BGD Partner Chaz Lavelle Discusses Changes to 831(B) and the Future in Captive Review
Bingham Greenebaum Doll LLP partner Charles J. Lavelle discussed the changes made by Congress to the provisions of section 831(b) and what they mean for small captive insurance companies in his latest column for the February 2016 issue of the Captive Review.
Beginning in 2017, Lavelle states the following changes will take effect in regards to the provisions of section 831(b):
- Increase the maximum amount of premiums to $2,200,000 (and index it for inflation) that an electing captive insurance company can have;
- Provide that captive with no more than 20% of premiums from a single policy holder; and
- Provide that if a captive does not meet clause (2), that no spouse or lineal descendant can own more of the captive than he or she owns in the operating company.
However, these changes have nothing to do whether the captive is a bona fide insurance company and the same tests of insurance will apply to large and small captive insurance companies. According to Lavelle, the IRS believes that there must be a non-tax business purpose for the captive insurance company.
In addition, he says the Tax Court requires that the risk insured must be an insurance risk and that risk shifting, risk distributions and the arrangement must be insurance in its commonly accepted sense.
Lavelle explains that the new law imposes a "diversification" requirement that may be met in either of two ways: a 20 percent cap on any single policyholder: or no wealth transfer. The attribution rules regarding the 20 percent cap are very broad, he says, and can encompass a wide variety of relationships. The new act also provides that the IRS can request information from the taxpayers concerning the diversification tests.
Wealth Transfer Prohibition
The premise seems to be that if the captive operates profitably, that the net income will be transferred to the owner(s) of the captive, Lavelle says. Thus it would also seem that Congress has determined that it does not want to permit captives to elect section 83l(b) treatment if there was wealth transfer.
Lavelle says that as companies review their particular fact situations, questions will arise concerning the treatment of various scenarios. While not all questions can be answered immediately, captives can rest assured that Congress’ Joint Committee on Taxation will likely publish a formal explanation, commonly referred to as the “Blue Book," so there may be additional Congressional explanation.
In addition, Lavelle says existing captives who would not qualify under the new legislation will likely fall into the following classes, with most lying within the first two categories:
- No change in ownership with the effect that the captive is taxed under section 83l(a);
- Ownership is changed so that the operating company and captive have mirror ownerships; or
- Some captives may have served their usefulness and are dissolved.
Only time will tell how these changes to section 831(b) will affect captive insurance companies. However, Lavelle says the vast majority of captives are formed as insurance vehicles, and not wealth transfer. Therefore, he explains that he doesn't believe the new legislation will substantially affect new formations of new captives.
Lavelle focuses his practice in the areas of federal tax controversy as well as formation, operation, and taxation of captive insurance companies. Lavelle also counsels clients in tax planning, especially for captive insurance companies and their owners. He is a frequent speaker on a variety of topics related to captive insurance and is one of only two individuals to be named in both the Captive Review Power 50 and ERC Pioneers lists for 2016.