Captive Insurance Arrangements Taking Advantage of Section 831(b) Election May Be Required to Report to the IRS

The Internal Revenue Service on November 1 issued Notice 2016-66, which requires information reporting with respect to certain insurance or reinsurance transactions involving captive insurance companies that claim the benefits of an election under Section 831(b) of the Internal Revenue Code available to certain small insurance companies, often referred to as micro-captive transactions. Information reporting for covered transactions would potentially be required for transactions occurring as far back as November 2, 2006 (no, that is not a typo).

The IRS and the Treasury Department are concerned that taxpayers are entering into potentially abusive micro-captive transactions (for example, by insuring against risks that are implausible or do not match a business risk of the insured), and are seeking to gain information on these types of transactions in order to better formulate a response to this perceived abuse. Acknowledging that related parties may also use micro-captive transactions for legitimate risk management purposes that do not involve tax avoidance, the Notice sets forth certain criteria that apply to require reporting. While these criteria are designed to target transactions more likely to present the perceived tax abuse, they are broadly crafted enough to potentially catch non-abusive transactions as well.

Information reporting and related record keeping requirements for covered transactions could potentially be required of the captive insurer, the insured (including potentially fronting companies used in a reinsurance model), and certain owners of the insured, as well as material advisors who provided tax statements with respect to the transaction. Because the penalties for failure to provide the required information can be significant, and because as stated above the criteria triggering these requirements are broadly crafted, taxpayers who have instituted micro-captive transactions and advisors who have advised on such transactions should, even if they do not appear to present the perceived abuse, review the transactions to determine whether these new requirements apply.