IRS Notice 2016-66On Tuesday, November 1 the US Internal Revenue Service (IRS) and Treasury Department issued a November surprise to the Captive Insurance industry in the form of Notice 2016-66.

What is Notice 2016-66?

Notice 2016-66 relates to captive insurance companies set up under U.S. code 831(b), also known as micro-captives. Stories of 831(b) captive abuse have been widely reported in recent times and have caught the eye of a number of U.S. agencies and lawmakers. There is a general understanding that there is an element of the micro-captive industry that improperly uses the tax exemption to shield taxable income. The IRS and Department of Treasury acknowledge this practice of tax avoidance and evasion, but as they point out in the early sections of 2016-66, there isn’t enough information currently gathered to properly target the offenders.

To combat this abuse, and to begin to gain a better understanding of the overall scope and use of 831(b)s, the two government agencies have teamed up on 2016-66. This new notice now defines certain 831(b) transactions as “transactions of interest” and now makes them subject to additional reporting of the transaction and imposes penalties for non-compliance.

Who does Notice 2016-66 Impact?

It is important here to understand exactly what the IRS is now terming a transaction of interest. Here is their definition (from IRS website):

  • A, a person, directly or indirectly owns an interest in an entity (or entities) (“Insured”) conducting a trade or business;
  • An entity (or entities) directly or indirectly owned by A, Insured, or persons related to A or Insured (“Captive”) enters into a contract (or contracts) (the “Contracts”) with Insured that Captive and Insured treat as insurance, or reinsures risks that Insured has initially insured with an intermediary, Company C;
  • Captive makes an election under § 831(b) to be taxed only on taxable investment income;
  • A, Insured, or one or more persons related (within the meaning of § 267(b) or 707(b)) to A or Insured directly or indirectly own at least 20 percent of the voting power or value of the outstanding stock of Captive; and
  • One or both of the following apply:
    • the amount of the liabilities incurred by Captive for insured losses and claim administration expenses during the Computation Period (defined in section 2.02 of this notice) is less than 70 percent of the following:
      • premiums earned by Captive during the Computation Period, less
      • policyholder dividends paid by Captive during the Computation Period; or
    • Captive has at any time during the Computation Period directly or indirectly made available as financing or otherwise conveyed or agreed to make available or convey to A, Insured, or a person related (within the meaning of § 267(b) or 707(b)) to A 10 or Insured (collectively, the “Recipient”) in a transaction that did not result in taxable income or gain to Recipient, any portion of the payments under the Contract, such as through a guarantee, a loan, or other transfer of Captive’s capital.

Benefits Exemption:

It should be noted here that any captive arrangement that has secured a Prohibited Transaction Exemption (PTE) from the US Department of Labor (DOL) to provide insurance for employee compensation or benefits covered by ERISA is not considered a Transaction of Interest under these new rules. This may have broad and deep implications on the employee benefit captive industry.

What are the Reporting Requirements?

Reporting of a transaction of interest must be done using Form 8886, which is the Reportable Transaction Disclosure Statement. The Form 8886 filing must describe the transaction in question enough so that the IRS understands how the transaction is structured and who is involved in it. There are additional Form 8886 filing requirements of the taxpayer and captive. These are described in detail here.

What are the Penalties?

Parties that do not comply with this new rule are subject to penalties under U.S. Code 6707A which states:

Subject to the maximum and minimum limits, the amount of the penalty is “75 percent of the decrease in tax shown on the return” as a result of the reportable transaction (or which would have resulted from such transaction if such transaction were respected for federal tax purposes).

  1. The maximum penalty in the case of a listed transaction is $100,000 for a natural person and $200,000 for all other taxpayers. In the case of a non-listed reportable transaction, the maximum penalty is $10,000 for a natural person and $50,000 for all other taxpayers.
  2. The minimum penalty for each reportable transaction (listed or non-listed) is $5,000 for a natural person and $10,000 for all other taxpayers.

It is pointed out in Notice 2016-66 that these rules may be revisited and transactions of interest may be redefined once the IRS and Treasury Department have a better grasp on the situation and better understand the abuse they are looking to eliminate. Further notices from the agencies will likely address this.

So, you own an 831(b) captive; what should you do next???

If you own an 831(b) micro-captive and are unsure of you need to fill out a Form 8886, contact our award-winning team of captive consultants, accountants and attorneys for an unbiased, independent review of your situation.

Alternatively, if you have been looking to write ERISA-covered employee benefits or compensation insurance into a micro-captive, now may be a great time to move forward. There are so many advantages to underwriting employee benefits and this ruling gives us yet another. Spring is the industry leader in employee benefit captive funding solutions and can help you evaluate your current situation and subsequently develop your plan and secure DOL approval. Contact us today!

Image credit: Isaac Bowen via flickr

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Karin Landry

Karin Landry

Managing Partner at Spring Consulting Group, LLC
Karin Landry, ACI, CLTC, GBA is the Managing Partner for Spring Consulting Group. Karin has over 25 years of experience in the insurance, health care, risk financing, retirement and benefits industries. She is an internationally recognized leader in captive insurance strategy, benefits and financing. She is Past-Chairman of the Board of The Captive Insurance Company Association and a member of the ERISA Industry Committee and was recently appointed to the Board of Directors for Fallon Community Health Plan. She is also a Professor of Employee Benefits and member of the finance committee for the International Center of Captive Insurance Education part of the University of Vermont. Karin’s expertise around benefits allowed her to co-author a white paper for Business Insurance Magazine titled “Captives for Benefits: How to Use a Captive to Save Money and Enhance Benefits Coverage”, which is currently a top seller. Both Vermont and the US Virgin Islands asked Karin for input and guidance with their recent legislative changes. Prior to joining Spring, Karin was President of Watson Wyatt Insurance & Financial Services in the United States and Head of the Health & Welfare division for the eastern region.