You are, no doubt, familiar with the law of unintended consequences. Jeffrey Sica, Contributor to Forbes On-Line summed it up well in a February 28, 2011 article titled, “The Law of Unintended Consequences: The Worst Mistake in Decades.”
The law of unintended consequences has long existed dating back to at least Adam Smith but was popularized in the twentieth century by sociologist Robert K. Merton. In his theory, Merton stated that often unanticipated consequences or unforeseen consequences are outcomes that are not the outcomes intended by a purposeful action. In some cases, the law of unintended consequences could create a perverse effect contrary to what was originally intended and ultimately making the problem worse.
CLICK HERE to read Jeffrey Sica’s article.
Why Should U.S. Captive Insurance Domiciles Be Up In Arms?
Bottom line, the Tax Relief Extension Act of 2015 is likely to 1) slow the growth of captive insurance companies domiciled in U.S. states, and 2) reverse the current trend of captives moving their homes from off-shore foreign domiciles to on-shore domiciles.
Background: The Tax Relief Extension Act of 2015
At the end of 2015, Congress passed and President Obama signed H.R. 34, titled the “Tax Relief Extension Act of 2015,” also known as the “Tax Extenders Bill.” This bill included Section 262 titled, “MODIFICATIONS TO ALTERNATIVE TAX FOR CERTAIN SMALL INSURANCE COMPANIES.”
These modifications impact small captive insurance companies (CICs) that make an 831(b) tax election. “Small” captives are real insurance companies that usually serve small and mid-market companies in the same way that “large” captives serve larger companies. 831(b) is simply a tax election designed to encourage small and mid-size companies to improve their risk management posture by owning their own insurance company.
Notably, the modifications include “diversification requirements” designed by Congress to force captive owners, making an 831(b) election to choose between obtaining the income tax benefits of a captive or the estate transfer benefits, but not both.
CLICK HERE to read about H.R. 34 and the new “diversification requirements.”
In most cases the “Tax Relief Extension Act of 2015” denies U.S. taxpayers the opportunity to obtain the income tax benefits of 831(b) if their captive is structured to achieve estate planning or estate transfer objectives.
Captive insurance companies provide many benefits to their owners, including vastly improved risk management, asset protection, wealth accumulation and favorable tax treatment. Prior to the Tax Relief Extension Act of 2015, small captive insurance companies that made an 831(b) election could also provide an ancillary benefit of facilitating more efficient estate transfer.
It is important to note that the new law does not apply at all to foreign captives which have not elected to be taxed under U.S. tax law. Consequently, present and future owners of such foreign captives can easily preserve both the income tax and the estate tax benefits of captives. Captive managers and entrepreneurial business owners are resourceful and creative. Those desiring the estate transfer ancillary benefit will likely relocate their U.S. based captives to offshore domiciles. Likewise, many new captives should be expected to choose homes outside of the United States.
What Is At Stake For U.S. Domiciles?
States benefit immensely from domiciling captive insurance companies. Captives make businesses stronger, protect jobs and usually keep money in state. Captives also create jobs in states that license and regulate them. Finally, captives also bring premium tax revenue and licensing fees into state coffers.
The captive industry experienced roughly 4% growth in new licensed captive insurance companies in 2015, bringing the official total to 6,408. This is steady growth, and there were two underlying trends. First, almost all of the growth in the captive industry is “small” captives as large captives have reached a saturation point. Second, there continues to be steady growth of U.S. domiciles at the expense of off-shore domiciles. According to the March 2015 edition of Captive Review, U.S. states added approximately 220 new captive licenses, while off-shore domiciles (comprised mostly of Europe and the Caribbean) lost 120 licenses.
What’s A State Government To Do?
There really is no reason to risk letting the current trends of captive growth and migration of off-shore to on-shore slip away. State Governors and Department of Insurance officials should consider pressing their Congressmen and Senators to strike the “diversification” requirements that were added to 831(b). Allowing some estate transfer benefits is a small price to pay to keep the U.S. captive industry and its on-shore assets vibrant and growing.