The IRS is growing increasingly uncomfortable that an increasing number of smaller companies and professional firms have been doing what larger companies do — creating their own or joining a captive insurer.

The IRS believes some of these smaller companies are creating these so-called “microcaptives” in order to lower their taxable incomes and not to insure against risks.



The New York Times recently reported on the types of captives the IRS is targeting, where the owners claim they are formed to insure against highly unlikely or costly specific risks but in reality they rarely pay out any claims, including one set up by a dentist who to insure against a terrorist attack in his dental office.
Originally, captives were created to provide coverage that was hard to find in traditional insurance markets but they have expanded well beyond that to provide almost all types of insurance. Many of the largest companies have at least one captive today and experts say they are gaining popularity among smaller and midsized firms, including professional services firms.
The vehicles are popular because under tax law the owners of a small insurance company can pay up to $1.2 million in tax-deductible premiums. Then, under Section 831(b) of the tax code, any small property/casualty insurer with annual premiums under $1.2 million may choose to be taxed on its net investment income as opposed to its premium income.
The 831(b) alternative tax provision used by microcaptives is also used by small, mutual and often rural insurance companies.
In February, the IRS placed captive insurance on its “Dirty Dozen” list of abusive tax scams. The IRS also has challenged the tax status of several microcaptives.
The IRS suspicions over captives is not new. It did not officially recognize them as legitimate tax structures until 2002. In 2008, it proposed and then dropped a bid to alter how captives are taxed after lawmakers from Vermont and other states complained. It has also questioned payment of what it believes are excessive premiums into captives by some owners.
Now the IRS is targeting small captives and what is says are “unscrupulous promoters” who persuade closely held entities to create captives onshore or offshore. They draft organizational documents and prepare initial filings to state insurance regulators and the IRS. Then, according to the IRS, the promoters assist with “creating and ‘selling’ to the entities often times poorly drafted ‘insurance’ binders and policies to cover ordinary business risks or esoteric, implausible risks for exorbitant ‘premiums,’ while maintaining their economical commercial coverage with traditional insurers.”

Captive Insurance Plans are a red flag- Contact Lance Wallach Today 516-938-5007