TECHNOLOGY
Captive Insurance Company
Jeremy Colombik , CPA
Additionally , there will be an annual adjustment for inflation starting in 2016 . Second , in order to qualify for the 831 ( b ) election the captive must pass 1 of 2 diversification tests . The two diversification tests are called ( 1 ) risk diversification and ( 2 ) relatedness test ( ownership test ). I have included below a thorough explanation provided by the staff of the Joint Committee on Taxation as well as an analysis of the Joint Committee on Taxation ’ s explanation regarding these tests .
Risk Diversification Test
According to the Joint Committee on Taxation , the Risk Diversification test is met when no more than 20 percent of an insurance company ’ s net written premium ( or , if greater , direct written premiums ) for the taxable year is attributable to any one policyholder .
For example , if a policyholder pays $ 1,000,000 of premium to a captive that they are the only policyholder in , that would mean that the policyholder of such company has 100 % interest in the net written premiums . Of course , because this interest is greater than 20 %, this would fail the Risk Diversification test . As a result of this failure , the Insurance Company would need to qualify for the Relatedness Test ( ownership test ) for the captive to qualify for IRC 831 ( b ) status .
Relatedness Test ( Ownership Test )
Under the Relatedness Test , according to the Joint Committee on Taxation , no person who holds ( directly or indirectly ) an interest in the company is a “ specified holder ” who holds ( directly or indirectly ) aggregate interests in the company that constitute a percentage of the entire interests in the company that is more than a de minimis percentage higher than the percentage of interests in the specified assets with respect to the company held ( directly or indirectly ) by the “ specified holder ”. Except as otherwise provided in regulations or other guidance , ownership of two percent or less is treated as “ de minimis .” Further , in the context of an insurance company , a “ specified holder ” is any individual who holds ( directly or indirectly ) an interest in the insurance company . This includes spouses or lineal descendant ( including by adoption ) of an individual who holds an interest ( directly or indirectly ) in the specified assets with respect to the insurance company . Here , an “ indirect interest ” includes any interest held through a trust , estate , partnership , or corporation . And , with respect to an insurance company , “ specified assets ” refer to the trades or businesses , rights , or assets for which the net written premiums ( or direct written premiums ) of the operating company are paid .
This test , in my opinion , is designed for estate planning purposes . For example , let ’ s say we have a father who owns 100 percent of an operating business and he establishes a captive to insure that operating business . Subsequently , if he transfers ( typically through a gift or “ bargain ” sale ) an amount greater than 2 percent of his stock in the captive to his 2 sons ( or any other “ related parties ” ---spouse , lineal descendant or adopted children ), the captive would not qualify as an IRC 831 ( b ) company because the father still owns 100 percent of the operating business . In particular , if the operating company pays premiums to the captive and the current captive owner has more than 2 percent captive ownership and does not own the same percentage of the operating company , then the Captive would not pass this test . Simply put , if you have a family business and you want to participate and qualify for an IRC 831 ( b ) election , under this test , you need to own the same percentage in the operating business paying premiums to the captive and the Captive itself .
If however , you own 60 percent of the Operating Company but you have 2 unrelated partners that own the other 40 percent of the Operating Company , and you are the only party who owns the captive , then you would pass this test .
61 TODAY ’ S PRACTICE : CHANGING THE BUSINESS OF MEDICINE