IRS Agrees to Drop Captive Insurance Tax Change

February 21, 2008

The Internal Revenue Service (IRS) has dropped plans to change the way that captive insurance companies are taxed.

U.S. Senator Patrick Leahy, D-Vt., and U.S. Rep. Peter Welch, D-Vt., said that the IRS informed them it has decided to withdraw a proposed regulation that Vermont and other states with captive insurers feared could hurt the industry.

“IRS officials listened, and they were willing to pull back an overly broad rule change that did not make sense for self-insuring companies,” said Leahy.

The proposed IRS regulation would have changed the taxation of captive insurance companies – which are a form of self-insurance sometimes used by large firms – that file joint tax returns for their consolidated affiliates. It would have prevented captive insurance companies from deducting from their corporate taxes the value of the reserves they have set aside to pay claims.

If a captive insurance company insures the risk of another member of the consolidated group, the rule change would have required that the transaction be recorded as if the two companies were divisions of a single entity, which is the treatment applied to non-insurance companies. That change would have prevented captive insurance companies from using the reserve accounting methodology that state insurance regulators require, and that applies for tax purposes to insurance companies that are not in consolidated groups.

Officials from Vermont and others with captive insurance companies worried that the changes could drive the industry out of the United States.

“The outcome of this would be significant economic damage to our states’ economies and the potential for the captive insurance industry to gravitate to foreign jurisdictions,” Welch and three others said in a letter to Treasury Secretary Henry Paulson earlier this week. “Such a result would be harmful to the nation’s economy and our insurance market, and would increase the cost of insurance for corporations currently utilizing captive insurance companies.”

The letter to Paulson was also signed by Democratic U.S. Reps. Neil Abercrombie and Mazie K. Hirono, both of Hawaii, and Shelley Berkley of Nevada.

Vermont is the third-largest home to captive companies in the world, with about 580 active ones, behind Bermuda and the Cayman Islands.

“It’s provided Vermont with very good high paying jobs with no environmental downside,” Welch said. “And it’s provided the Vermont treasury with millions of dollars of revenue.”

Vermont’s other U.S. Senator, Bernie Sanders, an independent, and Gov. Jim Douglas, a Republican, were also all on record opposing the tax change.

Vermont has been popular with captive insurance companies. Last year, the industry accounted for $22.8 million in state taxes, and about 1,400 jobs, according to the Vermont Captive Insurance Association.

“I am thrilled common sense prevailed and the IRS has yielded to our sound reason. This is a crucial win for Vermont business and for well-paying Vermont jobs,” Welch said.

The IRS decision was cheered by insurers as well.

“We’re pleased the IRS has withdrawn this proposal,” said Carl Parks, senior vice president for government affairs for the National Association of Mutual Insurance Companies. “The IRS has not shown – or even alleged – abuse of the consolidated return rules, and the proposed policy change would have had a significant and potentially negative effect on the insurance marketplace.”

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