Micro-captive insurance schemes have caught the attention of the IRS; last year it issued a notice indicating that these arrangements have a potential for tax avoidance or evasion and designating them as transactions of interest. Notice 2016-66, 2016-47 I.R.B. 745. In a micro-captive structure, a business owner sets up an affiliated insurance company; the tax structure then works as follows:
- The business pays premiums to the related party insurer, and it claims a business expense deduction on the premiums;
- If the insurer limits its premium income, it can qualify to pay tax only on its investment income, not on the premiums that it receives by making an election under section 831(b) of the Internal Revenue Code;
- The premiums accumulate creating a pool to pay claims; over time, the business may be able to reduce or eliminate its existing commercial coverage.