Professional Documents
Culture Documents
Presented by
Stuart Anolik, Esq. Managing Director, CBIZ MHM, LLC.
Seven Core Principles to Maximize the Value of Your Business During Its Life and Upon its Sale May 18th Creative Compensation Strategies to Maintain Morale and Retain Talent June 22nd Dont Be Held Captive: Go Captive to Manage Your Risk and Expenses July 20th Federal Incentives That Can Show You the Money August 17th Protecting Your Legacy with Succession Planning September 21st State Tax Nexus: No Physical Presence Required October 26th
All these webinars are from 2:00 3:00 ET. Here is the link for registration for any of these webinars - www.cbiz.com/strategicedge
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Agenda
1. 2. 3. 4. Introduction to Captive Insurance Why CBIZ Tax Issues Related to Captive Insurance Opportunities
Definition of a Captive
An insurance company owned and controlled by its policy holders.
Captive Illustration
Owner
Premiums Operating Business (Insured) Insurance Policies Captive Insurance Company (Captive)
CBIZ MHM is uniquely qualified to provide turn-key consulting services in regard to captive insurance as a result of its expertise in (i) accounting and tax for captive insurance companies through its Financial Services group and (ii) property and casualty insurance services through its Employee Services group, which includes our property and casualty professionals. CBIZ MHM can therefore develop and implement captive insurance solutions for traditional insurance coverages as well as for supplemental or non traditional coverages such as business interruption
Captive Benefits
Reduced Insurance Costs: Retention of underwriting profits Claims Settlement Casualty premiums are deductible Self-insurance is funded with after-tax dollars. Risk Management: Customized coverages. Not available in commercial markets Overly expensive Claims Management Wealth Preservation: Asset protection Owner control of stand-alone captive Flexible ownership structure
Accounts Receivable Administrative actions Business interruption Deductibles/Exclusions Earthquake Intellectual Property Litigation expenses
Loss of key customer Loss of key employee Loss of key supplier Mold Product recalls/warranty Subcontractor default Terrorism
Tax Implications
Anticipated loss reserves (subject to certain discounts) allowed as a deduction against underwriting income and investment income Have up to $1,200,000 Premiums. Are taxed on investment income and NOT underwriting profits - Tax rate is 36%. See IRC Section 831(b). Beneficial for most medium sized companies.
Treas. Reg. Section 1.162-1(a): Business expenses deductible from gross income included the ordinary and necessary expenditures directly connected with the taxpayers trade or business. Among the items included in business expenses are advertising and other selling expenses, together with insurance premiums. No definition in the Internal Revenue Code or regulations of insurance. Rely on judicial interpretation-Helvering v. LeGierse, 312 U.S. 531 (1941), must be risk shifting and risk distribution of insurance risk. Self Insurance is not deductible, unless loss sustained.
Risk Shifting- the transfer of the risk to separate party Risk Distribution- enough independent risks are being pooled to invoke the actuarial law of large numbers (e.g., spread risk among a large group)
Risk Shifting
Risk shifting occurs if a person facing the possibility of an economic loss transfers some or all of the financial consequences of the potential loss to the insurer, such that a loss by the insured does not affect the insured because the loss is offset by the insurance payment IRS will look to facts and circumstances Parental Guarantees
Risk Distribution
Pooling of Premiums Risk distribution entails a pooling of premiums, so that a potential insured is not in significant part paying for its own risks When a company insures unrelated risks, the arrangement constitutes insurance if a significant percentage of unrelated risks exists See, Ocean Drilling & Exploration Co, 988 F2d 1135, 1152-53 (Fed Cir 1993); Sears, Roebuck & Co, 96 T.C. 61, 100-02; Harper Group v Comr, 96 T.C. 45, 58 (1991) Brother-sister subsidiary corporations (i.e., subsidiary corporations of the same parent) may establish an arrangement and qualify as insurance for federal income tax purposes even if there are no insured policy-holders outside the affiliated group so long as risk shifting and risk distribution are present Rev. Rul. 2008-8 citing Humana, Inc, 881 F.2d 247 (6th Cir 1989); Kidde Industries v US, 40 Fed Cl (1997); Rev. Rul. 2002-89 A parent corporation with a direct arrangement with its own insurance subsidiary will still require sufficient risk pooling See Humana, Inc, at 257 (6th Cir 1989)
Rev. Rul. 77-316, IRS position that risk shifting and distribution do not exist in the context of a single economic family (i.e., parent-subsidiary) Exception: In Rev. Rul. 78-338, the IRS conceded that sufficient risk shifting and distribution are present where 31 unrelated parties pool risks In Rev. Rul. 2001-31, the IRS abandoned its position that risk shifting and distribution do not exist in the context of a single economic family It now appears arms length premium and loss reserve deductions attributable to brother-sister risk (i.e., other affiliates of the parent) will be accepted by the IRS But premium and loss reserve deductions attributable to parent risk will not be allowed without presence of significant unrelated party risk measured by premiums (30%?)(50%?)
Single parent captive otherwise properly formed and operated (adequate capital, no parent guarantees, loan backs, etc.) Not insurance if 90% of risks/premiums come from the parent Insurance if less than 50% come from the parent and the remainder are from unrelated parties
If your captive can have 50% 3rd party risk, may apply for a favorable tax ruling from IRS
Single parent captive otherwise properly formed and operated (adequate capital, no parent guarantees, loan backs, etc.) Insures 12 domestic subs - parent a holding company; no sub accounts for less than 5% or over 15% of total risk/premium Insurance under brother/sister doctrine
Industry group liability captive; exact number of participants not specified No member owns over 15%; has over 15% of vote; or accounts for over 15% of risk/premium; implies 7 equal owners OK No assessments or refunds Valid non-tax business purpose was a key factor IRS reinforces prior rulings on group captive insurance arrangements
IRS Holding: Captive constitutes an insurance company and premiums paid by participants are deductible
In situation 1, the IRS said there was no insurance if there is only one insured The same is true if there are two insureds - - one of which has at least 90% of the insurance
This was true for Situations 1 and 2 even if the parties were completely unrelated and all formalities were otherwise met The IRS ruled that single member LLCs that are disregarded for all other tax purposes are not counted as insureds Showed that single member LLCs that elect to be treated as corporations are counted as insureds
Caveats
The captive must still establish:
Presence of risk distribution That the captive should be respected as a separate and distinct taxable entity, i.e., it is not a sham
Non-Sham Status
Insurance status continues to require respect for the captive as an entity separate and distinct from its economic family:
Valid non-tax business purpose Adequate capitalization No parental support agreements Limited loan backs of captive assets to parent or affiliates (circularity of cash flow) Formation of captive in other than a weakly or non-regulated offshore domicile
Notice 2005-49
Notice 2005-49
The comments state that if each of these four factors are present in a loan back, there is insurance (if insurance otherwise exists):
Bona fide indebtedness (enforceable; reasonable terms and rates; appropriate security) Permitted or approved by the regulators Sufficient liquidity of the insurance company Sufficient liquidity of the borrower
Notice 2005-49
If less than all four factors are present, the comments state that the facts and circumstances must be reviewed to determine if the investment function undermines the essence of insurance
Cell A
Cell B
Cell C
Cell D
Notice 2008-19 requests comments on further guidance to address issues that arise if those arrangements do constitute insurance The Notice provides guidance that would address (a) when a cell of a Protected Cell Company is treated as an insurance company for federal income tax purposes, and (b) some of the consequences of the treatment of a cell as an insurance company. The proposed guidance would include a rule that a cell of a would be treated as an insurance company separate from any other entity if: the assets and liabilities of the cell are segregated from the assets and liabilities of any other cells and from the assets and liabilities of the Protected Cell Company based on all the facts and circumstances, the activities of the cell, if conducted by a corporation, would result in its being classified as an insurance company within the meaning of 816(a) or 831(c).
Foreign Captives
If the Captive is an offshore domiciled insurance company a Sec. 953(d) election to be taxed as a US Insurance Company may be made. It has these advantages:
Captive is NOT a Controlled Foreign Corporation US tax rates for Insurance Companies are as low as 15% No Federal excise Tax, Pass-through of income or Branch Profits Taxes Captive becomes a U.S. domestic corporation for all purposes of the U.S. tax code Captive files U.S. tax return and pays income tax (Form 5471 no longer required for shareholders) Eliminates U.S. trade or business concerns
Client
Build up in value benefits trust. Unused reserves can be distributed to trust as dividends.
Captive
Pays premiums to captive (deductible; not subject to gift tax)
Client Company
When the insureds actual claims are less than actuarially predicted, the captives reserves will grow.
If family members directly or indirectly own shares in the captive (e.g., through the dynasty trust structure), they benefit from this increase in value without any transfer tax liability.
In addition, the captive can distribute unused reserves to the captive shareholders (e.g., the dynasty trust) as a dividend (currently taxed at capital gains rates) or as a capital gain distribution upon complete liquidation of the captive.
The trust can distribute the income, if needed, for the trust beneficiaries.
Why CBIZ
CBIZ MHM has both the insurance expertise through its Employee Services (which includes our Property and Casualty professionals as well as the tax and accounting expertise to provide clients with fully integrated and seamless captive insurance services that are truly turn-key
Courtney W. Claflin joined CBIZ in January 2011. He has a 28 year career in Commercial Insurance Sales and has successfully designed hundreds of Alternative Risk Arrangements
Courtney brings with him a team of specialists to further CBIZs expertise in the captive insurance area.
Summary/Key Takeaways
Captive insurance solutions provides mid sized companies the benefits of maintaining underwriting profit in its group, control over risk management matters, control over claims management, thus creating potential significant savings in its costs of insurance Captive insurance provides mid-sized companies with flexibility in ownership thus allowing potential estate and wealth preservation opportunities CBIZ can provide a seamless, turnkey captive insurance solutions due to its expertise in (i) insurance tax and accounting and (ii) property and casualty and alternative risk
QUESTIONS?
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