Business owners can set up a captive insurance company to help protect their existing company from certain risks.
Commonly referred to as captive insurance company.
Do I Qualify for the Captive Insurance?
Setting up a captive insurance company can help protect your business from financial risk while giving you greater control over how your business is insured. It allows you to pay tax-deductible premiums to a captive insurance company you create, instead of a third-party insurer, saving you money that would otherwise have to be paid to the third party.
2022 Captive Insurance Details
A captive insurance company is a type of private insurance company business owners can establish to protect their existing company (known as the parent company) against certain risks. This is an alternative form of risk management that allows companies to protect themselves financially and have more control over how they are insured. The insurance company is owned and completely controlled by the insured company.
How does a captive insurance company help save on taxes?
A business can choose to pay tax-deductible premiums to its own captive insurance company, instead of a third-party insurer, saving itself the money that would otherwise have to be paid to the third party. In addition, many captive insurance companies have developed into profit centers with cash reserves that accumulate tax free when the premiums the parent company pays exceed the claims it makes. When excess reserves are pulled out of the captive insurance company, they're taxed at capital gains rates rather than ordinary income rates.
For example, assume a company is paying $500K a year in liability insurance. These expenses are deductible to the company, but the $500K cash is still leaving the business. If the same company creates a captive insurance company, they will still pay the $500K in insurance premiums, but the cash for the premiums will be paid to the captive insurance owned by the parent company and invested. These gains will be owned by the captive insurance company and, when distributed, are taxed at capital gains rates instead of ordinary income.
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• The business may see an increase in savings to its bottom line.
• The business will be exposed to less risk because it will be covered by more targeted insurance.
• Money in the captive insurance account can accumulate over time and be invested.
• May require a captive feasibility study to ensure it makes sense for the business to set up a captive insurance company and to document the reasons why the business is doing so.
• Burdensome regulatory requirements.
• High potential for an audit, as captive insurance arrangements are on the IRS’s “Dirty Dozen” list of abusive tax strategies.
Assumptions When Taking the Captive Insurance
• The purpose of the captive insurance company is to provide insurance to the parent company.
• None noted.
Requirements to Claim the Captive Insurance
• The arrangement must involve the existence of "insurance risk."
• There needs to be both risk shifting (transferring risk from one party to another) and risk distribution (spreading out an insurance company’s risks to ensure its success).
Business Entities That Can Claim the Captive Insurance
• Schedule C
• Schedule E
• Schedule F
• Farm Rental
• S Corporation
• C Corporation
The material discussed on this page is meant for general illustration and/or informational purposes only and is not to be construed as investment, tax, or legal advice. You must exercise your own independent professional judgment, recognizing that advice should not be based on unreasonable factual or legal assumptions or unreasonably rely upon representations of the client or others. Further, any advice you provide in connection with tax return preparation must comply in full with the requirements of IRS Circular 230.