- Robert Ferguson
What is an 831(b) Micro-captive?
Chances are, you are already familiar with the term 831(b) or “micro-captive.” If you’re not familiar with this increasingly popular, powerful and flexible captive structure, you should see if this middle-market platform is right for your business. Read on.
COMMERCIAL INSURANCE: CAPTIVES AND TAX ELECTIONS
What Is It?
831(b) Captive — a captive that may be taxed under Internal Revenue Code § 831(b), which provides that a captive qualifying to be taxed as a U.S. insurance company may pay tax on investment income only in any year that its written premium is at or below the threshold for the applicable tax year, which in 2017 was set at $2.2 million or less with the premium cap subject to inflation adjustments. Such captives are also known as "microcaptives."
Forming your own captive insurance company to reap this financial benefit sounds like a no-brainer, but it’s vital that you keep in mind the following characteristics that must be met in order to conform to the definition of “insurance company:”
Business purpose must be legitimate: your captive’s primary activity must be insurance, and it needs to be operated like an insurance company
Premiums and policies must be market-comparable and risk-based
Initial capitalization must be adequate: a 4:1 premium to capital ratio is a good rule
It must meet the requirements to be considered an insurance transaction, which means two very important features must be present:
Risk transfer – the shifting of risk from one party to another. There must involve a significant chance of loss to meet this requirement.
Risk distribution – risk can be spread amongst one or more entities
What’s Covered?
Any risk that’s currently covered by commercial insurance – property, general liability, product recall, etc. – as well as many others. But often, a micro-captive reflects business risks which are often not insured or under-insured. Examples can include:
Gap fillers
Deductible layers
Cyber risk
Directors & Officers
Intellectual property
Errors and Omissions
Warranties
Malpractice
Legislative Risks
Reputational Risks
Business Interruption (domestic terrorism or pandemic)
Generally, if a potential liability exists for the captive owner and an actuarially-supported premium can be developed, you can include it in an 831(b).
What Industries?
While 85% of franchise automobile dealers have successfully used micro-captives since the 1970s, ANY business which has risks (which is all of them) should explore this powerful and flexible business tool signed into law by congress and President Ronald Reagan in 1986. There is a reason 90% of Fortune 500 companies use some sort of captive and more than 70,000 middle-market business have adopted a micro-captive strategy. Industries which currently partake in 831(b) election include:
Agriculture and Agribusiness
Automobile
Aviation and Aerospace
Construction
Law Firms
Hospitality
Manufacturing
Medical and Dentistry
Oil & Gas/Energy
Real Estate
Retail and e-Commerce
Technology
Transportation
...many more
What Are Next Steps?
If you can meet the above requirements, an 831(b) might be a good choice for you. However, due to their popularity and subsequent abuse, the 831(b) structure has come under close scrutiny by the IRS. Since this tax benefit has been realized, it’s been oversold by accountants, wealth managers, financial planners and the like, often without meeting the requirements listed above.
It’s vital that you reach out to a trusted resource representing a legitimate service provider - preferably one with a team of experienced professionals, hundreds of established clients and reflecting a decade of positive testimonials within the industry. These top providers will help determine your eligibility and talk about how to proceed.
To learn more about setting up a captive insurance company, contact us today. At Reinsurance Specialties™, we help businesses leaders mitigate business risks, adjudicate claims, protect assets and build wealth through tax-advantaged premium.