BY KEVIN M. HEDLEY, MS, CPA, PFS<\/p>\n
Business owners are generally more concerned
\nwith day to day business matters and
\nmay not realize some of the opportunities that
\nmay arise from solving problems.<\/p>\n
You may be concerned about the loss of key
\nemployees, vendors or major clients, legal expenses,
\nor a myriad other concerns. All of these
\ncan result in a catastrophic loss if they occur
\nand are the types of items that can keep you up
\nat night. When dealing with all of this it isn’t
\noften that a single solution can be found to solve
\nmultiple problems facing business owners, but
\nthere is such a solution available in the tax law.<\/p>\n
One potential solution is known as a Captive
\nInsurance Company (CIC). The key difference
\nwith the insurance to be discussed here and
\ninsurance you obtain from your local insurance
\ncarrier is you own the insurance company. The
\nInternal Revenue Code Section 831(b) effectively
\nallows a business to claim a deduction of up to
\n$1.2 million in a calendar year and have that premium
\ngo to an insurance company that is owned
\nby the business owner. The added benefit of the
\nself owned insurance company is you do not pay
\nany tax on the receipt of the insurance premium.
\nYes, you read that correctly, you deduct the premium
\nfrom one company you own and exclude
\nthe income in another company you own.<\/p>\n
So how can a CIC help your business?<\/p>\n
\nSpecifically, there are risks in your business
\nthat are uninsured or under insured. First you
\nwill need to determine the risks, the actuarial
\ncost of the risk and determine a premium that
\nan operating company will pay to the CIC. The
\noperating company pays the premium to the
\nCIC to cover those risks that are needed. It is
\nimportant to note that the risks must be real, as
\nan example you could not insure your local business
\nfacility against a tidal wave because no such
\nrisk of a tidal wave exists in upstate New York.<\/p>\n
As long as the annual premium paid to the
\nCIC is under $1.2 million, the CIC will pay no
\ntax on the receipt of the premiums. The CIC has
\ncertain obligations and liquidity needs to pay any
\nclaims that arise but it is also allowed to invest its
\nassets. The income from its earnings is taxable.<\/p>\n
What is this worth to you and your company?<\/p>\n
Assume after doing the analysis we determine
\na premium for the series of risks is $1 million.
\nYour company pays and deducts the $1 million
\nbusiness income thereby reducing your taxes. If
\nyou had not deducted the $1 million, then your
\nbusiness would have an additional $1 million
\nof income.<\/p>\n
Therefore, you would be in the highest tax
\nbracket for federal purposes, which is 39.6 percent
\n(not including the effective rate increase
\nfrom various phase outs) or an effective rate as
\nhigh as 43.592 percent after taking into account
\nthe effective costs of phaseouts; plus New York
\ntaxes of anywhere from 6.85 percent to 8.82
\npercent.<\/p>\n
These make an effective combined tax rate
\nwith federal and state taxes of 50 percent or
\ngreater. That $1 million deduction results in a
\nsavings of $500,000. Remember that your CIC
\ndoes not pay tax on the $1 million of revenue
\nas illustrated n the example. At this point, you
\nhave saved $500,000 or more in tax. Furthermore
\nyou have protected yourself against claims and
\nliabilities which, up to this point, have not been
\ncovered.<\/p>\n
As you fast forward a few years and insure
\nyour risks, pay claims from your CIC as claims
\narise and after a few years the company has sufficient
\nreserves on hand to pay claims. At this
\npoint the CIC can distribute the funds as long
\nas it does not jeopardize its reserves.<\/p>\n
These distributions would be taxable to the
\nindividual owners at the long term capital gains
\nrate as a qualifying dividend. Currently the
\nqualifying dividend rate ranges from 0.0 percent
\nto 20 percent, plus the 3.8 percent ACA tax.<\/p>\n
So the tax cost of receiving the dividend in
\ncurrent law may be 23.8 percent for a qualifying
\ndividend (exclusive of effective tax costs of
\nphaseouts) or 24.592 percent with effective costs
\nof phaseouts, plus the state rate of anywhere
\nfrom 6.85 percent to even 8.82 percent.<\/p>\n
Therefore the tax paid on receiving the qualifying
\ndividend is approximately 30 percent. A
\nbusiness can deduct the premium in one year,
\nsave taxes at perhaps at rates of 50 percent or
\nhigher and then several years later receive earnings
\nback from the CIC and pay taxes at a rate
\nof closer to 30 percent. This is a 20 percentage
\npoint benefit to the owner.<\/p>\n
The CIC needs to be properly structured,
\ndesigned for risk transfer, and managed as an
\ninsurance company to be acceptable. The CIC
\nmay be owned by the owners of the operating
\ncompany or may be owned by others as well.
\nCICs have expenses separate from the current
\noperating company to maintain and operate on
\nan annual basis.<\/p>\n
It is safe to assume the operating costs of the
\nCIC can be $50,000 to $70,000 annually, but if
\nyou have saved $500,000 in taxes you are still
\nahead $430,000. This, I argue, is an expense well
\nworth having.<\/p>\n
Hedley is a partner with Hedley & Co. PLLC.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":" BY KEVIN M. HEDLEY, MS, CPA, PFS Business owners are generally more concerned with day to day business matters and may not realize some of the opportunities that may arise from solving problems. You may be concerned about the loss…<\/p>\n","protected":false},"author":121,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[4,9],"tags":[58],"class_list":["post-18398","post","type-post","status-publish","format-standard","hentry","category-banking-asset-managment","category-business-reports","tag-business-reports"],"yoast_head":"\r\n