Tax Loopholes for business owners are still out There if one know what they are doing.
Certain tax and wealth planning benefits provided by CICs have prompted the United States Internal Revenue Service (IRS) to increase scrutiny and examinations of these structures (3); but, as we can see in Rent-A-Center, Inc. v. C.I.R., 142 T.C. No. 1 (2014)., captives are still viable entities when it comes to certain tax deductions. Captive insurance companies (CICs) are defined by the National Association of Insurance Commissioners (NAIC) as legal structures established for the purpose of insuring risks faced by owners of business enterprises (1). A CIC can be formed as a domestic business entity, but interested parties may also go offshore and seek foreign incorporation for this purpose (2).
“CICs can benefit individuals from an estate planning and wealth management point of view, but everything must be treated as a business,” explains Rocco Beatrice, Managing Director of Estate Street Partners, LLC, parent company of UltraTrust.com. “Individuals must pass an income and revenue check as it relates to the business entity they control; in essence, the company must have annual revenues of at least $1 million and net income of $500,000. This is not a matter of individual net worth; it is all about making money from a business enterprise.”
…In a way, the millions of dollars the company spent on litigation against the IRS probably came from the savings realized through years of CIC coverage.
At the heart of Rent-a-Center v. the Commissioner of Internal Revenue, there is a large commercial enterprise that has substantial levels of risk through numerous locations and complex operations (5). This is a brand that operates all over the U.S. and thus must operate with considerable levels of liability. As is often the case with such large commercial enterprises, Rent-a-Center ran into certain operational risks that proved expensive to insure through third-party commercial insurance companies.
Mr. Beatrice commented on this particular CIC strategy before expanding on the case: “We can see the financial reasons for Rent-a-Center to form a CIC in Bermuda. In a way, the millions of dollars the company spent on litigation against the IRS probably came from the savings realized through years of CIC coverage.”
“The Rent-a-Center CIC structure is quite complex, but what the IRS seemingly had an issue with were the large payments made by the company to the CIC they controlled. The IRS determined that these were not tax deductible for insurance premiums, which are normally deemed as trade or business expenses deductible as per Section 162 of the Internal Revenue Code (6).
Rent-a-Center decided to take on the IRS in a case that resembles the David v. Goliath parable, and they have scored a major victory in battle, but there is also a chance that the IRS may appeal.” Mr. Beatrice also added: “To justify the costs of setting up a CIC, the insurance premiums payable from the business owners to the captive must be at least $100,000, which could be split among two or more owners; but, when we are talking about economically viable CIC operations, we can see premium payments of $500,000 or more.”
Mr. Beatrice’s further commented that “The Tax Court opinion is important on two levels: The first being that the IRS has shown a certain disposition towards examining CIC structures as sham entities, which the Tax Court did not see in Rent-A-Center, Inc. v. C.I.R. (4). The other is that public opinion of the CIC industry is bound to improve as a result of this ruling. CICs are not for everyone, but for business owners who face estate and taxation issues these structures can be excellent wealth preservation tools.
To this effect, let’s consider the following estate planning feature: When a CIC is dissolved, the funds that come out of the structure are considered long-term capital gains assets for taxation purposes instead of being labeled as personal income. This could be a great advantage to certain business owners who are planning for retirement and looking out for the financial status of their beneficiaries and future survivors.”
It may take a few months before the CIC and estate planning industry learns of a possible appeal by the IRS in this case. The dissenting opinion on the ruling (4) was strong, which indicates the possibility of an appeal. However, as Jay Adkisson notes on his Forbes article on this issue (5), case law shows that appellate courts have not been entirely favorable to the IRS in previous issues related to captives.
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