Succession Planning after ATRA 2012 – Captives With Exit

Fred M. Whitaker, P.C.'s Tax Planning Legal Blogs

Licensed for 27 years

Attorney in Newport Beach, CA

Fred M. Whitaker, P.C.

Free initial consultation, Credit cards accepted, Fixed hourly rates

Serving Newport Beach, CA

  • Serving Newport Beach, CA

  • Free initial consultation, Credit cards accepted, Fixed hourly rates

Managing Partner at firm Cummins & White, LLP

Serving Newport Beach, CA

Free initial consultation, Credit cards accepted, Fixed hourly rates

Awards AV Preeminent

For the last three months we have been examining the use of a Captive
Insurance Company – specifically, Internal Revenue Code Section 831(b)
small insurance company captive to save current taxation.  In summary,
you can self-insure company risks and pay premiums to your own wholly
owned insurance captive.  Instead of paying tax on profits, you receive a
deduction for premiums.  Your Section 831(b) small insurance company is
allowed to earn up to $1.2mm per year in premiums without paying any
federal income tax on them.  It only pays tax on the investment income.

Last month we showed that life insurance can be a tax efficient
investment vehicle for the Captive.  Since the premiums paid to the
Captive are not taxed, but the investment income is taxed, tax free
growth inside a life insurance policy can be very attractive.  This
month we will wrap up the discussion of Captives with exit and
succession planning.  In other words, several years down the road, how
do we tax efficiently exit? 

When an insurance company has no claims and builds up too many
reserves, it is required by law to do one of two things – provide return
premiums to the insured, or pay dividends to the shareholders.  If we
return premiums to your operating company that creates taxable income
where we took a deduction.  Not very efficient. It can work when you
need cash back in the operating company and don’t mind the taxable
income.  The deferral of taxation has some value. However, the best exit
strategy is to instead pay a dividend to the shareholders of the
Captive.  In the top income tax brackets under ATRA 2012, the Federal
tax rate is 20%.  You just took profits taxable at 39.5% Federal and
paid no tax on them for several years, then took them out at almost 20%
less in taxation.   If the next generation are the owner’s of the
captive, we have added succession to the exit by moving the without the
40% gift and estate tax.  We also protected it from your creditors.  

The final exit/succession benefit is in the transition. If you intend
to pass the operating company down to the next generation, the years of
premiums depressing earnings have depressed the value, helping reduce
estate and gift tax and/or lowering the sales price.  If you intend to
sell to a 3rd party, you can demonstrate the free cash flow from
discontinued premiums, increasing the sale price. So you took out
profits without tax, but can still harvest the value.   Nothing in the
current law beats captives for the amount of tax value.

Next month, we’ll look at the tax affects of the Affordable Care Act and how to mitigate them.

___________________________________________________________________________________________

IRS Circular 230 Disclosure:

To
ensure compliance with requirements imposed by the IRS, we inform you
that any U.S. tax advice contained in this communication (including any
attachments) is not intended or written to be used, and cannot be used
for the purpose of (i) avoiding penalties under the Internal Revenue
Code, or (ii) promoting, marketing or recommending to another party any
matters addressed herein.

For the last three months we have been examining the use of a Captive
Insurance Company – specifically, Internal Revenue Code Section 831(b)
small insurance company captive to save current taxation.  In summary,
you can self-insure company risks and pay premiums to your own wholly
owned insurance captive.  Instead of paying tax on profits, you receive a
deduction for premiums.  Your Section 831(b) small insurance company is
allowed to earn up to $1.2mm per year i

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