Today’s topic is microcaptives. But before discussing microcaptives, we should first review what a captive is.
A captive is a risk management strategy employed by companies. In short, the company becomes its own insurer, using its own money to pay claims. The upside? Companies who know their risk outlook better than an outside insurer might be on their way to underwriting profits. The downside? It takes plenty of time and resources, and there is a good deal of risk. Such is life in the insurance business – and a captive places a firm right into the insurance field.
Microcaptives are captives, but on the small side; to qualify, the annual premium must be less than $1.2 million. As with captives, they offer risk management advantages for companies. Microcaptives can also offer tax advantages, as up to $1.2 million in premium income can be excluded from taxation. When running smartly and soundly and above-board, microcaptives can make perfect sense for some firms.
However, microcaptives have also been used as tax shelters by firms, and the IRS has begun to zero in on these schemes. Per IRS guidance, the most egregious of the scams are set up largely to take the premium deduction, with companies paying their captives larger-than-reasonable premiums while keeping other insurance in place to manage commercial risks.
We’ll say it again: captives must be risk management tools first. They are insurance businesses. Companies simply looking to work an angle have to know the IRS is watching.