Schedule a Consultation Today  |  624 North Front Street, Wormleysburg, PA 17043

Law Blog

Do You Have a Captive Insurance Company? What Might Catch the Attention of the IRS…

IRS examinations of captive insurance arrangements are on the rise. You may now wish to revisit your captive insurance arrangement.

IRS examinations of captive insurance arrangements are on the rise. You may now wish to revisit your captive insurance arrangement.

Captive insurance is a very powerful tool in insuring against business risks. An IRC §162 deduction is available for insurance premiums paid by the insuring business, plus up to $1.2 million of the captive insurance company’s earnings may escape taxation. The IRS is aware of these powerful benefits and believes that many of these arrangements exist for the tax benefits rather than to provide valid insurance.

In examining a captive arrangement, the IRS will initially demand copies of all promotional materials. Throughout the IRS examination, the IRS has made it clear it will look for the following “red flags”:

• Materials emphasizing the income tax goals of the captive insurance arrangement; i.e. the materials emphasize premium deductions versus insurance needs.
• The realistic probability of coverage applying to the business. If the likelihood of the insurable event happening is low, the IRS believes the cost of coverage should likewise be low.
• Reverse engineering the amount of premiums to equal exactly the $1.2 million exemption
• An impermissible circular flow of funds, i.e. where the premium monies, either through loans or distributions, end up in the hands of the insured business or a closely related party).
• Lack of adequate risk distribution or risk shifting. This arises where the captive insures only the single business and simply holds the premium monies in the event of a claim.
• Failure to obtain an actuarial study supporting the premiums charged (a valid underwriting process) by the captive.
• No analysis of the cost and availability of commercial insurance in the non-captive market. Insurance rates far in excess of commercially available rates indicate a tax purpose versus insurance purpose.
• Materials emphasizing the estate planning benefits of the captive insurance structure. The IRS position is that I.R.C. §831(b) was not enacted as an estate planning tool, but to assist taxpayers who want to manage risk.
• The existence of guarantees, which is a sign of inadequate capitalization.
• Lack of claims history. No claims indicates that the insurance pool is insufficient and risk shifting may not exist.

These “red flags” do not automatically invalidate a captive arrangement. However, they are indicators that in substance the captive arrangement lacks risk shifting, risk distribution, and fails to qualify as insurance in the commonly accepted sense.

Apr 25, 2014 | Articles, Featured

Check Out Our Downloadable Guides

Our team has the knowledge and experience to provide you with sound legal advice and representation.

About Cherewka Law

We are a law firm in Harrisburg, PA dedicated to providing comprehensive, highly personalized planning services to individuals, couples, families and businesses.

Start the Conversation

Send us a message today!

"*" indicates required fields

This field is for validation purposes and should be left unchanged.

Download Your Elder Care Planning Guide Today

Learn how you can begin planning for the care of the elders in your life. Receive a download of our most current Elder Care Planning Guide by clicking the download button and filling out your information.

"*" indicates required fields

Name*
This field is for validation purposes and should be left unchanged.

Download Your Probate & Estate Administration Guide Today

Learn where you stand in your Estate Administration process. Receive a download of our most current Estate Administration Guide by filling out the form below.

"*" indicates required fields

Name*
This field is for validation purposes and should be left unchanged.

Download Your Estate Planning Guide Today

Learn where you stand in your Estate Planning process. Receive a download of our most current Estate Planning Guide by filling out the form below.

"*" indicates required fields

Name*
This field is for validation purposes and should be left unchanged.

Call Now Button