The IRS lately filed a petition to implement summonses issued to analyze tax legal responsibility stemming from a enterprise’s involvement in a captive insurance coverage transaction. Whereas captives can have many benefits—starting from elevated management, decreased prices, and favorable tax advantages—the IRS petition underscores the significance of structuring and implementing captives in accordance with all relevant legal guidelines.
Typically seen as a substitute for conventional insurance coverage markets, a “captive” is a wholly-owned subsidiary insurance coverage firm that gives protection for its mum or dad firm or group of associated corporations. Like a standard insurer, a captive is topic to jurisdiction-specific rules, like monetary reporting, solvency and reserve necessities, and annual actuarial opinions. Every jurisdiction additionally offers particular tips for the formation and administration of captives.
As is the case with conventional insurance coverage, the insured pays a premium to its captive insurer in alternate for protection. Nevertheless, as a result of the captive is owned and managed by the insured, it may well supply broader or extra tailor-made protection than conventional insurance coverage merchandise, together with defending some dangers that will in any other case be uninsurable. Different benefits of captives could embrace decreased working prices, elevated management over claims, and tax financial savings. For example, captive insurers pays dividends to house owners, and premiums could also be tax deductible enterprise bills if the captive’s risk-sharing association meets sure requirements.
Whereas captives supply many benefits, they’ll pose further challenges if not created and carried out appropriately, as evidenced by the IRS’s petition in United States v. Prince, No. 8:22-cv-1456 (M.D. Fla. filed June 27, 2022). In Prince, the IRS issued administrative summonses as a part of its examination of tax liabilities for 2 entities concerned in a captive insurance coverage transaction. Throughout two tax years, affiliated entities utilizing the captive insurance coverage association took enterprise expense deductions of greater than $425,000 for captive insurance coverage premium funds, all of which the captive reported on its returns as exempt from taxation. In response to the petition, which was served on the person shareholder and partnership consultant for the 2 captive entities, the businesses had didn’t adjust to the summonses.
Given the state of the insurance coverage market and ongoing difficulties with excessive premiums, much less favorable phrases, and decreased capability for a lot of traces of protection, corporations proceed to search for different threat switch choices—like captives, threat retention teams, and self-insurance—exterior the standard insurance coverage market. Captives could also be a pretty different given the potential flexibility, management, and value financial savings. Nevertheless, captives have to be structured and carried out appropriately to benefit from these advantages, together with any tax financial savings like these at problem in Prince. The IRS particularly scrutinizes captives to make sure that the entity is a bona fide insurance coverage firm, that it’s fashioned for a respectable enterprise objective, and that any preferential tax therapy of premium funds are permissible beneath relevant tax legal guidelines. Retaining skilled threat professionals at each stage of the method, together with attorneys to advise not solely on insurance coverage and regulatory compliance but additionally company and tax points, can assist maximize advantages in captive formation and decrease the danger of disputes with state, federal, or overseas authorities businesses.
