Update: New legislation passed in 2015, effective in 2017, affects ownership rules for captive insurance companies. See our official announcement.
Planning Opportunities Abound
While parts of the U.S. have been impacted by hurricane season, there is another storm facing U.S. policymakers. Unlike most storms, this storm creates opportunities for affluent taxpayers interested in comprehensive estate planning due to economic conditions, favorable tax legislation and historically low interest rates.
Recent tax legislation offers affluent taxpayers an unprecedented opportunity to give substantial wealth to the next generation tax-free, provided the gift occurs before December 31, 2012. To read more about this unprecedented opportunity, please click here for the full article entitled "Now is the Time to Give."
Tax-free transfers of wealth between family members are not only enhanced by recent tax legislation, but also by our historically low interest rates. To read more about the once-in-a-lifetime opportunities for preserving family wealth through family loan transactions, please click here for the full article entitled "Planning Opportunities in a Low Interest Rate Environment."
Q4 is Busiest for Captives
Historically, the fourth quarter sees the highest activity for captive feasibility studies and formations as middle market businesses move forward with putting their alternative risk planning programs in place before year end.
Similarly, the summer and fall are busy times for Capstone. This summer, the Capstone staff made presentations at conferences and professional services firms in New Orleans, Dallas, Galveston, Houston, New York City, Chicago, and London, educating owners of closely held businesses and their trusted advisers regarding the significant benefits of captives.
We kick off our busy fourth quarter with two concurrent presentations in October: October 19 Steve Cohen and Clete Thompson will be presenting to 35 tax partners at the BKR Tax Practice Group at the Drake Hotel in Chicago, IL. BKR International is a leading association of independent accounting and business advisory firms, representing the expertise of more than 145 firms in 300 offices in over 70 countries around the world.
Stewart Feldman will be presenting to 200+ professionals at the upcoming BKD Tax Seminar in St. Louis, Missouri. Capstone will be addressing members of BKD's National Manufacturing & Distribution and Construction & Real Estate Groups at the seminar. BKD is a national CPA advisory firm with 29 offices in Arkansas, Colorado, Illinois, Indiana, Kansas, Kentucky, Mississippi, Missouri, Nebraska, Ohio, Oklahoma and Texas.
If you have any questions or would like to meet with us while we are in your area, please give us a call and we will schedule accordingly. Capstone is the largest turnkey sponsor of mid-market captives in the nation. To learn more about how captive insurance can protect your business, contact us at WEB_TEL or email.
U.S. Tax Court Upholds Controversial Captive Insurance Arrangement
On January 14, 2014, the U.S. Tax Court, in a 10-6 decision reviewed by the entire court (as opposed to the usual one judge), held that the payments made by subsidiaries of Rent-A-Center, Inc. to their affiliated captive insurance company were deductible as insurance expenses for federal income tax purposes. The captive insurance industry has been awaiting this decision of the Tax Court for more than two years.
In summary, the holding affirms or reaffirms what Capstone and our Firm believed was existing law and reduced the IRS' ability to oppose such arrangements.
The Internal Revenue Service (the "Service") challenged, among other things, the brother-sister arrangement between Rent-A-Center's subsidiaries and its captive as well as a parental guarantee used by the captive to meet solvency requirements for Bermuda regulatory purposes. The IRS also unsuccessfully argued that the Rent-A-Center captive arrangement was a sham for tax purposes and lacked "common notions of insurance".
Some interesting points:
• There was no third party insurance or unaffiliated insurance written by the Rent-A-Center captive as opposed to the stronger position of the Capstone captive program with 50% (formerly 30%) unaffiliated insurance.
• The Tax Court rejected the Service's heretofore thought abandoned, but newly resurrected position, that brother-sister captive arrangements were not insurance arrangements. Capstone structures its insurance arrangements as brother-sister arrangements, a more conservative approach.
• The Tax Court looked to the many insurable risk exposures--and not merely the number of insured entities--as the Service sometimes argues is required, although there were numerous entities insured within the Rent-A-Center group.
Rejecting the Service's arguments, the Tax Court found the captive to be a bona fide insurance company that appropriately shifted and distributed risk. Furthermore, the Tax Court determined that the arrangement between Rent-A-Center's subsidiaries and captive constituted insurance in the commonly accepted sense. As such, the Rent-A-Center decision adds to a well-established body of tax law recognizing the validity of properly structured and appropriately administered captive insurance arrangements.
The full text of the U.S. Tax Court opinion is available for review on our website here under the heading "Rent-A-Center, Inc. and Affiliated Subsidiaries v. Commissioner, 142 T.C. No. 1, United States Tax Court."
“The Living By-Pass Trust”: Maximizing Today’s Opportunities With Traditional Strategies
The 2010 Tax Relief Act offers historic opportunities for the preservation of family wealth and the transition of operating businesses within families. A $5 million lifetime gift tax exemption equivalent -- a robust $10 million exemption for married couples -- is not only unprecedented in scope but also generous in its application.
As recently as 2009, the lifetime gift tax exemption equivalent was only $1 million during a year in which the estate tax exemption was $3.5 million. The previous spread between the gifting options available during life versus the exemptions available at death was the backdrop behind the extraordinary news of the increase in lifetime gifting options created under the 2010 Act. The question many clients are asking is "What is the best way for me to take advantage of this temporary and generous tax opportunity?".
The fact that the $5 million exemption is available to tax payers during periods of unprecedented budget deficits and "Occupy Wall Street" protests should be viewed as a non-recurring anomaly.
While the appropriate solution depends on the financial circumstances of each client, concern may be expressed by one spouse or the other regardingthe loss of access to the gifted assets. Particularly in light of our recenteconomic experiences in the United States, the desire for greater flexibility and control is a natural response. The desire for flexibility among some clients has led to renewed interest in implementing a classic estate planning strategy known as the By-Pass Trust or Credit Shelter Trust.
By using your available credit prior to December 31, 2012, rather than waiting until death, you can secure the advantage of the higher exemption amounts while offering access to your spouse in the same way as would be achieved in the traditional By-Pass Trust structure. In addition to securing the $5 million exemption while it lasts, you are able to shift the benefits of future growth in asset value to descendants and remove the growth from your gross taxable estate (and that of your spouse). In community property states like Texas, greater care should be exercised when implementing trusts with your spouse as beneficiary. However, with proper planning, the traditional By-Pass Trust structure funded during life offers significant benefits for wealth preservation.
The Patient Protection and Affordable Care Act
The patient protection and affordable care act (h.r. 3590) (the "act"), signed into law by President Obama on march 23, 2010, contains numerous tax provisions. The health care and education tax credits reconciliation act of 2010 (h.r. 4872) (the "reconciliation bill"), which is a companion bill to the act and also signed into law by the President, contains other tax changes, most notably as such affects our clients, an additional 3.8% tax on net investment income on so-called "high income" taxpayers.
Based upon rumblings from the Obama administration, there are more tax hikes to come. For example, click the link below for a recent article in the New York Post reporting that the current administration is testing the waters as to a national value added (aka "sales") tax (VAT). If enacted into law, the VAT should be in addition to the recently enacted 3.8% tax surcharge on net investment income, which is discussed below.
The act and reconciliation bill contain a wide array of new tax provisions affecting virtually all taxpayers. Rather than summarizing the myriad tax changes contained in the new legislation, we have highlighted below the most significant tax provisions affecting our primary client base (substantial closely-held businesses and their owners).
Additional Hospital Insurance Tax on High-income Taxpayers
Under the act, the employee portion of the hospital insurance tax part of FICA, currently amounting to 1.45% of covered wages (2.9% combined employer/employee wages), is increased by 0.9% on wages that exceed a threshold amount. The additional tax is imposed on the combined wages of both the taxpayer and the taxpayer's spouse, in the case of a joint return. The threshold amount is $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case. For self-employed taxpayers, the hospital insurance tax portion of the self-employment tax is also increased by 0.9% on self-employment income in excess of the threshold amount for a total of 3.8%.
Additionally, a new Medicare tax of 3.8% would apply to net investment income (e.g., dividends, interest, rents, royalties, annuities and taxable net capital gains) of individuals with adjusted gross income above $200,000 and joint filers with adjusted gross income above $250,000. Also, the new tax would apply to income earned from a trade or business that is a passive activity or trading in financial instruments or commodities. Active trade or business income and distributions from qualified retirement plans, including pensions and certain retirement accounts, are not subject to the new tax.
The new Medicare tax on net investment income casts a wide net as it applies to individuals, trusts, estates, partnerships and s corporations (e.g., schedule k-1 allocations). However, based on our preliminary reading of the new statute (irc § 1411), there may be planning opportunities available to reduce the impact of this additional tax on net investment income.
The provision applies to remuneration received and tax years beginning after December 31, 2012.
Economic Substance Doctrine
The act codifies for all transactions the "economic substance doctrine," which is a tax doctrine rooted in the common law that was previously incorporated in the internal revenue code only in limited circumstances. Under the new legislation, a transaction would have economic substance only if the taxpayer's economic position (other than its federal tax position) changed in a meaningful way and the taxpayer had a substantial purpose (other than a federal tax purpose) for engaging in the transaction.
Recognizing that many taxpayers will attempt to satisfy this provision by showing their transactions will be profitable, the new legislation states that profit potential may be taken into account only if the present value of the reasonably expected profit from the transaction is substantial in relation to the present value of the expected net tax benefits that would be allowed if the transaction were respected. Taxpayers must consider professional fees, other transaction costs and foreign taxes in computing profit potential. Furthermore, financial accounting benefits arising out of a reduction in federal income tax are disregarded in determining whether the taxpayer has a substantial purpose for entering into the transaction.
Failure to demonstrate the economic substance of a transaction will be subject to a stiff, automatically-applied penalty equal to 20% of the underpayment (40% if the transaction is not adequately disclosed on the tax return). The new legislation imposes virtual strict liability for these penalties by eliminating the reasonable cause and good faith defenses otherwise available under existing law. This no-fault penalty regime substantially raises the stakes for taxpayers considering a position potentially subject to an economic substance challenge by the irs.
It is particularly noteworthy that the now-codified economic substance doctrine does not authorize the IRS to issue regulations implementing the new rules. Thus, the Treasury Department may be limited in its ability to further expand the doctrine administratively. Furthermore, it neither exempts nor authorizes the Treasury Department to exempt particular types of transactions from the economic substance requirement.
This provision applies to transactions entered into after March 30, 2010.
Other New Statutory Provisions
The act does not require employers to provide health insurance coverage. However, employers that do not provide minimum essential coverage will be liable for an additional tax. The health care package also requires automatic enrollment in health insurance plans sponsored by large and mid-size employers.
Employers that fail to offer minimum essential coverage during any month for which a full-time employee has enrolled in a subsidized plan using the premium assistance tax credit or cost-sharing reductions would be liable for an additional tax. The penalty would equal the product of the applicable payment amount (with respect to any month, 1/12 of $2,000) and the number of full-time employees employed by the employer during such month. The penalty would apply to employers with 50 or more workers but would subtract the first 30 workers from the payment calculation. Businesses with fewer than 50 employees would be exempt from any employer responsibility to provide coverage.
This provision is effective for months beginning after December 31, 2013.
Excise Tax on Uninsured Individuals
The act requires U.S. Citizens and legal residents to maintain minimum amounts of health insurance coverage. Individuals who fail to maintain minimum essential coverage will be subject to a penalty. The act uses a formula to calculate the penalty taking into account the taxpayer's household income and a flat dollar amount.
Beginning in 2016, the penalty for failure to maintain minimum coverage is the greater of: (i) 2.5% of household income in excess of the taxpayer's household income for the tax year over the threshold amount of income required for income tax return filing under IRC section 6012(a)(1); or (ii) $695 per uninsured adult in the household. The penalty will be phased in during 2014 and 2015. For 2014, the penalty will be the greater of 1% of household income over the filing threshold or $95; and for 2015, it will be the greater of 2% of household income over the filing threshold or $325.
This provision is effective for tax years beginning after December 31, 2013.
Excise tax on high-cost employer plans the act imposes an excise tax on insurers if the aggregate value of employer-sponsored health insurance coverage for an employee (including, for purposes of the provision, any former employee, surviving spouse and any other primary insured individual) exceeds a threshold amount. The tax is equal to 40% of the aggregate value that exceeds the threshold amount. For 2018, the threshold amount is $10,200 for individual coverage and $27,500 for family coverage, multiplied by the health cost adjustment percentage (as defined in the act) and increased by the age and gender adjusted excess premium amount (as defined in the act).
The provision is effective for tax years beginning after December 31, 2017.
Notice: to comply with certain U.S. Treasury regulations, we inform you that, unless expressly stated otherwise in writing, any U.S. Federal tax advice provided by this firm, whether in this email or its attachments or otherwise, is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed by the Internal Revenue Service.
Summary: The Reid-McConnell Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (S.A. 4753) (the "Act")
On Friday, December 17, 2010, President Obama signed into law legislation extending the Bush-era tax cuts and extending unemployment benefits as part of a legislative strategy often referred to as the Tax Compromise of 2010. The relevant portions of the Act for our clients is the extension of two separate tax relief laws that were previously scheduled to expire on December 31, 2010, and the addition of additional tax benefits in key areas. Thus, this summary will focus on the temporary tax relief provisions contained in the Act. The key tax provisions of the Act are as follows:
Income Tax Relief Through December 2012
• Tax rate on qualified dividends remains at 15% vs. 39.6%
• Maximum income tax rate of 35% vs. 39.6%
• Long-term capital gains taxed at 15% vs. 20%
• No reduction in itemized deductions and exemptions for high income individuals
Income Tax Relief Through December 2011 (retroactive to January 2010)
• State and local sales tax deductions are allowed in full
• Tax-free distributions of IRA to charitable organizations up to $100,000 with the opportunity to treat January 2011 gifts as having been made in 2010
New Income Tax Provisions
• Two years of AMT relief for married taxpayers by increasing exemption amount to $72,000
• 2% reduction in social security taxes for employees and self-employed for 2010 tax year
Estate and Gift Tax Through December 2012
• $5 million estate tax exemption and generation-skipping tax exemption
o Estates in 2010 have option to apply $5 million exemption with benefit of full cost basis adjustment OR zero estate tax with limitations on cost basis adjustments
o Beginning in 2011, unused exemption amounts of a married individual can be used by surviving spouse
o Beginning in 2012, the $5 million exemption is eligible for inflation adjustments
• $5 million gift tax exemption beginning in 2011 with 35% rate
• Top estate tax rate of 35%
Other Tax Benefits for Businesses
• 100% bonus depreciation on machinery and equipment acquired and used after 9/8/2010 through 12/31/2011
• 50% bonus depreciation on machinery and equipment acquired and used during 2012.
• 15-year write-off for qualifying leasehold improvements and retail improvements
• Research & development credit extended through 2011.
Our attorneys have prepared strategies today for our clients to take advantage of the dramatically increased lifetime gift tax credits and the extension of lower gift tax rates at 35%. The new legislation contains many planning opportunities available to our clients today.
Treatment of Captive Dividend in Community Property States for Section 831(b) Clients Declaring a Dividend
This memo is directed to certain of our clients residing in community property states who have a §831(b) intermediate captive insurance company ("intermediate captive") making a dividend in 2010.
The community property states are Texas, Louisiana, California, New Mexico, Arizona, Nevada, Idaho, Washington, Wisconsin and Alaska. The following is a general discussion concerning the characterization of a corporate dividend to its shareholders as community property or separate property under Texas law. The character of a dividend made by a corporation under the laws of any other state is not covered in this memo. If you reside in a community property state other than Texas, you may wish to consult your local family law counsel as to the treatment of a dividend for this purpose.
In general, a corporate dividend of cash or other property paid to an individual is community property under Texas law, unless there is an effective pre-nuptial or post-nuptial agreement providing otherwise. This characterization of a dividend as community property is similar to the treatment of salary or business earnings. Please note, however, that the treatment of a dividend of cash or other assets under Texas law as community or separate property is subject to the facts and circumstances of the particular case.
Thus, under Texas law the dividend by your intermediate captive of cash and/or loan receivables will probably be community property in your hands. If the direct shareholder of the captive is a holding company (e.g., a limited partnership, limited liability company or trust) that you hold as a separate property asset, the captive dividend will most likely remain your separate property for so long as the holding company does not distribute the dividend to you individually. However, once the proceeds of the captive dividend is paid to you, the dividend will probably become community property in your hands.
You may wish to consider this potential result when deciding whether to contribute to your operating company as paid-in capital any loan receivable that was paid to you as a dividend by your captive. The transfer of a loan receivable held by you as community property to an operating company that you currently hold as your separate property could change the character of all or a portion of your ownership in the operating company from separate to community property in your hands. If this potential result is an issue for you, please let us know so we can discuss your possible options with respect to the disposition of the proceeds of the dividend made by your intermediate captive.