At the end of 2015, the Protecting Americans from Tax Hikes (PATH) Act of 2015 became new law. The PATH Act was part of a large budget and tax deal that cleared Congress and was signed by President Obama before year end 2015. Altogether, there were $622 billion in tax breaks in the massive bill.
On December 10, 2015, Section 333 of the PATH Act was introduced and modifies several provisions of the tax code related to Section 831b captive insurance companies (or small/micro captives).
Changes in the Law
Per our partner, Stephen Covington at River Oak Risk, the most significant changes to Section 831b are:
- 1. An increase in the limitation on premiums from $1.2 million to $2.2 million per year with the new limit indexed to increase with inflation.
- 2. A new requirement that applies when a spouse or lineal descendant (child, grandchild) of the business owner has an ownership interest in the captive (directly or through a trust).The new requirement provides that in order to qualify for the 831b election: (1) the ownership of the spouse or lineal descendant must be the same as his/her ownership of the operating company (with some de minimis exceptions); or (2) no more than 20 percent of the net written premium of the captive can be attributable to any one policy holder (policyholder means all companies in a control group).
- 3. These changes take effect at the beginning of 2017.
The increase in the premium limit to $2.2 million creates an opportunity for current captive owners to evaluate their programs and determine if there are additional risks that can be addressed by their captives. The increase will also make captives more appealing to larger companies that did not find sufficient benefit with the $1.2 million limit.
The changes regarding ownership will require many of the captives (already formed in various domiciles that included estate planning) to modify either their ownership structure or their insurance and reinsurance programs to fit within the new requirements.
In the EBS whitepaper, Do Not Overlook The Power of Captive Insurance Companies to Mitigate Risk and Build Wealth, we looked at how captives can be a value-added strategy for companies, allowing them to address uninsured risk in the business while creating a new profit center. When structured properly, captives can be used effectively:
- As a vehicle to optimize risk financing
- To retain underwriting profits
- To complement and work in concert with existing commercial insurance programs and/or group captives
- As a potential incentive for key employees/management
- In estate and/or business succession planning
Let’s look at an example of a business owner forming a captive with trust ownership with $1M in annual premiums over a 10-year period versus the status quo of not forming a captive:
These recent legislative changes underscore why it is critically important for business owners to work with a captive manager with extensive insurance, tax and legal expertise to ensure that the captive insurance company complies with all federal and state tax and insurance laws and regulations.