Risk management is an essential component of owning and operating a small business. As someone who has been involved in the risk management sector for over 35 years, I feel confident in the ability of microcaptive insurance plans to make a difference in business owners’ lives. Unlike traditional insurance plans, captive insurance allows businesses to protect themselves from unforeseen risks that may otherwise destroy them. Yet, the Internal Revenue Service is currently engaged in a targeted campaign against microcaptive insurance or 831(b) plans.
Captive insurance can be defined as a form of self-insurance, removing third-party involvement. This means that a company can provide insurance for itself. More specifically, microcaptive insurance is a form of captive insurance for small businesses with an annual premium of less than $2.8 million. Similar to a 401(k) plan, 831(b) microcaptive plans allow for tax-deferred dollars to be set aside in order to mitigate future unforeseen risks. Plans like these have become increasingly helpful in situations such as cybersecurity attacks or a pandemic, such as COVID-19.
The ambiguity of the 831(b) tax code has led many to be unjustly targeted by the IRS. How can business owners and tax professionals be expected to abide by a tax code when the IRS refuses to even clarify the rules and regulations within it? While microcaptive owners continue to demand clarity, the IRS responds with repeated attacks.
For example, the agency proposed illogical new regulations last April. Among other things, these regulations would mark microcaptives with a loss-ratio factor less than 65% over 10 years as “listed transactions,” or arrangements that the IRS has determined to be a tax-avoidance scheme.
An insurance plan’s loss-ratio factor is calculated by adding adjustment expenses to the amount of claims paid and then dividing by the total value of premiums earned.
In other words, the IRS will consider microcaptives that do not pay out a sufficient dollar amount worth of claims, relative to the premiums they earn over 10 years, to be a tax-avoidance scheme, even if they are operating entirely within the law.
Given that microcaptives are designed to allow companies to build up reserves in the event of a catastrophic emergency, and that the 65% figure was taken from a completely different insurance sector (health insurance), it is clear this was not a reasonable requirement but part of the IRS’s campaign to wipe microcaptives out.
Some may question the actual necessity of microcaptive insurance plans. Microcaptive plans allow for an extra layer of protection that is not associated with typical insurance plans. Unexpected risks, such as cyber-attacks or a pandemic, can be alleviated through these plans. To small business owners, this can be a game changer. Why should business owners avoid an insurance plan that promotes self-reliance and stability simply because the IRS refuses to be reasonable?
On April 1, I took over as the board chairman for the North Carolina Captive Insurance Association (NCCIA). The NCCIA, formed in 2014, works to educate and inform the state on the benefits of captive insurance. I am excited to step into a role where I can help hold the IRS accountable for creating a clear and fair framework for microcaptive plans to operate within.
North Carolina is the fourth-largest domicile in the United States. Captive insurance has become a staple of risk management in the state. The targeted campaign against microcaptives by the IRS is harmful to small businesses’ ability to properly manage risk. Being involved with the NCCIA has made it even more evident to me how essential captive insurance is for local businesses.
Another important lesson I have learned from being a part of the NCCIA board is the importance of legislative outreach and action. Inevitably, the IRS will continue to operate within the status quo. As the IRS continues to win cases against captive owners and build precedent, legislative action will become increasingly important. If we can push Congress to take action and establish rules through law, the IRS will be forced to adapt.
As we continue to move forward in this fight for clear captive guidelines, I hope that more risk-management professionals feel an obligation to speak out in favor of microcaptive insurance. Legislative change will not be feasible without elevating the voices of tax professionals and good-faith business owners who understand the complexity, and necessity, of these plans. If the IRS is unwilling to grow with the risk-management landscape, we must advocate for legislative action.