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Captive Insurance and Other Tax Reduction Strategies – The Good, Bad, and Ugly
By Lance Wallach May 14, 2008
Every accountant knows that increased cash flow and cost savings are critical for businesses in 2008. What is
uncertain is the best path to recommend to garner these benefits.
Over the past decade business owners have been overwhelmed by a plethora of choices designed to reduce
the cost of providing employee benefits while increasing their own retirement savings. The solutions ranged
from traditional pension and profit sharing plans to more advanced strategies.
Some strategies, such as IRS section 419 and 412(i) plans, used life insurance as vehicles to bring about
benefits. Unfortunately, the high life insurance commissions (often 90% of the contribution, or more) fostered
an environment that led to aggressive and noncompliant plans.
The result has been thousands of audits and an IRS task force seeking out tax shelter promotion. For
unknowing clients, the tax consequences are enormous. For their accountant advisors, the liability may be
equally extreme.
Recently, there has been an explosion in the marketing of a financial product called Captive Insurance. These
so called “Captives” are typically small insurance companies designed to insure the risks of an individual
business under IRS code section 831(b). When properly designed, a business can make tax-deductible
premium payments to a related-party insurance company. Depending on circumstances, underwriting profits, if
any, can be paid out to the owners as dividends, and profits from liquidation of the company may be taxed as
capital gains.
While captives can be a great cost saving tool, they also are expensive to build and manage. Also, captives are
allowed to garner tax benefits because they operate as real insurance companies. Advisors and business
owners who misuse captives or market them as estate planning tools, asset protection vehicles, tax deferral or
other benefits not related to the true business purpose of an insurance company face grave regulatory and tax
consequences.
A recent concern is the integration of small captives with life insurance policies. Small captives under section
831(b) have no statutory authority to deduct life premiums. Also, if a small captive uses life insurance as an
investment, the cash value of the life policy can be taxable at corporate rates, and then will be taxable again
when distributed. The consequence of this double taxation is to devastate the efficacy of the life insurance,
and it extends serious liability to any accountant who recommends the plan or even signs the tax return of the
business that pays premiums to the captive.
The IRS is aware that several large insurance companies are promoting their life insurance policies as
investments with small captives. The outcome looks eerily like that of the 419 and 412(i) plans mentioned
above.
Remember, if something looks too good to be true, it usually is. There are safe and conservative ways to use
captive insurance structures to lower costs and obtain benefits for businesses. And, some types of captive
insurance products do have statutory protection for deducting life insurance premiums (although not 831(b)
captives). Learning what works and is safe is the first step an accountant should take in helping his or her
clients use these powerful, but highly technical insurance tools.
Lance Wallach speaks and writes extensively about VEBAs, retirement plans, and tax reduction strategies. He
speaks at more than 70 conventions annually, writes for 50 publications, and was the National Society of
Accountants Speaker of the Year. Contact him at 516.938.5007 or visit www.vebaplan.com.
The information provided herein is not intended as legal, accounting, financial or any other type of advice for
any specific individual or other entity. You should contact an appropriate professional for any such advice.
National Society of Accountants