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Forming a micro-captive insurance company

Promoters who suggest using a micro-captive insurance company come from many professions: financial advisors, attorneys, accountants, actuaries, captive managers and others. One thing they have in common with promoters in many fields is the majority are honest, helping their client set up a lawful system for a legitimate purpose.

A minority of promoters—of particular interest to the IRS—advise an unlawful, fake system that appears legal, but its sole purpose is to avoid a tax burden.

A captive insurance company

A captive insurance company is one that legally operates outside the realm of commercial insurers to provide shared ownership between insurer and policy owner. In simple terms, a business can form its own insurance company, called a captive insurance company. Captives help business owners who cannot afford or find insurance to cover regular or unique business risk. A captive must follow regulations that govern commercial insurers. The business moves risk over to its captive insurance company and can usually pay lower rates than with a commercial insurance firm.

A micro-captive insurance company

Micro-captives, formed under Section 831(b) of the code, have tax benefits. The business must be of a smaller size (hence the term "micro") and take a relatively limited dollar amount in net written annual premiums. Micro-captives also have diversification requirements, allowing a single policyholder to pay only 20 percent of the premiums. Ownership must be no more than 2 percent in the micro-captive company. The insured business ownership level of a policyholder is not affected. As with a captive, micro-captive insurance companies can invest unused premiums. They have an additional advantage in that they can elect to only pay tax on investment income and exclude tax on income from premiums.

IRS micro-captive litigation

The IRS is leary of micro-captives for good reason. Promoters aggressively charge large fees to set them up as defacto tax shelters. They vaguely look like an insurance company, but they are on the IRS "Dirty Dozen" scam list. The scam operations include implausible risk coverage (a deli lists a terrorist activity risk), the business retains its old insurance, a poorly written micro-captive coverage contract exists with vague or ambiguous stipulations, premiums are exorbitantly high and set without industry-standard actuarial examination or underwriting; the business withdraws large amounts of money from the micro-captive, depleting capital needed to cover stated risk.

Promoters usually go along to manage the set-up and running of the micro-captive insurance company. If using their position to harvest fees for themselves and falsify business information, the company can take legal action against the promoter and any associates involved. The IRS is particularly aggressive in applying punitive sanctions against illegal tax shelters. A business should obtain experienced representation to address fraudulent behavior; the business will need all its options on the table to avoid the appearance of collusion with the promoter.

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