The complexities and future of 831(b)s
831(b)s are still being watched and litigated over in the US, with the IRS continuing to bring cases to court. Captive International investigates.
Certain topics have been constant in recent years. Recruitment. The hard market. The Great Retirement. And then there’s 831(b)s.
The 831(b) tax election, a crucial tool for small and medium-sized enterprises (SMEs) in managing risk, is currently—again—under intense scrutiny from the Internal Revenue Service (IRS), sparking significant debate within the captive insurance industry due to the impact of recent legal decisions.
Dustin Carlson (pictured), president of the 831(b) Institute, told Captive International that the cases of Keating and Swift, which involved captive managers Tribeca and Celia Clark, did not introduce much new information. These cases were similar to earlier ones such as Avrahami and Caylor, which centred around issues such as improperly issued policies, lack of formal claims processes, and non-arm’s length pricing of premiums.
Carlson pointed out that these decisions continue to cast uncertainty over the micro-captive sector, something that should concern all stakeholders.
“The biggest impact these cases will have is the IRS further touting Tax Court wins and leaving the micro-captive industry in a state of uncertainty,” he said. He emphasised that this uncertainty is particularly troubling given the vital role 831(b) captives play in providing risk management solutions for SMEs.
“Let’s bring together the IRS and industry participants to hash out these lingering questions.” Dustin Carlson, 831(b) Institute
IRS scrutiny and the challenges ahead
Carlson touched on the IRS’s shortcomings in providing clear guidance for taxpayers opting for the 831(b) election. He cited the RMC case as a stark example of the IRS’s failure to collaborate with industry stakeholders to establish robust standards.
“Rather than facilitating a collaborative environment with industry stakeholders, the IRS appears to be constraining the application of 831(b) almost to the point of obsolescence,” he argued. The jury’s decision in favour of RMC highlighted the need for better-informed decisions in future cases, he added.
The Chevron ruling, although not directly related to 831(b)s, was also mentioned by Carlson as a positive development. He believes it could help captive industry participants and owners defend their risk management programmes against IRS scrutiny. The ruling could challenge the IRS’s understanding of insurance, especially regarding its proposed regulations, such as the controversial 65 percent loss ratio requirement.
“This decision opens opportunities for seasoned insurance professionals to influence these cases, countering the IRS’s flawed grasp of insurance,” Carlson noted.
“Captives that make the 831(b) election are very good for insuring property/casualty risks.” Rick Eldridge, Intuitive Captive Solutions
Understanding the IRS audit process
Why has the IRS has been involved in so many cases? Carlson clarified that it is typically the taxpayer who petitions the court after receiving a notice of deficiency from the IRS. He described the IRS audit process for 831(b) micro-captives, which often begins with a broad Information Document Request (IDR). The field agent rarely delves into the specifics of the taxpayer’s situation, leading to a boilerplate notice of deficiency that disallows the entire premium deduction.
Carlson highlighted the inefficiencies of this process, noting that as of May 2023, more than 1,100 cases were pending in the US Tax Court, with only a handful reaching a decision.
Looking forward, he expressed the 831(b) Institute’s desire for the IRS to work collaboratively with industry stakeholders to address these issues. He acknowledged that while there have been abuses of the 831(b) tax code, the solution is not to discard this risk management tool entirely.
“Let’s bring together the IRS and industry participants to hash out these lingering questions and resolve them so SMEs can feel comfortable utilising 831(b) for risk management,” he urged.
Broader industry trends and legislative support
Despite the challenges posed by the IRS, Carlson remains optimistic about the future of 831(b) captives. He pointed out that the COVID-19 pandemic has made business owners more aware of the limitations of traditional insurance, particularly in covering business interruption and pandemic-related losses. This has led many to explore alternative risk financing options, with 831(b) plans emerging as a viable solution.
Moreover, the ongoing property insurance crisis has further underscored the appeal of 831(b) plans. “The property insurance market is experiencing a crisis marked by insurers withdrawing from certain states, hiking rates, and imposing stricter policy terms,” Carlson noted. This turmoil is driving more businesses to consider 831(b) captives as a means of securing financial stability.
Carlson highlighted growing legislative support for 831(b) plans. Members of Congress, recognising the limitations of traditional insurance and the benefits of 831(b) plans, are becoming advocates for this alternative risk management tool.
“At the end of 2023, Congresswoman Beth Van Duyne and other House Ways and Means Committee members sent a letter to IRS commissioner Daniel Werfel expressing their support for small captive insurance,” he said.
Captive insurance in the current landscape
Rick Eldridge, president and chief executive officer of Intuitive Captive Solutions, provided additional context on the importance of 831(b) captives, particularly in light of current challenges. He explained that captives have been a key risk management tool since the 1980s, especially for businesses facing liability crises, something that he has helped to highlight in an upcoming multi-author whitepaper put together by Intuitive for Captive International.
“During the COVID-19 pandemic, many businesses benefited from having captive insurance companies because they had purchased certain insurance coverages from their captive which were otherwise unavailable in the commercial insurance marketplace,” Eldridge said.
Eldridge pointed to the property insurance crisis, where deductibles and premiums have been rising while coverage capacity has decreased. He emphasised the central role 831(b) captives play in insuring high-severity risks such as hurricanes or excess liability.
“Captives that make the 831(b) election are very good for insuring property/casualty risks that have high severity but where losses may be infrequent and where capital can be replenished quickly,” he noted.
As the 831(b) Institute continues to engage with industry stakeholders and policymakers, the focus remains on ensuring that SMEs can effectively utilise 831(b) captives for risk management. Carlson’s and Eldridge’s insights underscore the importance of these captives in the current economic and insurance landscape.
By fostering collaboration between the IRS and the industry, and by advocating for clear and fair regulations, organisations such as the 831(b) Institute aim to secure a stable and prosperous future for captive insurance.
Click here to read Captive International's US Focus 2024 publication.
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