Parts of this article are from the book published by John Wiley and Sons, Protecting Clients
from Fraud, Incompetence and Scams, authored by Lance Wallach.
September 24, 2010
knocked out by a poem.
Every accountant knows that increased cash flow and cost savings are critical for businesses in
2009. What is uncertain is the best path to recommend for garnering those benefits.
Over the past decade business owners have been overwhelmed by a plethora of choices designed
to reduce the cost of providing employee benefits while increasing their own retirement savings.
The solutions range from traditional pension and profit sharing plans to more advanced strategies.
Some strategies, such as IRS section 419 and 412(i) plans, used life insurance as vehicles to
bring about benefits. Unfortunately, the high life insurance commissions (often 90 percent of the
contribution, or more) fostered an environment that led to aggressive and noncompliant plans.
The result has been thousands of audits and an IRS task force seeking out tax shelter promotion.
For unknowing clients, the tax consequences are enormous. For their accountant advisors, the
liability may be equally extreme.
Recently, there has been an explosion in the marketing of a financial product called Captive
Insurance. Small companies have been copying a method to control insurance costs and reduce
taxes that used to be the domain of large businesses: Setting up their own insurance companies
to provide coverage when they think that outside insurers are charging too much. A captive
insurance company would be an insurance subsidiary that is owned by its parent business(es).
There are now nearly 5,000 captive insurers worldwide. More than 80 percent of Fortune 500
companies take advantage of some sort of captive insurance company arrangement. Now small
companies can, too.
These so-called “Captives” are typically small insurance companies designed to insure the risks
of an individual business under IRS Code Section 831(b). When properly designed, a business
can make tax-deductible premium payments to a related-party insurance company. Depending on
circumstances, underwriting profits, if any, can be paid out to the owners as dividends, and
profits from liquidation of the company may be taxed as capital gains. Single-parent captives
allow an organization to cover any risk they wish to fund, and generally eliminate the
commission-price component from the premiums. Jurisdictions in the United States and in
certain parts of the world have adopted a series of laws and regulations that allow small non–life
insurance companies, taxed under IRC Section 831(b), or as 831(b) companies.
Captives can be a great cost-saving tool, but they can also be expensive to build and manage.
Also, captives are allowed to garner tax benefits because they operate as real insurance
companies. Advisors and business owners who misuse captives or market them as estate
planning tools, asset protection or tax deferral vehicles, or other benefits not related to the true
business purpose of an insurance company, face grave regulatory and tax consequences.
A recent concern is the integration of small captives with life insurance policies. Small captives
under Section 831(b) have no statutory authority to deduct life premiums. Also, if a small captive
uses life insurance as an investment, the cash value of the life policy can be taxable at corporate
rates, and then will be taxable again when distributed. The consequence of this double taxation is
to devastate the efficacy of the life insurance, and it extends serious liability to any accountant
who recommends the plan or even signs the tax return of the business that pays premiums to the
The IRS is aware that several large insurance companies are promoting their life insurance
policies as investments within small captives. The outcome looks eerily like that of the 419 and
412(i) plans mentioned above.
Remember, if something looks too good to be true, it usually is. There are safe and conservative
ways to use captive insurance structures to lower costs and obtain benefits for businesses.
Some types of captive insurance products do have statutory protection for deducting life
insurance premiums (although not 831(b) captives). Learning what works and is safe is the first
step an accountant should take in helping his or her clients use these powerful, but highly
technical insurance tools.
Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA
faculty of teaching professionals, is a frequent speaker on retirement plans, financial and estate
planning, and abusive tax shelters. He writes about 412(i), 419, and captive insurance plans.
He speaks at more than ten conventions annually, writes for over fifty publications, is quoted
regularly in the press and has been featured on television and radio financial talk shows
including NBC, National Public Radio’s All Things Considered, and others. Lance has written
numerous books including Protecting Clients from Fraud, Incompetence and Scams published by
John Wiley and Sons, Bisk Education’s CPA’s Guide to Life Insurance and Federal Estate and
Gift Taxation, as well as AICPA best-selling books, including Avoiding Circular 230
Malpractice Traps and Common Abusive Small Business Hot Spots. He does expert witness
testimony and his side has never lost a case. Contact him at 516.938.5007,
firstname.lastname@example.org or visit www.taxadvisorexperts.org or www.taxlibrary.us.
The information provided herein is not intended as legal, accounting, financial or any other
type of advice for any specific individual or other entity. You should contact an appropriate
professional for any such advice.