Jay Adkisson, former Chairman of the Captive Insurance Committee of the American Bar Association, is again out front alerting the insurance industry about important developments. In his December 9th article titled “2015 Extender Bill May Throw Out 831(b) Captives Baby With The Bathwater,” Mr. Adkisson cautions that passing such legislation without proper debate, industry input, and fine tuning will have negative economic consequences while minimally impacting government income tax collections through the bills hidden tax increases. He asserts the 2015 Extender Bill as written fails to protect legitimate use of 831(b) electing insurance companies by successful closely held businesses across the country. “Today, section 831(b) is used by numerous small insurance companies to fill gaps in traditional coverage where large insurance companies have either completely left the marketplace, or charge so much in premiums that the purchase of such insurance is uneconomical. Many smaller businesses today would be completely exposed to such things as products liability claims, employee practices claims, environmental claims, and numerous other claims but for their coverage from 831(b) insurance companies. This is the baby,” Mr. Adkisson states in his Forbes article.
Ironically, Mr. Adkisson is probably the single most responsible captive industry professional pointing a negative spotlight on the 831(b) captive industry; articles he has published in recent years have heightened concerns within the IRS and within state regulatory circles about the growing use of 831(b) qualifying captive solutions utilizing 3rd party risk pools. The use of risk pools as part of an 831(b) captive design is to protect the captive from shock losses in its early years, and often to more clearly meet complex risk distribution requirements under US federal tax rules for a captive to be deemed an insurance company for tax purposes, thus qualify for use of the 831(b) election and other tax incentives afforded insurance companies.
Notably his prior Forbes article published in March 2014 titled “IRS Noose Starting To Tighten In Sham Risk Pools” caused widespread industry concern and controversy. Other industry lawyers responded noting Mr. Adkisson in his earlier years as a captive professional spoke at conferences promoting the tax benefits of captive arrangements (read Sean Kings piece titled “Feeding Trolls” by clicking here), not the risk management benefits, suggesting Mr. Adkisson has in more recent years been trying to distance himself from “tax shelter promoter circles,” whoever they might be. If there are tax shelter promoters assisting clients or encouraging sale of life insurance in abusive situations driven only by tax impacts, some of them may have been schooled by Mr. Adkisson’s earlier analysis that perhaps helped birth the use of 831(b) captives by successful small family businesses. The tone and content of many of Mr. Adkisson’s writings in recent years directly or indirectly attacking the small family owned captive industry (captive insurance solution use by companies smaller than the fortune 1000) he helped create is hard to understand from any perspective other than scoring points with IRS enforcement officials, and to be well positioned for hire as special litigation counsel or an expert witness.
On the legislative front, and response to enacted changes to existing insurance statutes, suffice it to say that there likely will surface structural solutions should the 2015 Extender Bill or something similar to it pass. These structural solutions will emerge to help protect legitimate use of 831(b) captives by small closely held businesses. Sophisticated transactional lawyers nearly always find a way to legally restructure solutions where there is legitimate need as there is for expanded effective alternative risk finance and transfer programs.
Regarding abuse of tax incentives, it is important to remember tax incentives exist to be utilized, and there already is recently expanded tools in the IRS arsenal to combat tax abuse. One example is the new Economic Substance Test part of the Affordable Care Act. It should in and of itself prove sufficient over time to address clear 831(b) use abuses. The US already has the most pervasive and complex tax code in the world, and the largest enforcement agency behind it. Truly simplifying the tax code, and reducing the need for expansive audit and enforcement staff, is the best path should Congress and the IRS want to help make the US economy more competitive, create better job opportunities for our children, and stop the growth and deficit spending of the federal government.
For more insight on this issue, read the following comments to Mr. Adkisson’s re-publication of his article on LinkedIn:
Middle market businesses face a great number of risks for which insurance is not readily or affordably available in the commercial insurance market. For example, my friend in Charlotte who operates a number of fast casual restaurants, seven of which were closed for 3 days and two for 3 weeks as a result of flooding in Columbia, SC. He discovered that his flood insurance did not cover business interruption. And another Charlotte business owner, whose business relies heavily on online sales, who suffered a loss this year of hundreds of thousands of dollars when her website crashed; an event for which insurance is effectively unavailable. The threat to her business is existential.
While large companies have balance sheets that enable them to weather these storms and have formed captive insurance companies to help finance these and other risks, middle market businesses often do not have the strength to survive such events. By offering an incentive to finance risks in a captive insurance company, the election available under S.831(b) helps middle market businesses deal with adversity and so encourages entrepreneurship and job creation.
Is this the result of lobbying by traditional insurance companies, or just the IRS?
@Nigel — It is the result of (1) Sen. Grassley wanting to increase the 831(b) limit for farm mutuals — but needing a revenue offset to increase the limits, and (2) the IRS wanting to clamp down on “tax shelter captives” and by doing so providing Grassley with the revenue offset that he needs. Even if this doesn’t get past (and maybe more likely if it doesn’t), the IRS will likely come down in 2016 with some pretty onerous rules for 831(b) captives.
Click here for a direct link to Mr. Adkisson’s blog.