What is a captive insurance company?
A captive insurance company (CIC) is a licensed insurance company formed to write policies for a related entity or group. A small captive has annual income exclusions up to $1.2 million under the IRS code section 831(b).
IRS code section 831 (b) Benefits
• Annual premiums received by a small CIC are tax free if the total amount received is less than $1.2 million.
• Premium payments are tax deductible to the operating company IRS code section 162.
• The CIC’s net investment income is taxed at a C Corporation income tax rate.
• Once collected, the 831 (b) cannot be revoked without permission of the Secretary of Treasury.
• Companies with high cash flow businesses can create multiple CIC’s each having a $1.2 million per year contribution for each child (code 1563 attribution rules apply).
Ground Rules for a CIC
• Premiums and policies must be market-comparable
• Actuarial support is needed
• Insurance formalities compiled with risk distributions must be present
• Initial capitalization is required and is letter of credit accepted in many states, 4:1 ratio of premiums to capital, with certain minimums, and use of gift tax return form 709
Examples of Operating Company Types That Set up 831 (b) CICs
• Specialty pharmaceutical company in the Southwest with $65 million in gross revenue and approximately 15 employees
• Midwest real estate firm that engages in development and management of multi-family properties in U.S.
• Medical practice with annual revenues of approximately $4.6 million four doctor partners and 26 employees
• Privately held buyer of precious metals and jewelry with annual revenues of $60 million
• Single owner dermatology practice with annual revenues of $4.5 million
• Engineers and contractors proviinge engineering, construction and fabrication services to petrochemical and refinery industries
• Company specializing in logistics information management and transportation current revenues $4.5 million
Why I should own a small insurance company?
• Estate planning- CIC owned by dynastic trust for errors, jurisdiction is shopping for unlimited rule against perpetuates: AK,DE,FL (360 yrs.), can structure to allow client shared access to investments
• Buyout retirement planning- CIC can tie into a business buyout/retirement plan/employee benefits, more tax efficient than traditional methods
• Tax planning- premiums can be tax deductible, benefit to family can be the estate/gift tax free, profit can be accessed at lower tax rates
Risk Management Concept
Each business or practice has risk that it currently does not insure against including:
• Deductibles and copayments in existing policies: medical malpractice, commercial general liability, promises and products liability, E&O, D&O and others
• Liability risk that has no coverage: employee claims, partnership liability, government liability, etc.
• Economic risk for which there is no coverage: loss of income, revenue cutbacks, loss of key person, loss of key contract, etc.
Buyout and Retirement Concept
Business owners and employees are always looking for tax efficient ways to transfer wealth during, by and of younger partners and buyout of older ones.
• A business can concentrate on an internal buyout plan using the CIC reserves.
• With particular structures, funds can be accessed by senior (retiring) partners during their lifetime in a tax favored manner.
• The total retirement benefit of such arrangements can be significant.
• Operating a business or practice will pay tax deductible premiums to the CIC owned by the senior partners so funds will accrue to older owners for their retirement.
Insurable Within a Company Policy
• Everything a business currently self-insurer: deductibles, excess loss of coverage limits, construction defects
• Loss of income as a result of: losing key employee/salesperson, loss of license/professional risk, loss of key contract, weather terrorism, etc.
• Liability defense expenses: employee lawsuits for sexual harassment, wrongful termination, discrimination, environmental issues, professional claims.
Anything that might be considered a” Lloyds” risk
Summary of a Captive Insurance Companies (CIC)
A CIC is a bona fide insurance company licensed and domiciled in the jurisdiction with specific laws governing captive insurance companies. A CIC writes policies to an operating company. The CIC and an operating company have related party or affiliate ownership, hence a “Captive insurance company” (operating company can be a partnership, S Corporation, etc.)
In a “small” 831 (b) CIC, up to $1.2 million of premiums are taxed at 0% rate, per IRS code 831 (b). The premiums are deductible by the operating company per IRS code section 162. The CIC is taxed on net investment income at C Corp. rates.
If you find yourself applying any of this information to your business, please make the call to ask your questions during a free 30 minute consultation.