Six Examples of Insurable Risks

Own Your Own Insurance Company - Six Examples of Insurable Risks

Many trusted advisors have requested examples where a captive (IRC 831(b)) is utilized cap_logofor our clients. They are seeking self education as a way of adding value to their Tier 1 clients and prospects (owner operators with consistent taxable profits exceeding $2 million annually).
).

Owner operators unknowingly self-insure a large number of risks. These risks include the many hidden risks that are inherent in the operations of any business PLUS the many risks that are excluded by conventional insurance policies.

Hidden risks abound in business.

Here are two examples of where a captive is used by our clients.

Steel Service Company - insures against the political risk associated with trade sanctions affecting its supply chain.
Oil Field Service - insures against governmental actions which could adversely affect its business such as a drilling moratorium.

Click here for 4 additional examples. These are contained in an article we were requested to author for "Captive Review" a publication targeted to captive owners and their advisors.

I trust these examples are of value to you. Allow me now to share my 18 month observation of working at Capstone.

18 Months at Capstone - My observations

831(b) captive planning is detailed. It requires an immense amount of experience to properly optimize benefits (for captive owners), document and operate consistently. My two main observations are as follows:
• This is an area that requires seasoned tax attorneys whose experience block includes years of working with entrepreneurs AND years of being versed with 831(b) captive law.
• Capstone is the low cost solution for clients as we allow them to focus on their business vs. potential IRS/domicile headaches via other non tax attorney based captive managers.

It will be a pleasure for you to leverage, for your clients and prospects, our captive management / captive legal experience (since 1998) and outside counsel to entrepreneurs (30+ years).

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Captives Supplement Conventional Insurers

Businesses Use Captives for Increased ProtectionUS_Ins_market

Decades ago, the largest U.S. companies came to realize the benefits of a captive insurance program with the result that there are now as many as an estimated 10,000 captive insurers in place worldwide - with the majority affiliated with U.S. businesses. The reasons are obvious:

• Acme Manufacturing is a closely held business based in the Midwest. It generally offers a one-year warranty for its products, which can be supplemented with a multi-year extended service contract. This service contract can be structured as an insurance arrangement wherein a captive insurer backs up Acme's financial obligations in exchange for a premium. Structuring the contract as an insurance arrangement allows Acme to deduct the costs of its extended service contract upfront (rather than deduct warranty related service expenses as they occur). Meanwhile, the investment income in the captive can build up on a tax-advantaged basis.

• Federal Industrial Cooling Company provides industrial cooling equipment and services to commercial and industrial customers. It relies on its experienced HVAC engineers/salesmen to interface with architects and mechanical engineers who design the projects. Its senior management (COO and CFO) are also critical members of the management team. The loss of any of the engineering/sales staff or executive management would significantly impact Federal. While key man policies insuring against death are widely available in the marketplace, polices that insure against disability or simply a person's retirement or just plain quitting -- whether or not joining a competitor -- are more difficult to come by. The captive can insure these risks.

• Enviro Services has developed at great expense certain processes used in containing and cleaning up industrial waste. It wishes to insure these non-patentable processes against competitors' pilferage. Its captive insures the integrity and exclusivity of these processes against devaluation caused by the misappropriation of these processes by competitors.
Practically speaking in none of these situations is insurance readily available from conventional carriers to cover these company specific risks.

Already tens of thousands of businesses - representing industries ranging from manufacturing to fabrication to distribution, finance, construction, engineering and law - now participate in some type of alternative risk planning program to better insure risks of its parent company. These companies do not necessarily cancel their conventional liability or property or auto/truck coverages. Rather these businesses supplement their conventional coverages with carefully tailored policies that pick up where the conventional carriers fall short of the mark.

Click here for a pdf copy.

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CLIENT MEMORANDUMFeldlaw

Re: Recent Developments with Respect to State Premium Tax

Last year we informed you of the potential impact of the Nonadmitted and Reinsurance Reform Act (the "NRRA") on captive insurance companies. The stated intent of the NRRA was to unify premium tax reporting on surplus lines insurance, such being state licensed insurance brokers' use of out-of-state/nonadmitted insurance companies to write generally unusual coverages for clients. Heretofore, the state licensed brokers had to apportion premiums, file, and pay state tax in every state where the insureds did business, often requiring 50+ tax filings. The NRRA gave sole authority to tax "nonadmitted insurance" to the "home-state" of the insured, which is generally defined as the insureds' principal place of business.

As we explained in our previous memo, (click here for copy), the open definition of "nonadmitted insurance" in the federal statute led several states, including Texas and California, to conclude that the NRRA granted them sole authority to tax independently procured insurance (that is, the type of insurance issued by your captive) purchased by their home state insureds. Those states quickly amended their independently procured premium tax laws to tax 100% of premiums on such insurance acquired by their home state insureds.
At the behest of our Firm, which at the earliest stage identified the concerns with the loose language in the NRRA, Delaware and other state regulators and captive associations formed a coalition to address issues of the NRRA with respect to captive insurance. The Coalition for Captive Insurance Clarity has been working to coordinate efforts in promoting corrective legislation to the NRRA. The goal of the coalition is to address the misplaced reliance of certain states, including Texas and California, on the NRRA as authority to tax captive insurance premiums.

On December 18, 2012, the outgoing Chairman of the House Subcommittee on Insurance, Housing and Community Opportunity, Rep. Judy Biggert of Illinois, addressed a letter to the incoming Chairman and ranking member of the House Financial Services Committee, citing the unintended effects of the NRRA on the captive insurance industry (click here for letter).

The letter urges the House committee to consider a technical amendment to the NRRA to address the definition of "nonadmitted insurance" to make clear that the NRRA does not apply to captive insurance and therefore does not give states authority to tax 100% of the premiums paid to captive insurance companies by their home-state insureds. To date, no such technical amendment has been proposed or considered in Congress.
We previously noted that the Captive Insurance Company Association had commissioned a White Paper jointly with the Vermont Captive Insurance Association to address the issue that the NRRA was not intended to and did not apply to captive insurance. The White Paper is posted atwww.feldlaw.com/articles.html under the heading "Nonadmitted and Reinsurance Reform Act," along with other materials on the NRRA.

This area of the tax law remains in a state of flux. We will continue to monitor for further developments.  Treasury Circular 230 Disclosure: To the extent this communication contains any statement of tax advice, such statement is not intended or written to be used, and cannot be used, by any person for the purpose of, or as the basis for, avoiding tax penalties that may be imposed on that person. This communication is not intended to be used, and cannot be used for the purpose of promoting, marketing, or recommending to another party any matter addressed in this communication.

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Roth IRA Conversions

Summary
If you have a traditional IRA, you should promptly consider converting it to a Roth IRA in 2010 to take advantage of a recent change in law. We encourage you to contact our lawyers to assist you in overall tax planning before the end of this year. Our lawyers are implementing strategies for clients in light of the expected tax rate increases beginning in 2011.

background
Under pre-2010 law, the opportunity to convert a traditional individual retirement account (IRA) into a Roth IRA was limited to individuals whose adjusted gross income was less than $100,000. Beginning January 1, 2010, conversions from a traditional IRA to a Roth IRA are available to all individuals, regardless of their incomes. This opportunity creates a dilemma for high-income individuals holding traditional IRAs: do the benefits of allowing the assets of a Roth IRA to grow tax-free for a longer period of time outweigh the acceleration of income tax triggered by the conversion of a traditional IRA to a Roth IRA? The answer requires a close review of your objectives and circumstances.

Traditional IRA v. Roth IRA

It is necessary to compare the features of a traditional IRA and a Roth IRA to determine whether conversion is an attractive tax planning opportunity for you. Distributions from a traditional IRA are taxed at ordinary income tax rates. In contrast, qualified distributions from a Roth IRA are not subject to any income tax because contributions to a Roth IRA are made with after-tax dollars.

The distribution requirements for a traditional IRA also differ from a Roth IRA. For a traditional IRA, the owner must begin receiving required minimum distributions (RMD) in the year after the owner turns 70½. However, the RMD rules do not apply to Roth IRAs during the original owner's lifetime. Therefore, if an individual does not need distributions from his or her Roth IRA, the assets in the Roth IRA can continue to grow tax-free for a longer period of time than a traditional IRA. Depending on the time horizon and investment returns, this additional growth in a Roth IRA can be substantial.

Conversions

Beginning in 2010, all individual owners of traditional IRAs may convert their accounts into Roth IRAs. In addition, certain eligible rollover distributions from employer sponsored retirement plans, including 401(k) plans, can be rolled over directly into a Roth IRA. To determine whether a conversion from a 401(k) plan would be permitted, the terms of the retirement plan would need to be reviewed because many plans prohibit such distributions prior to the employee's separation from service.

Upon conversion from a traditional IRA to a Roth IRA, the entire value of the retirement account is subject to income tax as if the assets had been distributed to the owner. For conversions occurring in 2010, unless the account owner elects otherwise, the amount required to be included in gross income by reason of the conversion will be included ratably over two years, in 2011 and 2012. If the individual expects his or her tax rate to increase in the future, he or she may want to elect to pay the entire tax immediately.

Some factors to consider in evaluating the merits of a conversion include whether the individual is able to pay the income tax liability associated with the conversion with assets held outside the Roth IRA (so as not to reduce its value), the individual's current and anticipated future income tax rates, and the expected time horizon that the assets will be maintained in the Roth IRA. If an individual expects to be in a higher tax bracket in the future, it may be more advantageous to pay the income tax now at a lower income tax rate. Paying the income tax currently also provides the benefit of reducing the size of the individual's taxable estate. When the IRA owner expects to be in a lower tax bracket or plans to retire and move to a state with no income tax, the potential benefits of a conversion will be partly, but not necessarily wholly, diminished.

In addition, the benefits of conversion are amplified over a long period of time, such as when an individual converts a traditional ira to a roth ira at a young age or leaves the roth ira to his or her descendants at death so that the beneficiaries may "stretch" the ira tax deferral over their life expectancies. However, the benefits of a roth ira conversion may be undermined where the assets of the IRA account are depleted to pay the income tax on the conversion or to support the lifestyle needs of the owner.

The conversion can be undone if the taxpayer changes his or her mind (for example, if the value of the assets declines after the conversion) by "recharacterizing" the roth ira as a traditional ira. In the event of a recharacterization, the tax liability that would have been associated with the conversion is not incurred. The recharactarization can be made until the due date of the taxpayer's federal income tax return, including extensions, for the year of the conversion. Thus, a conversion done in this year is revocable until april 15, 2011, or october 15, 2011 (if a request for an extension is timely filed). If the ira owner recharacterizes his or her ira from roth to traditional, there is a waiting period before converting again to a roth ira.

Benefits of a Roth IRA Conversion

The primary benefits of converting a traditional ira into a roth ira are as follows:

1. Tax-free growth and distributions. Like a traditional ira, the roth ira allows for the tax-free accumulation of funds. However, the roth ira also allows an individual to withdraw funds on an income tax-free basis, provided that the withdrawal is made no earlier than five years after conversion and the individual is at least 59½ years old. When the value of a traditional ira is low or flat (as is currently the case for many ira accounts), it may be a perfect time to do a conversion and take advantage of the income tax-free treatment of future growth.

2. No required minimum distributions. traditional ira owners are required to begin minimum distributions at age 70½ or pay a substantial penalty for non-withdrawal. By contrast, roth ira owners do not have any required minimum distributions. Thus, roth ira owners have the option of leaving the roth ira funds intact as one of their last sources of money for retirement needs. Furthermore, many retirees find themselves paying tax on more of their social security benefits due to the additional income generated by required minimum distributions from a traditional ira. Since a roth ira does not have required minimum distributions, a retiree has more flexibility to decide when to withdraw such funds.

3. Estate planning considerations. if some or all of the funds in a traditional ira are pre-tax dollars at the time of conversion, the taxpayer's estate will decline by the amount of tax paid on the conversion. High-wealth individuals with significant taxable estates may reduce their estate tax liability in the future by converting a traditional ira into a roth ira and paying the resulting income tax. In addition, the beneficiaries of a roth ira will not be required to take minimum distributions as is the case with a traditional ira, and distributions to the beneficiaries are also income tax-free. Thus, a beneficiary has the flexibility of allowing the inherited roth ira to grow tax-free as well as taking distributions on a tax-free basis at his or her option.

4. Tax exempt fund. once the conversion is made, the roth ira may take positions in transactions having high profit potential with the income and growth of such investments and qualified distributions therefrom not being subject to income tax.

5. No medicare tax on distributions. the new 3.8% medicare tax on net investment income of high-income taxpayers takes effect on january 1, 2013. Distributions from qualified retirement plans and certain retirement accounts, including a roth ira, are not subject to this new tax.

what should you do?

Generally speaking, if given that income tax rates will likely rise significantly in the future and you do not anticipate needing the funds from the ira for at least five years, you may want to consider converting your traditional ira into a roth ira. However, because each individual's tax situation is different, you should consult with our tax attorneys on whether a conversion makes sense for you.

Our firm specializes in tax and business planning for closely held businesses and their owners. If we can assist you with these planning opportunities, please contact steven d. Cohen, thomas o. Foster, or stewart a. Feldman.

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.

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The Nonadmitted and Reinsurance Reform Act of 2010

As part of the 849-page Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Congress enacted the Nonadmitted and Reinsurance Reform Act (the "NRRA"). The stated intent of the NRRA was to unify premium tax reporting on surplus lines insurance; that is, the use of licensed brokers to place certain lines of insurance with approved but unlicensed insurance companies. The NRRA gave sole authority to tax "nonadmitted insurance" to the "home-state" of the insured, which is generally defined as the principal place of business of the insured. A recently published White Paper commissioned by the Captive Insurance Company Association (CICA) and the Vermont Captive Insurance Association (VCIA) and authored by James T. McIntyre, former Director of the Office of Management and Budget, concludes that the NRRA's nonadmitted insurance provisions did not change existing law as applied to captive insurance. The White Paper has been posted at www.feldlaw.com/articles.html under the heading "Nonadmitted and Reinsurance Reform Act."

As set forth in the White Paper, captive insurance arguably is not covered by the NRRA's definition of nonadmitted insurance, nor was it the stated intent of Congress for the NRRA to apply to captive insurance. However, the debate on this issue is ongoing as we speak; the issue is unsettled. Some states have taken the position that the purported NRRA's nonadmitted insurance provisions apply to captive insurance when enacting their respective legislation implementing the NRRA changes to their surplus lines insurance law. Simply put, the impact of the NRRA is that some states now take the position that they can tax 100% of "nonadmitted insurance premiums" as opposed to just taxing the premium which relates to the state at issue. Thus, if a state has a 3% nonadmitted premium tax, a captive with $500,000 in premiums would be subject to a $15,000 annual state tax.

Several different positions have been taken by states in implementing the NRRA. Some of the larger states, such as Texas and California, have concluded that the NRRA grants them sole authority to tax independently procured insurance and will tax 100% of premiums on such insurance acquired by their home state insureds.

Other states have implemented the NRRA home-state regime only as applied to surplus lines insurance and have continued to tax only the portion of independently procured insurance premiums that relate to insurance coverage on risks resident to that state. Still other states have applied the NRRA to independently procured insurance and have joined in a multi-state compact to apportion the premiums paid by their home-state insureds for purposes of collecting tax and forwarding collections to the other compacting states. Some states have taken no action with respect to the NRRA.

This area of tax law is in a state of flux. We will continue to monitor for new developments.

Click Here for a PDF copy of this memorandum.

Very truly yours,

Stewart A. Feldman
Steven D. Cohen
Logan R. Gremillion

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To Give Without Giving

In last month's newsletter, we emphasized the historic opportunities available for our clients as a result of low interest rates. Low interest rates offer clients the ability to transfer wealth without "giving away" assets, or by giving away less than expected. How is this possible?

The U.S. Treasury publishes monthly interest rate tables known as the Applicable Federal Rate (AFR). These tables establish a "floor" for the interest rate that may be charged between family members to avoid an imputed gift. The rates published for October are historic and attractive for those who may wish to transfer wealth or a family business to the next generation with minimal gift tax cost. The long term AFR for October is 2.95%, while the short-term AFR is a staggering .16%!!

What does this mean to you? Let's look at an example: Mary J. Client lends $1,000,000 to her Son, using a .16% fixed annual interest rate for a 30 month note, with principal due at the end of the term. The son purchases an investment yielding 2.5% annually. The difference between the interest payment due Mrs. Client and the interest received by Son through his investment is $23,400 to Son without a recorded gift!

Lower interest rates also assist in family business succession. Business owners looking to transition ownership to a descendant or other beneficiary should consider the use of owner-financed installment sales to an Irrevocable Grantor Trust. The same holds true for the owner of income-producing real estate or other investments. The following factors, which are all time sensitive, support these strategies:

1. Historically low interest rates;
2. Historically high gift tax credits available to "seed" the sale/loan; and
3. In many cases, low valuations as a result of market conditions.

Many of our clients have seized this opportunity to transfer a business or income-producing asset tax-efficiently. We have seen the interest in these strategies grow with the enactment of the 2010 Tax Relief Act, and the continuing use of entities such as limited partnerships and LLCs. These entities offer control features for the senior generation in addition to valuation discounts in certain instances.

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CLIENT MEMRANDUM

Re: Updated Developments with Respect to State Premium Tax

Last year we informed you of the potential impact of the Nonadmitted and Reinsurance Reform Act (the "NRRA") on captive insurance companies. The stated intent of the NRRA was to unify premium tax reporting on surplus lines insurance, such being state licensed insurance brokers' use of out-of-state/nonadmitted insurance companies to write generally unusual coverages (e.g., $50 million umbrella coverages) for clients. Heretofore, the state licensed brokers had to apportion premiums, file, and pay state tax in every state where the insureds did business, often requiring 50+ tax filings. The NRRA gave sole authority to tax "nonadmitted insurance" to the "home-state" of the insured, which is generally defined as the insureds' principal place of business.

As we explained in our previous memo, (click here for copy), the open definition of "nonadmitted insurance" in the federal statute led several states, including Texas and California, to conclude that the NRRA granted them sole authority to tax independently procured insurance (that is, the type of insurance issued by your captive) purchased by their home state insureds. Those states quickly amended their independently procured premium tax laws to tax 100% of premiums on such insurance acquired by their home state insureds.

At the behest of our Firm, which at the earliest stage identified the concerns with the loose language in the NRRA, Delaware and other state regulators and captive associations formed a coalition to address issues of the NRRA with respect to captive insurance. The Coalition for Captive Insurance Clarity has been working to coordinate efforts in promoting corrective legislation to the NRRA. The goal of the coalition is to address the misplaced reliance of certain states, including Texas and California, on the NRRA as authority to tax captive insurance premiums.

On December 18, 2012, the outgoing Chairman of the House Subcommittee on Insurance, Housing and Community Opportunity, Rep. Judy Biggert of Illinois, addressed a letter to the incoming Chairman and ranking member of the House Financial Services Committee, citing the unintended effects of the NRRA on the captive insurance industry (click here for letter). The letter urges the House committee to consider a technical amendment to the NRRA to address the definition of "nonadmitted insurance" to make clear that the NRRA does not apply to captive insurance and therefore does not give states authority to tax 100% of the premiums paid to captive insurance companies by their home-state insureds. To date, no such technical amendment has been proposed or considered in Congress.

On February 6, 2013, Rep. Scott Garrett of New Jersey, who is the co-author of the NRRA, addressed the Speaker of the House of Representatives, confirming that the NRRA was never intended to apply to captive insurance. Rep. Garrett stated, "In drafting this legislation, it wasnever contemplated to have the captive industry fall under the NRRA. In addition, this legislation has been subject to numerous Congressional hearings and has been approved by this body on multiple occasions. At no time was the legislation's application to the captive industry addressed or suggested." The Congressman said he looks forward to working with the Financial Services Committee to address the issue, if necessary, in the future.

We previously noted that the Captive Insurance Company Association had commissioned a White Paper jointly with the Vermont Captive Insurance Association to address the issue that the NRRA was not intended to and did not apply to captive insurance. The White Paper is posted at www.feldlaw.com/articles.html under the heading "Nonadmitted and Reinsurance Reform Act," along with other materials on the NRRA.
This area of the tax law remains in a state of flux. We will continue to monitor for further developments.

Treasury Circular 230 Disclosure: To the extent this communication contains any statement of tax advice, such statement is not intended or written to be used, and cannot be used, by any person for the purpose of, or as the basis for, avoiding tax penalties that may be imposed on that person. This communication is not intended to be used, and cannot be used for the purpose of promoting, marketing, or recommending to another party any matter addressed in this communication.


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