Business owners facing rising insurance premiums and less than adequate coverage from the traditional insurance market are exploring viable alternatives. One of these alternatives is captive insurance, which is a self-owned insurance company serving to provide insurance services to its parent. Captive insurance solutions have gained significant traction in the business world over the past two decades, and market share is expected to increase in the coming years. One of the terms business owners may discover when researching captive insurance options is that of a “micro captive”; in this guide, we will provide all of the details you can share with clients to help them make informed decisions about their insurance needs.
Captive insurance companies enjoy certain tax advantages. In most cases, premiums paid for insurance coverage are tax-deductible, thus lowering annual tax liabilities for the parent company. A micro captive is a small captive insurer that has special taxation rules. According to Section 831(b) of the Internal Revenue Code, a micro captive may pay taxes on investment income only in any year that its written premiums are at or below a pre-set limit. In 2019, the annual inflation-adjusted limit for small property and casualty captives is $2.3 million. It is important to note that these special rules do not only apply to micro captive insurance companies; any small insurance company or captives like single parent, group, or protected cell captives (“rent-a-captives”) may enjoy these tax advantages.
As with may rules in the Internal Revenue Code, there are certain qualifying factors for captive insurance firms that allow them to take advantage of the special tax rules. An insurer must:
If the entity qualifies, the micro captive does not pay taxes on underwriting income but rather only on investment income. A captive insurance company – or any small insurance entity – that does not experience property losses in a given year only pays taxes on investment income. Profits from underwriting can be returned to shareholders or be retained as surplus for subsequent years.
The Internal Revenue Service (IRS) has added qualifications to its tax code to prevent smaller insurance firms from being formed solely to take advantage of tax breaks. In other words, captives formed for tax-reduction purposes only do not qualify and may be subject to steep financial penalties. A micro captive must have a legitimate business purpose – to provide insurance coverages and services to its parent – in order to remain within the law. As regulated financial institutions, captive owners must take the steps needed to ensure their entities meet IRS scrutiny.
Caitlin Morgan Captive Services provides clients with captive insurance solutions supported by years of experience in establishing the successful formation and implementation of a wide range of captives. To learn more about how we can help you, please contact us at (855) 975-4949.