With all the advertising produced by major insurers such as Allstate, Progressive and State Farm, you probably will never hear such commercials about captive insurance policies. Captive insurance, as its name suggests, refers to insurance policies that are created and controlled wholly by its insureds.
There are a number of reasons why captive insurance policies exist. The first, of course, is to provide a resource to compensate losses. But the cost and tax benefits are enticing as well. A captive insurance company may cover a broader range of losses compared to a commercial insurance company, and a captive insurance owner may experience greater cash flow through this operation. Essentially, for every dollar that is spent through captive insurance, a business may save 10 to 25 cents.
Additionally, the money spent on premiums could be deemed tax deductible.
But as the old adage goes, pigs get fat…and hogs get slaughtered. The story of Phoenix jewelry store owners exemplifies this statement. A Tax Court judge found that they failed to report nearly $500,000 stemming from payments and distributions from a captive insurance company created to cover the store.
In what is viewed to be a first case in which the audit of a captive resulted in litigation, this case appears signal the next wave of cases that will be brought to tax court. Because of this, small businesses that create these insurers must be diligent in the record keeping and tax implications these companies can have.
If you have questions on how a captive insurer can affect your tax liability, an experienced attorney can help.