Many honest businesses take advantage of forming their own insurance companies. Called a “captive insurance company,” this arrangement is legal. It helps companies obtain insurance for a unique type of business risk that makes standard insurance either unaffordable or hard to find.
Smaller businesses are also allowed the option to form their own insurance companies. The name “micro-captives” given to these insurance companies indicates the lesser size of their formation businesses.
Rules for a captive insurance company
A captive business-formed insurance company must follow the same government regulations as commercial insurers. To avoid IRS suspicion, the business should discontinue regular commercial insurance and move over to its own captive insurance company. The distinct advantage is that the business can set and pay lower rates than a commercial insurance company would charge them for the same coverage.
Tax benefits for a micro-captive insurance company
Promoters are professionals from a variety of financial jobs who approach a small business about opening their own micro-captive insurance company. Most promotors help small businesses set up law-abiding micro-captives for a legitimate business purpose. Micro-captives have attractive tax benefits under Section 831(b) of the tax code.
Unfortunately, some micro-captive promoters are not honest; their hidden (or sometimes open) agenda is to use the micro-captive only for the tax advantages available to a small company. Any small business approached by a dishonest promoter should run—not walk—away. Why? The U.S. government is aggressively pursuing these tax dodges and have listed dishonest micro-captive insurance company formations on the IRS “Dirty Dozen” scams operation list.
Spotting a fraudulent micro-captive promoter
What does a promoter gain from helping a small business set up a micro-captive? The promoter can take an initial organizing fee to set up the insurance company, but most promoters also manage and run the micro-captive insurance company. Any small business should thoroughly investigate the promoter; a dishonest person can use the company’s trust to falsify business information and set up a fraudulent tax shelter for the business without the company’s knowledge.
Any small business owner who suspects their micro-captive promoter has set up the new insurance company as an illegal vehicle for the sole purpose of raking in consulting and on-going management fees should watch for signs such as higher premiums, no actuarial examination, large capital withdrawals to cover risk and other suspicious behavior. The business owner should hire professional representation to internally investigate the promoter’s activities to avoid suspicion of collusion should the IRS decide to target the micro-insurance company as a potential scam.