The IRS release (IR-2015-19) states that while captive insurance companies can be a legitimate tax structure, certain closely held entities may be persuaded by “unscrupulous promoters” to create captive insurance companies. The captives are intended to qualify as small insurance companies under Code section 831(b). Under that section, small insurance companies are taxed not on their premium income, but on their investment income.
The IRS stated that these promoters assist with creating and “selling” to the entities 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.
The total amounts of annual premiums 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. Underwriting and actuarial substantiation for the insurance premiums paid are either missing or insufficient. The promoters manage the entities’ captive insurance companies year after year for hefty fees, assisting taxpayers unsophisticated in insurance to continue the charade.
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