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Philip J. Tortorich
+1.312.902.5643 philip.tortorich@kattenlaw.com Partner Katten Muchin Rosenman LLP
Business Owner
100%
100%
Payment of Premium
Operating Business
Issuance of Policies
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What is Insurance?
In order to achieve the income tax benefits the payments must be for insurance and must relate to insurance contracts. The following slides explain these requirements in more detail. Anyone can form a captive and have the captive insure risks from operating businesses. However, that does not necessarily mean that the structure implemented will result in any income tax efficiencies. The remainder of this presentation assumes that the business owner desires more than a mere loss control vehicle. In order for the captive to provide any income tax efficiencies, the captive must provide insurance under the Internal Revenue Code. Interestingly enough, the terms insurance and insurance contract are not defined in the Internal Revenue Code. Rather, the IRS and Courts look to the definition of insurance provided by the Supreme Court in Helvering v. Le Gierse. Namely, that insurance has two components:
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Risk Distribution
Requires that the captive distribute its risk among several insureds. Works off the statistical law of large numbers.
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Harper Group v. C.I.R., 96 T.C. 45 (1991), aff'd, 979 F.2d 1341 (9th Cir. 1992)
2 subsidiaries and customers of another subsidiary make payments to a captive. The 2 subsidiaries payments constitute 70% of the total premiums, the customers (i.e., third parties) payments constitute the remaining 30% of the total premiums to the captive. The payments are deductible by all of the insureds. There is sufficient risk shifting and risk distribution.
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2013 - All Rights Reserved - Philip J. Tortorich
United Parcel Service v. C.I.R., 254 F.3d 1014 (11th Cir. 2001)
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Subsidiary 1
$500,000 in premiums 100% owner
$500,000 in premiums
Subsidiary 8 Subsidiary 9
Third-Party Risk
(Purchased from Reinsurance Companies)
P R E M I U M S
100% owner
* No one subsidiary having more than 15% nor less than 5% of the total premiums paid to the captive.
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In negotiating with the insurance commissioner in the jurisdiction where the captive is formed, it may be possible to have some portion of the required capital satisfied by a letter of credit.
2013 - All Rights Reserved - Philip J. Tortorich
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100% owner
$800,000 premiums
Operating Business
Insurance coverage
Depending on entire structure may need to reinsure risks of third parties to qualify as insurance for tax purposes
Note: Capitalization requirements generally run around of the anticipated initial premiums, with this percentage going down in offfshore jurisdictions.
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CIRCULAR 230 DISCLOSURE: Pursuant to regulations governing practice before the Internal Revenue Service, any tax advice contained herein is not intended or written to be used and cannot be used by a taxpayer for the purpose of avoiding tax penalties that may be imposed on the taxpayer.
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