What You Need to Know About Captive Insurance Compliance

Are you planning to form a Captive Insurance Company or CIC for your business? Before you make any decision, you should understand this insurance option for your business.

What Is Captive Insurance?

To understand the legalities of CICs, it’s best to hire a captive insurance lawyer who is more knowledgeable about pre-audit compliance and audit defense.

Moving on, “captive insurance” pertains to business insurance coverage provided by an insurance company that is owned by one or more clients or businesses. It is often interchangeably used with self-insurance, which is simpler and more affordable.

This kind of insurance service offers captive insurance. A captive is a closely held insurance company primarily controlled by its owners. Owners pay regular premiums to the insurance carriers in captive insurance contracts, which is the same with commercial insurance contracts.

Captives, however, provide tax, business, and operational advantages to owners and companies. A local group of farmers, for example, can create an insurance company to protect themselves in case they incur losses brought about by crop damage. Another example, a financial-services business can set up its omissions and errors insurance carrier to exclusively serve itself.

The IRS Crackdown

Internal Revenue Service sign

In reality, many captive insurance companies are often formed off-shore in low-tax, and sometimes even no-tax, jurisdictions. Because of this advantage, the formation of CICs has become a common practice, especially for large business organizations.

The US Internal Revenue Service (IRS) has publicly stated its concern with the growth of CICs. Thus, they have initiated audits of hundreds of businesses with captive insurance companies. The interest and penalties can be significant for those taxpayers being audited. The IRS is even auditing practitioners assisting CICs with compliance.

Captive Insurance Compliance

U.S. owners of off-shore captive insurance companies need to be particularly mindful of the countless compliance requirements demanded by the IRS. Even failure to file forms has draconian penalties.

If you are seeking to form or protect your CIC, ensure you are up to code. Don’t wait until the IRS starts an audit on your CIC. Make sure that your lawyers can provide services such as compliance reviews, documentation and substantiation assistance, state audit presentations, and risk pool reviews.

Audit Defense

On the other hand, if your business doesn’t comply with IRS standards, you will face severe consequences. You could face negligence and understatement penalties, as well as the loss of significant tax benefits and the potential unwinding of the captive formation. In this case, your lawyer should be able to offer audit defense, a pooling analysis or risk assessment of your captive, and documentation and substantiation assistance.

Businessman checking financials with calculator and magnifier

Background Review

Before you make any decision, take this time for a background review.

A captive is an insurance company formed and owned by a non-insurance company so that the risks of its owner are insured. Captives are created to cover many different kinds of risks. A captive can provide every risk underwritten by any commercial insurance company.

Once established, captives operate like all commercial insurance company. Because of that, they are subject to regulatory requirements, including requirements for reserve, capital, and reporting. Compliance with these requirements is crucial.

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