Changes to 831(b) Do Nothing to Limit the Estate Planning Benefits of Small Captive Insurance Companies

By Sean King, JD, CPA, MAcc

Principal, CIC Services, LLC

When it comes to estate tax planning, there’s generally only one key objective–transfer assets from senior generation’s name to junior generation’s names without triggering gift taxes, estate taxes, or generation skipping transfer taxes.

Most popular techniques that facilitate these inter-generational wealth transfers--such as annual gifting strategies, GRATS, GRUTS, family limited partnerships, and intentionally-defective grantor trusts–offer little or no income tax benefits, only estate and gift tax advantages.  The key insight is that the usefulness of estate and gift tax planning techniques is generally not measured by whether they reduce income taxes.

This is important because Old Guard commentators are celebrating recent changes to Internal Revenue Code Section 831(b), that will in some instances deny the income tax benefits of 831(b) to captive insurance companies owned primarily by or for the benefit of junior generation, as their long-predicted “crack down” on the “abusive” use of captive insurance companies for “estate planning” reasons.

Only, the recent changes are hardly a “crackdown”.   I cannot overemphasize the fact that these new rules do not impact the estate and gift tax planning benefits of captive insurance companies AT ALL.  Even without any income tax benefits, a senior generation’s business payment of fair market value premiums to an insurance company owned by or for junior generation still allows senior generation to move potentially millions of dollars per year to junior generation estate and gift tax free, saving nearly 50 cents in eventual taxes on each dollar so transferred.  This was so before the recent “crackdown” and remains so after.

So, what are we to make of this?  Well, for one, it seems that Congress does not share the concerns of the IRS or the Old Guard regarding “abusive” use of captive insurance companies for estate planning purposes.   Over the last several months, Congress was invited repeatedly by the IRS and Old Guard, via specific legislative proposals, to truly crack down on estate planning with captives by banning trust ownership of captives and prohibiting captives from owning life insurance.   And yet, after months of consideration and debate, Congress declined their offer and instead passed a much more measured law that simply denies certain captives certain income tax benefits.

While captives may in limited instances be less useful as income tax planning tools than they were before the co-called “crack down,” they remain as valid estate and gift planning tools as any other and far more effective than most.  While the primary purpose of any captive insurance company must be to function as a real insurance company, and they should only be formed for that primary purpose, Congress now seemingly agrees that there is absolutely nothing wrong with a junior generation, or a trust for its benefit, owning a captive that will receive premiums paid primarily by senior generation’s businesses, nor with a captive purchasing life insurance on senior generation or family members.  Perhaps such a captive won’t receive all of the income tax advantages in the future that captives with different ownership structures will, but…so what?

The Old Guard begged Congress to shut down its  “New Wave” competitors (financial planners, life insurance agents, estate planners and assets managers) by killing the estate planning benefits of captives, and Congress declined.  Now the Old Guard’s hopes ride on the IRS successfully turning the tide in its 30 plus year losing battle against captive insurance companies.  Given the outcome in the recent Rent-a-Center, Securitas, and RVI cases, that’s looking increasingly like a “Hail Mary”.

In short, let the legitimate estate planning continue with renewed confidence.