As the new tax law is further analyzed, it appears there are sections that may affect captives. Before dumping your captive, it is appropriate to reconsider the reasons for forming a captive in the first place.
Some may need to be reminded: taxes are not a reason to form a captive. This new law reminds one of that premise. But you ask, why? Taxes can be a big part of the financial considerations when examining the factors affecting captives. Why should they be ignored or pushed back?
In fact, they should not be ignored. They are a part of every financial analysis of captive formation. However, close analysis usually reveals that taxes are not a major aspect. Profit is, or should be, the major aspect, along with coverage for loss in the business operations.
Captives are a viable and highly useful financial tool to deal with exposures to one's business operations that are otherwise expensive or impossible to insure to an outside party.
Let's say that you manufacture a product unlike any other product, underground platinum widgets, in either usage, construction, or impact. Traditional insurers can't/won't find a proper classification to apply a rate that makes sense financially to you or them.
If their actuary can't classify and rate the exposure, they usually don't want the extra expense of determining a premium or coverage parameters. But the risk is still on your books and may take a big bite out of your financials as an unsecured block on your balance sheet.
If that unsecured block becomes an insurance company, owned outside of your company and operated professionally, then coverage is available, and the unsecured block becomes a tax deductible, even now, in the form of a premium—a usual and ordinary business expense.
That transaction is the root and true purpose of a captive. When outside advisers begin to point out what are deemed greatly advantageous uses of the captive for other purposes, such as tax avoidance or estate planning, then the complications arise.
I do not say that there are no advantageous uses for the captive beyond the actual coverage of an exposure. I do believe, based on experience, that some of those advantages are heavily for the benefit of the proposers, tax attorneys, accountants, and others who probably don't understand, nor care, about the exposure to insurance loss.
Those advisers are greatly interested in the aspects of the new tax law. But be aware: their interest is not due to eroding coverage for loss to an exposure to loss of your business. Their interest is to changes that must be made to their business models of forming and using tax-advantaged schemes. If they can charge you to make those changes, and they will try, then the new tax law is not so bad.
I also do not say that any useful aspects for multiple purposes should be ignored. I am merely saying to be careful of advice given in the form of making changes for the new tax law. Make such changes only if truly needed.
Whatever changes may affect, potentially, your captive and other aspects, a thorough analysis by a party familiar with your business's operations and your ultimate goals for a captive should be made.
Using the 831(b) exemption, of which the maximum premium amount was just raised by inflation, is often one of the structures proposed that has no effect on coverage. Yes, it is valid and legal and useful to those qualified to use it. It is, or should be, a side issue and should be considered very, very carefully. There are many side costs to its use. Higher management fees should be considered against any perceived tax advantages.
Costs must be closely investigated by someone who understands such matters. An actuary, tax attorney, accountant, or a qualified manager can usually perform this. My point is to avoid those advisers who are merely addressing what they perceive as the basic threats to your side uses of your captive, which are dependent on their advice. Don't wander from the basic purpose of the captive as you analyze side effects.
Those qualified advisers may well determine that a change in domicile or structure is in order to accomplish your goals. The new tax law does make some changes on those issues; it does not make changes on the basic purpose of your captive.
Further, a close analysis of new costs, if any, may dictate changes. Those decisions should be made in light of the true goal: coverage. Remember that one of the purposes of the new tax law is to make charges for those entities engaging in accounting and legal maneuvers to lower or eliminate rightful taxes through the use of complicated tax planning structures. Another purpose is lowering taxes.
Those new costs/rules may show that thought must be put into the number of dollars paid in taxes, domicile charges, ownership adjustments, etc. versus the true goal. Only the captive owner should make such decisions. Is a new structure needed for an offshore captive worth the cost against lowered corporate taxes versus increased trust charges and the adviser fees accompanying them?
At the end of the day, after careful analysis, it may be determined that nothing needs to be done.
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