As many small business owners grapple with their personal tax returns, it is worth spotlighting the ongoing tax-related challenges faced by microcaptive insurers in the United States. A few months into 2024, the IRS has notably triumphed in two cases against this self-insurance mechanism for small businesses, namely Keating v. Commissioner and Swift v. Commissioner.
These rulings, however, have not shed light on how microcaptive insurers operating in good faith should structure their arrangements to maintain compliance. Rather, they seem to project the idea that most or all microcaptives are tax shelters or tax schemes, thereby overshadowing the reality of the matter.
The Protecting Americans from Tax Hikes Act of 2015 allows companies to qualify for insurance under Section 831(b) of the tax code if the owner of an insured business has no greater interest in the insurer than they do in their business. This was intended to assist small to mid-sized insurance companies by excluding part of their income from taxation and thus enable them to compete more effectively with larger insurance providers.
Unfortunately, this provision is under threat as around 1,100 microcaptives are currently facing IRS investigation. Driven by an audit program designed to capture a significant quantity of microcaptives and their owners, the difference between the number of IRS’s court victories and the number of audits it conducts is concerning. The agency appears to focus on those cases where a win is nearly guaranteed, leaving other taxpayers in a state of legal uncertainty and immense strain.
The IRS’s negative view of microcaptives stands in stark contrast to Congressional support. This adds layers to the complex legal landscape impacting microcaptive insurance and fuels the perception that the IRS is undermining laws created by elected representatives. This issue reached a point where several members of the House Ways and Means Committee expressed their concerns and called for a harmonious path forward.
However, the lack of clarity continues amidst shifting power dynamics between insurance regulation and tax laws. The decision in Keating seemed to tread on regulatory boundaries set by the McCarron-Ferguson Act of 1945, which excludes the federal government from regulating insurance, a power designated to individual states.
The future still holds many uncertainties for microcaptive insurers, especially with potential new cases on the horizon. Unless Congress takes action or the IRS changes its strategy, the scrutiny facing microcaptive owners is likely to persist. Documentation for Keating v. Commissioner and Swift v. Commissioner reflect these ongoing challenges.
Note: The original content was provided by Van Carlson, founder and CEO of SRA 831(b) Admin.
For the full story, visit Bloomberg Tax.