Increasing premium limits, reporting requirements, ownership restrictions, and increased scrutiny from the Internal Revenue Service (IRS) has made prospective captive owners more cautious about forming 831(b) captives.
This is according to David Kirkup, chief operating officer and chief financial officer of Captive Alternatives, who spoke to Captive International ahead of the Vermont Captive Insurance Association (VCIA) annual conference taking place in Burlington, Vermont, this week.
The Tax Reform Act of 1986 created the 831(b) section of the Internal Revenue Code with the intention of making captive solutions more accessible and advantageous to small and medium-sized companies. But the IRS has questioned the way such captives have been used and the practice of deducting premiums from taxes.
“The problem with the 831(b) is you have the premium limit, which was increased to $2.2 million, that’s a problem for many companies,” Kirkup said. “The second problem is the Form 8886 annual reporting requirements, which you’ve got to report every year to the IRS. The third problem is the ownership restrictions. The ownership of the business has to match the ownership of the captive. A lot of people set up 831(b)s with a trust ownership of a captive, and they would have different owners of that trust.”
Kirkup suggested the IRS is auditing hundreds of 831(b) captives, and there are further issues with compliance that could come to light.
“Even if you think you are following the rules, they can still flag the captive for audit,” Kirkup said. “Until some of the court cases are settled one way or the other, it’s all up in the air. Businesses are less likely to want to get into that if they’re not already in it.”
In November 2016 the IRS announced in Notice 2016-66 that it was placing all 831(b)s under full scrutiny to make sure they were legitimate.
“The 831(b) legislation was passed quite some time ago and the purpose was to put small companies on the same playing field as large companies, and to allow them to protect themselves against catastrophic risk,” explained Kirkup. “The biggest cause of a company failure is some unforeseen occurrence. Regulations change, they lose a major supplier, they lose referral sources, brand is damaged, there are cyber risk implications.”
About two years ago, Captive Alternatives moved all of its captives into a cell structure in Puerto Rico, and has found the domicile to be quite unique in that it operates under US federal law but also benefits from a low-tax environment.
Kirkup believes an advantage of forming a captive in Puerto Rico is that the domicile does not allow the use of this type of captive, something that has helped the domicile in attracting new business. There are around 200 captives now domiciled in Puerto Rico.
Captive Alternatives now manages around 200 protected captive insurance companies, all centralised in Puerto Rico, where the inception-to-operation curve climbs faster than other US domiciles or offshore locations, Kirkup claims.
“We’ve really got some amazing benefits here,” said Kirkup. “We can create a captive in less than a month, whereas it can take three to six months to create captives in other domiciles.”
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Captives, Premium limits, Reporting requirements, Ownership restrictions, IRS, Internal Revenue Service, Captive Alternatives, United States, Puerto Rico