A pure captive insurance company is an insurance company created by the owners of an operating business to provide supplemental property and casualty insurance to such operating business. The shares of the captive insurance company can be owned by owners of the operating business or an irrevocable trust for the benefit of such owner’s heirs.
For many years the IRS argued that premiums paid into a captive insurance company were not deductible due to the related ownership of the insured and insurer (referred to as the “economic family doctrine”). In 2001, after consistently losing in tax court on this premise, the IRS abandoned the economic family doctrine. IRS not only abandoned the economic family doctrine but also began to provide guidance, through revenue rulings 2002-89, 2002-90 and 2002-91, as to how to properly create a captive insurance company. Since 2002, as this area of planning has evolved, the IRS has continued to provide clear guidance which uphold the validity of captive insurance arrangements.
In today’s litigious environment, many large and small businesses have captive insurance arrangements in place which insure a wide range of risks not insured in their commercially procured property and casualty coverage. Certain captive arrangements may elect IRC 831 (b) status which allows the captive insurance company to receive annual premiums of less than $1.2 million income tax free.
In addition, small business owners can incorporate dynastic estate planning concepts into the ownership structure of the CIC to allow for wealth preservation. Done correctly this can afford the small business owner the opportunity to transfer assets to the next generation free of gift and estate taxes. Further, by not having the captive in the owner’s name, assets of the captive are protected from certain creditors.