IRS Scrutinizing Arrangements of 831(b) Captives

IRS Scrutinizing Arrangements of 831(b) Captives

IRS Scrutinizing Arrangements of 831(b) Captives

Artex Risk Solutions, the Bermuda-based captive management subsidiary of insurance broker Arthur J. Gallagher & Co., has been the part of a probe by the IRS into captive insurers formed under 831(b) of the Internal Revenue Code. Under Section 831(b), insurance companies earning no more than $1.2 million in annual written premiums can opt not to pay taxes on those premiums and be taxed only on their investment income.

These types of captives are increasingly popular and attractive from a tax perspective, which has prompted IRS investigation. In fact, IRS probes into 831(b) captives was a hot topic at the most recent annual Vermont Captive Insurance Association Conference that took place in Burlington. In an article that appeared last month in Business Insurance, Robert H. Myers Jr., partner at Morris, Manning & Martin L.L.P. in Washington, stated: “The IRS is now looking into microcaptives, focusing on the pools some microcaptive arrangements use in an effort to demonstrate the risk distribution needed to qualify for insurance treatment by the IRS. “If the IRS determines the pools aren’t valid, it will then treat the pool participants as tax shelters rather than insurance vehicles.”

U.S. Government vs. Artex

In the Artex case, according to the IRS petition, it’s allegedly examining whether Artex’s transactions involving captive insurance plans under 831(b) “constitute abusive transactions.” Artex confirmed that an ongoing investigation is taking place, and believes at least a dozen other captive managers are involved in the IRS investigation. David McManus, president of Artex Risk Solutions, as quoted in Captive International, said:

“We have already communicated with our small captive customers and referral partners on this and it’s really no surprise that Artex, as one of the largest captive managers in the world, is involved. The IRS clearly recognizes captives as a legitimate tool for businesses, when used correctly and Artex believes that its small captive formation and management activities are lawful and will withstand IRS scrutiny. Like all industries, the captive marketplace continues to evolve and in the end of the day if this investigation drives out abuses the industry will only emerge all the stronger and better for it.”

During the investigation, which began in January of this year, two IRS administrative summonses were issued for an Artex representative to provide testimony, and produce for examination records and documents, including contracts, policies, promotional materials, and claims related to its captive insurance program or arrangement. While Artex did appear in early January before the IRS agent assigned to the case, no documents were presented. The IRS then went to court to petition for Artex to show cause as to why the firm was not complying with the summonses.

During court procedures, Artex stated that it refused to comply with the summonses based on certain arguments, including bad faith on the part of the IRS; abuse of power by the agency; the scope and relevancy of the information requested (business records for a six-year period were requested); the IRS did not followed its own internal procedures for initiating the summonses; the agency did not provide Artex with reasonable procedures and deadlines to produce the necessary information at a reasonable cost and it was not provided with specific facts to justify an investigation; among other issues. Just this week, the IRS won its petition for Artex to show cause as to why it should not have to comply with it summonses.

Most Fortune 500 companies have captive insurance companies. Moreover, with section 831(b), increasingly more middle-market and closely held companies are forming captives. As a result, while the IRS recognizes the economic benefits of setting up a captive, there is an uptick by the government agency to see if they’re being properly formed. We’ll keep you abreast of this and other cases as they unfold.

Caitlin Morgan specializes in captives, delivering deep experience and expertise in this area to determine and create a solution that is right for insureds. If you have any questions about a specific captive, please feel free to call us. Our professionals can be reached at 877.226.1027.

Sources: Business Insurance, Captive International, Riser Adkisson LLP