Middle Market Captive Growth & Alternative Risk Planning


Anguilla Captive Insurance

"Middle Market Captive Growth" Published in US Captive

From The Feldman Law Firm LLP - Captive Client Memorandum

April 28, 2009 - Last month, Capstone hosted a reception in Houston for Niguel Streete and Lanston Connor, senior regulators for the British overseas territory of Anguilla.  Anguilla has fast become the "domicile of choice" for captive insurance companies affiliated with privately-held businesses, especially those affiliated with U.S. insureds.

In connection with our work in Anguilla, Capstone this month co-authored the feature article for US Captive on the growth of alternative risk planning for middle market companies.  Click on the link below for a copy of the article, "Middle Market Captive Growth" which was co-authored with Lanston Connor, Anguilla's Registrar of Companies (Secretary of State).

US Captive is an international publication, distributed at conferences for insurance professionals held throughout the world.

Click here for US Captive article

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Obama's Recent Foreign Tax Proposals and Alternative Risk Planning

From The Feldman Law Firm LLP - Client Memorandum

May 18, 2009 - We have received several inquiries from clients, CPAs and referral partners asking whether President Obama's recent foreign tax proposals, if enacted into law, would adversely affect captive insurance/alternative risk planning.

Summary Response: None of these foreign tax-related initiatives should have any impact on captive insurance/alternative risk planning.

Background: These foreign tax proposals, which were outlined in a release by the White House on May 4, 2009, are designed to "level the playing field" by replacing tax advantages for creating jobs overseas in favor of incentives to create jobs at home and "getting tough on overseas tax havens." To create more jobs in the United States, the Obama Administration proposes tax legislation that would do, among other things, the following:

  1. Reform deferral rules to curb a tax advantage for investing and reinvesting overseas; and
  2. Close foreign tax credit loopholes.

The proposal would also "get tough on overseas tax havens," as follows:

  1. Eliminate loopholes for "disappearing" offshore entities.
  2. Crack down on the abuse of tax havens by individuals.
  3. Devote new resources for IRS enforcement to help close the international tax gap.

None of these foreign tax-related initiatives should have any impact on captive insurance companies located in either foreign or domestic jurisdictions. Although captive insurance companies are often located in non-U.S. jurisdictions primarily for non-tax, regulatory purposes, they are usually domesticated as U.S. taxpayers for all federal income tax purposes under a special election process designed by the IRS. Therefore, captive insurance companies - even when formed in a British Overseas Territory (e.g., Bermuda) - do not involve "tax havens" targeted by this White House plan. These insurance companies, even when based, for example, in Bermuda, file U.S. tax returns, have an EIN and are subject to all U.S. tax laws, paying tax at the rates set forth in the Internal Revenue Code.

If you have any additional questions, please feel free to contact us.

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Tax Efficient Investments for Intermediate IRC Section 831(b) Captives

Tax Efficiency

From The Feldman Law Firm LLP - Captive Client Memorandum

May 29, 2008 - An 831(b) insurance company ("intermediate captive") pays regular C corporation tax on its investment income.  We want to again call to your attention a sometimes-overlooked investment benefit that is available to C corporations.

IRC §243 allows a C corporation a 70% dividend received deduction on dividends received from a publicly-held corporation. Thus, 70% of the dividends (but not capital gains distributions) received are tax exempt to your intermediate captive, resulting in an overall effective, 10±% overall effective tax rate on such dividends.  This is an attractive result, especially given the range of high yield (8±%) preferred stock issues available in the market today.  Note that this dividend-received deduction is not applicable to §501(c)(15) type captives.

Additionally, you may want to consider tax-exempt securities for part of the captive's diversified portfolio of investments.  While the Firm does not give investment advice, clients seeking a diversified portfolio of investments can direct their tax exempt securities purchases to the intermediate captive, achieving a tax free result.  Of course, upon liquidation of the captive in the ordinary course of business over a few years, the resulting gain on liquidation is taxed at low, capital gains rates, presently at 15%.

Sometimes it is helpful for the captive to use a subsidiary (such as an LLC) in which to make its investments.  These and other matters can be discussed with us on a case-by-case basis.  We encourage all captive owners to have competent investment professionals to assist in managing and diversifying their captives' assets.  We recommend that strong consideration be given to maintaining a diversified portfolio.  Any concentration within the portfolio should be evaluated in light of its profitability, security and liquidity of the concentrated investment, as well as insurance regulatory concerns with a non-diversified portfolio.

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Tax Planning Idea for Section 501(c)(15) Captives

From the Feldman Law Firm LLP - Captive Client Memorandum

December 10, 2009 - This tax planning idea is specifically directed at owners of Section 501(c)(15) captive insurers. As you are aware, gross receipts for your captive cannot exceed $600,000.00 for any calendar year. This $600,000.00 annual amount is based upon realized income. That is, if your captive holds appreciated equities or appreciated stock, for federal income tax purposes, the appreciation is only counted as part of "gross receipts" when the stock is sold. Thus, for example, your captive can have literally millions of dollars of unrealized gain from stocks that have not yet been sold and still meet this $600,000.00 cap. However, upon liquidation of a Section 501(c)(15) captive, these unrealized gains are taxed within the captive as "deemed sales."

One tax planning idea to avoid this result is to carefully calculate how much gain your captive can realize in a particular calendar year and "release" at least some of the gain annually by selling stock or mutual fund positions. Subject to the wash sale rules, the captive can reinvest the proceeds immediately in a similar security. For example, your captive can sell a large cap value mutual fund sponsored by Vanguard before year-end and immediately invest in a large cap value mutual fund run by American Funds, thus essentially minimizing market risk by investing in a similar fund. The gain can then be recognized tax free subject to the gross receipts (all premiums received plus all investment income) of the captive being less than $600,000.00 in a calendar year. Note for planning purposes, in calculating gross receipts, capital losses do not reduce capital gains.

By implementing this strategy, captive owners will help ensure that upon an orderly liquidation of the captive, the captive's shareholders would only be subject to a 15% capital gains tax. Otherwise, if all the unrealized gains are realized in the year of the captive's liquidation, the Section 501(c)(15) captive may become taxable as an intermediate captive under Section 831(b), resulting in the investment income being taxed at regular rates within the C corporation before the 15% tax is imposed at the shareholder level. It is for this reason that Section 501(c)(15) captives often invest their assets in interest bearing securities.

In carrying out this strategy, it is important that you carefully and accurately project your Section 501(c)(15) captive's earnings for each calendar year, so you do not exceed the absolute prohibition of $600,000.00 on all gross receipts and so as to ensure that premium revenue is more than 50% of gross receipts. If you plan on selling any appreciated stock or securities prior to year-end, please use the Tax Compliance worksheet recently sent to you by Capstone's Megan Brooks. Also, we strongly advise consulting with Capstone's Megan Brooks, John Boskat and Chuck Earls prior to significant sales so they can review the Tax Compliance worksheet with you.

In applying this strategy, it is important to consider mutual funds' capital gains and dividend distributions usually made during December of each year. You should be careful to include these year-end distributions in your captive's pro formas. If you invest in mutual funds, the website of the mutual fund sponsor usually contains up-to-date information on capital gains and dividend distributions.

Also, click this link which contains recent information on capital gains and income distributions on many mutual funds. By way of example, click this link  and see under "Fund Operations" the dates of historical dividend and capital gains distributions. Even if nothing is listed yet for 2009, you should still expect distributions on the anniversary date of the last income and capital gains distributions.

By careful managing the recognition of gain, many clients can free up and release large gains on mutual funds and managed monies.  Please feel free to contact Steve Cohen, or Stewart Feldman with any technical tax questions, or Megan Brooks, John Boskat or Chuck Earls at Capstone on administrative issues.

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Texas Gross Margin/Franchise Tax Temporary Exemption Increase

Gross Margins

On June 16, 2009, Governor Rick Perry signed House Bill (H.B.) 4765 that raises the small business exemption to the state franchise tax from $300,000 to $1,000,000 (in annual revenue), effective for reports due on or after January 1, 2010. Under the sunset provisions of this legislation, the $1,000,000 exemption would revert to $300,000 for reports due on or after January 1, 2012. Thus, for calendar year taxpayers, the increased exemption would be effective for reports based on the 2009 and 2010 accounting periods. If a taxpayer's annual revenue exceeds the $1,000,000 exemption, it would be required to compute tax on the entire amount. There would be no exclusion for the first $1,000,000 of revenues. See Comptroller's Letter, No. 200609762L.

While Texas operates under the unitary state sales tax approach whereby certain entities are combined for reporting purposes, this new higher exemption amount presents various planning opportunities. The percentage ownership to determine a combined affiliated group is more than 50%. In addition to the common ownership test (direct or indirect), entities are combined if they also meet any of the following three additional tests: (i) same general line of business; (ii) vertically structured enterprise or process; or (iii) functional (horizontal) integration with centralized management. These complex rules present tax planning opportunities. Depending on the facts, combined reporting can result in either higher or lower taxes than the total taxes calculated by a separate reporting basis. That is, because of the many factors which are part of the design process for a new entity or for a group of existing entities, it is important to evaluate the specific facts of each situation in order to determine the various tax planning opportunities.

Our Firm is actively engaged in the representation of closely-held businesses in tax, corporate, and related financial matters affecting the operations of such businesses and their principal owners.

For additional questions, please contact Steven Cohen at WEB_TEL. Thank you.

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The American Recovery and Reinvestment Act of 2009

From The Feldman Law Firm LLP - Client Memorandum 

February 18, 2009 - On February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009 (the "Act"), which includes $300 billion in tax cuts as part of an overall $787 billion economic stimulus package designed to revive the economy and save millions of jobs.

The Act includes a wide variety of tax cuts for individuals and businesses. The most publicized tax provision in the new law is the "Making Work Pay" credit of $400 for individuals and $800 for married couples in 2009 and 2010 that will be distributed in small increments to wage earners through changes in the tax withholding tables. The phase-out for the credit is $75,000 for individuals and $150,000 for joint tax returns. The Act also provides for another one-year $70 billion patch for the alternative minimum tax on individuals.

For businesses, the Act will continue to allow 50% first-year bonus depreciation without limitation on the cost of new equipment acquired in 2009. It also extends through 2009 the section 179 deduction allowing businesses to expense up to $250,000 for the cost of new property placed in service. This expense limit was set to decrease to $125,000 for 2009 under existing law.

The final version of the legislation contains the same spending and tax provisions that were in the House and Senate conference report, which we outlined in our recent client memo dated February 13, 2009 (see link to memo below). Steve Cohen, a senior tax attorney with our Firm, is our resident expert on the individual and business tax provisions in the new legislation. He would be happy to discuss with you the tax planning opportunities presented by this new legislation or any other matters of interest to you. His email address is scohen@feldlaw.com.

 The American Recovery and Reinvestment Act of 2009 

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The White House's Budget Proposals

From The Feldman Law Firm LLP - Client Memorandum

February 28, 2009 - In his 10-year, $3.6 trillion budget plan released on Thursday, February 26, 2009, President Obama increases taxes on "high-income" individuals and business owners to help pay for his promise to make health care more accessible and affordable.  These new tax proposals, together with Mr. Obama's existing plan to roll back the Bush-era income tax reductions on households with annual income exceeding $250,000, would be a pronounced move to redistribute wealth by reimposing a larger share of the tax burden on businesses and the most affluent taxpayers.

Starting in 2011, the combined effect of Mr. Obama's proposals will raise the top income tax rate on individuals with income of $200,000 or more ($250,000+ for married couples) from the current 35% rate to a new 39.6% rate, and the tax rate on dividends and capital gains will increase from 15% to 20%.  However, the hike in rates is only part of the story.

The tax proposals would place stricter limits on itemized deductions (such as mortgage interest, state and local taxes and charitable contributions).  President Obama proposes to reduce the value of itemized tax deductions for everyone in the current top income tax bracket of 35%, and many of those in the 33% bracket - roughly speaking, starting at $250,000 in annual income for a married couple.

Under existing law, the tax benefit of itemizing deductions rises with a taxpayer's marginal tax bracket (the bracket that applies to the last dollar of income).  For example, $10,000 in itemized deductions reduces tax liability by $3,500 for someone in the 35% bracket.  Mr. Obama would allow a saving of only $2,800 -- as if the taxpayer were in the 28% bracket.  The White House argues it is unfair for high-income people to get a bigger tax break than middle-income people for claiming the same deductions or making the same charitable contributions.

In a 134-page document summarizing its proposals, the White House said it would finance health coverage for the uninsured in part by "rebalancing the tax code so that the wealthiest pay more."  In that sense, the budget is payback by the new Democratic administration.  As expected, taxes will rise for singles earning $200,000 and couples earning $250,000, beginning in 2011 -- for a total increase of $656 billion over 10 years.  Income tax rate hikes would raise $339 billion alone.  Limits on personal exemptions and itemized deductions would bring in another $180 billion.  Higher capital gains rates would bring in $118 billion.  Additionally, the estate tax, scheduled to be repealed for 2010 only, would instead be preserved, with the value of estates over $3.5 million -- $7 million for couples -- taxed at 45%.

Businesses would be hit, too.  The budget envisions reaping $210 billion over the next decade by limiting the ability of U.S.-based multinational companies to shield overseas profits from taxation.  Another $24 billion would come from hedge fund and private equity managers, whose income would be taxed at regular income tax rates, not capital gains rates.  Oil and gas companies would be hit particularly hard, with the repeal of multiple tax credits and deductions.

These new taxes proposed by the President, if passed by the Democratic-controlled Congress, are not expected to take effect until 2011.  The next two years will be critical for high-income individuals and businesses to put in place tax planning opportunities that are currently available and not targeted for repeal.  If you would like to discuss planning ideas in contemplation of this fast-approaching high-tax environment, please contact any of our senior tax lawyers.


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