Captive Insurance Companies (CIC) are insurance companies created to insure the risks of related entities. Utilizing a CIC allows the insured to better protect itself from risk while having more control over the insurance provided. Under Internal Revenue Code (IRC) § 831(b), small insurance companies for which the premiums do not exceed $1.2 million are only taxed on their investment income. The increased cost of insurance and the unwillingness of the third party insurance companies to provide certain coverage, coupled with the beneficial tax treatment of small CICs, have led to a growth in the use of CICs for risk management purposes. The growth of these CIC arrangements has recently prompted increased scrutiny from the IRS. In fact, the Service added captive insurance companies as part of their “Dirty Dozen” for the 2015 filing season. Compiled annually, the “Dirty Dozen” lists a variety of common scams that taxpayers may encounter (click here to view the official release from the IRS). Currently, there are several promoter audits of CIC managers and providers, along with a large number of their CIC clients under IRS review.
Congress Considers Action
Congress also is contemplating legislation that would make it more difficult for taxpayers to form CIC arrangements. On February 9, 2015, the Senate Finance Committee discussed changes to IRC § 831(b) that would increase the premium limit to $2.2 million, indexed for inflation. Additionally, the original proposal restricted the application of IRC § 831(b) to companies for which no more than 20 percent of premiums are attributable to any one policyholder. The proposal also required that the CIC take on no risk through reinsurance. After discussion, the proposal was modified so that only the premium increase was included in the bill that the committee agreed to. However, it is clear that Congress is not done considering ways to reduce perceived abuses in this area. During the hearing, Senator Grassley asked Assistant Secretary for Tax Policy, Mark Mazur, if he was aware of the concerns regarding CICs, specifically CICs taking advantage of the special tax treatment. Secretary Mazur responded affirmatively and expressed a willingness to undertake a study identifying abuses of CICs and whether legislation is necessary to address it.
Taxpayers who have a CIC need to be aware of the issues in this area that the IRS and Congress have under review and should seek advice from knowledgeable practitioners as to compliance. For more information contact John Dies at (713) 877-9600 or [email protected]