December 21, 2015 (Houston, TX) - On Friday, December 18, 2015, Congress passed and President Obama signed into law the Consolidated Appropriations Act, 2016. As part of this Act, certain changes were made to Internal Revenue Code Section 831(b), which imposes tax on investment income only (underwriting income is tax exempt) for certain property & casualty insurance companies. These changes may affect your captive insurance company beginning in 2017. That is, nothing is set to occur in 2015 or 2016.
New Captive Legislation Explained
Beginning in calendar year 2017, the first part of the changes increases the cap on premiums for Section 831(b) captives from $1,200,000 to $2,200,000, and indexes the cap for inflation thereafter. The $1.2 million cap had remained unchanged since 1986.
The second part of the captive legislation essentially requires the captive to be owned by the same persons and in the same proportions as the insureds. More specifically, the new law beginning in 2017 sets forth an additional requirement to qualify for the alternative tax under Section 831(b). The changes to Section 831(b) require an insurance company to have no more than 20% of its premiums from a single policyholder (as defined). If an insurance company does not meet this qualification, it can still qualify for Section 831(b) treatment if the spouse and lineal descendants (the younger generations) of the owner of the insured operating business own no more than a 2% greater interest in the insurance company than they do in the insured business.
The changes also authorize the IRS to impose a reporting requirement for an insurance company to certify that it meets either of these new requirements.
These changes do not go into effect until January 1, 2017. They were pushed through by Senator Charles Grassley from Iowa, who promoted these changes as a benefit to the farm mutuals in his state. Senator Grassley’s support combined with the concern that captive insurance companies were being used to circumvent the estate tax led to the two new qualifying conditions.
The changes were a minor provision of a much larger tax extender bill that was rushed through Congress in the eleventh hour. As such, the Section 831(b) changes did not receive much thought or attention. Captive insurers who may be impacted by the new law have two tax years to take remedial action before the changes take effect.
The new legislation did not make any changes to Section 501(c)(15) captive insurance companies.