22 December 2023ArticleUSA analysis

Ways and Means enters the captive insurance discussion

Reading the tea leaves of Congress is hard work. There is a brewing dispute between the executive and legislative branches of the US government relating to small captive insurance companies. The nature of the dispute relates to proposed regulations released in April 2023 drafted by the Internal Revenue Service (IRS) to classify almost all 831(b) captive transactions as a “listed transaction”. The net effect of a listed transaction designation precludes most businesses from making the election. Consequently, the IRS’s proposed regulations seek to eliminate Internal Revenue Code (IRC) 831(b)s.

In response to the proposed regulations, the industry and regulators submitted dozens of thoughtful responses. The large response was heard by Congress. The committee’s unequivocating condemnation of the proposed regulations includes language remarkably similar to various comments filed by members of the industry and captive insurance regulators. This suggests that at least a few members of Congress reviewed the comments, or a summary of them, and were convinced by the general logic underlying them. Moreover, this strongly suggests that the IRS reviewed the comments.

Although comments were submitted by the captive insurance industry in the summer of 2023, the IRS has declined to issue a response to the public. The sole development in half a year is a surprisingly direct response from the House Ways and Means Committee.

Separation of powers governs the US government: Congress drafts the laws; the executive passes them and then enforces them. The executive lacks the power to eliminate laws it finds quarrelsome or confusing to enforce. Congress’s powerful Ways and Means Committee issued a statement to the Commissioner of Insurance highlighting a number of constitutional concerns with the IRS’s proposed rules. Eight members of the majority party brought attention to the following problems with the proposed regulations:

· The proposed regulations seek to effectively eliminate the 831(b) election

· Executive agencies lack the power to legislate

· Neither the IRS nor the Treasury Department may eliminate laws that are tricky to enforce or otherwise perceived as troublesome to the executive branch

· Congress not only supported the 831(b) election in 2015 via the PATH Act but continues to do so

The letter signed off with an explicit request to coordinate with the IRS regarding captive insurance regulation.

Captive insurance is officially a political football. Congress outlined concerns with the IRS’s approach to enforcing the IRC. The IRS has been silent but it is virtually a guarantee that the Commissioner and the Secretary of Treasury took the Ways and Means Committee’s comments into advisement.

Several questions remain. Will the IRS amend its proposed regulations in light of Congress’s explicit support for small captive insurance companies? If not, then will Congress amend the IRC to bolster protections for small captive insurance companies? Finally, the actual form of the regulations may provide a number of avenues for private parties, such as captive managers or captive owners, to challenge the regulations under various theories of Constitutional law.

There is some good news

First, the IRC 831(b) election lives. Congress indicated that it is not interested in permitting the IRS to unwind the rights of taxpayers to create captives for risk financing.

Second, the language of the letter directly stated that Congressional intent is for the IRC 831(b) election to provide the ability for the formation of small captive insurance companies. This is a welcome development, as the IRS argued on several occasions that the 831(b) election was never intended for captive insurance development. In a strictly legalistic sense that position was correct a few decades ago, but the proliferation of 831(b) captive insurance companies altered Congress’s view of the election.

Third, the government is talking. It takes a cynical mind to believe that Congress can issue a clear and stern statement against executive over-reach without any degree of coordination between the IRS and the House. If the stakeholders are deliberating the issues then it stands to reason that the IRS’s proposed rules are more likely than not to be amended before publication and may be delayed while the stakeholders work out a deal.

In general, this is a positive development for the captive insurance industry. The statement lacks the force and effect of law, but it elevated captive insurance into the discussion with regard to the separation of powers. Congress has an appetite to defend captive insurance.

Matthew Queen is the owner of The Queen Firm. He can be contacted at: matthew@thequeenfirm.com