resolution. “At the rate they’re going, it will take 20 years to clear the current backlog of micro-captives under ‘review’,” he warned. Eventually, he believes the IRS will be forced to acknowledge it is “out over its skis” – American slang for being well beyond one’s depth. Only external pressure – from Congress, the President or the courts – can force meaningful change.
“We don’t want chaos,” he concluded. “We need a tax-collecting body. But we also need one that respects the law and the businesses trying to follow it.”
For now, business owners, tax professionals and legal advisers alike will be watching carefully as the battle over 831(b) captives continues to unfold – hoping for clarity, if not fairness, from an agency long accused of wielding the law more as a cudgel than a compass.
Peter Dawson will be presenting a session on “Tax: updates and strategies” at our upcoming USA Captive Summit 2025 in Chicago on June 3-4. Don’t miss the chance to engage with Peter Dawson and other industry leaders during insightful panels, workshops and networking opportunities.
Learn more about the event here: www.uscaptivesumit.com.
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