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Captive Insurance and Other Abusive Tax Shelters - HGExperts.com
y years that captives were merely (non-deductible) self-insurance programs, and unsuccessfully challenged captives on these grounds. Eventually, the IRS gave up on challenging captives as self-insurance programs, and instead recognized the concept of the captive and published guidelines as to what constitutes a proper captive insurance arrangement.
It is precisely because of these guidelines and existing case law that captive insurance companies do not work in all but the rarest of circumstances for physicians.
The attraction of a small captive is simple to understand. A property and casualty insurance company with net premium income of less than $1.2 million may elect under IRC Sec. 831(b) to be taxed only on its investment income. This means it is not taxed on its insurance underwriting income. If an insured is able to pay tax-deductible premiums of up to $1.2 million to its own captive, which then pays no claims, the insured reduces its taxable business income by $1.2 million and doesn’t pay tax when the captive earns that $1.2 million as premium income.[1]
The Problem with Life Insurance
The hope of selling a large cash-value life insurance policy with pre-tax dollars -- via the captive in this case -- has life insurance agents ringing up their physician clients just as every pre-tax life insurance scheme does. The problem is that cash-value life insurance makes a captive arrangement look and smell like a tax shelter. Real insurance companies typically buy little, if any, life insurance as an investment. Instead, they generally hold more traditional and relatively liquid investments like stocks and bonds.
Owning a cash-value life insurance policy in a captive reduces the captive’s liquidity, and thus its ability to pay claims as they arise. It's just not something that a real insurance company would purchase as its principal asset.
The fact that the IRS has never issued guidance that says that a captive insurance company cannot invest in a cash-value life insurance policy doesn’t mean that it’s not a bad idea. Captive owners have worked hard over the years to gain the IRS’s begrudging acknowledgment of the validity of legitimate captive insurance arrangements for tax purposes.
Using a captive as a device to buy cash-value life insurance with pre-tax funds makes it look much less like a bona fide insurance company, and much more like a tax shelter.
One thing is certain: the IRS has shown a strong distaste for arrangements that end up with the pre-tax purchase of life insurance. Captive-owned life insurance will be no different. Think 412(i) plans and 419A(f)(6) or so called 419e plans, and keep that Form 8886 handy.
Some captive arrangements more easily cross the line into the criminal. In an indictment in Michigan, the promoters had their clients make payments for "loss of income" policies to the promoters' captive in the U.S. Virgin Islands. The premiums were later returned to the clients in the form of loans.
ABOUT THE AUTHOR: Lance Wallach Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA faculty of teaching professionals, is a frequent speaker on retirement plans, abusive tax shelters, financial, international tax, and estate planning. He writes about 412(i), 419, Section79, FBAR and captive insurance plans. He speaks at more than ten conventions annually, writes for more than 50 publications, is quoted regularly in the press and has been featured on television and radio financial talk shows.
Copyright Lance Wallach, CLU, CHFC
More information about Lance Wallach, CLU, CHFC
While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.
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ReplyDeletey years that captives were merely (non-deductible) self-insurance programs, and unsuccessfully challenged captives on these grounds. Eventually, the IRS gave up on challenging captives as self-insurance programs, and instead recognized the concept of the captive and published guidelines as to what constitutes a proper captive insurance arrangement.
It is precisely because of these guidelines and existing case law that captive insurance companies do not work in all but the rarest of circumstances for physicians.
The attraction of a small captive is simple to understand. A property and casualty insurance company with net premium income of less than $1.2 million may elect under IRC Sec. 831(b) to be taxed only on its investment income. This means it is not taxed on its insurance underwriting income. If an insured is able to pay tax-deductible premiums of up to $1.2 million to its own captive, which then pays no claims, the insured reduces its taxable business income by $1.2 million and doesn’t pay tax when the captive earns that $1.2 million as premium income.[1]
The Problem with Life Insurance
The hope of selling a large cash-value life insurance policy with pre-tax dollars -- via the captive in this case -- has life insurance agents ringing up their physician clients just as every pre-tax life insurance scheme does.
The problem is that cash-value life insurance makes a captive arrangement look and smell like a tax shelter.
Real insurance companies typically buy little, if any, life insurance as an investment. Instead, they generally hold more traditional and relatively liquid investments like stocks and bonds.
Owning a cash-value life insurance policy in a captive reduces the captive’s liquidity, and thus its ability to pay claims as they arise. It's just not something that a real insurance company would purchase as its principal asset.
The fact that the IRS has never issued guidance that says that a captive insurance company cannot invest in a cash-value life insurance policy doesn’t mean that it’s not a bad idea. Captive owners have worked hard over the years to gain the IRS’s begrudging acknowledgment of the validity of legitimate captive insurance arrangements for tax purposes.
Using a captive as a device to buy cash-value life insurance with pre-tax funds makes it look much less like a bona fide insurance company, and much more like a tax shelter.
One thing is certain: the IRS has shown a strong distaste for arrangements that end up with the pre-tax purchase of life insurance. Captive-owned life insurance will be no different. Think 412(i) plans and 419A(f)(6) or so called 419e plans, and keep that Form 8886 handy.
Some captive arrangements more easily cross the line into the criminal. In an indictment in Michigan, the promoters had their clients make payments for "loss of income" policies to the promoters' captive in the U.S. Virgin Islands. The premiums were later returned to the clients in the form of loans.
ABOUT THE AUTHOR: Lance Wallach
Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA faculty of teaching professionals, is a frequent speaker on retirement plans, abusive tax shelters, financial, international tax, and estate planning. He writes about 412(i), 419, Section79, FBAR and captive insurance plans. He speaks at more than ten conventions annually, writes for more than 50 publications, is quoted regularly in the press and has been featured on television and radio financial talk shows.
Copyright Lance Wallach, CLU, CHFC
More information about Lance Wallach, CLU, CHFC
While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.