New disclosures may be required for certain captive insurance arrangements
Our firm has been extensively involved in captive insurance arrangements since the 1970s. While for much of the period since then the users of captives have primarily been tax-exempt organizations and large for-profit groups, the scope of participants in the industry has expanded dramatically over the past ten years from its original core. Recently, captives have become extremely popular with closely-held businesses and individuals as an income and estate tax planning device due in large part to the proliferation of “micro captives” (sometimes referred to as “831(b) captives”) – a special subset of insurance companies that are not subject to federal income tax on their underwriting profits provided that their premiums do not exceed $1.2 million.
In response to the government’s view that the establishment and use of micro captives is creating abuses from a tax perspective (in many cases, the arrangement is designed so that the captive is not expected to have losses on the coverage it provides), Congress implemented tax reform measures to be effective next year that limit the estate tax benefits of such structures (while increasing the premium threshold to $2.2 million). Moreover, the IRS has stepped up its enforcement measures in this area by initiating litigation against both taxpayers and service providers perceived to be “promoters” of abusive micro captive arrangements.
Empowered by the information that it has received in connection with its audits of micro captive transactions, the IRS has continued to raise the stakes for those participating in the industry in the following ways: first, for the past two years, it has identified micro captives on its “dirty dozen” list of tax scams, and second, this week, it published a Notice (2016-66) classifying certain micro captive arrangements as “Transactions of Interest,” resulting in a mandatory federal tax disclosure for taxpayers and “material advisors” involved in certain related-party micro captive structures. For example, such arrangements may need to be disclosed on an IRS Form 8886 and/or 8918 to the extent that the losses paid by the captive generally are less than 70% of the premiums that it receives or the captive has transferred any value/assets to an insured in a non-taxable manner (typically pursuant to a loan-back).