insuranceshot.com

Forming a Captive Insurance Company

Part of a CPA's job is to evaluate the potential tax benefits of various business and estate planning strategies.

One planning strategy that is gaining more and more acceptance is the formation of a captive insurance company, which has important tax considerations. The three primary tax aspects to evaluate in the captive structure are deductibility of the premium from the parent to the captive, tax treatment of the premium once it is received by the captive, and taxation of the money if it is distributed from the captive.

What is a Captive?A captive is an insurance company established primarily to insure the risk of its parent company and affiliated organizations or groups. Comparisons are often made to self-insurance. While the retention of risk is the obvious similarity, a captive generally provides greater tax benefits. A company that self-insures incurs a tax deduction only when a claim is paid, whereas a captive allows the parent to claim a deduction for premium contributions to the insurance company.

Just because a captive is considered an insurance company does not mean the premiums are automatically deductible to the parent. The IRS states that for a transaction to be considered insurance, both "risk shifting" and "risk distribution" must be present.

Risk shifting occurs when a person or entity facing economic loss transfers some or all of the potential loss to an insurer. Under FAS 113, for a transfer to be considered insurance, there must be at least a 10 percent chance of a 10 percent loss. Simply stated, there must be some chance for underwriting losses between premiums paid and the limits of the policy.