831(b) Premium Adjustment for Micro-captives in 2018

The Internal Revenue Service has announced its first annual inflation adjustment for the Section 831(b) tax election (see page 19 of Revenue Procedure 2017–58). As a result, the premium limit for micro-captives has increased by $100,000 from $2.2 million to $2.3 million for the 2018 tax year.

A micro-captive is a captive insurance company operating with annual written premium of less than $2.3 million. Effective in 2017, H.R. 34 increased the maximum premium revenue allowable from $1.2 million to $2.2 million, allowing for inflation adjustments in subsequent years.

In the United States, such captives are taxed under Internal Revenue Code § 831(b), which provides that a captive qualifying to be taxed as a US insurance company will pay tax only on investment income.

Section 831(b) of the Internal Revenue Code

Section 831(b) of the US Tax Code stipulates special income tax rules that apply to any type of small insurance company, not just captives. These rules can be used by all types of captives, whether single owner, group owned, or rented, provided that the captive meets the following qualifications.

• The captive insurance company or the captive cell must qualify as an insurance company for tax purposes. Very briefly, this means it must have adequate risk shifting and sharing and it operates and is regulated like a "real" insurance company (i.e., with adequate capital to allow it to take risk).
• The company must be a US taxpayer, either domiciled in the United States or domiciled offshore but having elected and qualified under Tax Code § 953(d) to be taxed as a US insurer.
• For the tax year 2018, the gross premium income for the tax year in question must be less than $2.3 million. This premium threshold applies to all insurers included in a single consolidated tax filing.

Micro-captives have become popular because, if a captive is taxed under § 831(b) of the Tax Code, it does not pay tax on its underwriting income. It pays income tax only on its investment income. The benefit of this provision is clear for captives that write risks that have a quick reporting and loss payout profile, such as property insurance. If a captive that pays income tax on its underwriting income issues a high-deductible property policy and has no property losses, the premium paid to a larger captive, less any expenses, will be taxed, as well as tax being paid on any investment income. But, if the gross premium is less than the threshold established under 831(b), only the investment income is taxed. The underwriting profit can either be returned as a shareholder dividend or remain in the captive as surplus.

(Information in this article is based on "Micro-Captives 101," by Kathryn A. Westover, a captive consultant and author, The Risk Report, Volume XXXV, No. 2, October 2012, and "Strong Headwinds for 831(b) Captives," Captive Insurance Company Reports, July 2012. Both are published by International Risk Management Institute, Inc., Dallas, TX.)