Like so many individuals and companies around the world, those in the captive insurance industry are working hard to provide the support necessary to weather the current COVID-19 pandemic and the economic impact it has on businesses, their owners and employees. While parts of the industry, such as enterprise risk captives, or 831(b)’s, have been much maligned by the Internal Revenue Service (IRS) and others, these same captive insurance companies are now being vindicated as they play a critical role in helping businesses to survive the current crisis.
Many of the risks being faced during the COVID-19 outbreak, in general, are high severity, low-frequency issues. Addressing the hard commercial market the industry currently faces and finding coverage for related businesses risks such as supply chain disruption, loss of key customers, contaminated property clean up, business interruption and trade credit losses, in light of COVID-19 will be difficult to find in the commercial market for some time. As captive insurance comes into play in many of these situations, the important role it plays during these times of high severity risk is, and will continue to be, abundantly clear. In fact, when congress established Internal Revenue Code Section 831(b) in 1986, it sought to provide a risk mitigation tool for exactly such purposes, largely informed by the economic and embargo crises of the 1970s and early-1980s.
During a meeting with the IRS several years ago, agency staff questioned the validity of captive structures covering some of these current and very real risks, such as loss of key customers, supply chain or even contaminated property. They also continue to be critical of captives suggesting that a lack of paid claims generally, or within a specific time frame, is indicative of a lack of actual risk. This is a logical fallacy. Today’s environment should not only change that erroneous perspective but demonstrates the ongoing need for captive insurance to cover such risk. Due to the lack of commercial insurance capacity in the market, along with the various exclusions for COVID- 19-related claims, a significant portion of the risk is now being placed in the captive insurance market. Further, there is little doubt over the past two weeks that captives are paying a significant number of claims to their insureds resulting from this crisis and will continue to do so.
The same day that many states across the country began to institute ‘stay at home orders’ and require the closure of non-essential businesses, captive owners across the country received approximately 150,000 ill-timed letters from the IRS, sent out based on 2018 disclosures. Keep in mind that many of these businesses are shut- down, inaccessible, or operating at diminished capacity, scrambling to help customers and employees while keeping their operations afloat.
In short, the IRS letter requires recipients to access and report information about their captive insurance programme that might not be available to them because of the emergency, to report that information under penalty of perjury, and to do so by 4 May 2020, or face the risk of audit. Never mind that this taxpayer deadline may prevent many owners from being able to comply, or that IRS staff, many rightly teleworking, will even be receiving mailed forms.
Further, the IRS letter requires taxpayers who have ceased participating in micro-captive transactions to report the date they ceased participating. This generalised request, attached to a threat of perjury, has no specifics as to which data is required, whether that is the date of licensure, surrender, or even liquidation. If owners continue to operate as a captive, the letter outlines the need for filings and consideration of amended returns, while outlining recent court cases, and increased enforcement and audit activities.
Among the threats and data requirements in the letter, there is one glaring omission. If the IRS looked into the tens of thousands of forms they required industry participants to file under Notice 2016-66, they would find most of this information at their disposal, simply by looking at Form 8886, a form which the IRS has required from captive owners, managers and participants for over two years. This begs a larger question as to what exactly the IRS is doing with the tens of thousands of paper forms they are holding.
At a time such as this when congress is enacting stimulus policy to assist these same businesses and their employees, and the IRS itself has delayed filing and tax requirements across the board, this letter is ill-timed and aimed at hurting the same businesses that congress and the administration are aiming to help.
Given the current pandemic, combined with the timing and burden being placed on these businesses by the IRS, the Self-Insurance Institute of America (SIIA) and our members have asked that the IRS cease this wrongly-timed and unnecessary demand and allow these businesses operating captive insurance to mitigate the risks that congress and the tax code allows them to appropriately undertake.
Further, SIIA is talking with a number of members of congress on the egregious and unnecessary nature of the IRS’ actions on American business. For those not necessarily in the 831(b) space, this is a slippery slope that deserves attention and concern.
This letter is less about needed data collection and more of a scare tactic towards business owners in light of recent court wins, regardless of the risk or what the structure looks like.
However, while understanding the IRS’s ongoing concern over certain 831(b) captives, the fact remains that the vast majority of the industry and businesses who operate captives are doing the right thing. This letter, and other IRS actions, mistakenly assume that everyone operating a captive that makes an 831(b) election is somehow doing something wrong. This flies in the face of the underlying Internal Revenue Code and is contrary to recent actions by congress as outlined in the Protecting Americans from Tax Hikes (PATH) Act of 2015, provisions of which require the IRS to have yet to issue safe-harbour guidance for 831(b) structures. Despite it being almost five years after enactment, and after numerous congressional inquiries, the IRS refuses to do anything. The IRS was given tools in this law change to curb certain practices, yet has failed to do so while continuing to paint a broad brush across the 831(b) space. Business owners and captive industry participants deserve clarity and guidance.
While SIIA and its members appreciate the need to identify abusive captive structures, we can all agree that the timing and rationale behind the recent letter request are simply wrong and wrongly timed. America’s small businesses deserve better. If the IRS is serious about halting certain abusive practices, our longstanding and ongoing request for meetings to better understand and have a productive dialogue still stands.
