Service providers, lobby groups and regulators provided comments in a public hearing on the Treasury and IRS’ latest proposals concerning micro captive transactions on 19 July.
Captive Intelligence reported in April the IRS had proposed new regulations for “micro captives” – those making the 831(b) tax election – at the same time as obsoleting Notice 2016-66, having had it struck down by the courts in March 2022.
The proposed regulations for 831(b) captives initially divided opinion across America’s captive landscape, but there is a growing consensus that some of the proposals, such as the 65% loss ratio threshold, are a nonsensical criteria for identifying potential abuse of the tax election.
Under the Notice, the IRS proposed regulations which would see certain micro-captive transactions deemed “listed transactions” and other micro-captive transactions labelled “transactions of interest”.
The full proposed rules have been published on the Federal Register here, while EY published its own alert on 19 April.
Having reviewed the full transcript from the hearing, Captive Intelligence shares some of the standout contributions.
Steve Kinion, Oklahoma Insurance Department
When discussing the 65% loss ratio threshold Steve Kinion, captive insurance director at the Oklahoma Insurance Department (OID), noted that following 9/11, Congress recognised the “unique challenges” of insuring commercial enterprises against terrorism attacks and passed the Terrorism Risk Insurance Act (TRIA) in November 2002.
He said the fact that there are no terrorism acts should be celebrated.
However, he said that this would be an “unwelcome celebration” as under the current IRS proposals, “a lack of claims suggests an engagement in tax evasion or tax avoidance”. Therefore, he argued that the IRS proposal is contrary to TRIA.
“One of TRIA’s purposes is to encourage the coverage of terrorist risks by private insurance, so that businesses do not need to rely upon federal assistance,” he said.
“The proposal is simply a disincentive to ensure terrorism risks through a captive insurer.”
Kinion also noted that Oklahoma partially funds its firefighter employees’ pensions by taxes paid by captive insurers domiciled in the state.
“The consequence of the proposal’s adoptions would be the formation of fewer captive insurers, and those that exist today, some will dissolve in order to avoid becoming reportable transactions,” he said. “This results in fewer taxes paid to pension systems.”
Kinion referenced Oklahoma’s Insurance Commissioner, Glen Mulready, and said the Commissioner knows no one at the IRS desires that result.
“That is why he extends the invitation to IRS leadership to work together to identify the IRS’s concerns, as well as to address the unforeseen consequences, which I have just described that this proposal can present,” Kinion added.
He said the OID is willing to take the lead to formalise the process, which can take a number of forms of working together.
“It can be in the form of an NEIC, National Association of Insurance Commissioner, working group or other format.”
Mulready had previously called on the IRS to withdraw its Notice of Proposed Rulemaking (NPR) concerning micro captives and form a joint task force consisting of the IRS, regulators and representatives of the captive insurance industry.
James Perna, Law Attorney
Law attorney James Perna argued there is no doubt some bad actors in the captive industry, “just as there are bad priests, bad ministers, bad doctors, and bad lawyers”.
“But that does not mean that such professions or all small captives should be eradicated,” he said.
He noted that the Treasury and the IRS have had over 35 years to consult with industry experts, academics, lawyers, actuaries, underwriters, and accountants to develop safe harbours and best practices.
“The IRS has totally failed in this regard,” he said.
Perna said the Treasury and IRS are harming the American economy with their “misguided efforts” to eradicate micro-captives.
In relation to the loss ratio threshold, Perna referenced a recent AM Best graph showing the loss ratios of large commercial home insurance companies for the period of 2010 to 2022 for the US nationally and for California.
The US fluctuated from about 50% to 70% nationally and California’s loss ratios fluctuated from around 40% to 200%.
“Property & casualty loss ratio caused by acts of God, war, weather, accident, and chance cannot be as stable as the medical loss ratios that the IRS referenced in formulating its proposed regulatory loss ratio test,” he said.
“In making a comparison, the IRS is making a fundamental error, comparing apples to oranges to justify its presumptive biases.”
Perna said that the private bar had suggested that a few higherup individuals at Treasury and IRS are trying to accomplish by administrative devices what they were unable to convince Congress to do legislatively in 2015 and repeal section 831(b) and to shut down the captive industry.
“It is readily apparent that the IRS is trying to repeal by pretextual regulation what Congress has authorised, accepted, and approved,” Perna said.
“The IRS would throw out the baby with the bathwater, rather than develop reasonable standards in cooperation with the small captive insurance industry.”
Matthew Queen, Queen Firm
Lawyer Matthew Queen said that the proposals are unconstitutional on at least two grounds.
“First, it violates federalism because an attempt to govern the business of insurance conflicts with the McCarren-Ferguson Act which established that the business of insurance is State law,” he said.
“Second, this violates the intent of Congress and effectively strikes a whole section of the law passed pursuant to bicameral legislation.”
He said that along with the McCarren-Ferguson Act, Section 831(A) and B constitutes a large part of Congress’ vision, and the net effect of this transaction proposal will basically eliminate 831(b) captives.
“I believe that raises some issues with major questions doctrine because the enabling statute under the AJCA does not permit the IRS to unilaterally remove 831(b) for captive insurance companies just because of perceived abuses or some troublesome litigation,” he said.
Joe Magyar, Crowe LLP
Joe Magyar, partner at Crowe LLP, speaking on behalf of the National Automobile Dealers Association (NADA), referenced the IRS’ exemption to its recent proposals for certain consumer coverage arrangements.
He requested the IRS consider modifications that will better align this exception to the circumstances of the automobile dealer arrangements, “and thereby facilitate compliance without creating undue reporting hardships, where there is low risk of abuse”.
“The IRS examined these types of captives in the past, and determined there was no need to characterise them as listed transactions,” Magyar said.
He added that without the recommended changes, a number of legitimate captives will be subject to burdensome information gathering, testing and recording requirements.
“In circumstances where the dealership is technically, a transitory, a residual obliger under the contract due to various factors, NADA requests that, where the customer is the ultimate beneficiary, the dealer should not be considered an insured, within the meaning of the proposed regulations,” Magyar said.
He also noted that NADA urges the Treasury and the IRS to expand the type of consumer coverages listed in the exemptions to include coverages for diminished value.
“This is another coverage that is currently purchased by consumers, to cover the loss in value of vehicle may occur from a covered peril that does not result in a total lost vehicle,” he said.