Captive insurance companies are privately owned insurance companies sometimes used by larger businesses and sophisticated investors for the purpose of providing insurance coverage where other insurance alternatives are either unavailable or unreasonably priced. Such companies are essentially a form of self-insurance in that they accept and hold premiums from a parent entity for the purpose of covering unforeseen future insurance claims by that entity. In addition to reducing both cost and risk, they provide their owners with a very significant tax advantage. In fact, the ownership of privately owned captive insurance companies is one of those significant tax benefits that politicians and news agencies are referring to when they discuss tax breaks that benefit large corporations but are generally not available to smaller businesses and individuals.
Larger businesses have used captive insurance plans as a lower cost alternative to standard commercial insurance for quite some time. Like a standard insurance company, the captive insurance company “collects” premiums from the insured entity in exchange for providing loss and damage coverage in the event of an unanticipated occurrence. If no claims are made, the insurance company keeps the premiums that have been paid. The difference is that, through the use of a privately owned captive insurance company, a business or investor insures itself, thereby maintaining direct control of their insurance program. Because captive insurance company owners are putting their own capital at risk, they often re-insure certain types of loss in order to limit their exposure in the event of a significant occurrence.
In addition to risk management and cost savings, a properly used captive insurance plan provides significant tax benefits. Specifically, a privately owned operating company may pay its separately operated, privately owned captive insurance company up to $1.2 million annually and receive a full tax deduction for the premiums paid. The captive insurance company itself is not required to report the premiums received and is only taxed on the income it receives from investing those premiums. Meanwhile, the operating company achieves a significant tax savings. For example, the full amount of the deduction for a company paying $1.2 million in captive insurance premiums at a 40% tax rate would yield a tax deduction of almost a half a million dollars annually. In addition to this significant tax savings, captive insurance company owners enjoy gift and estate tax planning benefits, tax deferred wealth accumulation, asset protection and favorable tax treatment of distributions.
The most common type of captive insurance company is an Internal Revenue Code 831(b) “mini-captive”. This is a privately owned insurance company that elects, under Internal Revenue Code Section 831(b), to be taxed only on its investment income provided that it receives less than $1.2 million in premiums each year. The 831(b) election is filed along with the company’s first annual income tax return and may not be revoked without Internal Revenue Service consent. The focus of an 831(b) captive is generally to insure risk where coverage is not available through traditional insurance companies. Some of the insured risks include directors and officers insurance, business interruption, product liability, extended warranties, kidnapping and embezzlement. For high income taxpayers and taxpayers with capital gains transactions, the use of privately owned captive insurance companies may provide the combined benefits of risk management, tax savings and wealth accumulation.
The experienced professionals CGT Solutions have a thorough understanding of the benefits and risks associated with captive insurance plans as well as the regulations governing their use. If you are interested in investigating the possibility of protecting your business or personal assets using a captive insurance plan, contact us today!
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