At the beginning of 2017, the Protecting Americans from Tax Hikes (“PATH”) Act went into effect. One of the changes implemented by the Act altered how small and medium-sized business owners can use captive insurance companies (“CIC”). A CIC is an insurance company that is owned by the business itself either solo or along with other businesses that have the same insurance needs, rather than owned by a third-party provider. The CIC is a favored device of small and medium-sized business owners, because of special tax treatment the IRS allows to certain CICs.
Pursuant to the PATH Act, if a CIC receives $2.2 million or less in net premiums annually (the cap was previously $1.2 million), then the CIC is not taxed on the premiums received, but instead only on investment income earned from those premiums. Additionally, the business owner who pays those premiums gets to deduct them from his or her taxable income as an ordinary business expense. That means a business which otherwise would have $2.2 million of taxable income could deduct that sum, reducing taxable burden or even triggering a taxable loss to be carried back and forward to other tax years. Moreover, the dividends that the CIC pays out to its shareholder beneficiaries are taxed at capital gains rates, which are lower than ordinary rates.
CICs, if structured properly, may also be a tool for Section 8(a) owners to comply with SBA’s total assets test, which states that the individual upon whom eligibility is based may not have total assets exceeding $6 million. Total assets include the value of the business and the individual’s principal residence. Section 8(a) program participants with successful businesses may find it difficult to comply with the total assets test, especially if the individual upon whom eligibility is based owns 100% of the company. Consequently, removing cash from the company and putting it into a CIC can help lower the company’s total assets and thus help an 8(a) owner keep his or her certification. However, caution is warranted since, depending on the way the CIC is structured, SBA could find that the companies owning the CIC are affiliated, which may create size issues. Further, there are tax considerations which must be considered before investing in a CIC.
ABOUT THE AUTHOR: David Medalia is a new associate at PilieroMazza who focuses his practice in the business and corporate group. He may be reached at [email protected].