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Private Captive Insurance Companies-§831 in Brief
Highlights:
- Allows you to take a $1,200,000 deduction
- Allows you to reduce the tax rate from 35% to 15% by changing ordinary income into dividend income without paying corporate tax
- Potential tax savings of over $500,000+ per year
- Suitable for business owners with more than $500,000 per year of income, even better for individuals with very high income
How it works:
- You set up your own insurance company, which insures your other operating businesses
- Your operating business takes a deduction of up to $1,200,000 per year for business-related premiums paid to your insurance company
- Your insurance company pays no income tax on premium income, but it pays tax on its investment income
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Private Captive Insurance Companies-§831 in More Depth:
Since the enactment of Tax Reform Act of 1986, many companies and high-net worth families have seen the benefit of having their own for-profit “captive” insurance company. As per Section 831 of the Internal Revenue Code, these companies do not pay any taxes on premiums they charge to related businesses. It also allows such related businesses to take a deduction for any business-related premiums paid to their affiliated insurance company.
Yes, that’s right, if you pay up to $1,200,000 premium to this company to cover business risks, you get to deduct it as an expense, and keep the money in your insurance company without paying tax on it or on its return. You could say this is a giant self-directed, no penalty IRA.
Want more? Although they can established in the U.S., many of these reinsurance companies are incorporated and licensed in countries like Bermuda, Panama, Nevis, the British Virgin Islands and the Turks and Caicos Islands. These controlled reinsurance companies are often also controlled foreign corporations (CFCs), but the IRS’s CFC or PFIC rules generally do not apply to them.
Here are the basic rules. In order to qualify for these benefits under IRC 831, an organization:
- Must be an insurance company or association: a license to conduct insurance business activities shall serve as strong evidence that the company is in effect an insurance company.
- Must not be a "life insurance company”: limit yourself to casualty, liability and similar insurance risks.
- Must have $1,200,000, or less in premium income,
- Must issue or reinsure contracts of insurance which shift and distribute a risk of loss: Risk distribution requires the pooling by the insurer of a number of independent risks, such as for example insuring multiple business units; and
- Must not be a "sham" corporation (i.e. you should not be undercapitalized).
There is one disadvantage, these companies are expensive to set-up and maintain. Total fees and expenses to start a captive insurance company (inclusive of all contingencies) will run anywhere from $40,000 to $80,000 on average, sometimes more. Annually, the management fees/expenses will run you about $30,000 to $50,000. The minimum required capitalization for these captives is generally around $100,000. However, it allows you to defer taxation on up to more than $500,000 per year, depending on your situation, or to reduce taxation by over $200,000 on a current year basis.
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