There is now a tax provision that allows’micro-captive’ insurance companies – formed to provide insurance to small businesses – to collect premiums tax-free. Ultimately, this was meant to give consumers with more cheap insurance coverage. These have not been an issue when the insurance organization is sufficiently diversified.
Unfortunately, some taxpayers have misused the system in order to profit themselves, either by not providing true or actual insurance plans, or by giving insufficient insurance at exorbitant fees. Concerns about micro-captive insurance firms with 100% deductible premiums and no tax payments, and with little to no opportunity for the IRS to evaluate them, have provided justification for policy change. As a result, numerous proposed rules in President Biden’s green book would make those arrangements far more expensive for captive insurance companies. The following is a summary of the proposed guidelines and their implications:
• Proposal to create a system of untaxed income accounts (UIA). This applies to any captive insurance company that receives 20% or more of its premiums from a single policyholder or a group of policyholders.
• Impact on captive insurance companies: It exempts the firm from paying taxes on these premiums, but dividends or loans paid to insured parties are viewed as a presumed distribution from the UIA and are taxed at a high rate.
• Agribusiness implications: Many captives will ensure that no connected group of enterprises pays more than 20% of total premium income (the threshold that would create a tax payment by the insurance company). If the corporation exceeds this and pays taxes, it will essentially lower the benefit to farm operations that have created these captives, limiting captives’ ability to continue and leaving a large tax debt on the table for earlier net premiums received.
“At this early point, particularly in light of recent IRS activities, we’re waiting to see what will emerge to stand before Congress.” “However, we fully expect new tax rules in some form to eliminate the capacity of those captives exploiting the tax-free option for tiny insurance companies,” says Lance Wallach, a captive insurance expert witness whose side has never lost a case.
If you own or participate in a “micro-captive” insurance firm, talk to your captive manager about their reinsurance and ceding percentages, as well as your captive manager and captive tax return preparer about the potential consequences of these ideas.
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