Congress Should Address IRS Oversight and Support Small Businesses

Editor's Note:  In this article from the 831(b) Institute, Matthew Queen addresses the Internal Revenue Service's (IRS's) heightened scrutiny of small captive insurance companies and urges Congress to reassess this oversight. He emphasizes the crucial role of captive insurance in bolstering small businesses' risk management strategies, especially in the face of growing global risks. 

The recent cyber-security issues at CrowdStrike highlight a significant gap in the reinsurance market's ability to address global cyber-security failures. Commercial insurers often prioritize claims from high-profile clients over middle-market firms, and the complexities of business interruption coverage add further challenges. For companies with significant cyber-security risks, captive insurance should be a key part of their risk management strategy. However, the IRS has increasingly targeted small captive insurance companies, driven by concerns that some may be used primarily for tax avoidance rather than legitimate risk management. 

With provisions from the Tax Cuts and Jobs Act set to expire and Congress currently debating major tax legislation, now is the time to reassess IRS policies. The widespread impact of CrowdStrike's security lapse, which affected millions of computers and caused billions in damages, exposes the systemic vulnerabilities in our institutions. The IRS's aggressive stance against certain self-insurance solutions may hinder businesses from effectively mitigating these correlated risks. 

Commercial insurers cannot meet every need. To address this, Congress previously enacted tax laws under Section 831(b) of the Internal Revenue Code to encourage the development of small insurance companies, providing an economic incentive to manage complex risks. Yet, the IRS continues to challenge these small captives, applying scrutiny that some argue is necessary to prevent abuse, while others see it as an overreach that unfairly targets legitimate risk management strategies. 

Currently, over 1,000 small businesses are facing legal challenges and scrutiny from the IRS, forcing them to either dismantle their micro-captives or incur substantial legal costs defending their alternative risk financing solutions. If the IRS continues to restrict the growth of self-insurance solutions while commercial carriers fail to cover claims, businesses are left with limited options. 

The IRS's actions against captive insurance effectively force businesses to rely on a narrow group of commercial insurers approved by tax authorities, sidelining entrepreneurs who seek innovative ways to manage unique risks. It is concerning that accountants and tax attorneys, rather than risk management professionals, are defining what constitutes an insurance company—a situation that urgently needs correction.