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Captive Insurance Company Taxation - Key Captive
Insurance Tax Issues
This page
titled
"Captive
Insurance Taxation"
provides an
overview of Captive Insurance Company
Taxation and the
Taxation of Captive Insurance Companies. It
includes a brief discussion of the following topics:
There is also a
section titled "Captive
Insurance Tax Benefits" which contains a more detailed
explanation of the specific tax benefits you can receive from a
Captive Insurance Company
created by WMS. These benefits include:
And finally, there
is also a section titled "Our
Captive Insurance Tax Capabilities" which provides a detailed list of the specific
steps WMS will take in order to ensure that your
Captive Insurance
Company receives every penny of the tax benefits and incentives it is entitled
to.
Captive Insurance Companies are formed offshore in well
regulated domiciles in order to avoid costly and burdensome regulation by the
insurance and tax authorities in each state. While some states have captive insurance
legislation which greatly reduces these costs and regulatory burdens, many
offshore domiciles still have a comparative advantage over even the best states
when it comes to selecting a domicile for your captive. The most favorable
offshore domiciles offer specific Captive Insurance Legislation, low annual
licensing and registration fees, greatly reduced reporting and regulatory rules,
extensive support services, and low or no corporate taxes, gross receipts taxes,
premium taxes, withholding taxes, income taxes, or other taxes.
Regardless of where a Captive is formed, it must avoid any
activities which create a nexus or connection with a particular state in order
to avoid state regulation of the Captive. By avoiding any nexus with a state,
the captive can legally underwrite US property and casualty risks which are
located in a particular state, while avoiding regulation by the state
where those risks are located. The US Supreme Court has ruled that
underwriting risks which are located in a particular state does not in and of
itself constitute conducting a trade or business in that state.
Although the primary reason for forming a Captive
offshore is to legally avoid burdensome or prohibitive insurance regulation by
state insurance regulators, an ancillary benefit is no state taxation of the
Captive. Provided that the Captive does not engage in the conduct of a trade or
business in the state, and performs no activities which the state considers
create a nexus for tax purposes, it should not be taxable by the state
in which the risks it underwrites are located. Our team of experienced
professionals will help you to structure your captive to legally avoid
state regulation or taxation of your captive by any state in which the risks it
underwrites are located.
Although, forming a
Captive Insurance Company offshore is
essential to avoiding state insurance regulations, it creates a potentially
expensive tax problem whenever any US person, business, trust, etc, owns
or controls a foreign corporation. Fortunately, the US Congress has
established section 953(d) of the
Internal Revenue Code which permits a
Foreign
Insurance Company to make an election (
a.k.a. an
IRC 953(d) election ) to be taxed as a domestic US corporation.
Only Foreign Insurance Companies can make an
IRC section 953(d) election,
however, those that do are treated the same as any other domestic
corporations for US tax purposes. This eliminates the problems caused by
numerous sections of the US Tax Code which are unfavorable to transactions
between any US person, business or trust and any foreign corporations they
control a.k.a. Controlled Foreign Corporations or CFC's.
Making the
IRC section 953(d) election also
eliminates the invasive and burdensome information reporting
requirements, in addition to the various taxes which are imposed by these IRC
sections dealing with Controlled Foreign Corporations
since
the foreign insurer is treated as a domestic US corporation, and not a foreign corporation, for
US tax purposes.
The US Tax Code also provides an incentive for
small
non-life insurance companies under
IRC section 831(b). If a non-life or
property and casualty insurance company elects to be taxed under
IRC section
831(b),
and has annual premiums which do not exceed
$1,200,000, the company pays no taxes on its premium income. Although an
insurance company that makes an
IRC section 831(b) election would pay zero taxes
on up to $1.2 million in annual premium income, it would still be taxed on its
investment income at the normal corporate tax rates. The
IRC section 831(b) election is also commonly referred to as
any of the following: IRC section 831
election , IRC Section 831(b), IRC section 831(b) election , section 831 ,
section 831(b) , section 831(b) election, or the Small Insurance Company Tax
Election. (See
IRC section 831 of the US Tax Code)
WMS will
carefully design your Captive to qualify for
IRC section 831(b) tax
incentives. Every Captive Insurance Company we create meets the
IRS
Captive Insurance Safe
Harbor Rulings. These
IRS Safe Harbor Tax Rulings set forth a number of
key features which must be present in any Captive
Insurance Company program or transaction in order for
the IRS to treat the
Captive as an insurance company for federal tax purposes.
The good news is that as long as your captive satisfies the guidelines set forth
in the
IRS Safe Harbor Rulings, it will be treated as an insurance company for
federal tax purposes. This is very important because both the
section 953(d)
election and the
section 831(b) election are only valid if the
Captive is
treated as an insurance company for federal tax purposes. To learn more about these
IRS
Captive Taxation Safe
Harbor Rulings you can click on this
IRS
Captive Insurance Tax Rulings
link.
In addition, we will gladly act on your behalf to
request a
Private Letter Ruling from the IRS which states that
your Captive will receive favorable tax treatment from the IRS on its
most important tax aspects. This virtually eliminates all tax risks
associated with owning or operating a Captive Insurance Company and ensures that
your Captive will receive every penny of its IRC section 831 tax incentives.
Here are some of the
key features and benefits associated with every Captive Insurance Company that
WMS creates.
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Your
Captive will Pay No Federal Taxes on its Insurance Premium
Income up to $1,200,000 per year! Small property
and casualty insurance companies that make an election to be taxed
pursuant to Section 831(b) of the Internal Revenue Code pay
no taxes on their Insurance Income provided their
premiums (both direct written and net) do not exceed $1,200,000
per year. WMS will structure your Captive in such a way
that it will qualify for IRC Section 831(b) tax
treatment and WMS will also make the required IRC Section
831(b) election on your behalf.
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Your
Captive will Pay No State Taxes on its Insurance and Investment
Income. WMS will form your Captive Insurance Company in an
off-shore or foreign domicile in order to avoid State Insurance
Regulations. All operations, transactions, and management of your
Captive will occur in this off-shore domicile and not in any
State(s) where your existing businesses are located. As a result,
your Captive will have no nexus from a State Tax perspective and
will therefore not be liable for any State Income Taxes. Note:
The IRC Section 953(d) election which your Captive will make
to be taxed as a Domestic Corporation for Federal Tax purposes has
no effect on your Captive from a State tax perspective.
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i. Whether there is requisite risk
shifting and risk distribution necessary to constitute insurance for
purposes of determining the deductibility of premiums as ordinary and
necessary business expenses: and
ii. Whether the requisite risk shifting
and risk distribution are present for determining whether an entity is an
insurance company for federal income tax purposes.
All WMS Captives meet the
IRS Captive Insurance Tax Safe Harbor Rulings and Guidelines which govern the taxation of
Captive Insurance Companies.
As a result,
WMS will gladly act on your behalf to obtain a
Private Letter
Ruling from the IRS which states that all insurance
premiums paid to your Captive by your existing businesses will be
100% tax deductible as ordinary and necessary business expenses
pursuant to IRC Section 162, and that your Captive will be
taxed as a small property and casualty insurance company pursuant to
IRC Section 831. This virtually eliminates all Tax
Risk associated with forming and operating a Captive Insurance
Company and we highly recommend that all WMS clients obtain a
Private Letter Ruling for their Captive. |
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Dividends Paid by Your Captive are Qualified Dividends. Federal Tax Code changes in 2003 reduced the Federal
Tax rate on Dividend income received by an individual shareholder from a
Domestic or Qualified foreign corporation to 15% through the end of year
2008. The election your Captive will make under IRC Section 953(d),
which permits a foreign insurance company to be treated as a
domestic corporation for US Tax purposes, will Qualify any dividends
which your Captive pays to its US Shareholders for the reduced 15%
Federal Tax Rate.
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No
Loss of IRC Domestic Corporation Tax Benefits including Tax Free Transfers , Capitalizations, Reorganizations
and Liquidations. There are a number of important non-taxable
transactions which are permitted to domestic corporations under
various sections of the Internal Revenue Code. US businesses
have come to rely on these non-taxable transactions and derive
significant tax advantages from them. Non-taxable transactions
between domestic corporations or entities include non-taxable
transfers of assets, tax free capitalizations, tax free reorganizations (mergers
and acquisitions), and tax free liquidations. Foreign
corporations, are specifically denied these beneficial non-taxable
transactions. However, since WMS will make an IRC Section
953(d) election for your Captive, it will be taxed as a domestic
corporation for US Tax purposes and will be entitled to the same
non-taxable treatment of its transactions that are available to any
other domestic US corporation under various sections of the Internal
Revenue Code.
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No Costly CFC, Excise, or US Source Income Taxes.
A Foreign Insurance Company
that makes an election under Section 953 (d) of
the Federal Tax Code to be taxed as a Domestic Corporation is also able to
avoid
costly taxation otherwise applicable to Controlled Foreign Corporations
(CFC's), Related Person
Insurance Income (RPPII), Federal Excise Taxes of 1% to 4% on gross
subject Premiums, a
flat 30% withholding Tax on US Source Income paid to a foreign entity,
taxation of the dividends received by a US Person from a foreign corporation at a maximum
ordinary income tax rate of 35% versus the reduced Qualified Dividend rate of 15%,
and reclassification of the gain on the sale of appreciated foreign stock to
ordinary income taxable at up to 35% versus capital gains taxable at 15%.
Since WMS will make an IRC Section 953(d) election for
your Captive, none of these costly tax problems will ever be a
concern to you or your Captive.
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In addition to losing
all the favorable tax
treatment provided to Domestic Corporations under several IRC Sections (see
the list above), a
Foreign Insurance Company which loses its IRC Section 953(d) election, would also run a
high risk of being taxed as either a Foreign Personal Holding Company or as
a Passive Foreign Investment Company. Both of these options would be very
expensive from a tax perspective. However, since WMS structures
every Captive to meet the
IRS Safe Harbor Rulings
and Guidelines, none of these costly tax problems will
ever be a concern to you or your Captive.
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Reduced Information Return and Tax Return Filing Requirements will
Save You Time and Money, while Protecting your Privacy. US Citizen or Residents who are Directors or
shareholders in Foreign Personal Holding Companies, Controlled Foreign
Corporations or who directly or indirectly own or control 5% or more, by
vote or value, of a foreign corporation must file Information Returns and
Tax Returns with the IRS that require the payment of substantial taxes and
disclose a lot of otherwise confidential financial information to the IRS.
Fortunately, Foreign Insurance Companies that make an IRC Section 953(d) election, are exempt from all
of these information returns and costly taxes because they are treated as a Domestic,
not a Foreign, corporation for US Tax purposes. Since WMS will
make an IRC Section 953(d) election for your Captive, none of
these burdensome information returns or costly taxes will ever be a
concern to you or your Captive.
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No need to have a Foreign Bank Account which Must be
Reported to the IRS and the US Department of the Treasury.
In order to avoid US taxation, some Foreign Insurance Companies
who insure US property and casualty risks choose not have an operating
account with a US Bank, since this would mean they are engaged in the
conduct of a Trade or Business in the US; making all of their insurance transactions
taxable by the US. Unfortunately, if an
United States person, has a financial interest in, or signature
authority, or other authority, over any financial accounts, including bank,
securities, or other types of financial accounts in a foreign country, and
the aggregate value of these financial accounts exceeds $10,000 at any time
during the calendar year, they must report that relationship each calendar year
by filing US Treasury Department Form TDF 90-22.1 with the Department of the Treasury on or before June
30, of the succeeding year. In addition, they will have to disclose the
existence and nature of these foreign accounts and interests each
year they are present when responding to several interrogatories
that deal with this subject on their personal US 1040 Tax Return.
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WMS will establish and document the business
purpose(s) for creating your Captive Insurance Company. This is
critical in order to avoid being treated as a "sham" entity which would
eliminate all tax benefits associated with your Captive.
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WMS will
conduct a market price study to insure that all premium charged by
your Captive are "arms length" and market competitive.
This is critical in order to avoid having your Captive regarded as a "sham"
entity which would eliminate all the tax benefits associated with your
Captive.
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WMS will structure
your Captive to
meet IRS Safe Harbor Rulings and Guidelines
(especially
those contained in
Internal Revenue Bulletin No. 2002–52
) which govern the definition and taxation of Insurance
Companies. This will enable your Captive Insurance Company to be taxed as a
Small Non-Life Insurer pursuant to IRC Section 831 (b) and to deduct
all premium payments made by your existing businesses to your Captive as
ordinary and necessary business expenses pursuant to IRC Section 162.
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An IRS Private Letter Ruling
will virtually eliminate all tax risks associated with owning or operating
your Captive. As a result, WMS will gladly act on your behalf to
obtain a Private Letter Ruling from the IRS which will state
that your Captive will receive the following favorable tax
treatment from the IRS:
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Your Captive will be taxed as an insurance company
pursuant to IRC Section 831. (Under IRC section 831 (b)
a property and casualty insurance company pays no Federal Tax on
insurance premiums it receives as long as they do not exceed $1,200,000
in any given year.)
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All insurance premiums paid by your existing
businesses to your captive insurance company will be fully tax
deductible as ordinary and necessary business expenses pursuant
to IRC Section 162.
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WMS will select a well
regulated, zero tax domicile in which to incorporate, license, operate and
manage your Captive. This domicile will have no premium taxes, no tax on the
insurance or investment income generated by your captive, no capital gain or
dividend distribution taxes, and no gross receipts or other taxes.
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WMS will structure
your Captive to avoid costly State taxes and insurance regulations.
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WMS will structure
your Captive's underwriting
to include sufficient unrelated risks to meet
IRS Safe Harbor Rulings and
Guidelines. As the number of unrelated insureds, increases, there
is more "risk distribution" which is an essential part of meeting the
IRS Safe Harbor Rulings and
Guidelines.
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In order to insure that your
Captive will meet
IRS Safe Harbor Rulings and
Guidelines, WMS will structure your
Captive's underwriting to include a sufficiently
large number of independent
homogenous risks for each line of insurance, As the number of independent
risks, increases, there is more "risk distribution" which is an
essential part of meeting the
IRS Safe Harbor Rulings and
Guidelines.
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WMS will acquire a Federal
Tax ID Number on behalf of your Captive.
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WMS will make the
IRC Section 953(d) election for your Captive.
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WMS will make
the
IRC Section 831(b)
election for your
Captive.
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WMS will assist you in
the selection of a licensed professional Insurance Management Firm
that will provide a "permanent office" for your Captive in the
domicile and will also manage the day to day
operations of your Captive in the Domicile. It is critical to
establish a "permanent office" for your Captive in the domicile in
order to avoid taxation by any of the 50 US States in which your
existing business are currently located or operate. By hiring a licensed
professional Insurance Management Firm to manage the day to day
operations of your Captive in the domicile you will be able to demonstrate
the presence of true "economic substance" to the IRS. This is
critical in order to avoid being treated as a "sham" entity which would
eliminate all tax benefits associated with your Captive.
Footnote
1 - Assumes
that annual dividends received are less than or equal to $150,000.
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