I speak with small business owners and entrepreneurs on a daily basis. While they come from a variety of industries, there is one constant refrain: What else should we do to manage our risk? There are nearly limitless answers to this question. However, one of my recommended strategies is to establish an 831(b) captive, also known as microcaptive insurance.
Unfortunately, due to regulatory and investigative pressure from the IRS, many small business owners are hesitant to take advantage of this section of the Internal Revenue Code (IRC) as established by Congress in 1986.
A microcaptive is a small insurance company that is owned by a parent company. The parent company forms the microcaptive for the purpose of insuring itself against a specific risk. For example, a rancher might decide to form a microcaptive and create an animal mortality policy to cover his herd in case of unforeseen death from a weather event.
Microcaptive insurance, like all insurance, is designed to manage risk and provide peace of mind to small business owners. The advent of microcaptive insurance allows small business owners to bridge gaps in commercial policies (risk that traditional carriers are unable or unwilling to insure), offer lower premiums (if a carrier will insure the risk), or provide specific risk coverage in an area that traditional carriers are not familiar with.
As I mentioned previously, section 831(b) of the IRC was passed into law in 1986. This legislation allowed small, non-life insurance companies with less than $1.2 million in premiums an avenue to protect themselves from risk and create competition in the insurance marketplace.
In 2015, Congress reaffirmed its support of microcaptive insurance by passing the PATH Act, raising the premium threshold from $1.2 million to $2.2 million and tying it to inflation.
Despite Congress’s clear position on the issue, the IRS continues to ramp up its aggressive treatment of microcaptive owners. The agency has trapped hundreds of small businesses in legal limbo, placing them under audit while refusing to take all but the most egregious cases to trial. These tactics end up costing a fortune in legal fees, forcing many plan owners to close their microcaptive insurance company due to legal costs and unknown outcomes, two items that the legislation was clearly trying to mitigate.
In April of this year, the IRS proposed new microcaptive regulations. Industry experts have indicated that, if finalized, these regulations will force the majority of microcaptive insurance companies to shut down. The purview of the IRS should be how to make microcaptive insurance companies work for the largest amount of small business owners as Congress intended, not actively discourage companies from utilizing this critical tool.
While it is true that a minority of microcaptive owners have acted inappropriately as the IRS alleges, the agency should not punish thousands of law-abiding small business owners. Instead, the agency should work with industry leaders and interested members of Congress to build a framework for policy owners to work within.
It is vital that we protect risk management strategies like this for small businesses here in Texas and across the country. I know one of our local representatives in Congress, Rep. Beth Van Duyne, is on the House Ways and Means Committee and has repeatedly demonstrated her passion for helping small businesses thrive. My hope is that she will continue to do so on this important issue.
Jeff Nash, CPA CFP® has over 20 years of combined experience working in public accounting and financial services. He is the principal owner of various companies where he focuses on tax strategy, risk mitigation, and alternative investment advising.