On December 16, 2015, Congress passed the Protecting Americans from Tax Hikes (PATH) Act of 2015, and the President signed the bill into law.
Section 333 of the PATH Act changed several provisions related to 26 US Code 831 – Tax on Insurance Companies Other Than Life Insurance Companies, specifically Section 831(b).
Considering the Changes - Increase in premium cap on 831(b) captives and tightener language regarding wealth transfer benefits
The PATH Act increases the limitation on premiums from $1,200,000 to $2,200,000 and indexes it to inflation.
The Act also establishes a new diversification requirement that comes into play when a spouse or lineal descendant of the business owner will own the captive. In those cases, in order to qualify for the 831(b) election, either (1) no more than 20% of the net written premium of the captive can be attributable to any one policyholder, or (2) the ownership of the spouse or lineal descendant of the captive must be the same as his or her ownership of the company (de minimis difference allowed), thus limiting estate planning and wealth transfer benefits of captive insurance companies. In traditional situations when the captive is owned as part of the corporate structure of the insured entity, the 831(b) election will remain intact at the increased limit.
All changes are effective for tax years beginning after December 31, 2016.
The increase in the limitation on premiums from $1,200,000 to $2,200,000 will create an opportunity for current captive owners to re-review their insurance program to determine whether they can take on additional risk in their captive. It will also create an opportunity for more middle-market companies, which might not have found significant benefit in setting up a captive at the $1,200,000 limit, to take advantage of establishing a captive to more effectively manage their risk.
Businesses with captives set up for estate planning and wealth transfer may need to modify the ownership structure of their captive for tax years beginning after December 31, 2016. Even if the captive was not formed to take advantage of the estate planning benefit, this legislation and recent IRS activity show that the IRS is interested in captives that are not correctly structured (truly insurance, requirements of risk shifting and risk distribution have been met, premium supportable, investments okay, risk pool is satisfactory, etc.).
Proper understanding of the tax law and rules and regulations that surround the captive insurance industry are critical in the establishment and ongoing operations of a captive insurance company for it to enjoy all the benefits and solutions it can offer. If your captive is affected by these recent changes, or if you have concerns over your captives structure, please contact us for a Captive Checkup.