Due to the significant tax incentives afforded properly designed and operated insurance companies, the IRS is increasingly concerned many owners may have a primary tax savings, not risk management business objective, in forming small closely help captives. It is expected the IRS examiners will start to use the newly codified economic substance test and related penalties in audits of captives they feel are not designed and operated correctly or for the right business reasons. Click here to view the IRS website and form guidance on this new codified test.
Tom Cifelli
On August 25, 2015, CICA, the leading US captive insurance association, issued a press release with additional guidance on how to do small 831(b) micro-captive programs right. Click here to review the press release and best practice guidance memo. Click here for information on purchasing CICA’s full practice standards guidance report.
Our captive programs meet or exceed all of these practice standard guidance. In fact our Managing Director helped establish these best practice standards when he worked at the executive level with several of the top US captive managers, and authored an article in 2014 published by Captive Review on best practice standards. Read his article by clicking here, as it has far more detailed guidance than the CICA guidelines. Click here to read an in depth article on claims handling best practice standards.
We at Captive Experts are thrilled to see this pro-active trend to improve practice standards by other managers to help protect the long-term viability and reputation of the micro-captive industry.
For more detail on Captive Experts’ turnkey captive design, formation and management best practice standards and procedures, click here.
Click here to read the full article by Active Captive’s General Counsel and Chief Compliance Officer, Dana Hentges Sheridan, featured in Captive Visions July 2015 publication, titled“Best Practices in Handling Claims for Captive Insurance Companies”.
US IRC 831(b) amendments are not a new thing. They happen almost annually. Nothing meaningful has passed into law in recent years. However some change effective for 2016 is a real possibility. Any change will create planning opportunities and challenges (Activity summary below from http://www.captiveglobal.com/831b-legislativeupdates).
Spring 2015 Action in US House and Senate on 831(b) Legislation
This page will supply a running account of important activity in both the House and Senate on amendments to existing 831(b) legislation that will impact small insurance companies, including captives. It is likely to become long, with the most recent updates at the top. We think that it makes sense to keep everything on a single page throughout the coming weeks. We will supply dates for each update.
CaptiveGlobal.com wishes to thank Ryan Work, Senior Director of Government Relations, Self-Insurance Institute of America, Inc. (SIIA) for supplying these updates from Capitol Hill.
July 22, 2015: BREAKING NEWS FROM WASHINGTON, DC: Follow this link to download the 831(b) specifications (‘specs’) issued from the Joint Committee on Taxation (JCT).
In summary, JCT is proposing an outright ban on captive ownership based on familial relations, with a 5% de minimis exception. This prohibition looks to be much broader than trusts, and goes into additional entities and corporate structures. The spec includes language outlining a “consideration” for a broader family rule. Congressional staff is currently reviewing the specs to determine if this proposal adversely affects certain constituencies, particularly family owned mutual companies.
JCT specs are typically issued as a recommendation or response to legislative proposals. It is important to note that JCT’s specs are not an indication that 831(b) legislation is moving any time soon. As previously reported, if any 831(b) legislation were to move at all, the proposal would be most likely be included in the Highway Trust Fund Reauthorization currently being negotiated by the House and Senate, or other end of year tax legislation. Currently, staff does not know whether and when these two legislative vehicles will move, and whether an 831(b) proposal would even be added to these vehicles as they are processed through Congress. As the process continues, we will provide additional updates.
April 29, 2015: House bill HR 1788 was introduced a week or so ago, and was a reintroduction of a bill dropped last Congress.
Shortly after Chairman Hatch introduced captive legislation in the U.S. Senate, Reps. Erik Paulsen (R-MN) and Ron Kind (D-WI) introduced a variant captive bill in the U.S. House of Representatives, which was reported to the Committee on Ways and Means. This legislation, HR 1788, proposes an 831(b) threshold increase to $2.2 million tied to an inflation index with no Treasury study language.
The House legislation is not unexpected and, like the Senate bill, was introduced to assist farm mutuals, which are heavy in both co-sponsoring Member states. Also important, it is a reintroduction of a similar bill introduced last Congress, HR 4647, partly to counter then Ways and Means Chairman Dave Camp’s (R-MI) proposal to eliminate IRC 831(b) as part of his tax reform package. As previously discussed, Ways and Means Committee staff, as well as the Joint Committee on Taxation, have both expressed concerns in the past over captive abuse and have proposed placing restrictions or prohibitions on its use.
With legislation being introduced in the House, it does bring the issue into both chambers as we had expected. Now dealing with two different bills, and not mirroring legislative text, questions remain as to which one will be the main legislative vehicle and how might it be changed during the process. As in the Senate, the House bill may be modified at both the committee level and on the floor under the amendment process. Any differences between House and Senate legislation would require a conference committee or, more likely, an agreement on legislative language that could be attached to a general revenue bill that may come up for consideration.
April 14, 2015 – Legislation is currently being considered in both the U.S. House of Representatives and the Senate that seeks to increase the written premium threshold of IRC § 831(b) from the current $1.2 million to $2.2. Million. There is also the potential for language restricting the future of captive usage.
Background
When Congress first placed IRC § 831(b) in the code in 1986, it intended to extend the tax benefits previously given only to mutual insurance companies to all small insurance companies, encouraging companies to build up reserves to protect against losses, a tool critical to most small and mid-sized businesses.
Recently, concerns have been raised to Congress by the IRS/ Treasury that some of these small captive insurance companies are being marketed for abusive purposes. Instead of the risk management and insurance purposes outlined above, the concern is that some small captives are being marketed only to accomplish estate planning benefits. While structuring the ownership of captives to achieve estate planning benefits is neither unreasonable nor prohibited, the intent of Congress was not to excessively promote that usage.
Because of these concerns, legislative text was considered by the Senate Finance Committee in February of 2015 that, along with a non-controversial goal of increasing the threshold for written premiums under IRC § 831(b) from $1.2 to $2.2 million, would place potentially devastating limitations on the use of captives by businesses. These original restrictions — subsequently removed from the legislative text due to deep seated industry concerns from SIIA and others — would have prohibited the use of reinsurance and limited 20% of net written premiums to a policyholder under a single taxable year for purposes of IRC § 831(b).
The final legislative text passed unanimously by the committee, and introduced earlier this month by Senate Finance Chairman Hatch (R-UT), S. 905, would increase the written premium threshold to $2.2 million without additional restrictions. The legislation also calls for a U.S. Treasury study on the use of captives as an estate planning tool and requests specific legislative language to address abuse, to be completed no later than February of next year.
In terms of additional Congressional action, Chairman Hatch’s bill was simply the formal filing of the legislative language and report passed out of the Finance Committee and has no bearing on the opposition or acceptance of additional restriction language, or an indication that a clean bill is a certainty. It does indicate, however, that the 831(b) proposal is now one step closer to floor consideration, where additional changes and/or amendments to the legislation can and will be proposed.
SIIA Captive Industry Proposal
Understanding the concerns surrounding the potentially abusive usage of captive insurance for estate planning purposes, SIIA and industry participants believe that instead of a broad brush approach that would inadvertently damage an industry that is working well, it would be beneficial if incentives for abusive estate planning designs were curbed in two key areas.
- First, restrict certain ownership structures of captives that use irrevocable trusts to avoid the estate tax. Ownership by a trust that does not accomplish estate tax avoidance should not be restricted.
- Second, restrict the purchase of life insurance using the assets of the captive. Because the premium paid to the captive is deductible by the insured business and not taxed in the captive, a business owner could use this technique to indirectly purchase life insurance with pre-tax dollars.
While putting in place restrictions, the SIIA group believes that it also makes sense to grandfather those who previously entered into captive arrangements within the current parameters of the law. Such a grandfather provision would ensure that small and mid-sized businesses that formed insurance companies before this proposal was enacted are not penalized.
The dangers of being under-insured are real.
Financial Planning Comparison
Think of financial planning and the 1st bucket they tell you to save for, a rainy day fund of at least 90 days of expenses. What would financial planners advise if you had the choice of building that rainy day fund in pre-tax dollars rather than after tax dollars? Read this well written article detailing how to finance a business protective rainy day fund efficiently.
Insurance Brokers are Consummate Sales Professionals – Usually Lacking Captive Expertise
As quintessential sale professionals, insurance brokers walk that fine line of offering a value proposition to business owners without trying to sell them every possible policy in the commercial marketplace and driving up their cost of insurance.
The Best Insurance Brokers Now Introduce Captive Concepts to All Business Clients
More and more of the really good commercial insurance brokers today introduce custom captive insurance solutions to successful middle market private business owners. They do so because captives often have a strong value proposition when used in coordination with strategic commercial policy investments. Mitigating risks of under-insurance is one of those captive value propositions. Controlling future increases in costs of needed commercial insurance cover another.
Read a good article on the many dangers of under-insurance with specific industry examples by clicking here.
Advanced Legal, Tax, Financial & Insurance Planning for Medical Marijuana Industry Businesses
Summary
Of all the industries in the US, medical marijuana businesses face the greatest operational challenges today. The legal regulatory environment for any medical marijuana enterprise is full of landmines. This article addresses strategic methods to retain and protect more of the income and wealth being accumulated by successful businesses in the burgeoning medical cannabis industry.
Introduction
All successful entrepreneurs who make a lot of money building valuable enterprises start to worry and lose sleep over income taxes, estate taxes and losing everything they worked so hard to build due to disputes, mistakes or catastrophic events beyond their control.
Some experienced lawyers can help you recognize the issues and implement well established strategies and techniques involving tax, asset protection and estate planning. Few lawyers however also have experience in designing advanced risk management science structures, precisely what is needed by medical marijuana industry businesses in light of the complex and controversial legal environment they must navigate.
Asset Protection/Estate Planning
Asset protection involves techniques designed to prevent a loss of assets in the event of catastrophic unfavorable litigation, bankruptcy and even potentially protecting assets from government forfeiture proceedings. Estate planning involves techniques to efficiently manage and fairly distribute tax efficiently accumulated wealth during one’s lifetime and on one’s death.
Implementing asset protection techniques after you know about a problem threatening your assets is usually not effective due to fraudulent conveyance statutes and similar case law created judicial doctrines that make it improper to move or hide assets once you know they may be needed by a 3rd party who has claims against you. Basically if you procrastinate and delay planning until your assets need protection from a known 3rd party, it is likely already too late to assure success. In fact it could be criminal to attempt to hide assets after someone makes a rightful claim against you or their right to has already arisen due to something you or your business did that injured or damaged them.
Typical asset protection techniques include but are not limited to:
- planned systematic gifts of personal and business assets to children or others directly or indirectly through complex trusts and other vehicles;
- creation of affiliate businesses owned by children or family trusts;
- taking advantage of special protective legislation, such as homestead exemptions excluding the value of personal residence from creditors.
Typical estate planning techniques often considered include but are not limited to:
- (basic plan) having a revocable living trust, a will, one or more powers of attorney, a living will and some manner of testamentary instructions;
- (more advanced) one or more irrevocable trusts in combination with the above;
- structured business ownership interests with varying classes of ownership, buy-sell agreements, options to acquire and other complex business transaction agreements.
The most important thing about effective asset protection and estate planning is to get started early with fact finding and due diligence followed with documenting alternative solutions and associated costs to implement and maintain.
Risk Management & Finance – Custom Privately Held Captive Insurance Company Solutions
Good insurance for medical marijuana operations has always been difficult to find, and was expensive. This is more the case now than ever. On June 3, 2015, Lloyd’s of London announced a ban on its insurance broker syndicates writing any new policies in the USA to businesses growing or selling medical marijuana. Lloyds was not the only source for insurance but they were the most competitive. Other insurance carriers may follow since cash generated from the sale of marijuana, even when used to buy insurance, invariably implicated federal Anti-Money Laundering laws, even though for the time being the US federal government has indicated an intention not to enforce them against businesses operating legally under state medical marijuana laws.
Fortunately there exists a well established method of addressing risk management and risk finance objectives of medical marijuana businesses – closely held captive insurance companies, known as CICs. CICs are now licensed by over 30 US states. CICs are designed to provide custom insurance coverage that is not available from commercial insurers, is too expensive, or is simply not adequate in coverage design or claims handling to meet business needs.
Most of the Fortune 1000 have had CICs for some time. In the past 10 years, more and more successful closely held businesses in nearly every industry have formed their own affiliate CIC.
The benefits of CICs are many and are most easily understood when compared to retail insurance and self insurance as shown in the chart below:
CICs are licensed insurance companies, under special provisions that allow them to sell insurance to affiliated businesses, but not the general public. This allows them to be more economic to form and operate, as compared to traditional insurance companies.
Because the tax advantages of CICs can be substantial, the IRS has made it clear they do not like CICs. Nevertheless designed and operated correctly, provided your primary reason is to improve enterprise risk management, and not tax avoidance, your CIC could very well create significant income and estate tax savings, not to mention if claims losses are controlled, accumulate significant investment reserves assets that could also be asset protected. CICs certainly allow far greater control over your insurance and claims handling practices then does commercial insurance even if affordably available.
Types of Insurance Coverage a CIC Can Write to Protect a Medical Marijuana Business
CICs can write a host of insurance policies. The following are some of the types of insurance a CIC can write that are particularly appropriate for medical dispensaries and cultivators:
- crop insurance
- loss of producing plants
- product liability
- product recall
- intellectual property
- unfair competition
- legal defense
- regulatory liability risks
- crime
- employee theft
IRC Section 831(b)
One special tax provision designed to encourage use of CICs to finance insurable risks is known as section 831(b). This special income tax provision allows all underwriting income of a qualifying CIC to be exempt from federal income tax. This results in premiums paid by the operating medical marijuana business to deduct the insurance premiums paid the CIC if they qualify under section 162 (ordinary and necessary business expense), yet not be subject to income tax by the CIC. This creates a more economically efficient method to build loss reserve investments inside the CIC over self insuring risk.
IRC Section 280E
Another special obstacle medical marijuana businesses face is the US Treasury I.R.C. Section 280E provision, pertaining to expenditures in connection with the illegal sale of drugs, which states in part “no deduction or credit shall be allowed for any amount paid or incurred during the taxable year in carrying on any trade or business if such trade or business … consist of trafficking in controlled substances….”
Most tax advisers believe expenses which comprise cost of goods sold (COGS) are deductible under 280E. It is important when designing a CIC for a medical dispensary or cultivator to be aware if 280E and maximize insurance coverage which can be included as COGS.
Conclusion
Medical marijuana dispensaries and medical marijuana cultivators have great need to do advanced planning to address acute problems they face involving legal, tax, financial and insurance impacts of their business operations. Opportunities for effective solutions exist if you contact qualified professionals. We encourage readers to discuss the above topics with their legal, tax, financial and insurance advisers.
About the Author:
Thomas A. Cifelli is an Arizona attorney and also owns a specialty captive insurance solution provider firm. Visit www.TomCifelliLaw.com and www.CaptiveExperts.com for more information.
Click here to read a well written article thoroughly exploring the recent captive industry tax developments, legal issues and underlying political and public relations campaigns.
More and more small family owned businesses today want their own captive insurance company. Congressionally approved tax incentives in existence since the 1980s encourage use of small insurance companies to build investment reserves to protect against insurable losses. The IRS does not like the growth in use of micro-captives. They are taking action to stop captive managers who do not do captives for primarily legitimate risk management reasons, and who fail to take required underwriting and actuarial work seriously, thus essentially promoting captive’s as tax shelters to convert income tax liabilities into investment reserves held within a captive insurance company.
It is critically important to properly design and operate your small business captives today and to integrate the captive’s coverage with commercial insurance portfolios when possible. It is also important not to write inflated policy premiums, as many captives have done when no losses occur for several years yet they continue to keep premium levels at very high solvency confidence levels without even doing any additional underwriting and actuarial work after the formation year.
Read this February 2015 IRS release giving clear notice that they intend to object and take corrective action against abusive applications of captive insurance companies.
by Bill Kenealy (reprinted from Business & Insurance – see link following for more info)
NASHVILLE, Tennessee — As a global trend toward urbanization and large infrastructure projects looks to spike demand for services in the coming decades, the construction industry is at a crossroads.
While the industry has benefitted from a raft of advances in building design and technology, it still needs to address lingering concerns about labor shortages and construction defects. The recession decimated the construction industry and thinned the ranks of skilled workers, and worries persist about whether there are enough workers to go around as the industry’s workload scales up, experts say.
“You need the right people for the right job,” said Timothy R. Kania, New York-based senior vice president for energy and construction with Liberty International Underwriters. “So you have to be concerned about the qualifications of the people executing the job.”
Many in the industry express concern about the implications of the labor shortage for worker safety.
David B. Walls, Dallas-based president and CEO of Austin Industries, said the issue of worker safety became an overriding passion for him early in his career after the father of an inexperienced worker who was killed on a jobsite Mr. Walls was overseeing confronted him with the words, “ “Why did you kill my son?’ “
“The good news is that the construction industry has continued to improve its safety record over the last few years,” Mr. Walls said earlier this month at the International Risk Management Institute Inc.’s 34th Construction Risk Conference in Nashville, Tennessee. “The bad news is that it is, according to the Bureau of Labor Statistics, still the worst of any industry.”
In addition to implementing best practices to avoid common jobsite accidents such as falls and electrocution, a world-class safety regimen must value people and be effectively communicated at all levels of an enterprise, Mr. Walls said.
“Leadership is the weakness when it comes to safety at constructions firms,” Mr. Walls said. “Most companies nail the structural processes for safety, but forget about the leadership.”
Bill Noonan, New York-based vice president of risk management at construction services provider Structure Tone, agreed that effective communication is vital to worker safety.
“The only thing worse than not having a safety program is having one that nobody pays attention to,” Mr. Noonan said. “You get the behavior you tolerate, so you have to have employee buy-in from the start.”
Effective communication is critical when dealing with subcontractors, Mr. Noonan said, adding that to be truly effective, risk managers need to move beyond email exchanges and insist on face-to-face meetings with the people on their jobsites.
“I think town hall meetings are extremely important,” Mr. Noonan said. “It’s important that we invite subcontractors in to talk to us instead of just firing off a letter.”
Likewise, Frank Keres, Chicago-based risk manager with Clune Construction Co., said safety and risk management are inherently linked.
“I can’t be a risk manager unless I’m the safety guy,” he said. “So, if you are a risk manager, you have to be out in the field.”
Moreover, risk managers need to leverage the expertise of their insurers to ensure they get the proper coverage.
“When it comes to worker safety, the broker/agent might be the most important person we have,” Mr. Keres said. “They can be a true intermediary and smooth communication between a contractor and underwriter.”
Nonetheless, he said risk managers looking to create a better safety culture need to be receptive to input from all quarters.
“Safety should flow from the bottom up because workers are the ones getting hurt,” Mr. Keres said. “You should be listening to your employees, not just your owner and insurance people.”
Sonja Guenther, Denver-based vice president and workers compensation specialist at IMA Financial Group Inc., said no suggestion to improve workplace safety should go unexamined.
For example, when data revealed a propensity for soft-tissue injuries and muscle strains in certain trades, such as masons, on jobsites, a relatively straightforward, low-cost resolution presented itself, Ms. Guenther said.
“We used to laugh at the idea of workers stretching before work,” Ms. Guenther said. “You wouldn’t think about playing golf without stretching, so why would you allow a mason to lay brick in cold weather at 7 a.m. without stretching?”
http://www.businessinsurance.com/article/20141123/NEWS06/311239987?tags=|338|308|302|84
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