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An insurance company, including a captive, may elect under 26 U.S.C. sec. 831(b) to be taxed on its investment income only, so long as the company receives less than $1.2 million in premium each year ($2.2 million beginning in 2017 and indexed against inflation thereafter). The 831(b) election is filed along with the company's first tax return, and cannot be revoked without the consent of the Secretary of the Treasury.
This election is an incentive provided by Congress to encourage the formation of new insurance companies. What 831(b) effectively allows a small insurance company to receive up to $1.2 million per year in premiums, without paying any income taxes on those premiums.
The 831(b) election does not affect -- at all -- the deductibility of the premiums paid by the operating business to the captive. So long as those premiums are otherwise deductible, they may be deducted by the operating business just like any premium payments to a captive. This has the effect of creating an up to $1.2 million deduction in the operating business, with the premium moneys transferred to the captive, and with the captive not paying any income taxes on the receipt of those premiums.