It’s April 15, and business owners across America are mailing checks to the IRS. One way to look at mailing a large check to the IRS is, “it’s a good thing because it means we made money.” Another way to look at mailing a large check to the IRS is, “what tax avoidance vehicles would enable us to better serve our business and hold on to hard earned profits for the future?” To what lengths should business owners and professionals go to reduce their taxes and keep more of their hard earned money?
Congress wants businesses and business owners to avoid taxes. Yes -that’s right – Congress wants businesses and business owners to avoid paying taxes. Congress provides American taxpayers with a myriad of ways to legally avoid taxes. In return Congress wants Americans (or businesses or business owners) to adopt certain behaviors.
Here are a few simple examples.
The mortgage interest deduction encourages home ownership. A byproduct of higher home ownership (versus most homes being owned by landlords) is that it fuels more real estate transactions boosting the real estate, appraisal, home inspection and mortgage industries.
Green energy credits encourage businesses and individuals to purchase “greener” technologies like tankless water heaters, electric cars, etc.
Charitable deductions encourage giving to non-profits which have enabled enormous aid to the needy, benevolence, education, healthcare research, religious observance, ministries and numerous other beneficial organizations.
Depreciation expenses encourage companies to purchase new equipment. This helps companies increase capacity and also creates sales for the equipment manufacturer. Tax avoidance incentives often spur economic activity, create jobs and strengthen the very businesses that benefit from tax avoidance. Tax avoidance strategies often encourage companies to act in their own long-term best interest.
Speaking of long term best interest, there are few tax avoidance strategies that rival the benefits of owning a captive insurance company. After all, all insurance companies avoid taxes to one extent or another on reserves set aside for future claims.
What Is A Captive Insurance Company?
In short, a captive insurance company is a fully licensed insurance company owned by the business, its owners or related parties. It is also a unique insurance company and includes its own corporation, insurance license, reserves, policies, policyholders, and claims. It is a formal way for business owners to self-insure risk. Captives are generally formed to insure (primarily though not exclusively) the risks of one or more businesses owned by the same or related parties.
What Are The Benefits Of Owning A Captive Insurance Company?
Some of the most common benefits of captive ownership include:
- Improved Risk Management – the captive provides increased or improved insurance coverage to the parent company
- Funding Loss Reserves For The Future – the captive can accumulate reserves for potential losses in the future
- Asset Protection – if properly structured, the captive and it assets (reserves) may be unreachable by the parent company’s creditors
- Flexibility – the captive gives the parent company flexibility if the commercial insurance market changes or additional risks are identified
- Cost Control – as a licensed insurance company, the captive has access to reinsurance markets
- Wealth Accumulation – the parent company and / or its owners can accumulate wealth as reserves of the captive
- Wealth Transfer – the business owner’s heir (s) or key employees or other related parties can own the captive
How Can a Captive Insurance Company Function as a Tax Avoidance Vehicle?
A captive insurance company receives favorable tax treatment on the premiums it collects. As an example, consider a limited liability company (LLC) with a single owner. The business has an annual profit of $500,000 and after tax retained profit of $250,000.
However, the business owner could own a captive insurance company and pay $500,000 in insurance premiums annually from the parent company to the captive. The business would benefit from improved risk management and reduce the parent company’s taxable income to $0 in this example. Since annual premiums are below $1.2 million, the captive could make a small insurance company tax election known as an 831 (b) election. The captive pays taxes at a 0% rate on premiums collected. Assuming administration and claims total $50,000 annually, the captive will have retained reserves of $450,000.
What Can a Captive Insurance Company Do For your Business?
Simply put, it can enable your small or mid-sized business to access the same tax avoidance strategy employed by large insurance companies. This tax avoidance strategy is provided for by Congress to encourage businesses to adopt more sophisticated risk management. For instance, a typical captive insurance company created for legitimate risk management and asset protection reasons can save as much as half a million dollars a year or more in combined federal and state income taxes. Congress wants business owners to keep more of their hard earned profits, if it encourages them to adopt a more robust and sophisticated risk management strategy. And captive insurance company ownership enables business owners to do just that.