Bench & Bar March/April 2026

FEATURE: POTPOURRI

taxpayers’ abusive tactics, the IRS heavily scrutinizes this segment of the insurance market, and the IRS has targeted “micro captives” in the past several years with additional reporting requirements. 31 The IRS recently has won some court battles against taxpayers who were improperly using a microcaptive structure to artifi cially lower their corporate tax burdens. 32 In most of the cases, it appears that these tax payers were attempting to maximize their premiums limits, rather than making gen uine underwriting and risk considerations. Additionally, the captives routinely charged premiums that were far more expensive (5-15x) than the commercial marketplace; the taxpayers put in writing that they were seeking tax breaks; they lacked risk diversi fication; they lacked claims protocols (and even discouraged claims); they didn’t have legitimate insurance policies; and they also permitted loanbacks of premium to the related insureds or to the owner of the business. Any lawyer seeking to help his/her clients understand how NOT to operate a cap tive would be well-served by reading the cases cited in the endnotes. These cases provide great examples of why retaining a good captive manager is critically import ant. A manager that is worth its fees will always focus on the insurance needs of the business and provide arm’s length underwriting, actuarial assessment, claim management, independent accounting, and other compliance services. They will also have their clients domiciled in jurisdictions with sophisticated and actively engaged regulators. Notwithstanding the IRS’s ongoing scru tiny of microcaptives, publications such as Forbes , 33 the New York Times , 34 and the Wall Street Journal 35 have generally praised the benefits of captive ownership in recent years. Given Kentucky’s burgeoning reputa tion as a business-friendly state, the time is ripe for organizations within the Common wealth to revisit the importance of captives as a risk management tool. Year after year, captives assume more commercial prop erty/casualty risks throughout the US, and thousands of businesses in Kentucky could reap the benefit of captive ownership. Attor neys who practice corporate law, insurance

to learn how a captive might be able to help protect their clients from losses and stabilize the premiums paid each year. The leading captive domiciles like Vermont, Delaware, Tennessee, North Carolina, etc., publish and maintain lists of approved captive managers, actuaries, and CPAs on their websites. Ken tucky does not maintain such lists (though it would be helpful if it did) and its captive insurance trade association appears largely inactive given the last event that it hosted was in 2020. 27 Thus, attorneys and entities interested in exploring captive ownership in Kentucky would be well-served to speak with their commercial insurance brokers to obtain referrals for captive managers, review various industry trade journals ( e.g. , Business Insurance magazine, www.captive. com, www.captiveinternational.com, etc.), obtain referrals from the Self Insurance Institute of America (“SIIA”), and/or attend other states’ industry conferences, which are usually hosted by the state’s captive trade association. Captive managers serve as independent third-party administrators and provide expertise in underwriting, actuarial, policy library, claims processing, accounting, and regulatory compliance subjects—which many businesses and public entities may not have in-house. Reputable captive managers will work with a company’s risk managers and legal and financial advisors to assess and form the appropriate type of cap tive and develop a captive program. They will also ensure that the captive’s finances are audited annually in accordance with insurance industry accounting standards. The cost of such a consultant is manage able; captive managers typically charge an annual fee that is either a fixed amount or a small percentage of the captive’s annual gross written premium. Critically, before even considering whether to utilize a captive, organizations must rec ognize and accept that captives are regulated entities. While Congress has created cer tain tax incentives to encourage businesses to establish and use captives, businesses should treat them as stand-alone, distinct corporate entities deserving of the same corporate formalities as any other business. Because captive insurance is not sold to the general public, Kentucky (like most states)

exempts captives from most of the laws and rules that regulate commercial carriers. 28 Nonetheless, captives still must operate with professional underwriting, actuarial assessment, risk diversification, and claims and financial management. The ultimate purpose of any captive, as with a commercial carrier, is its ability ( i.e., liquidity and solvency) to pay claims as they arise. This is the goal that regulatory over sight is meant to support. Thus, oversight should be welcomed, not feared. When properly formed, and when paired with an entity that manages its risks well, a captive insurer can become a lifeline. A well-managed captive can also serve as a profit center. Congress and state govern ments have provided many incentives for insurance. For one, insurance premiums – including premiums paid to a captive – are deductible as an ordinary business expense under section 162 of the federal tax code. 29 And, in the case of captives, those deductible premiums are going to an affiliated corporation. Further, when the underwriting profits from a captive are invested wisely, they generate revenue as well. A captive can therefore convert a traditional business expense into a new revenue stream. Moreover, Congress has enacted specific incentives for small and medium-sized businesses to use captives. In 1986, Con gress, enacted section 831(b) of the federal tax code which allowed captives earning no more than $1.2 million in annual premium to avoid paying corporate income tax on that revenue. Instead, these “microcaptives” are taxed only on their investment income. In 2015, Congress enhanced this section of the tax code by passing the Protecting Americans from Tax Hikes (PATH) Act, which increased the premium threshold for 831(b) captives to $2.2 million (adjusted annually for inflation). The PATH Act also prescribed different tests to ensure risk transfer and risk diversification thresholds were met to prevent the captive from being used as a tax evasion scheme. 30 For 2026, that premium threshold is now $2.9 million. Of course, any entity considering the tax implications of captives should consult a qualified professional. Due to some

26 march/april 2026