From an estate planning perspective, there are a variety of ways to structure the ownership of a captive insurance company to enhance the overall tax and asset protection benefits available through §831(b) captive planning. But first, a few words on Captive Insurance Companies and Internal Revenue Code section 831(b):
What is a captive insurance company?
Simply put, a captive insurance company is an insurance company that is owned by one or more business owners to provide insurance for the business. Let us be clear, a captive is an insurance company, not an insurance contract or insurance product. A captive enters into insurance agreements with a business, but it is not insurance in and of itself. The key benefits of a small §831(b) captive include the potential for making income tax deductible insurance premium payments of up to $1,200,000 per year for property and casualty insurance.
In fact, with regard to IRC Section 831 the IRS issued three separate “Safe Harbor” rulings in 2002 that provide clear guidance on how to arrange the captive. Later in 2005 and 2008 the IRS issued other rulings further defining the parameters of the “Safe Harbor” 831(b) captive insurance company.
While our firm does not assist clients in setting up the Captive—in fact we feel strongly that only those who specialize in this area of the law should provide such service—we do recognize that the establishment of a captive insurance company in Nevada, or any other permissible jurisdiction can provide significant risk mitigation benefits to business owners. With this powerful risk-management planning tool, other estate planning, asset protection and income tax benefits might also be obtained. And that brings us full circle back to the question of who should own a captive…
Who should own the captive?
While the estate plan should certainly be customized to fit the specific needs of those benefiting from ownership of a captive insurance company, three basic trust types can be used as the basis for the captive ownership structure. These trust structures are as follows: (1) a State Income Tax Protection Trust; (2) an Asset Protection Trust; and (3) the Estate/GST Tax Trust, or Dynasty Trust, as they are sometimes called. A simple diagram of each of these three structures can be obtained by clicking here: Captive Insurance Company Ownership Structures.
The estate planning benefits of owning a captive can be summarized as follows:
State income tax minimization. Nevada is the only jurisdiction that allows for the Nevada Incomplete Non-grantor (“NING”) trust. This special type of trust might be established to own the captive so that any income eventually recognized and distributed from the captive will be taxable in the State of Nevada (Nevada has no state income tax), rather than in another high-tax state, like California, New York or Illinois. In other words, if a California resident, for example, establishes a NING trust to own his or her Captive Insurance Company, it is conceivable that any income eventually recognized by the captive or the NING would not be subject to state income tax in the State of California.
Asset protection. Nevada (and other states such as Delaware, South Dakota, Alaska, Wyoming and Utah) has an asset protection trust statute (See NRS 166). Even though the assets of a captive insurance company are very well insulated from the general creditors of the business, its owner, and even the owner of the captive itself, limited liability and other general corporate law does not provide a way for distributions to be made to the owners of a captive who are otherwise not vulnerable to creditors and creditor remedies, such as the charging order remedy.
With a Nevada asset protection trust owning the captive, it is workable for distributions to be made from the captive, to is owner the Nevada asset protection trust, and then out to the trust’s beneficiaries, all without subjecting such distributions to attack by creditors of the beneficiaries.
Transfer tax (gift, estate, GST) minimization. Using a dynasty trust or legacy trust, as they are sometimes called, to minimize the taxes payable in the business owner’s estate, because of gift, estate and/or generation skipping transfer (“GST”) tax makes sense for any captive owner who eventually wants to pass his or her estate on to family or other loved ones when they pass. Transfer tax liability can devastate family businesses when the original owners die, and using a captive insurance company, owned by a trust which is not includable in the business owner’s estate, can be a slick way to hedge against this significant and real risk.
Concluding thoughts on captives and estate planning…
While a captive insurance company is certainly not for everyone, for those cases where a captive makes sense, estate planning can offer huge additional benefits to the captive owners.
Feel free to contact our office to discuss the estate planning and asset protection benefits of owning a captive insurance company in a specialized trust.