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Microcaptive tax-free limits rising to $2 million

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The amount of money so-called microcaptives can elect to have be free of federal taxes has nearly doubled under tax extension legislation recently approved by Congress and signed into law by President Barack Obama.

Under the package, captives formed under Section 831(b) of the Internal Revenue Code can avoid taxation on up to $2 million in premiums per year, up from the current $1.2 million, effective for 2017.

Such captives, typically used by family-owned businesses and small to midsize employers, generally meet the IRS' tax-exempt requirement if no more than 20% of either net written premiums or direct written premiums, whichever is greater, are attributable to any one policyholder in a taxable year, according to the legislation passed and approved last week.

“That's for group captives, like farming mutual insurance companies, where if you have at least five members you are all set,” said J. Scot Kirkpatrick, Atlanta-based leader of the trusts and estates practice at law firm Chamberlain, Hrdlicka, White, Williams & Aughtry.

He said the higher premium limit essentially reflects inflation.

“One of the big advantages of having a captive is if you run your own business, you can make the choice of what layers you want to keep for yourself because you can manage it and buy the commercial insurance that fits your needs,” he said.

But if an 831(b) captive looks as though it's been set up for estate planning purposes, such premiums would not be exempt from taxes, he said.

“I'm not sure this is a bad thing for the insurance world; it's going to require more focus on how (microcaptives) are structured and how they are used, and these are risk management tools, not tax devices,” Mr. Kirkpatrick said. “But if you comply with the tax laws, you will get the benefits that Congress has intended.”

“None of these new rules deal with the issues the IRS has been litigating for the past 10 years,” he said.

In rulings in 2014, courts held that captives can meet the risk distribution requirements by insuring a large number of risks rather than, as the IRS contended, a large number of related policyholders.

The increase in tax-free premiums allowed came despite the IRS earlier this year putting 831(b) captives on its Dirty Dozen list of tax scams that allow some companies and wealthy individuals to avoid paying taxes.