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New Senate Finance Committee proposal seeks to bolster microcaptives

U.S. Senate plan would bolster 831(b)s


A proposal that could have put many “microcaptives” out of business was withdrawn before a Senate Finance Committee vote last week and replaced by one that will make 831(b) captive insurers even more financially attractive.

Those surprising actions came just a week after the IRS added 831(b) microcaptives to its Dirty Dozen list of “tax scams,” saying they allow some companies and wealthy individuals to avoid paying taxes if they abuse the legitimate tax structure. The captives — an estimated 3,000 of them — derive their name from the section in the U.S. Tax Code authorizing them.

Under current law, parents of 831(b) captives can make up to $1.2 million in tax-deductible premium contributions to the captives each year, and such captives' underwriting income is exempt from federal income taxes. There is no limit on the percentage of business from a single party.

But the Finance Committee proposal, known as the “chairman's mark,” would have limited to 20% net written premiums from a single policyholder in the captive.

In addition, it would have considered related family members as one policyholder, which experts say would have put 831(b) captives out of reach for many, if not all, family-owned companies.

When the legislation emerged from the Senate Finance Committee last week — approved on a bipartisan voice vote — the proposal had changed: the 20% premium limit from a single policyholder was removed, while the maximum tax-deductible premium limit was nearly doubled to $2.2 million, with that increase boosted annually in line with rises in the cost of living.

With the higher contribution limit, “831(b) captives would become even more attractive,” said Aidan Kelly, senior vice president and chief operations and compliance officer in the global captive practice in Atlanta with Willis Group Holdings P.L.C.

“Our legislation updates a key threshold for small insurance companies,” Sen. Charles Grassley, R-Iowa, who championed the proposal, said in a statement following the Senate panel vote.

Sen. Joe Donnelly, D-Ind., said in the Grassley statement: “Small mutual insurance companies are important to Indiana's economy, and this common sense bill would make a much-needed update to the law.”

Still, “the proposal in its current form will be strongly resisted by the IRS,” said Robert Myers Jr., a partner with Morris, Manning & Martin L.L.P. in Washington.

It isn't clear what led to the rapid demise of the earlier proposal, but sources say several committee members, including Sen. Grassley, are longtime supporters of 831(b) captives.

“Members of Congress want to protect the interests of constituents,” said Delaware Captive Insurance Director Steve Kinion in Wilmington.

However, “the IRS hates 831(b) captives. They talked to (Senate Finance) committee staffers to get the provision in the bill,” said a source, who asked not to be identified.

But when senators who support 831(b) captives saw the legislative language, they got it removed and replaced with the current proposal, which has been discussed in prior congressional sessions, the source said.

The earlier withdrawn proposal “would have severely damaged interest in new formations and caused many existing companies to reconsider their positions,” said Art Koritzinsky, a managing director at Marsh Captive Solutions in Norwalk, Connecticut.

The proposal, as it was sent to the Senate committee, “would severely handicap the 831(b) captive insurance industry,” said Tom Jones, a partner with McDermott, Will & Emery L.L.P. in Chicago.

“This would have been very damaging to the captive insurance industry. The approach was too broad,” said David Snowball, captive insurance director of the Utah Insurance Department in Salt Lake City.

Still, the proposal is far from becoming law. A vote by the full Senate on the legislation has not yet been scheduled, while the House of Representatives also has not considered the bill.

“We will have to wait and see after the House weighs to see if the provision stays,” said Bruce Wright, a partner at Sutherland Asbill & Brennan L.L.P. in New York.

“The IRS will fight the proposal as written, but I think the IRS will propose restrictions, which if adopted, the administration then would support the legislation,'' said Charles Lavelle, a partner at law firm Bingham Greenebaum Doll L.L.P. in Louisville, Kentucky. “But if the new proposal is overly restrictive, the captive industry would lobby lawmakers to lessen those restrictions.”