Captive insurance companies have become a popular risk management tool due to the ability to insure specific or otherwise uninsurable risks while also creating the potential for substantial tax savings. In a typical arrangement, a business establishes a licensed insurance company (the “captive”) which can be owned by the same (or related) owners of the business. The captive then writes insurance policies for the business, generally for risks that are expensive or hard to insure through standard insurance companies. The business expenses 100% of the premiums paid to the captive. Then in a popular structure called a “micro-captive,” the eligible captive company (which writes annual premiums of $1.2 million or less) elects under IRC §831(b) to be taxed only on its investment income, excluding all premium income from its taxable income each year, resulting in significant tax savings!
Transactions of Interest
Because of this favorable tax treatment, many businesses have set up captive insurance arrangements to save tax dollars. However, this favorable treatment has also led to abuse of the law, whereby many captive insurance arrangements do not actually contain any transfer of risk and exist solely as tax avoidance vehicles. Consequently, the IRS has recently identified certain micro-captive transactions as “Transactions of Interest,” meaning that parties in a micro-captive arrangement (as defined in IRS Notice 2016-66) must disclose the transaction to the IRS on Form 8886. All micro-captive transactions that meet the definition must be disclosed, even if there is no intent of tax evasion and an actual transfer of risk does occur.
Although it appears the IRS is beginning to scrutinize captive insurance arrangements more closely, captives are still an excellent tool for risk management and tax planning. It will take some additional time to complete and file Form 8886, but that should not discourage any business from forming a captive insurance company if it makes sound business sense.
For more information on the IRS’ recent guidance regarding captives or how a captive insurance arrangement can benefit your company, have a member of the Barnes Dennig team contact you here, or call 513-241-8313.