IRS Faces Uproar Over Draft Regulations for Client-Owned Insurers

State lawmakers, actuaries and others are trying to persuade the Internal Revenue Service to change draft regulations that could affect business-owner clients who use their own small insurance companies, or “micro captive” insurers, to manage risk.

The IRS held a teleconference hearing on the draft Wednesday. Four Treasury Department and IRS officials appeared, along with five micro captive advisors and the CEO of a bank that owns a micro captive.

IRS Concerns

Some business owners have set up micro captives based on section 831(b) of the Internal Revenue Code. For 2023, the micro captive annual premium size limit is $2.65 million.

The IRS sees many of the micro captives as efforts to reduce federal income taxes by turning what should be taxable income into premium payments for insurance against highly unlikely events, such as catastrophic earthquakes. The government taxes the captive’s investment income but not its premium revenue.

The IRS proposed requiring a micro captive to spend at least 65% of its premiums on claims and to meet other standards. The agency noted that, in addition to requiring abusive micro captive owners to pay the taxes previously avoided, it might impose a 20% or 40% penalty.