Generally, insurance companies can defer the unearned portion of gross premiums and can also deduct reserves for unpaid losses, including IBNR/incurred but not reported items. If the captive is qualified, the premium payments made by the parent/affiliates should qualify as an ordinary business expense. In some cases, the IRS may assert that the captive is without substance because the risk of loss has not been shifted or a sufficient risk distribution has not been achieved and the favorable tax treatment is not available.
Steps a captive insurance company should take to ensure favorable tax consequences include:
- Have a formal business purpose
- Adequate capitalization
- Comply with any local insurance regulations
- Use of conventional investment strategies
- Use of a risk-transferring insurance contract
- Ensure sufficient risk distribution
- Demonstrate of arms-length rates and pricing
For state tax purposes, captive insurance companies are normally subject to an excise tax rather than an income tax.
A specific IRS provision [code 831(b)] exists for smaller privately held companies for the creation of captive involving premiums up to a level of $1.2 million.
Have questions about tax issues faced by captive insurance companies? Post a comment below, or contact our Tax Planning and Preparation Group at 440-449-6800.