WHAT IS A CAPTIVE INSURANCE COMPANY?
A Captive insurance company is a company created to insure the risks of a specific business(s). Although risk management policies exist in the market, exclusions forces business owners to absorb the hefty costs of claim coverage.
Owning a Captive can minimize these exclusions, since they are a variety of risks that are generally not offered in the conventional insurance market.
What is an 831(b)?
An 831(b) effectively allows a small insurance company to receive up to $2.3 million per year in premiums, without paying any income taxes on those premiums.
The 831(b) election does not affect — at all — the deductibility of the premiums paid by the operating business to the Captive. Premiums are otherwise deductible, they may be deducted by the operating business just like any premium payments to a Captive.
This has the effect of creating an up to $2.3 million deduction in the operating business, with the premium moneys transferred to the Captive, and with the Captive not paying any income taxes on the receipt of those premiums.
How does a captive work?
An individual, company or trust sets up and forms an insurance company. Once licensed, the Captive functions just as most insurance companies do. It can sell insurance coverage (but generally such sales are only to its owners), receive premium dollars and invest them to pay claims and, when needed, approach the reinsurance market to purchase reinsurance to cover losses.
If the insurance claims are low, the Captive will, over time, accumulate significant money. Depending on the structure of the Captive, the income will be taxed in various ways during the wealth accumulation phase (as well as the payout phase) to the Captive owner.