Over the past 20 years, many small businesses have begun to secure their own risk with a product called “Captive Insurance.” Small occupied (also known as the capture of single parents) are insurance companies formed by the owners of closely held companies looking to ensure risks are either too expensive or too difficult to guarantee with traditional insurance market. Brad Barros, expert in the field of captive insurance, explains how “all souls are treated as a business and must be controlled in the method in accordance with the rules set by both the IRS and the appropriate insurance regulator.”
According to Barros, often single-parent captives held by the trust, partnership or other structure established by the premium payer or his family. When properly designed and administered, companies can make tax-deductible contributions to related parties insurance company. Depending on the situation, insurance claims gains, if any, can be paid out to the owners as dividends, and profits from liquidation of the company may be taxed at capital gains.
High payers and occupied them can collect tax benefits only when prisoners works as a real insurance company. Also, consultants, and business owners who use prisoners as estate planning tools, asset protection vehicles, tax deferral or other benefits not related to the true business purpose insurance company may face serious regulatory and tax consequences.
Many people think insurance companies are often formed by US companies in jurisdictions outside the United States. The reason for this is that the foreign department offer lower costs and greater flexibility than their US counterparts. As a rule, US companies can use foreign-based insurance companies, as long as the jurisdiction meets the insurance regulatory standards required by the Internal Revenue Service (IRS).
There are several notable abroad who have insurance regulations are recognized as safe and effective. These are Bermuda and St. Lucia. Bermuda, but more expensive than other countries, is home to many of the largest insurance companies in the world. St. Lucia, more reasonable price positioning small fortunes, is worth noting that the laws that are both progressive and compliant. St Lucia is also acclaimed for recently passing “Incorporated Cell” legislation, modeled after a similar law in Washington, DC.
Common Captive Insurance abuse; While occupied remain very beneficial to many companies, some industry analysts have begun to inappropriate market and abusing these institutions for purposes other than intended purpose by Congress. Abuse are the following:
1. Improper risk shifting and risk distribution, aka “Bogus Risk Pools”
2. The high deductibles held-combined arrangements; Re insuring prisoners through private placement variable life insurance scheme
3. Improper marketing
4. Abnormal assurance of integration
Meeting the high standards imposed by the IRS and local insurance regulators can be complicated and expensive proposition and should only be done with the assistance of competent and experienced counsel. The consequences of not being insurance can be devastating and can include the following sanctions:
1. Loss of all deductions on premiums received by the insurance company
2. Loss of all deductions from the premium payer
3. Power distribution or liquidation of all assets of the insurance company effectuating the additional tax for capital gains or dividends
4. possible adverse tax treatment as Controlled Foreign Corporation
5. the potential adverse tax treatment Foreign private Holding Company (PFHC)
6. the potential regulatory penalties for insuring jurisdiction
7. the potential tax penalties and interest the IRS.
All in all, tax consequences may be greater than 100% of the premiums to the captive. In addition, lawyers, wealth advisory CPA’s and their clients may be treated as a tax shelter promoters of IRS, resulting in fines as much as $ 100,000 or more per transaction.
Clearly establish captive insurance company is not something that should be taken lightly. It is important for companies trying to establish a captive work with competent attorneys and accountants who have the requisite knowledge and experience needed to avoid the pitfalls associated with abusive or badly designed structures insurance. A general rule of thumb is that a prisoner of insurance products should be legal inspection covers main aspects of the program. It is well known that the opinion given by an independent, regional or national law firm.
Risk change and the risk of abuse; Two key elements of insurance they are shifting risk from the insured to the other (risk of change), and the allocation of risk among a large pool of (risk distribution) insured. After years of litigation, in 2005 the IRS released Revenue ruling (2005-40) describes in principle required to meet the changing risk and distribution requirements.
For those who are self-insured, the use of captive structure adopted in 2005-40 Rev. ruling has two advantages. First, parents need to share risks with other parties. In Ruling 2005-40, the IRS announced that the risks can be shared within the same economic family as long as separate subsidiaries (the minimum required 7) are formed outside the tax business reasons, and the separation of these subsidiaries are also business reasons. Furthermore, “risk distribution” is provided as long as no secured subsidiary has provided more than 15% or less than 5% of premiums held captive. Second, specific provisions of insurance allow prisoners to take a deduction for the current assessment of future losses, and in some cases shelter income earned on the investment of the reserves, reduced cash flow necessary to fund future requirements from 25% to almost 50%. In other words, well-designed captive meeting the requirements of 2005-40 can bring cost savings of 25% or more.
Although some companies can meet 2005-40 within their own pool related parties, most privately held companies can not. Therefore, it is common for captors to buy a “third party risk” from other insurance companies often spend 4% to 8% per annum on the amount of coverage needed to meet IRS requirements.
One of the key components acquired risk is that there is a reasonable probability of loss. Because of this exposure, some promoters tried to circumvent the intent of Revenue ruling 2005-40 by directing customers to the “bogus risk pools.” In this fairly common scenario, lawyer or other promoters will have 10 or more captives of their clients into the collective risk-sharing arrangement. Included in the contract is written or unwritten agreement not to make claims on the pool. Customers like this arrangement because they get all the tax benefits of owning a captive insurance company without the risks associated with the insurance. Unfortunately for these companies, the IRS looks at these kinds of arrangements and something other than insurance.
Risk Agreements such as these are considered without merit and should be avoided at all costs. They study nothing but glorified pretax savings. If it can be demonstrated that the risk pool is bogus, protective tax status of the prisoner may be rejected and the serious consequences of tax described above will be enforced.
It is well known that the IRS looks at the arrangements between the owners of the prisoners with great suspicion. Gold standard in the industry is to buy risk third party insurance company. Anything less opens the door to potentially catastrophic consequences.
abusively High deductibles; Some promoters sell prisoners and the captives of them are involved in a large risk pool with a high deductible. Most losses fall within the deductible and are paid by the captive, not risk pool.
These promoters can advise their clients where the deductible is so high, that there is no real likelihood of third-party claims. The problem with this type of arrangement is that the deductible is so high that the prisoner fails to meet the standards set forth by the IRS. Prisoner looks more like a sophisticated pre-tax savings account, not the insurance company.
Of particular concern is that customers can be advised that they can pull all their premiums paid in the risk pool. In the case where the risk pool has few or no requirements (compared to a loss withhold participation exiles with a high deductible), premiums assigned to pool risks are simply too high. If the requirements are not, the premiums should be reduced. In this scenario, if challenged, the IRS will prohibit deductions made by the captive unnecessary premiums ceded risk pool. The IRS can also treat prisoners as something other than an insurance company because it did not meet the standards set out in the 2005-40 and previous related rulings.
Private placement Variable Life reinsurers Schemes; Over the years, promoters have tried to create a capture solutions designed to provide abusive tax benefits or “exit” from the capture. One of the more popular system in which companies create or work with captive insurance company, and the competence to Reinsurance Company the portion of the premium in proportion to the part of the risk insured again.
Usually Reinsurance Company is a wholly owned foreign life insurance company. Legal owner reinsurance cell is a foreign property and casualty insurance company that is not subject to taxation US income. Practically, ownership Reinsurance company attributable to the cash value of life insurance policies of foreign life insurance to the majority owner, or related parties, and ensuring the principle owner or related parties.
1. The IRS can apply Sham-trade theory.
2. IRS may challenge the use of reinsurance contract as inappropriate attempt to direct income from taxable to tax-exempt entities and will reallocate income.
3. Life insurance issued to the Company may not be considered life insurance for US Federal income tax because it violates the investor control restrictions.
Investor Control; The IRS has repeatedly in published revenue rulings his private letters its ruling, and other administrative order of filed, the owner of a life insurance policy will be considered tax owner of property legally owned life insurance policy if the policy owner lives “incidents of ownership” of these assets. Generally, in order for a life insurance company to be considered the owner of the assets in a separate account, control of individual investment decisions should not be left to the policy owner.
The IRS prohibits the policy owner or person related to the policyholder have no right, either directly or indirectly, to require the insurance company, or a special account, to acquire an asset with the money in a separate account. In fact, the policy owner can not say líftryggingafélagid any specific assets to invest in. And, the IRS has announced that it can not be predetermined schedule or oral understanding of what specific assets may be invested in a separate account (commonly referred to as “indirect control investing”). And, in a continuing series of private letter rulings, the IRS applies a constant look through approach to investment separate accounts of life insurance to find indirect control investors. Recently, the IRS issued guidelines for any investor control restriction is violated. This guide discusses reasonable and unreasonable levels of participation policy owner, so come harbor and impermissible levels of control investors.
The final factual decision is straight-forward. All court will ask if it was understood that it verbally communicated or tacitly understood that special consideration policy life insurance will invest his money in a reinsurance company issuing reinsurance for property and casualty policy that insured the risk of a company in which life insurance policy owner and the insured under life insurance policies are related or are the same person and the owner of the company minus the payment of property and casualty insurance premiums?
If you can answer yes, then the IRS should be able to successfully convince the Tax Court to manage investor restriction is violated. It says that income earned by a life insurance policy is subject to tax on life insurance policy owner as it is conducted.
The controlling investor restriction is violated in the structure described above, these systems generally provide for Reinsurance Company will be owned by a separate account life insurance policy insuring the life of the owner of the business persons related to the owner of the company. If one draws a circle, all the money paid as premiums of companies can not be available to unrelated third parties. Therefore, any court looking at this structure could easily conclude that every step in the development was predetermined, and to command investor restriction is violated.
Suffice it to say that the IRS announced in a notice 2002-70, 2002-2 CB 765, it would apply both the sham transaction doctrine and §§ 482 or 845 to reallocate income from a non-taxable to taxable to conditions that include property and casualty reinsurance arrangements similar to that described reinsurers.
Although property and casualty insurance premiums are reasonable and meet the risk-sharing and the distribution of exposures so that the payment of these premiums is deductible in full purpose US income tax, their ability to now reduce their contributions on their US tax returns physically separate from the question of whether life insurance policy just like life insurance for US income tax purposes.
Improper Marketing; One of the ways that captives are sold through aggressive marketing designed to highlight the benefits other than real business purpose. Are captive companies. As such, they can offer valuable opportunities to organize shareholders. However, the potential benefits, including the protection of assets, estate planning, tax advantaged investing, etc., will be the second in a real business purpose insurance company.
Recently, a large regional bank began to offer “Business and estate planning prisoner” customer trust department. Again, the rule of thumb in captivity is that they must operate as real insurance. Real insurance companies sell insurance, not “estate planning” benefits. The IRS can use abusive sales promotion materials from promoters refuse compliance and subsequent deductions related to prisoners. In light of the significant risks associated with inappropriate presentation, a safe bet is to work only with promoters sales materials focus on captive insurance company ownership control; no estate, asset protection and investment planning benefits. Better still would be for the Project to have a large and independent national or regional law firm review their content is consistent and confirm in writing that the material meets the standards set forth by the IRS.
The IRS can look back a few years to offensive material, and then to believe that the Project is marketing abusive tax shelters, start costly and potentially devastating examination of the insured market.
Abusive Life Insurance arrangements; A recent concern is the integration of small captives with life insurance. Small occupied treated under section 831 (b) do not have the legal authority to reduce insurance premiums. Also, if a small captive uses life insurance as an investment, cash value life policies may be taxable to capture, and then be taxed again when distributed to the ultimate beneficial owner. The consequence of this double taxation is to destroy the activity of life insurance and it reaches serious levels of responsibility to any accountant recommended plan or even signs the tax return of the company that pays premiums to the captive.
The IRS is aware of several large insurance companies are promoting life insurance policies and investment by small capture. The result looks eerily like that of thousands of 419 and 412 (i) plans are now under review.
All in all captive insurance arrangements can be tremendously helpful. Unlike in the past, there are now clear rules and case histories define what constitutes a properly designed, marketed and regulated insurance company. Unfortunately, some promoters abuse, bend and twist the rules in order to sell more prisoners. Often, a business owner who is buying captives are unaware of the enormous risks he or she faces the promoter acted improperly. Unfortunately, it is the insured and the beneficial owner of the captive that face painful consequences when their insurance company is considered to be offensive or non-compliant. Capture industry has skilled professionals who provide compatible services. Better use of experts supported by major law firm and slick promoters who sells something that sounds too good to be true.