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831(b) Tax Option Changes Topic of SRS Webinar

Laptop Computer Woman Webinar
January 11, 2016

The features of the 831(b) tax option passed by Congress at the end of 2015 and the ongoing auditing activity of the Internal Revenue Service (IRS) were the topics of discussion during "831(b) Captives—The Latest Developments," a recent webinar hosted by Strategic Risk Solutions.

Webinar presenters were Charles Lavelle, Bingham Greenebaum Doll LLP; Daniel Kusaila, Crowe Horwath, LLP; and Michael O’Malley, Strategic Risk Solutions.

Key points webinar presenters made during the presentation include the following.

  • The 831(b) federal tax option, which exempts small insurer underwriting income from federal taxation, has been around 30 years. The intended primary beneficiaries of this tax option were small insurers serving rural and agricultural communities.

  • The legislation that Congress passed and was signed by the president (H.R. 2029) includes an increase in the maximum premium allowable to $2.2 million for electing the 831(b) option, which subsequently will be indexed for inflation. The changes will be effective for taxable years after December 31, 2016.

  • The "tighteners" in the legislation included optional diversification tests that an insurance company must meet to be eligible to make an 831(b) election, as follows.

    • Test 1—No more than 20 percent from any one policy holder.

      • Premiums are the greater of net written or direct written premiums.
      • Related insureds are treated as one policyholder.
    • Test 2—The same person owns the operating and the insurance company.

      • There is a 2 percent de minimis tolerance for different ownership.
  • There is the prospect of IRS interpretations prior to the effective date of the changes to the statute.

  • Once an insurance company makes an 831(b) election, it cannot revoke the selection. This means if the insurance company has an underwriting loss in a particular year it still must pay federal taxes on its investment income. If a qualifying insurance company exceeds $2.2 million of premiums, the company will be taxed like any insurer with more than the maximum permitted premium.

  • The changes in section 831(b) do not have any bearing on the definition of insurance.

  • The increased 831(b) premium limit will create opportunities for some small captives. Issues for small captives or businesses considering starting a captive include the following.

    • Long-tail versus short-tail nature of risk

    • Frequency and severity of risk

    • Loss history and expected future results.

The webinar panelists also briefly discussed ongoing IRS audits. The panel pointed out that promoter-originated small captives are not the only captive insurers being audited. Suggested audit tips included the following: (1) the captive feasibility study/business plan should include the reasons for the creation of the captive and coverages it provides, and (2) premiums should be substantiated through use of an actuary.

The common types of risk currently present in 831(b) captives include the following.

  • Weather risks (i.e., earthquake, windstorm, and flood)

  • Difference in limits and conditions

  • Property risk and related coverages

  • Cyber

  • Excess liability

  • Pollution liability and cleanup

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