Lions And Tigers and the IRS … Oh My!
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:
Both the Department of Labor (DOL) and Internal Revenue Service (IRS) have announced that they are significantly increasing their audits of qualified retirement plans (401(k) plans, 403(b) plans, etc.). The DOL is hiring 700 new auditors in support of the cause. Why? Well, during 2010 alone, before the increased focus on qualified plans, the Department of Labor collected over $1 billion in employer fines from its retirement plan audits. It’s estimated that nearly 70% of the plans audited each year result in additional revenue for the federal government.
Not to be outdone, the IRS has likewise “intensified its qualified plan audit activity and demonstrated its own authority to impose significant monetary penalties” (Plan Sponsor FYI 2012 Q4 Newsletter). A recent article written by New York Life, a significant recordkeeper of such plans, summarizes the threat posed to retirement plan sponsors by the DOL and IRS as follows, “The anticipated increase in DOL and IRS audit activity in the coming years exposes retirement plan sponsors to heightened plan compliance risk as these regulatory bodies focus resources on discovering fiduciary breaches (12-6-2012 Plan Sponsor.com).”
Given this increased risk, should businesses hesitate to adopt qualified plans? Should those businesses that have adopted them consider curtailing them to avoid increased audit risks? Are CPAs and attorneys advising their clients to “proceed with caution” when adopting such plans?
Of course not. The economic benefits of such plans are extraordinary. A business owner would be crazy to choose not to adopt such a plan or to curtail an existing one due to concerns of increased audit risks. Rather, the appropriate course of action is to simply manage any such plan in compliance with the law and to utilize the services of experts to make sure that happens.
Our experience suggests that fears of CIC ownership boosting odds of an audit are simply unfounded. Best estimates show that businesses with CICs are audited at about the same rate as those without. We have personally yet to encounter a business that was audited for having a CIC.
But, even if that were not the case, business owners should evaluate captive insurance companies in the same ways that they evaluate other business decisions, like sponsoring a qualified plan. They should perform a cost-benefit analysis on the enhanced risk management, asset protection and tax savings afforded by a captive insurance company and weigh it against the costs of setting up and managing a captive, and the increased risk of audit, if any. Armed with this information, a business owner can make the best decision for his or her company.
Blowhards on the web hyping increased audit risk should not deter business owners from following a plain reading of the law and choosing to own their own captive insurance company if it is the right move for their business.
We have been helping businesses benefit from a plain reading of the law since 2005. We can do the same for you.