Hot Topic Issue: What is The Tax Shelter Captive?

should your public entity participate in a risk sharing pool

Hot Topic Issue: What is The Tax Shelter Captive?

When the federal government adopted The Tax Shelter Captive IRC 831(b), captive insurers were provided the opportunity to deduct premiums from their tax bill. The benefits are obvious. Unfortunately, those benefits led to an abuse of the system. Some captive insurance groups are merely tax shelters that offer little to no risk coverage.

How do you know that the captive you are joining, or the one that you are in the process of setting up, is reputable? Choose your captive carefully and look for red flags that indicate non-compliance.

Self-Owned and Self-Insured Advantages

Captive insurance companies are advantageous to industries that find themselves in need of extended coverage, whether that is cyber insurance or terrorism insurance. Industries that are high-risk, such as life sciences or health and wellness, also take advantage of forming pools that distribute risk across members, thus lowering everyone’s risk and everyone’s premium.

Insureds are also owners, so when the established captive insurance liability company is formed, all members enjoy a share of profits. Finally, the greatest advantage of captive insurance groups is their relatively unlimited geographic range. Thanks to captive insurance software, overhead costs are low despite the need to coordinate policies across third parties or the necessity of adhering to regulations that change across borders.

Understanding Your Motives and Goals

The advantages outlined above provide many companies with a motive to form or join a captive insurance group. And here’s where the tax shelter captive option adds another benefit. This option ensures that captives that generate less than $1.2 million in premiums will not have to pay taxes on premium income. In this instance, all owners and stakeholders can write off premium income.

If your goal is to shelter funds, then manipulating the tax shelter captive option might be of interest to you. If your goal is to lower your premiums, mitigate risk and provide protection for your employees, then the captive tax shelter option might not be of interest. Recently, the option has come under scrutiny by the IRS, an agency that is quite interested in small group insurance agencies.

The IRS and Tax Shelter Captives

A recent tax court ruling has made it clear that insurance companies using the tax shelter captive option must meet certain requirements. Premiums must not be excessive, risk must be distributed, claims must have the potential to be paid and there must be a proven insurance risk. Insurance management software easily runs data analytics across siloes, ensuring that regulations are met. If any of these criteria go unmet, then the captive is not operating as a true insurance company. After an audit, such a company will be subject to fines and other punitive measures.