With captive insurance, a business or a group of businesses essentially creates its own insurance company. This option generally exists in contrast to buying insurance from a provider or opting for self insurance. There are numerous advantages to captive insurance, but before taking the leap with your organization, you may want to look at some of the tax implications.
Tax Deduction for Insurance Premiums
Normally, when you buy insurance, you can claim a deduction for the cost of your premiums just as you do for almost any other business expense. That rule also applies to captive insurance policies — even though you basically own the insurance company, you can still claim a deduction for the cost of premiums.
Liquidated Funds Are Long-Term Capital Gains
With a traditional insurance policy, you pay the premiums, but you never get any money back unless you make a claim. With captive insurance, your premiums go into the fund, and if you don’t need them, they stay in the fund, growing over time. Eventually, you can liquidate the fund, and when you take the money, you don’t have to pay income tax. Instead, the funds are considered to be a long-term capital gain and you face capital gains tax which is significantly lower than most income tax.
Internal Revenue Service Concerns
Unfortunately, in a few cases, the Internal Revenue Service (IRS) has rejected some tax claims related to their captive insurance plans. In cases involving Securitas Holdings, Rent-A-Center, and other entities, the taxpayer has gone to tax court to prove the legitimacy of the captive insurance company. In most cases, the tax court upheld the taxpayer’s right to use captive insurance companies and to reap any associated tax benefits.
However, the main issue that comes up in these cases is the legitimacy of the captive insurer and its relationship to the parent company. To ensure you don’t face any tax hurdles like that, you should consider consulting with a professional accountant, but you should also work with an experienced company who can help you set up your captive insurance plan.
Lower Tax Rates
The captive insurance company also experiences tax benefits. As of 2018, small captive insurance companies that receive annual insurance benefits of less than $2.3 million are taxed at 0% on their underwriting profits. Their investment income faces a 21% corporate tax rate — the Tax Cuts and Jobs Act lowered this rate, as previously it was up to 35%.
In some cases, profits from captive insurance companies can also benefit from the pass-through deduction. Although the specifics of the pass-through deduction are complicated, the main idea is that if you own a business when you have to report the profits as personal income, you may be able to claim up to a 20% deduction on those profits. However, this amount varies based on the type of industry, and there are income-related caps. For specifics, you need to consult with an accountant.
If you’re ready to enjoy the benefits of a captive insurance company, if you’re looking for ways to lower your insurance premiums, or if you just have questions, contact us today. At Venture Captive Management, we can guide you through the process.