Captive insurance companies have been around for centuries. Many captives more formally insure business risks that are often currently self-insured. Well-run companies use them to customize their coverage in a tax efficient manner. Not surprisingly, many of the Fortune 1000 companies operate captives. Some segments of privately held businesses have utilized captive insurance arrangements, but a recent tax law change is making captives more appealing for more privately held businesses.
Many mid-sized business owners have formed captives in the past few years, utilizing a tax efficient captive insurance planning opportunity by utilizing a “Small Captive”. Small Captives are authorized under Internal Revenue Code Section 831(b) to incent mid-sized businesses to improve their risk management programs. This law incentivizes owners to create Small Captives by allowing owners to pay premiums from their operating business into their captive each year. Their captive receives these funds tax free. However, they must be formed properly with real policies and market-priced premiums and are subject to insurance regulations. Small Captives were recently enhanced by Congress under the Protecting Americans from Tax Hikes Act of 2015 “the PATH Act”.
So Why a Small Captive?
8 Great Reasons to Form a Small Captive
- Improve Risk Management. Captives cover gaps in a business’ P&C program and also add custom coverages unique to the business.
- Reduce Taxes. Companies may take up to $1.2 million in deductions in 2016. The limit rises to 2.2 million dollars beginning in 2017.
- Protected Assets. Move wealth from your exposed business to your protected asset. In our litigious society, this is very important.
- Increase Investments. Captive assets are invested by your advisor. What would have gone to the IRS in taxes is put to work to protect your business and grow your wealth.
- Reduce Costs. Savvy owners raise their deductible levels and move more risk into their Small Captive over time. This lowers their costs and often pays for their captive.
- Painless Claims. If you have ever had to file a large claim with your insurance carrier, you know that attorneys are often involved. However, if you own the insurance company, the claims process is lessened.
- Create a War Chest. Captives build wealth that may be used to invest in your business, buy competitors, or issue qualified dividends.
- More to Heirs. Properly formed, a Captive is not subject to Estate or Gift Taxes. A Captive may be used to efficiently transfer assets, subject to certain limitations under the 2015 PATH Act.
Small Captives are designed for profitable, privately-held companies, generally with at least $10 million in revenue and $1.5 million in taxable income. They have many benefits, but need to be formed by professionals.
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IRS Circular 230 Disclaimer:
The content in this blog is limited to the matters specifically addressed herein and is not intended to address other potential tax consequences or the potential application of tax penalties to this or any other matter. All written advice provided is based on reasonable factual and legal assumptions, exercises reasonable reliance, and uses reasonable efforts to identify and ascertain the facts relevant to the Federal tax matters.
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