Upcoming Changes to Section 831(b) Tax Code Legislation
The 2015 Appropriations Bill, passed by Congress in late 2015, updates the rules and requirements of small or mid market businesses electing the 831(b) tax code. The following major changes will take effect in 2017:
Compliance means passing one of two diversification tests:
Diversification Test #1
No more than 20% of premiums may be paid from any single policyholder.
- Businesses paying premiums to the captive
- Businesses owned by the heirs of the business owner, business' owner's spouse or members of the same "control group" of companies
Single owner micro captives must have four separate risk pools to meet diversification standards—and they can't have the same owner.
Diversification Test #2
The business owner's heir or spouse cannot directly or indirectly own more than 2% than the interest they own in the insured business.
Let's Use an Example to Translate
Say Mom owns 50% of a business and Daughter owns 50%. To qualify for section 831(b), Daughter can only own up to 52% (50% + 2%) of the captive.
If Mom owns 100% of the business, Daughter may only own 2% of the captive.
The Point of the Diversification Requirement
The new rules mitigates abuses of section 831(b) related to estate planning and the transfer of funds between family members.
Micro captives are absolutely not meant to be vehicles for wealth transfer. It's called captive insurance for a reason. Forming or joining a micro captive is for insurance purposes solely: pooling risk among a heterogeneous or homogeneous group and transfer risk among business partners you trust.
Conclusions: Election Abuses & IRS Response
The U.S. Congress and IRS remain vigilant against companies abusing the 831(b) tax code. Some believe this batch of legislation doesn't do enough to punish captive companies who game the system, and only sets the precedent for the IRS to take a larger role in enforcing standards for micro captives.