On July 19, a public hearing was held by the IRS regarding imposing further regulations on 831(b)s. The Internal Revenue Service (IRS) has proposed regulations that, if enacted, could significantly limit access to 831(b) programs for small- and medium-sized businesses in the U.S. These programs have been a lifeline for such businesses during the pandemic.

As insurance carriers withdraw from various states, small to mid-size businesses are increasingly compelled to explore alternative risk mitigation strategies, such as 831(b) plans. Recently, Liberty Mutual announced its decision to cease selling business insurance products in California, joining a growing list of insurers exiting certain markets.

The IRS’ Proposed Rule 109309–22 aims to intensify regulation on certain 831(b)-electing captives. This includes introducing a loss ratio requirement of 65%, loan back limitations and 10-year retroactive provisions. These 831(b) plans allow small to mid-size businesses to allocate tax-deferred dollars to address risks not covered by traditional insurance, promoting self-reliance in catastrophic events and reducing dependence on government bailouts.

Instead of crafting regulations that align with the original intent of Congress when it approved micro-captives under Section 831(b) of the Code, the IRS has opted for a different approach, which has raised significant issues within the industry. These include:

• Enforcement Tactics: The IRS has employed concerning tactics that have resulted in a number of high-profile lawsuits and regulatory proposals. These tactics have become a major source of contention and concern within the insurance industry.

• Deviating Ownership Requirements: The IRS's interpretation of ownership requirements for 831(b) micro-captives diverges from the guidelines that Congress established. This deviation has led to confusion and inconsistencies in how these regulations are applied.

• Rigid Loss Ratio Computation: The IRS has proposed a strict loss ratio requirement of 65% for 831(b)-electing captives. This rigid computation does not consider the unique risk profiles of micro-captives, making it an inaccurate measure of compliance.

• Disregard for Original Intent: The IRS’s current enforcement tactics not only stray from the original intent of the 831(b) tax provision but also place undue burdens on small insurance companies operating within the micro-captive framework.

• Overlooking Industry-Specific Nuances: By imposing inflexible requirements, the IRS is undermining the growth and competitiveness of small insurers and hindering the overall effectiveness of the 831(b) micro-captive structure.

In 2020, the world changed for entrepreneurs, regardless of their previous success. As state and local governments declared businesses non-essential, entrepreneurs found themselves in a precarious situation. When traditional business interruption insurance proved insufficient due to lack of direct property loss, many business owners were left in a dire state.

On March 15, 2020, the Trump administration announced its “15 Days to Slow The Spread” initiative. Nearly overnight, non-essential businesses were forced to close across the United States. It would not be until 10 days later that President Trump would sign the CARES Act. In the meantime, business owners were left with limited cash flow to fund their fixed expenses such as payroll, rent and utilities. Once passed and implemented, entrepreneurs turned to the CARES Act programs to sustain their businesses through the Covid lockdowns; entrepreneurs who were self-reliant before the pandemic were left to rely on government assistance to keep their businesses afloat.

Through the CARES Act, the U.S. government created programs for businesses, including the Paycheck Protection Program (PPP) and the Employee Retention Credit (ERC). Each program had qualifying elements and restrictions on recognized expenses. Initially, businesses chose one of the programs to participate in. By and large, businesses worked with their bankers to borrow funds through PPP as regional banks heavily marketed it. Eventually, The Consolidated Appropriations Act of 2021 would allow businesses to utilize both programs regardless of which they had previously participated in, leading to a rise in ERC promoters offering to assist in completing the ERC paperwork for upwards of a 30% fee.

While an undeniable lifeline for businesses, the CARES Act was rampant with fraud. A 2021 paper by three finance professors at the University of Texas at Austin estimated that 15% of PPP loans, or $76 billion, had at least one indication of fraud. In December 2021, the U.S. Secret Service estimated that nearly $100 billion in Covid relief was stolen. In addition to rampant fraud, there have been devastating knock-on effects from injecting trillions of dollars into the U.S. economy. In 2022, U.S. inflation soared to its highest in four decades. As a result, the Federal Reserve raised interest rates at a record pace to combat inflation. As a result of these steep rate increases, regional banks began to have significant mark-to-market losses on debt holdings, which recently led to the second largest bank failure in U.S. history, Silicon Valley Bank. There are growing concerns that the financial woes of regional banks will lead to a credit crunch, which would disproportionately impact small to mid-size businesses.

Was there a way to empower businesses to be self-reliant through Covid and avoid the economic fallout created by government stimulus? The answer to this question was passed by Congress nearly 40 years ago when it created 831(b), a section of the tax code allowing businesses to set aside tax-deferred funds for unforeseen events. A New York Times article from March 2020 labeled 831(b) a crisis lifeline that would prove its worth during the pandemic.

An 831(b) plan can be customized to cover specific risks that are underinsured or uninsured altogether by traditional insurance policies, such as data breaches, third-party business interruption, indirect business interruption (including pandemics), supply chain interruption and brand protection, among many others. These plans allow businesses to tailor their insurance coverage to meet their specific needs and protect themselves against emerging risks. In fact, during the Covid lockdowns, SRA 831(b) Admin saw a significant increase in claims against 831(b) plans for business interruption. Unlike traditional insurers, some firms were able to issue claim payments to their clients for their losses, in some cases before PPP was even an option, allowing businesses to remain self-reliant and maintain their cash flow throughout.

Why aren’t 831(b) plans a standard business practice? The lack of clear rules and requirements surrounding 831(b) plans has emerged as a significant concern, posing challenges for businesses seeking to ensure their compliance with the tax code and operate these plans lawfully. There have been numerous instances where Congress and the Internal Revenue Service have failed to provide sufficient guidance for companies that elect under the 831(b) tax code.

Congress should create legislation or pressure the IRS to clarify the rules and requirements for companies utilizing the 831(b) to ensure it is used as intended. The 831(b)-tax code was created to encourage businesses to self-insure their risks, and the code must be used to promote this goal. By clarifying the rules and requirements for operating an 831(b) plan, Congress can help entrepreneurs maintain their self-reliance and avoid the need for widespread government assistance.

Entrepreneurs know it’s not a matter of if but when the next storm comes to disrupt their business. An 831(b) plan enables entrepreneurs to sleep peacefully, knowing when that storm comes, their bailout is funded through their efforts and planning. Those funding an 831(b) plan won’t be left relying on a government bailout that may never come; they will rely on themselves to weather the storm.

Van Carlson is the founder and CEO at SRA 831(b) Admin. Carlson is an industry leader in enterprise risk management solutions with over 25 years of experience. Along with the responsibility of bringing SRA’s new products to market, he helps clients achieve their financial goals and aid in protecting a business’s assets through times of uncertainty. Of SRA’s many products, the company is most known for plans that aid mid-market businesses in mitigating risks more effectively. Carlson began his career with Farmers Insurance Group as an agent, where he saw firsthand the benefit of how 831(b) plans can assist small to mid-size businesses. He is a veteran of the U.S. Coast Guard.