Thinking of a Captive? IRS Issues Warning

Every year, the Internal Revenue Service identifies its “Dirty Dozen” tax scams.  For the 2015 filing season, small or “micro” captive insurance companies have been added to the list.

A captive insurance company is often defined as a company that provides risk-mitigation services for its parent company.  However, parent companies need to weigh the high cost of a captive insurance company.  Some risk types a captive company might insure against may result in larger expenses than the parent company can afford, leading to bankruptcy.

Among the reasons the IRS includes for adding captive insurance to the annual list are:

• Closely held entities are persuaded to participate and assisted in creating captive insurance companies onshore or offshore, as well as drafting organizational documents and preparing initial filings.
• The entities are often receiving from promoters “poorly drafted ‘insurance’ binders and policies to cover ordinary business risks or esoteric, implausible risks for exorbitant ‘premiums,’ while maintaining their economical commercial coverage with traditional insurers.”
• Annual premiums totals often “equal the amount of deductions business entities need to reduce income for the year; or, for a wealthy entity, total premiums amount to $1.2 million annually to take full advantage of the Code provision.”
• The underwriting and actuarial substantiation is often missing or insufficient.
• Hefty fees are charged by the promoters for managing the captive plan.

With all of the regulatory changes going on today many people are selling “pixie dust” solutions, which illustrate unrealistic cost projections.  But, as we all know, when something seems to be too good to be true, it usually is.