The captive insurance industry anxiously waited as Congress and President Obama negotiated its way from the impending fiscal cliff this past December. While the business and economic motivations for employing a captive were likely to remain, the uncertainty over the tax implications of proposals to increase dividend rates to the ordinary income level of 39.6% and increase capital gains rates to 20% were troubling. These proposals, together with the net investment income tax imposed by Obamacare, presented challenging prospects.
Fortunately dividends were spared the onerous almost 30% tax increase and we now have direction and comfort that captives continue to offer attractive business, investment, wealth transfer and tax advantages, that if not already employed in a dealers entity structure, should be considered. While year-end is often the time for tax planning, the year-long business and investment advantages of captives add to the possibilities. Many dealers already employ captives for their reinsurance, or use retro arrangements for vehicles service contracts. A dealers’ short list of risk management considerations to maximize their profits should also include:
• Taking advantage of small property and casualty tax provisions, that is no tax on underwriting profits;
• Considering risks that could be self-insured to increase annual premiums to $1.2 million;
• Covering large deductible risks in the captive adding to underwriting profits;
• Providing for the opportunity to accumulate investment income and defer the appreciation of investments;
• Taking advantage of favorable risk diversification rulings (safe harbors) that still apply;
• Providing substantial wealth transfer possibilities through ownership by children or grandchildren;
• Purchasing life insurance in irrevocable trusts that can be funded with captive surplus or distributions; and
• Deducting premiums at the dealership level (at the 35% or 39.6% rate) when paid to a dealers’ captive at a no or low tax rate.
A captive insurance company continues to permit dealers exceptional opportunities. Business owners should consult experienced captive consultants to determine if a captive is suitable to their circumstances.
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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.