Pension Funding Act of 2004
This section examines the provisions of sections 501(c)(15) and 831(b) of the Code, which were amended in April of this year with the passing of the Pension Funding Act of 2004, and the effect of the recent changes and the potential use of these regulations for captive insurance companies going forward.
Internal Revenue Code §501(c)(15)
Prior to the recent changes the revenue threshold to qualify under 501(c)(15) was $350,000 in direct or net written premium, whichever was the greater. This definition had inadvertently opened up the 501(c)(15) regulation to abuse by insurance companies with questionable insurance risk and overcapitalization. The most recognized of these cases was an individual who formed a 501(c)(15) to write less than $5,000 in premiums and avoided federal taxes on $173 million in income by contributing appreciated assets into the insurance company and liquidating those assets.
April 2004 Changes - To clamp down on the potential abuse of IRC §501(c)(15), a significant change was made to the revenue threshold for eligibility. The $350,000 premium threshold was replaced by a threshold of $600,000, but applying to gross receipts. Premiums received must account for at least 50% of gross receipts. For the purposes of eligibility, the gross receipts of all members of a related group are aggregated. This would include parent and brother, sister companies of the insurance company, whether or not they are insurance companies themselves.
Applicability to Captives - These changes effectively remove the 501(c)(15) election as an option for captives. To qualify the total revenue of the captive and its parent combined would have to be less than $600,000 (and premium income would have to be more than 50% of the combined revenue). Virtually all 501(c)15 captives formed in recent years no longer meet the requirements under this definition and starting with fiscal year 2004 will no longer be tax exempt.
Internal Revenue Code 831(b)
April 2004 Changes - The Pension Funding Act of 2004 removed the minimum size criteria to be eligible for the election. This had previously been set at direct premium (or written if greater) of $350,001 to dovetail with the IRC §501(c)(15) election. The maximum size criteria was left unchanged at $1.2 million in direct premium (or written if greater). No gross receipts measure is applied to 831(b) companies.
The $1.2 limitation includes all premiums written by companies within the same consolidated group. Companies must also be deemed insurance companies for tax purposes to be eligible for the election.
