Summary: The Final Legislative Changes to IRC 831(b)

Abstract

The IRS began forensically auditing small captive insurance arrangements around 2009-2010 and started probing large captive insurance providers sometime around 2011-2012. The investigations gained momentum over the last few years, culminating with the placing of “certain” captive insurance transactions on the IRS dirty dozen tax scams list and several court cases. On a conference call on November 17, 2015, the ABA’s Captive Insurance Committee detailed the most fully developed case outlining the various arguments used in the Avrahami case. As of this writing, none of these cases have reached a verdict. However, Avrahami’s outcome appears to hinge on the viability of a specific insurance policy and the premiums charged for that policy. This author was a panel member of the ABA call. The Service opened another line of attack in the spring when the Senate Finance Committee considered amendments to the Internal Revenue Code (“IRC”) 831(b) statute that would have gutted the statute. The industry responded, effectively helping influence the eventual form of the changes. But at the end of that committee hearing, Senator Hatch asked the U.S. Treasury Department’s (“Treasury”) representative to write a report detailing the estate planning/captive insurance nexus. While the Treasury hasn’t issued the report, it’s safe to say the Service determined the practice is abusive, as the newly minted changes to IRC 831(b) are clearly targeted towards that practice. It is remarkably easy to fit a captive into a broader wealth transfer plan. The basic methodology is simple: a parent forms a captive making the children shareholders. Every premium payment accomplishes two goals: payment for insurance coverage and intra-generational wealth transfer. The theory is that since the premium represents payment for services, there are no gift tax implications. If the children own the captive outright, the premium payment effectively transfers the money outside of the parent’s gross estate. This practice was not without its detractors. This article discusses the potential problems with this transaction derived from the business purpose doctrine.