Captive Insurance (831(b)): Turning ‘Sunk Cost’ Premiums into Tax-Efficient Wealth
Captive Insurance (831(b)): Turning ‘Sunk Cost’ Premiums into Tax-Efficient Wealth
COACHING POINTS
- The Paradigm Shift: Insurance is usually a “use it or lose it” expense. With a Captive, if you don’t have claims, the premiums you paid stay in your subsidiary company’s bank account, not a third-party insurer’s pocket.
- The Tax Arbitrage: Under IRC Section 831(b), small insurance companies (premiums <$2.8M) pay 0% Federal Income Tax on premium income. Your operating company gets a deduction, and the Captive gets tax-free revenue.
- The Risk Coverage: Captives cover “Enterprise Risks” that commercial policies often exclude or overcharge for: Supply Chain Interruption, Key Man Loss, Cyber Attack Deductibles, and Regulatory Changes.
You pay $500,000 a year in business insurance. Over 10 years, that’s $5 million gone forever. What if you could pay that $500,000 to your own insurance company? The Micro-Captive Strategy allows successful business owners to build a massive “War Chest” of reserves inside a tax-privileged entity, converting an expense item into a balance sheet asset.
How the money moves and grows.
- Operating Co: Pays $1M Premium. (Deductible Expense). Tax Saved @ 40% = $400,000.
- Captive Co: Receives $1M Premium. Tax Paid @ 0% (831(b)). Net Cash = $1,000,000. IRC 831(b)
- Result: $1M moved from a high-tax environment to a zero-tax environment. The Captive invests this $1M (taxed only on investment gains, usually at lower corporate dividend rates).
What-If Scenario: 10 Years of No Major Claims
Annual Premium: $500,000. Investment Return: 5%.
| Strategy | Commercial Insurance | Captive Insurance |
|---|---|---|
| Total Cost (10 Yrs) | $5,000,000 (Gone) | $5,000,000 (Paid to Self) |
| Accumulated Reserves | $0 | ~$6,000,000+ (Invested) |
| Outcome | Sunk Cost | Asset on Balance Sheet |
Visualizing the Wealth Retention
*Figure 1: Net Worth Impact. The Green line (Captive) accumulates wealth that the Red line (Commercial) gives away.*
Execution Protocol
COACHING DIRECTIVE
- Do This: If your profitable business has $5M+ revenue, significant uninsured risks, and you can commit to $250k+ annual premiums.
- Avoid This: If you are just looking for a tax shelter and have no real risk. The IRS has listed “Abusive Micro-Captives” as a “Dirty Dozen” tax scam. Do it right or don’t do it at all. IRS Notice 2016-66
What is a Captive Insurance Company?
A Captive is a licensed insurance company owned by the business it insures. Instead of paying premiums to a third party (like AIG or Chubb), the operating business pays premiums to its own Captive. This allows the business owner to retain the underwriting profit if losses are low.
What is the 831(b) Election?
It is a provision in the tax code for small insurance companies (Micro-Captives). If the Captive receives less than ~$2.8 million in premiums, it pays 0% Federal Income Tax on that premium income. It is taxed only on its investment income.
Is this a tax shelter or legitimate insurance?
It MUST be legitimate insurance. To qualify, the Captive must pass the ‘Risk Transfer’ and ‘Risk Distribution’ tests. If the IRS determines the arrangement is a sham solely for tax avoidance, they will disallow the deductions.