Want to make a grown man (Joe) cry? Tell him the amount of his income tax bill (after he was originally thrilled by a great profitable year). For the year 2013 there is an unbelievable increased top rate—39.6% for taxable income over $400,000 if single, $450,000 if married.


Wait. Joe is old enough to think about his estate tax liability (top rate of 40%). Joe knows numbers… makes $1 million dollars and the IRS takes $400,000 (rounded), leaving $600,000 (which he will never spend because of his other assets). When Joe goes to heaven, the estate tax monster strikes with a vengeance, taking a $240,000 bite. Joe’s family gets only $360,000.

DOUBLE TAX… double ouch!

Is there a way to legally avoid this bad-law double tax?..Not entirely. But the answer is a loud ‘Yes’ for up to $1.2 million per year. How?… Joe creates a captive insurance company (Captive) for his business, Success Co.


What is a Captive?… How is it structured?

A Captive is a property and casualty insurance company (P&C Co.) created by a business (Success Co.) under Section 831(b) of the Internal Revenue Code to provide a broad range of risk management capabilities for Success Co. Basically, a Captive insures risks a P&C Co. does not insure… for example, loss of a large customer, loss of a key employee. More on Captive insured risks later.

Now, let’s take a look at the typical structure for a Captive: Joe has Success Co., create a Captive (typically an LLC). The Captive would form an investment LLC to hold its assets and invest its funds.


Note: The investment LLC can invest its fund in stocks, bonds, real estate or other investments. Joe, if he wants to, can manage the investments.


How much can you save?

First, a few basics: (1) The big saving is the fact that the payment of premiums (up to $1.2 million per year) paid by Success Co is 100% deductable, but is tax-free when received by the Captive; (2) the Captive invests the premiums received; (3) earnings on the investments are taxed as if the Captive is a C corporation; (4) the assets of the LLC are used to pay to Success Co. the risks insured (claims) by the Captive.

The law firm—located in Marietta, Georgia—of Moore Ingram Johnson & Steele specializes in Captives. The firm explains the savings with this example: Success Co. pays $1.1 million in premiums per year to the Captive. Claims are 5% of the cash available in the Captive, while cash invested earns 3%. Current tax rates are used to pay required taxes and deduct all costs. At the end of the three years, the Captive is liquidated. Joe ultimately dies. The three-year example saves $1,198,815. In five years the savings jump to $1,860,484.


Can a Captive be used as an estate planning strategy?

This example appeared in an article in the June 6, 2010 issue of “Accounting Today”: Joe’s children are the beneficiaries of a dynasty trust, which owns 78% of the Captive. Annual premiums are $1 million per year, while taxes, claims and operating expenses total $120,000. Investment assets grow at eight percent per year. After 10 years the Captive has in excess of $14.6 million… $11.4 million (78%) would be excluded from Joe’s estate.

Wait, there’s more. The Captive distributes annual dividends to purchase a $10 million life insurance policy. Then the family wealth, which is in the dynasty trust, (combining the insurance death benefit and the Captive liquidation) would be increased over $21 million… all estate tax free.



Can a captive be used to build a retirement fund?

Yes! This time Joe owns the Captive. When the time comes for Joe to retire, he simply liquidates the Captive to capture its assets at low capital gains tax rates.


What does a Captive insure?

First, let’s compare premiums paid to your typical P&C Co. to premium payments to your own Captive. Say you pay $500,000 in premiums to a P&C Co., and have no claims. Obviously, 100% of your money is gone.

Next, the same premium paid to your Captive, followed by no claims. Great money saving advantage: You still have every penny of that $500,000 premium, plus investment earnings.

Now, following is a list of the most common risks a Captive insures (no list could ever be complete, as some businesses require unique coverage).

  1. Everything a business currently self-insures
  2. Loss of income because
  3. Anything that could be considered a “Lloyd’s” risk (If Lloyd’s of London would insure it, so could your Captive.)
  • Excess losses above coverage limits
  • Construction defects
  • Warranties (Can deduct reserve for future warranties, don’t have to wait to incur warranty costs to deduct.)
  • Deductibles (property, vehicle accidents, workers comp., general liability and product liability)
  • Lost a key employee(s), salesperson(s)
  • Lost a key contract (government contract)
  • Lost major customer(s)
  • Strike
  • Weather, terrorism and other calamities

No attempt is made in the article to explore all the rules, traps and opportunities in forming your own Captive. Warning: Only work with qualified, experienced advisors.

The right advisors can tailor your Captive to fit your business and your circumstances perfectly.

Now the key question: Is a Captive for you?. If costs were not an issue, the answer would be a resounding ‘YES’ for almost every business. Unfortunately, costs are a factor.   It’s interesting to note that about 80% of the Fortune 500 take advantage of the Captive benefits. For a Fortune 500 company, it’s a slam dunk: The insurance cost savings and tax-benefits are well worth the required costs to create and administer a Captive.

Logic tells you that the more profitable your business, the more a Captive should be a top priority for your tax planning (i.e. make $500,000—before-tax—or more. Captive is a must). Costs are easily covered by Captive benefits.

Want to learn if a Captive will work for your business? Fax the following (on your company letterhead) to 847-674-5299 or email me (irv@irvblackman.com). Your name, title, type of business, total number of employees and any other information you think would be helpful. Also include all phone numbers where you can be reached (business, home, cell). Please mark “Captive” at the top of your fax or in the email subject.

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When people of means contact me to help do their estate plans (or review their existing plans), they typically have two goals concerning their estate tax:

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