Successful businesses face multiple risks in their daily operations including loss of a license or professional certification, legal defense reimbursement, collections risk, privacy violations, and reputational risk. Small- to medium-sized businesses can benefit from risk-management tools that can help them handle such risks more effectively and reduce their overall insurance costs. To that end, the business may want to consider the establishment of a Captive Insurance Company (CIC) to protect themselves from risks not typically covered by traditional insurance companies.
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Captive insurance planning is a strategy for business owners to manage risk through the purchase of a property-casualty insurance policy. Premiums paid by the business to a properly structured CIC should be tax-deductible to the business under section 162(a) of the IRS code just like their workers’ compensation or other business coverage.
When the company forms a CIC, it receives premium income tax-free up to $1,200,000 per year, per captive. Profits that come out of the CIC come out as a distribution from a C-corp. as qualifying dividends or long-term capital gains, which are currently 15%. Furthermore, the CIC may retain surplus from underwriting profits within reserve accounts, free from income tax. Profits that accumulate within the CIC can be used as a tax-deductible sinking fund in order to save money on insurance premiums by shifting to a high deductible policy and/or insuring that deductible through the CIC.
There are no hard-and-fast rules regarding the minimum amount of gross revenue from a business or the minimum amount of insurance premiums paid by a business before considering the establishment of a CIC.
The establishment of a CIC creates immense planning opportunities for business owners because of the flexible ownership of the CIC. The CIC is set up as a C-Corp and someone or some entity owns the shares of the C-Corp. While it’s important to keep in mind the primary business purpose of the CIC is for risk management, some potential planning opportunities include the following:
1. Wealth Accumulation/Surplus Retirement Income: Business owners own the CIC outside the business for surplus dollars in retirement.
2. Asset Protection Planning: Most business owners have the CIC owned inside an asset protection trust to potentially shield pre-tax dollars and assets from judgment creditors or litigation.
3. Estate Planning/Wealth Transfer: Business owners who don’t need access to this money may be interested in having the CIC owned outside of their estate to also bypass gift and estate taxes with each premium payment.
4. Business-Owner Benefits: By the CIC not being an employee benefit plan, it is not subject to the non-discrimination rules of ERISA, and therefore only benefits the owners of the business.
5. Non-Mandatory Participation for All Business Owners: Owners at smaller levels can join together to create a CIC for economies of scale.
Business owners would be encouraged to discuss the various CIC planning strategies with their tax, estate planning, and other legal professionals to ensure that the most appropriate structure is utilized to fit their unique planning objectives. As part of our services to the business, we would be happy to meet with the management and advisors to answer any questions and start the process of the feasibility of a CIC for the business. As reassurance, this is already IRS-tested, and we strictly adhere to each IRS Safe Harbor Revenue Ruling for a conservative model offering very predictable risk management and tax planning results.
While this is not intended to be a thorough discussion of CICs, it is meant to initiate a conversation with businesses or conduct due diligence with their key advisors as to the many potential benefits of establishing a Captive Insurance Company.
Mr. Guy P. Jones is a Certified Financial Planner in Houston, TX who has specialized in serving the financial planning needs of business owners and their families since 1990. He can be reached at 832.677.1692, email: firstname.lastname@example.org, or by visiting his website: www.guypjones.com