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Captive Insurance Company Tax Benefits

Leverage Capital & Increased Investment Income

2013 Propery and Casualty Risk Financing and Captive Insurance Trends

A company needs financial capital in order to operate and grow its business. The significant insurance costs and special tax savings generated from a captive formation directly results in additional profits. These additional reserves allow for more accessible funds that can help your business leverage its capital. Our staff not only manages our clients insurance companies from issuance of premiums to monthly financial reporting, it also assures suitable tax and audit treatment. Our experienced finance team is positioned to support all financial functions for maximizing tax savings, increased cash flow, and investment returns.

Qualifying As Insurance For Tax Purposes

For a captive to obtain the tax benefits of a captive , it must be considered an insurance company. The IRS has indicated that a corporation qualifies as an insurance company for a particular year if more than half of the corporations business during that year consists of activities that, for federal tax purposes, constitute insurance. For an arrangement to constitute insurance, two requirements must be met: there must be risk shifting and risk distribution.

  • Risk Shifting occurs where a party facing the possibility of an economic loss transfers some or all of the financial consequences of that risk to another party so that a loss does not affect the insured, i.e. party that shifted the risk. With an insurance arrangement, the loss is offset by the insurance payment. Risk shifting is generally the easier of the two requirements to meet.
  • The Institute of Risk Management and Insurance offers the following definition of Risk Shifting:

    Used in tax deductibility discussions, the term connotes the transfer of risk to a separate party. In tax disputes, the Internal Revenue Service and numerous courts have required the presence of both risk shifting and risk distribution to find a financial arrangement to be insurance.

    Thus, to qualify as insurance, the risk of loss must be transferred from the entity exposed to the risk to another entity willing to accept the consequence of loss.

    How Is A Captive Insurance Company Formed

    Captives are not a short-term solution to a companys corporate risk challenges. If structured incorrectly or implemented for the wrong reasons, they can become a costly exercise in futility for the parent company.

    Therefore, the first step is to work with a captive expert advisor who can help determine if a captive is a viable solution for the organization. This begins with a feasibility study.

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    What Is Captive Insurance

    A captive insurance company is a subsidiary formed by a private company to finance its retained losses in a formal structure under the guidance of an appropriate state insurance department. Captive insurance companies are normally formed to supplement commercial insurance, allowing companies to retain the money that would otherwise be spent on insurance premiums.

    The first active captive insurance company in the United States was started in Ohio by Fred Reiss, who in 1953 founded Steel Insurance Company of America for Youngstown Sheet & Tube Company in Ohio. Reiss drew the term captive from the steel companys captive mines, which were sending ore back to the companys mills. In a short time, U.S. businesses began to realize that they could create a profit center out of an ordinary business expense: the cost of insurance.

    United States Tax Court decisions have, over time, brought clarity to captives established in a compliant manner.

    Congresss rationale was that it should encourage smaller companies to create the necessary insurance coverage to protect their enterprises. While commercial insurance is a prudent component of sound business development, it represents a cost that frequently limits the growth of smaller businesses. IRC section 831 allowed midsized businesses to grow their balance sheets more quickly to support the risk of their owners and resulted in a rapid growth of captive insurance companies among mid-sized businesses.

    New Revenue From Insurance Warranties

    Workers Compensation Captive

    Captive insurance companies provide greater opportunity to diversify revenue streams for business owners. Small and medium size companies can effectively manage risk and provide their own protection warranty plans and service contracts. Not only does this create a new revenue line for the company, it also provides a new product or service to its customers. This is another example of how owning a captive can turn a companies risk into profit.

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    What Does The Irs Say About Captives

    While these plans and structures are legal under the IRC, the IRS has taken issue with the design of many captives. Litigation often results when a captive insurance company is overly aggressive, and the insurance premiums paid have no economic substance or questionable relevance to the actual business.

    The good news is that the IRS has subsequently issued safe Harbor rulings. This means that if the requirements of these rulings are satisfied, the IRS will generally not challenge the deductibility of premiums paid to the captive. Most captives today are structured to cover the Safe Harbor rules. If structured properly, the IRS will generally not take exception.

    Captive Insurance Tax Benefits All Business Owners Should Be Aware Of


    If youre a business owner, chances are youve heard of captive insurance. But did you know there were captive insurance tax benefits? A lot of company owners miss out on tax breaks because theyre not aware of how it all works.

    If youre interested in learning more about captive insurance benefits, just keep reading.

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    How Does An Offshore Captive Insurance Company Work

    The insured companies pay the insurance premiums. The funds are deposited into an account in the name of the captive insurance company. The people who own the insurance company typically own own the insured company or companies as well. So rather than an outside insurance company profiting from the premiums and claims, those who established the entity can benefit from the profit that institutional insurer would normally realize.

    How Are Captive Insurance Companies Taxed

    Life IUL/Supplemental Income

    With captive insurance, a business or a group of businesses essentially creates its own insurance company. This option generally exists in contrast to buying insurance from a provider or opting for self insurance. There are numerous advantages to captive insurance, but before taking the leap with your organization, you may want to look at some of the tax implications.

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    Captive Insurance Tax Benefits

    The company paying the premiums receives a tax deduction, and the captive insurance company receiving the premiums receives the first $2.2 million tax-free. The statutory captive insurance company will elect to be classified as a domestic insurance company as indicated under IRC Section 953. It will, therefore, file US tax returns annually. However, premium income up to the first $2.2 million is exempt from taxation. In the following calendar year, another $2.2 million can be contributed, for a total of $4.4 million over two years, $6.6 million in premiums are tax deductible over three years, etc.

    Why Do Companies Form Captives

    Companies that have difficulty obtaining appropriate coverage for unique risks, feel insurance markets havent rewarded their excellent loss histories or want a more effective way to finance their risks may explore captive insurance programs. Under the right circumstances, captives can be an excellent insurance solution and cost-saving tool. Companies form captives to retain control of their destiny with their risk program. Companies should carefully consider the captive insurance pros and cons, however, as this may not be the right solution for every organization.

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    Types Of Captive Insurance Entities

    There are three types of captives that have evolved in the United States. They are:

    Pure captives

    Association captives

    Agency captives

    With pure captives, the risks associated with a single group of related entities are insured by the insurance entity.

    With association captives, the risks associated with the members of a specific association are covered by the insurance company.

    With agency captives, the captive company is operated and owned by one or more insurance agents to insure their clients risks.

    Pure captives carry the highest level of benefits compared to the other two, so the following content focuses on that type of captive insurance company.

    What Are The Benefits Of Forming A Captive

    Captive Insurance Companies Create Tremendous Insurance &  Tax Benefits

    The goal of a pure captive is to cover the risk of currently self-insured economically. This could include higher deductibles on current or existing policies, assuming the risk of traditional insurance, or simply taking risks for existing exclusions and deductibles.

    The insurance and tax benefits are compelling:

  • The ability of the operating entity to immediately deduct insurance premiums paid.
  • The ability of the captive company to avoid paying tax on the first $2.3 million in premiums received in a given year.
  • Captives can cover certain types of insurance coverage are difficult to obtain or simply unavailable in the marketplace. This is typically due to historic high loss experiences for a given industry or sector. This could include medical malpractice, the situation concerning construction defects, or environmental issues.
  • Investment income and capital gains generated by the reserves are taxed at the favorable C-Corp 21% rate. This is lower than the highest individual tax rate of 37%.
  • The IRS allows 50% of the dividend income is excluded from taxation under the C-Corp.
  • The captive may be owned by a Roth IRA, thereby enabling the investment profits of the captive to receive dividends tax-free. You can find out more about that here and here.
  • The insurance company could be owned by the children or relatives of the operating company owner. This can allow for effective estate planning.
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    Possible Risks To Avoid With Captives

    Captives first came on the scene in the 1950s, when the IRSs approach towards them was rather aggressive, with captives coming under attack. In modern times, the IRS has modified its approach by implementing safe harbor rules to maintain regulations of captives while reserving the right to evaluate the captive arrangement based on each captives circumstances and facts.

    As a result of the IRSs approach, its essential for captives to correctly adhere to the principles of risk distribution and risk sharing. Its also essential that the investment program is properly administered.

    Appropriate levels of capitalization also need to be maintained.

    On the flip side, the following risks need to be avoided to keep the captive in good standing with the IRS:

    Excessive loan-back to the operating company

    Attempts to offer life insurance arrangements

    Excessive distributions to shareholders

    Offshore Captive Insurance Company Formation

    Why set up an offshore captive insurance company? Tax benefits and savings on insurance premiums are two of the many reasons that attract so many businesspeople to set up such a captive insurance company. For example, research shows that about 80% of the Standard and Poor 500 companies own one or more captive insurance companies. Offshore captive insurance is the main source of insurance for both large and small companies. U.S. Internal Revenue Code Section 831 specifically allows for this particular type of insurance company. The shareholders or principles of the insured company also own the insurance company. The insured, related company which pays the premiums into the plan receives a tax deduction for the premiums as an ordinary and necessary business expense.

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    What Is The Purpose Of Captive Insurance

    Captive insurance companies enable organizations to enhance protection, customize policies and benefit from underwriting profits that generally go to a third-party insurance carrier. This type of alternative risk management carries more risk than a traditional, guaranteed cost insurance program but less risk than self-insuring.

    Is It A Listed Transaction

    ICICI Pru Term Insurance – Tax Benefits

    The IRS has issued Notice 2004-65 which has successfully de-listed the Section 831 statutory captive insurance company as a tax shelter. So, it is not a listed transaction and the IRS does not require special notification that one is participating in such a program. IRS Commissioner Mark. W. Everson has states, Based on disclosures from taxpayers and examination of tax returns, we have determined problems associated with these transactions are no as prevalent as initially believed. Accordingly we are no longer classifying them as listed transactions.

    See Captive Insurance Minimum Capital and Surplus Requirements by jurisdiction.

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    What Are The Benefits Of A Captive Insurance Company

  • You are in the insurance business: many of our clients got into the insurance business to control costs and then discovered the associated underwriting profit. Insurance is a business opportunity and can be more profitable than the existing, successful business that led to the creation of the captive.
  • Draft your own insurance coverage: captives can often provide coverage for unique or specific risks that are not transferrable in the retail market.
  • Protect Your Assets: cash reserves held on the balance sheet of the parent company are subject to claims and lawsuits of general creditors. Having reserves set aside in a licensed, regulated entity helps ensure that you stay in control of your money: every dollar you pay to the captive is one less dollar left in the business. A properly designed captive is a bona fide insurance company where it would be very difficult for a creditor to successfully argue the payment of legitimate premium is a fraudulent transfer of assets.
  • Ability to participate in favorable claims experience: rather than a third party benefiting from these profits, the business can benefit. Technically, the party that owns the captive is the one that receives any profits, so if the captive is a subsidiary captive, the business receives the profits. Otherwise, whichever party owns the captive receives the profits.
  • Take Advantage Of Captive Insurance Tax Benefits

    The captive insurance tax benefits make having the coverage well worth it. Its good to know that as a business owner, youll receive incentives for your company endeavors.

    If youre considering getting captive insurance, hopefully, the information above helps you make a decision. Of course, the tax perks should be a good incentive as well.

    To read more content like this, browse our website. We publish tons of informative content for our readers. Were sure youll really enjoy our articles!

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    Operating A Captive As A True Insurance Company

    Its clear that the tax benefits associated with smaller, mini-captives are clear. With that said, its essential that businesses dont forget that captives must operate like a true insurance entity. To support this requirement, the utilization of a reputable and experienced captive management company is essential to support the day-to-day operations of the captive company. Such a company can support the need for:

    Annual financial statement audits

    Support investment activities for planning to ensure liquidity needs are met

    Additional legal and regulatory requirements

    This list of requirements typically falls outside of the scope of experience or expertise of general business managers and owners, and even if they have the expertise, they might not have the time to conduct whats required appropriately for captives.

    It doesnt make sense for all companies to create a captive insurance entity, though, for many, the benefits are numerous. Since its a complex endeavor, its best to consult captive experts to ensure compliance and that a true insurance company exists and is maintained.

    How Is The Insurance Company Structured

    Understanding how captive insurance works for small businesses

    These companies are structured so that reasonable insurance premiums can be paid from the affiliated entity to the insurance company and be fully tax deductible by the insured. The code allows the first $2.3 million indexed by inflation to be tax exempt upon receipts into the captive insurance company. This results in an excellent opportunity for owners looking to reduce their current income tax liability and transfer wealth without excellent estate planning tools.

    The captive company is required to be a C corporation and is subject to chapter C and chapter L of the Internal Revenue Code. There are a variety of different captive insurance companies. This includes pure captives, risk retention groups, group captives, and producer-owned reinsurance businesses. This post focuses on pure captives, which are designated and structured to ensure the risks of business entities related to or affiliated with the ownership of the captive.

    When these structures were initially approved, they were typically used by Fortune 500 companies in an attempt to lower insurance costs. The fees involved were very high, and the plans covered a lot of complexities. But for large corporations, the benefits far outweighed any of the costs.

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    Offshore Captive Pros And Cons

    Financial havens with strong insurance statutes are the locations where professionals form the most companies. In addition to the tax benefits described above there are several additional convincing reasons why captive offshore insuring vehicle should be considered. One is able to self insure to an extent not available otherwise. The cost of insurance are often significantly reduced. Plus, the arrangement can enhance your risk management. Moreover, if a standard policy is not available or extraordinarily expensive, the plan may be the only viable option. Professional malpractice, pollution and hazardous materials as well as catastrophic risk are excellent examples of rates-gone-awry. US insuring companies frequently raise rates or deny coverage without warning. Whereas, owning your own offshore captive company can give your plan longstanding solidity and direct access to reinsurance markets.

    Types Of Captive Insurance Companies

    A captive is a wholly owned subsidiary of a company that is not primarily in the insurance industry. Its main function is to insure some or all of the risk of its parent company. As the industry has grown those involved have sought new methods of enhancing the captive structure to create means by which a variety of industries can benefit. Here are a number of different structures a are being used

    • Single Parent Captives Only underwrite the risk of related group companies.
    • Diversified Captives Underwrite unrelated risk in addition to related group companies.
    • Association Captives Underwrite the risk of members of a specific industry-type or trade-association. Medical malpractice is often insured in this fashion.
    • Rent-A-Captives Companies that offer access to captive structures without needing to establish ones own insurance company. The participant pays for the use of the company and needs to provide collateral so that the rent-a-captive is not exposed to substantial risk experienced by the participant.
    • Special Purpose Vehicles Used to secure risk. These are reinsurance companies that execute contracts with their parent company and yield the risk to risk the capital markets. This is typically accomplished by a bond issue.
    • Agency Captives Established by insurance agents or brokers to enable them to participate only in low-risk activities under their control.Requirements

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