Captives are not for everyone
Despite their advantages, it is important to point out that captives are not right for every organization. Unfortunately, this doesn’t keep promoters from convincing organizations to use captives in inadvisable ways.
I am continually surprised at how many organizations are led to believe they can use a captive in ways that range from being wrong for their business to being simply illegal. For example, I spend much of my time speaking to attorney-, accountant-, and insurance-professional associations. As a result of my 30-40 presentations per year, we are blessed to be seen as a resource for these groups. I recently got a call from an attorney in California whose client just signed an engagement letter to form a captive with a national promoter. The captive was an offshore captive and the policy the client’s captive would write is terrorism insurance. I told their attorneys I needed more facts. Once they started describing that the client manufactured high-end, handcrafted musical instruments in a remote town of California with a population of less than 10,000, it did not make sense. With annual profit of $2,000,000, it was ridiculous to think the IRS would designate $1,200,000 in terrorism insurance premium an “ordinary necessary business expense.” In this case, the IRS would not even have to challenge the legitimacy of the captive insurance company; they could simply outright deny the deduction for the insurance.
The very next day, we got a call from two anesthesiologists from the other coast. They went to a seminar by a national promoter and got very excited at the prospects of a captive. They had all but agreed to do it when they talked to their attorney. The attorney referred them to us and we had a brief conversation. Here is what our fact finding revealed:
- The proposed captive domicile was offshore,
- the owners were each anesthesiologists with two employees, and
- they are both looking at funding $1,200,000 in sexual harassment insurance premiums.
I told them I didn’t feel the IRS would think $1,200,000 in premiums for this coverage would be justified.
With the right professional guidance, a company can relatively quickly learn the specific potential benefits to operating a captive. It can also learn the potential pitfalls. The reality is that running a captive is running an insurance company. It must be taken seriously and handled professionally. If what someone is trying to sell you doesn’t look or feel like a legitimate insurance operation, get a second opinion from a professional before making any significant decisions. As with anything else, if it seems too good to be true, it probably is.