American businesses continue to reel as their insurance costs dramatically increase annually, leading many to look for alternatives to traditional insurance. One popular alternative is the creation and use of a micro-captive insurance vehicle—an effective way to control business costs, and potentially realize tremendous tax advantages. However, be mindful that micro-captive insurance recently has come under extreme scrutiny by the IRS. Additional compliance and care must be taken to take full advantage of a micro-captive, but potential tax savings still exist.
Micro-captive insurance companies are established by businesses utilizing a related entity structure. The business subsequently pays insurance premiums to its own micro-captive- related party. The captive company then provides insurance coverage to the active business, essentially as a form of “self-insurance.” The insurance premiums paid to the captive are treated as a deductible business expense like any other insurance premiums paid.
So what is the benefit? The micro-captive company is not subject to income tax on the premiums received. It is taxed only on the investment income earned, and therefore can exclude the payments received under the contracts from income. This means that, to the extent insurance claims are not made, this strategy creates substantial annual tax deductions, with minimum income pick-up in the micro-captive entity. The maximum annual deductible premium for calendar year 2017 is $2.2 million, and this amount will be indexed to inflation for years thereafter. Prior to 2017, the maximum deductible premium was $1.2 million.
But, businesses beware: the IRS has recently deemed most micro-captive arrangements created after November 2, 2006, as “transactions of interest.” What does this mean for current or prospective captive owners? The compliance costs have increased due to significant notice requirements (timely filing of IRS Forms 8886, 8918). Also, the micro-captive must be structured and managed properly. Businesses must hire legitimate insurance actuaries and underwriters, properly structure—as if done in an “arms-length” manner—the insurance contracts to make economic sense for both the active business and the micro-captive, and comply with state insurance laws and risk pooling requirements to qualify.
If you have any questions about micro-captive insurance, or would like to request a speaker on this topic for your organization or event, contact one of our executives below, at (800) 270-9629.
