The Safe Harbor Group Monthly Digest
At a Glance
by Brent Robbins, CPA, MPrA, July, 2016
Forming a captive insurance company may be one of the best risk management and wealth planning tools available to business owners today. In addition, captives are one of the best – if not the very best – asset protection tool available to business owners.
Assets in captives are not reachable by creditors and attorneys, and they are only available to pay valid insurance claims approved by the claims department of the captive insurance company. The captive shareholders can direct the investments of the captive into a wide variety of funds and investments. Any lawsuits, claims, divorce, or other action against the operating company or shareholders is entirely separate from the captive, meaning the funds in the captive are fully protected against any litigation risks.
A captive is a privately held insurance company that insures a business. It issues policies, collects insurance premiums, and pays claims. Historically, captive insurance companies were only for large corporations: 80% of Fortune 1000 companies use captive insurance programs. The enactment of favorable tax regulations and other legislation has made captives available to middle-market and family businesses.
Most business owners knowingly or unknowingly self-insure a significant amount of risk. With a captive, nondeductible self-insured risks can be converted into tax-deductible insurance premiums that are paid to a captive. In addition, if the net insurance premiums paid to the captive are under $1.2 million each year ($2.2 million starting in 2017), the premium income is not taxable to the captive under Internal Revenue Code section 831(b).
IRC section 831(b) was passed in 1986 to encourage the formation of new insurance companies. A qualifying captive making a valid IRC section 831(b) election results in a tax deduction of premiums paid to the captive insurance company by the shareholders operating company, while paying income tax only on the captive’s investment income.
In 2002, the IRS issued pronouncements that restated the service’s position regarding captives and provided three safe harbor Revenue Rulings for captive formation, operation, and management. Following established IRS guidance avoids the pitfalls many in the captive industry have encountered by failing to follow the rules.
The Internal Revenue Code, related IRS rulings, and case law all support the use of captive insurance companies to manage risk. When properly utilized, the use of a captive insurance strategy can help businesses better manage insurance costs, capture underwriting profit, obtain tax benefits, asset growth, and protection, all with the accumulation of wealth on a tax-deductible basis.
Captive ownership is very flexible. A captive can be owned by multiple parties, including LLCs, partnerships, corporations, trusts, key employees, children, grandchildren and the shareholders of the operating entity.
The IRS has publicized many of the questionable practices and outright scams involving real or purported captive insurance companies. As with any industry, there are those who shortcut the proper processes and short-change their clients. Most of these improperly formed captive insurance companies use inflated premiums (insurance premiums charging exorbitant rates to create the desired tax deduction), fail to provide actual risk shifting or utilize improper risk transfer pools and remit most of the money back to the operating company owners without properly structuring a legitimate exit strategy.
Due to our turn-key, personalized approach, we are able to deliver efficient and affordable captive formation and management services. We follow IRS safe harbor guidance and insurance industry best practices to provide a compliant captive insurance company. Today, captives are the premier risk management and risk-financing tool for middle market companies.
To learn more about Captive Insurance or to get started, visit our Captive Insurance homepage or speak to one of our Captive specialists please call 1-(844) 631-8373 or email firstname.lastname@example.org