““The clarifications offer
a much-needed lookthrough
provision that was
unintentionally left out of the
original PATH Act.”
Ryan Work, Self-Insurance Institute
investment income taxed at the lower 21 percent corporate rate—
compared with up to 35 percent previously.
“I don’t think that the US tax reform legislation at the end of 2017
has had a material effect on insurance companies that have elected
to be taxed under section 831(b). These insurance companies
are used for risk management purposes, and tax reform has not
materially changed the financial consequences of insuring with an
affiliated small insurance company,” says Lavelle.
Karl Huish, executive vice president, North America, Artex Risk
Solutions, adds that tax considerations are just one of many factors
that influence the decision that a company evaluates when deciding
to start a captive insurance programme.
“Although companies are generally paying less federal income tax
post-tax reform, it isn’t the huge reduction that some companies
expected a year ago, especially for pass-through entities such as
partnerships and S corporations,” says Huish.
“There are many reasons that companies form captives that are
not dependent upon tax. Those reasons have not changed post-tax
“In addition, the clarifications offer a much-needed look-through
provision that was unintentionally left out of the original PATH Act.
Together, these changes hopefully provide some needed guidance
for the entire industry.”
In August 2017, Avrahami v Commissioner was the first high-profile
US Tax Court case against microcaptives, with Judge Mark Holmes
concluding that the arrangements made by Benyamin and Orna
Avrahami through their captive, Feedback Insurance Company,
were not insurance for federal tax purposes.
There are concerns that the outcome of this case has hurt the
reputation of captives that make the 831(b) election, and that this
decision would embolden the IRS to audit more structures.
Reserve Mechanical v Commissioner is the IRS’s latest win
against small captives, as the court determined that captive insurer
Reserve Mechanical’s risk pool entity, PoolRe Insurance, operated
by Capstone Associated Services, was not a “bona fide insurance
company” because it did not distribute risk.
There is debate over whether PoolRe—when it was used as a stop
loss insurance company from 2008 through 2010—constituted
Capstone had disputed the tax court’s comparison to Avrahami,
arguing that PoolRe’s payment of substantial claims and inclusion
of unaffiliated third-part reinsurance to its legitimate insuring
of a mining business were valid reasons as to why the insurance
transactions were legitimate and different from the comparisons
The industry is still awaiting the opinions on several cases currently
pending before the US Tax Court, which involve insurance companies
that have made the section 831(b) election. At the time of writing
they include Caylor v Commissioner, Wilson v Commissioner and
Syzygy Insurance Co v Commissioner.
Lewis says that this continued IRS scrutiny is definitely a concern
to existing and potential 831(b) captive owners.
“The IRS has clearly stated that it recognises there are legitimate
captives and is searching out the abuses, but the process of
identifying what is a legitimate captive continues to need guidance,
in addition to what was provided by the Appropriations Act,” she
“More and more companies are considering how to integrate
small captives into their overall risk profile and continued guidance
to provide clarity will help these companies to set up captives in
accordance with both the letter and the intent of the law.”
US tax reform
The US Tax Cuts and Jobs Act 2017 represents the first major
overhaul to federal taxes since 1986, and there are provisions that
US and international captives should be wary of.
Large captives benefit in two ways: their tax on underwriting profits
is reduced from 35 percent down to 21 percent, and their tax on
investment income is reduced to 21 percent.
831(b) captives would still be taxed 0 percent on their underwriting
profits, but they now have the added benefit of having their
22 US Captive 2018 www.captiveinternational.com