Tax Benefits of a Captive Insurance Company Could Be Lost if Improper Business Purpose or Failing Economic Substance Test

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Read this excellent primer article written by two leading captive insurance lawyers on the importance of the business purpose test and what the IRS seems to be looking for when they are concerned about whether or not a captive insurance company was created for the right reasons, by clicking here.

Click here to read more about the new Economic Substance Test and its relation to business purpose in forming a captive and other complex transactions with significant tax benefits associated with them.

Caution: Be reasonable and conservative when designing your captive

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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.

Avoiding Sham Risk Pools and Protect Pool Collateral From Misuse

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Captive Experts LLC manages a risk pooling arrangement for members of the Harbor Risk Pool Association (www.HarborRiskPoolAssocation.com). This is the most cost effective risk pooling arrangement we are aware of in the closely held family business enterprise risk micro-captive industry.

It also addresses the shortcomings of many risk pools including but are not limited to weak underwriting, inflexible pool reinsurance formulas not properly priced for different policy terms and limits, a lack of actuarial support for reinsurance pooling formulas, lack of regular reporting (no transparency), inadequate or excess collateral requirements, no claims investigation, and no capacity for participants to protect misuse of collateral.

The contractual pool arrangement of participant captives who are members of the Harbor Risk Pool Association addresses these concerns. This pooling arrangement also provides periodic financial, claims and pooled risk exposure reporting.






Good example of self insured risks all companies face perfect for enterprise risk captive coverage

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Read this excerpt by a Los Angeles class action lawyer explaining the complexity of self insured risks most companies are not aware of. Properly formed and managed captives can provide a source of recovery for companies to defend these actions and pay associated losses. Without a captive serious business liquidity issues could arise.  http://marcprimo.blogspot.com/2014/02/portland-firm-settles-two-lawsuits-with.html

Another Captive Withstands IRS Challenge on Risk Distribution – Tax Court Securitas TC Memo 2014-225

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The IRS lost another challenge to captives in the recent Securitas tax court case. Captives help businesses improve risk management and build liquid loss reserve investment portfolios to protect the enterprise from an ever increasing risk environment which is especially true for US businesses today. Over 90% of the world’s litigation and regulatory actions are in the US. It is unfortunate the IRS continues challenging captives rather than publishing more definitive guidance to prevent practices it feels are abuses. Click here to read an excellent summary by a tax CPA of the recent Tax Court victory for captives that further amplifies the findings of the Rent-A-Center case that risk distribution is not merely measured by number of insured companies.