Disclaimer: Nothing herein is legal, tax, financial, insurance, accounting or investment advice. The information herein may be dated. No obligation to update or make corrections is intended or implied.
Caution: As use of captives making the 831(b) election has proliferated in recent years, the IRS too is increasing its attention and review of these transactions. IRS Associate Counsel stated the IRS does not want to chill proper use of captives but are concerned about potential abuses. This scrutiny may be warranted. Some captive promoters and managers may not know how to or do not care to follow best practice standards, but rather focus nearly exclusively on the tax benefits of captive structures. Some may lack the requisite risk management experience to design and manage them first and foremost as legitimate and effective risk management vehicles. Shortcomings in some programs may relate to weak or questionable practices regarding risk assessment, policy selection, policy pricing, policy periods, and risk pools that may not be designed and operated correctly themselves.
Technically there is no such thing as an 831(b) captive. 831(b) is a reference to U.S. Code, Title 26, Subtitle A, Chapter 1, Subchapter L, Part II, section 831, subsection (b), of the United States Internal Revenue Code, titled “Alternative tax for certain small companies.” Therefore 831 (b) applies only to insurance companies that are US taxpayers. You can read this 831(b) statute on the Cornell University website by clicking here.
The following chart lays out the bigger picture of the tax impacts of a captive insurance company in “for profit” enterprise groups:
IRC 831(b), providing for exemption from income tax of a qualifying small insurance company’s underwriting income, is a US tax code provision enacted as part of the 1986 Tax Reform Act by Congress during President Ronald Reagan’s 2nd term. At this time the US insurance markets were a very “hard” market, meaning affordable insurance was expensive and for many companies and professionals difficult if not impossible to find. Section 831(b) specifically created a powerful tax incentive for the formation and operation of small insurance companies. It helps US businesses create loss reserves with formalized insurance programs under their control. This tax incentive is valuable to make sure US businesses will hopefully never again find themselves in the disastrous commercial insurance market conditions existing in the mid-1980s that left 1000s of US businesses without adequate protection from or liquidity to survive high severity operational risks.
This section 831(b) election is available to qualifying insurance companies who timely make the necessary election; otherwise applicable taxes dictated by section 831(a) applies to all insurance companies except life insurance companies. All US insurance companies, whether electing 831(b) benefits or not, must file IRS tax form 1120-PC (click here to see the form, or click here to see instructions).
Section 831(b) (2) (A) limits its application only to insurance companies if:
- The greater of net written premiums or direct written premiums do not exceed $1,200,000 in the taxable year, and
- Such company elects the application of section 831(b) for such taxable year.
There is some disagreement and confusion on the interpretation of “written premium” in a taxable year. Some believe it is measured on a cash basis reading the statute literally, others think accrual methods control particularly where tax returns are prepared that way. The author does not believe there is yet definitive guidance.
Various Names Used for Small Captives
Increasingly the term “micro-captive” was used to describe these small 831(b) election qualifying captives from 2009 into 2014, hence why it is incorporated into the title of this book. As of 2014 the term “enterprise risk captive,” coined by some of the leadership at SIIA, is emerging as the preferred description. Suffice it to say technically there is no such thing really as a micro-captive, or an 831(b) captive, or even an enterprise risk captive.
Captives are all unique (when designed properly) and are nothing more than an insurance company licensed under an enabling insurance statute in the US or abroad whether large or small and irrespective of the types of insurance coverage it is designed to issue. Being an insurance company for US tax purposes is distinct from being a licensed insurance company for insurance regulatory purposes. Just because your captive receives approval and a license to conduct its insurance business does not mean the IRS must agree it can avail itself of favorable tax incentives and treatment afforded an insurance company under the US Internal Revenue Code.
Learn more by reading this inexpensive eBook – “831(b) Enterprise Risk Micro-Captive Insurance Companies – Design and Tax Planning Guidance.”
For information on best practice standards today in the micro-captive industry, read this article.