New Jersey Captive Insurance Association Presents Captive Insurance! Basic Taxation Sponsored by Presented by Christopher J. Ridge, JD, MS (RM)! Manager - Alternative Risk Finance! Perr&Knight! Harborside Financial Center! Plaza 10, Suite 802 Jersey City, NJ 07311 843.425.9038! cridge@perrknight.com! www.perrknight.com Harry M. Baumgartner, Esq. Bressler, Amery & Ross, P.C. 325 Columbia Turnpike Florham Park, NJ 973.966.9675 hbaumgartner@bressler.com www.bressler.com
Recording This webinar will be recorded and available at www.njcia.org
How to Ask Questions During the Webinar You can send questions at any time during the presentation. Please type your question into the questions box on the right side of your screen.
Webinar Agenda This webinar will outline basic captive taxation issues including: Qualifying as an insurance company for federal tax purposes New Jersey premium tax structure Mini-captives under Internal Revenue Code Implications of Dodd-Frank Act Schedule 1. Introduction (3 minutes) 2. Webinar Presentation (25-30 minutes) 3. Closing Commentary (5 minutes) 4. Questions & Answers (10-15 minutes)
Harry M. Baumgartner, Esq. Bressler, Amery & Ross, P.C Florham Park, NJ Full Service Insurance Law PracFce Including CapFve FormaFon & Regulatory Compliance Former General Counsel, GAB Robins North America - P&C Claims AdministraFon - CapFve Claims Management Former Director- Treasury/Legal Services, Industrial CorporaFon - Formed, Operated Vermont CapFve - Merged Acquired CapFve - Associated with Two Off- Shore CapFves Legal Counsel in FormaFon of New Jersey CapFves Member, Advisory Board, New Jersey CapFve Insurance AssociaFon
Perr&Knight Perr&Knight is a leading provider of insurance support services and a strategic resource that companies use to reduce their fixed costs while increasing the efficiency and value of their insurance operations. Risk Services for the Alternative Risk Transfer Market Actuarial Services Captive Feasibility Studies Domicile Selection Captive Formations Captive Management Insurance Program Analysis Risk Management Consulting Loss Portfolio Transfers Captive Closure Solutions Board of Director Services
Your Host:! Gregg Sgambati, President! New Jersey Captive Insurance Association
Disclaimer The following presentation is for general informational purposes only. It is not intended as professional legal, accounting or tax advice, and any such intention or advice is expressly disclaimed. The application and impact of laws can vary widely based on the specific facts involved, or may change, and you should consult directly with your legal, accounting, or tax advisor with respect to your particular inquiries and needs. Neither the NJCIA nor any sponsor or presenter is responsible for any errors or omissions contained in this presentation. All information is provided "as is", with no guarantee of completeness, accuracy, timeliness, and without warranty of any kind, express or implied. In no event will NJCIA, its sponsors, or presenters be liable to you or anyone else for any decision made or action taken in reliance on any information in this presentation or for any consequential, special or similar damages, even if advised of the possibility of such damages. Circular 230 Disclosure: To comply with U.S. Treasury Regulations, any information contained in this presentation is not intended or written to be used, and cannot be used by the recipient or any other person, for the purpose of (1) avoiding penalties or any other restrictions that may be imposed under the Internal Revenue Code or any other applicable tax law, or (2) promoting, marketing or recommending to another party any transaction, arrangement or other matter in violation of the IRC or any other applicable law or regulation.
Insurance Company Taxation Premiums paid to an insurance company generally are deductible as an ordinary business expense Properly formed and operated insurance companies may be able to accelerate deductibility of claim reserves In contrast, reserves established for self-insured risk are not deductible until claims are paid Are premiums paid to captive insurance company treated as deductible third-party insurance or nondeductible self-insurance? Can captive accelerate deductibility of claim reserves? Deductibility of reserves the principal tax benefit of a captive: Insured deducts premium paid to captive as ordinary expense Captive pays premium tax, deducts discounted loss reserve From a strictly tax standpoint, captive is best used for coverages that require larger reserves (e.g., long-tail claims)
Qualifying for Federal Tax Purposes Key question from federal tax standpoint: Is the captive a bona fide insurance company? Courts, IRS will look for: Legitimate business purpose (i.e., non-tax purpose) Genuine insurance risk Common indicia of insurance Risk transfer Risk distribution
Qualifying for Federal Tax Purposes Common indicators of insurance Appropriate capitalization No parental guarantees Appropriate reserves Actuarial support Arm s length pricing Proper policy forms Standard investments Beware related party loans Corporate formalities, independence, separation of accounts Non-tax business purpose
Qualifying for Federal Tax Purposes Risk Shifting Entity facing potential loss (i.e., insured) transfers financial consequences of the loss such that insured remains unaffected because loss will be offset by insurance recovery Key factors may be how captive is capitalized, whether any entity (e.g., parent corporation) guarantees captive s performance, arm s length pricing, etc.
Qualifying for Federal Tax Purposes Risk Distribution Means risk sharing among different entities Allows insurer to reduce possibility that a single claim will exceed the ability to pay Spreads losses over time Entails pooling of premiums, so insured is not essentially paying for its own risks Risk distribution exists in either of two scenarios: Sufficient third-party (i.e., unrelated) business Brother-sister corporate arrangements
Risk Distribution: Third-Party Risk Parent Company Third-Party / Pool Risk Sub Sub Sub Sub Sub Sub Captive Premium Payments Tax-Deductible 50% unrelated risk stated as a safe harbor from Revenue Ruling 2002-89; other percentages may be allowed.
Risk Distribution: Brother-Sister Approach Parent Company Sub Sub Sub Sub Sub Sub Sub Captive Not Tax-Deductible Premium Payments Tax-Deductible* Key questions may be how many subsidiaries involved, concentration of risk in any single entity *Note: Subsidiaries must be legal C corporations or other qualifying associations but not disregarded entities for tax purposes
Small Captives Internal Revenue Code Section 831(b) Election available to captives that qualify as insurer for tax purposes Must have risk shifting, risk distribution, etc. Election allows captive to be taxed on investment income only; i.e., no underwriting income taxation at federal level State premium taxes still apply Can make election if net written premiums for taxable year do not exceed $1,200,000 in all captive entities under same ownership Election generally can be revoked only with approval of IRS Ideal for low-frequency / high-severity losses Example: $1.2M x 40% tax rate = $480,000 (less captive expenses) 16
831(b): How it Works Owner(s) Premium Claim Payments Dividends 831(b) Small Captive Insurance Company Premium Claim Payments Dividends Insured(s) Reinsurance (Optional) Legend Possibly Definitely Premium(s) deductible Premium income accumulates tax free Investment income taxed as ordinary income Dividends taxed at capital gains rate But beware potential changes in rate Claim payments are tax neutral
Small Captives and Estate Planning Must have risk shifting and risk distribution (i.e., legitimate insurance) Applies for family owned, privately held captives Captive owned by heirs Potentially shifts wealth from higher tax-rate individuals to lower tax-rate individuals Profitability dependent upon risks insured, underwriting profits or losses Not a short-term arbitrage 18
Dodd-Frank Act Non-admitted Reinsurance and Reform Act of 2010 effective July 2011 Applies to surplus lines and self-procured insurance from nonadmitted insurers 34 states have self-procurement taxes N.J. = 5% on gross written premium Previously paid self-procurement tax proportionately to states in which risk located NRRA prohibits any state, other than home state of insured, from collecting premium tax for surplus lines and non-admitted insurance Goal: Eliminate inefficiencies of multi-state system Home state has option to enter into multi-state tax-sharing compact Or NOT
Dodd-Frank Act Does it apply to captives? Some states e.g., Vermont say no Legislative history indicates it applies only to surplus lines, not captives No state other than home state of an insured may require any premium tax payment for non-admitted insurance Non-admitted insurance means any property and casualty insurance permitted to be placed directly or through a surplus lines broker with a non-admitted insurer eligible to accept such insurance Captives generally are not admitted in any state other than domicile state Premium tax means, with respect to surplus lines or independently procured insurance coverage, any tax, fee, assessment, or other charge imposed by a government entity directly or indirectly based on any payment made as consideration for an insurance contract for such insurance Independently procured insurance means insurance procured directly by an insured from a non-admitted insurer
Dodd-Frank Act of 2010 What does this mean for captives? Some captive owners may not remit self-procurement tax, and they may continue to take such a position Act has raised awareness that the tax provides a source of revenue for the states Potentially substantial amount to states with large corporate presence e.g., New Jersey, New York Debate regarding whether NRRA applies to captives Must consider state-specific self-procurement laws Uncertainty regarding how states are going to pursue / enforce Potential financial impact to corporation, potential audit risk Pay, reserve, ignore? 21
Implementation of N.J. Captive Laws New Jersey captive laws were enacted on February 21, 2011, and became effective on May 23, 2011 Modeled after Vermont captive laws Provide for creation of pure, association, industrial, branch and sponsored (protected) cell captives Five captives approved, several more in pipeline Competitive premium tax rates Tax on Direct Premiums Rates:.38% on first $20M, plus.285% on next $20M, plus.072% on each dollar thereafter Tax on Reinsurance Premiums Rates:.214% on first $20M, plus.143% on next $20M, plus.048% on next $20M, plus. 024% on each dollar thereafter Minimum / Maximum Amounts Annual minimum aggregate tax is $7,500 Annual maximum aggregate tax is $200,000
Perr&Knight Commentary Perr&Knight is a leading provider of insurance support services and a strategic resource that companies use to reduce their fixed costs while increasing the efficiency and value of their insurance operations. Christopher J. Ridge, J.D.
Captive Manager s Perspective Onshore vs. offshore domicile decision 831(b) captives Reinsurance arrangements Dividend distributions
How to Ask Questions During the Q & A Please type your question into the questions box on the right side of your screen.
Recording This webinar will be recorded and available at www.njcia.org
!! Thank you for joining us.!! New Jersey Captive Insurance Association " Captive Insurance Basic Taxation. Christopher J. Ridge, JD, MS (RM)! Manager - Alternative Risk Finance! Perr&Knight! Harborside Financial Center! Plaza 10, Suite 802 Jersey City, NJ 07311 843.425.9038! cridge@perrknight.com! www.perrknight.com Harry M. Baumgartner, Esq. Bressler, Amery & Ross, P.C. 325 Columbia Turnpike Florham Park, NJ 973.966.9675 hbaumgartner@bressler.com www.bressler.com