Victories in 831(b) cases would prompt IRS to target larger captives

The scrutiny that some types of captives – in particular 831(b)s – face from the IRS is unlikely to go away, and advisors must get smarter about how they educate clients, according to Anne Marie Towle, captive consulting practice leader at JLT Insurance Management, speaking at the Vermont Captive Insurance Association’s (VCIA) annual conference in Burlington, Vermont.

“If you’re going to set up an 831(b), do it the right way, with all the right parameters and all the right tests. There are some very good ones out there,” she said.

Tax code Section 831(b) allow small captive insurers to deduct up to $2.2 million in premium income from taxes.

Towle was speaking following a session she moderated on pending tax items that will impact the captive industry. Speakers included Charles Lavelle, partner at Bingham Greenebaum Doll; Bruce Wright, partner at Eversheds Sutherand (US); and Tom Jones, partner at McDermott Will & Emery.

In November 2016, the IRS stated it believes 831(b) transactions have a “potential for tax avoidance or evasion”.

Depending on the outcome of pending court cases relating to 831(b)s, large captives may also find themselves under increased scrutiny from the IRS, the experts warned.

“Rest assured, if the IRS piles up these victories against small captives, they’re going to go back after big captives,” warned Bruce Wright, partner at Eversheds Sutherland (US).

Julie Boucher, managing director at Marsh Captive Solutions, added that the industry is hoping to gain some very clear guidance from cases such Avrahami v Commissioner.

Boucher said: “Everyone is looking for some very clear guidance about 831(b)s, what are the problem transactions, coverages or structures, and what might not be,” said Boucher.

“We will all have to wait and see if the Avrahami decision will give us that.”

Towle stressed the importance of understanding what the key points are for audit.

“If you are audited, which most companies be at some point, to be prepared you need documentation in place, justification - actuarial is preferred - and how are you allocating your premiums if they're in a multi-company segment.

“There must be justification for the allocation of premiums and sufficient capitalisation. And really very limited loan backs or transactions back to the parent company. Those are the five key points.”

In spite of the scrutiny and potential audit, Towle believes 831(b)s are still an attractive option for smaller companies looking to set up a captive.

“There are small companies that really are trying to do it the right way, and they still have an interest because they want to retain their risk or are already retaining the risk. There are real risk management reasons, so they're not necessarily being turned away because we're still seeing the formations, it just it may take them a little longer than historically,” Towle said.

This article was first published on Captive International.