July 2013

Should Fear of an Audit Trump Winning Business Decisions?

A common concern we encounter when discussing the risk management and numerous other benefits of owning your own captive insurance company (CIC) is that owning a CIC may increase the risk of an audit by the IRS.  Such fears are often expressed by a client’s CPA or attorney who just doesn’t know any better, and occasionally by a few who do (or at least should).

Whether the IRS actually is conducting an audit sweep of captives is actually the subject of quite a bit of debate within the captive industry at the moment.  There is much rumor and innuendo and very little by way of facts.  But, here are a few facts regarding audits that are not debatable:

Tax avoidance is perfectly legal and encouraged by the IRS,

but tax evasion is against the law.

–         Internal Revenue Service Website

Countless business owners across America mailed checks to the IRS this week.  It certainly is difficult to part with hard earned profits.   Which begs the question, to what lengths should business owners and professionals go to reduce their taxes and keep more of their hard earned money?

The words “tax avoidance” may sound a bit sinister, particularly in a culture where politicians and the media

Most small and medium size businesses are under-insured.  Today, businesses face far greater risks than similar businesses faced in the past.  In addition to common risks like theft, fire and general liability, there are a host of other risks that businesses face that are specific to their industry and exacerbated by shifts in technology, regulations and the legal system.

Lawsuits are far more common in the current business climate, and lawsuits can come from both outside or inside a company.  Businesses face more and more regulations, and it’s not uncommon to read a news article about a business crippled or closed down by regulators.  Many businesses today also face cyber risks and threats to data security and IT systems.  As if that is not enough, terrorism in the U.S. now poses a legitimate threat to businesses.  And, many of these “new” risks are not covered by typical third party insurance policies.  These types of coverage often require additional policies that are often very expensive.

In addition to gaining the ability to self-insure and to own a profitable second business, a captive insurance company is one of the most formidable asset protection vehicles available to businesses and business owners.

However, prior to addressing this unique benefit, it’s worth noting the primary reasons that businesses form their own insurance company – specifically a captive insurance company (CIC).

1. To manage business risk by formally self-insuring certain risks with pre-tax dollars
2. To protect assets from creditors of the operating business and its owners or other risks
3. To realize profits and accumulate wealth inside of a separate business entity

These are well known reasons that legitimate captive insurance companies are formed by businesses. Assuming a captive insurance company is formed for the above reasons (or similar ones), it can also serve as the backbone (and full body armor) of a business owner’s asset protection strategy.