Captive Tax Shelter — How to Exit?

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Are you one of those U.S. citizens who have badly entangled themselves in the small captive insurance programs? If yes, then it’s time to exit this program for good.

Many U.S.taxpayers, facing losses from their captive insurance program for two consecutive years supplemented by adverse judgments of the U.S. tax courts are planning to exit these programs as soon as possible. However, it’s going to be extremely taxing and time-consuming to do so.

So, what’s your way out out of this mess? This article will help you with all you need to know about captive insurance programs and how to exit it.

What are the issues you might face for signing out of your captive insurance program?

Contractual Obligation

The first issue that you might face while wanting to exit your captive insurance program could be a contractual obligation for a particular term. This could be because of an obligation to a risk pool through which such programs allow you to distribute risk. Since the other participants of this program rely on you (Captive) for risk distribution too, an immediate withdrawal might not be a possible solution because it will impact the other participants of the captive insurance program.

Tail Liabilities

The captive insurance program has different types of tail liabilities divided among all the participants. Therefore, the regulators might find it prudent that you exhaust the coverage tail before exiting the program. Good news is, for many of you who are susceptible to IRS scrutiny, the lines of insurance placed through you would be relatively short-tailed,

Tax Considerations

Since the driving force behind your decision to exit a captive program is the IRS’s scrutiny, you can consider mitigating your tax liabilities connected to such a program. Though some of the transactions of a captive insurance program are considered abusive by the IRS, you cannot simply conclude it as a bad one because many of such programs have seen reforms over the years. Thus, you need to initially determine if your captive program rests on a captive tax spectrum or not.

If you realize that your program will not survive the IRS scrutiny and if the captive owner is currently under audit, then you can apply for a qualified amended return. By doing so, you can avoid paying the deduction for the captive insurance premium and exclude underwriting income to avoid tax penalties.

While filing this qualified amended return, you need to consider if your statutes of limitations have expired or not keeping the captive participation years in mind. Another thing to recheck is if all factors related to qualified amended returns are satisfied or not.

All about IRS audit considerations

Under the IRS tax audit, you can consider offering the payment of proposed tax and interest related to the understatement and request for the abatement of all tax penalties, though, it is less likely that the revenue agent would settle for anything less than a full tax concession and payment of partial penalty. This is because, during examinations, captive owners are not offered penalty and tax abatements.

All about Mounting Cost Considerations

If you are a captive owner, then you cannot avoid the cost of representation with the Office of Tax Shelter Analysis (OTSA) during the IRS audit process and filings. You need to be prepared for the IRS information documentation process which can be vast and tedious. It might require you to accumulate a lot of documents for the IRS audit process. Before sending such documents for scrutiny, ensure to get them reviewed by your attorney or accountant because these documents might contain some privilege or confidential information. This would lead toward mounting additional cost of such experts in addition to the already due penalties and interests. Therefore, we may say that this activity of the IRS audit has made defending captives a cost-heavy matter.

Other things to keep in mind

Once you plan on exiting the captive insurance program, ensure that you review all documents thoroughly and understand the legal exposure and forfeiture of rights on your exit. You advisor shall also understand your duties as a captive owner, and how a potentially damaged captive program shall be handled. The IRS in this situation suggests advisors get a conflict waiver from their clients before representing them in front of the IRS.

What happens when you finally exit?

Once you are done with fulfilling all the liabilities and procedures, you would need to give a thought on how to handle the funds available within the corporation. You might come across a shortage of options because of a prior tax position, but then what shall be your course of action? You can consider using the traditional liquidation process and be done with the funds held, assets, company tax issues, merging with an operating entity, and so forth. Another option could be participating in a split-dollar arrangement involving life insurance or investing funds in foreign pension etc.

The Bottom Line

In conclusion, it’s essential to look at all the factors affecting an exit from a captive insurance program. To understand your liabilities and seek professional guidance to help you deal in finalizing the exit, contact your MyTaxFiler expert and understand all aspects of the captive tax program, and shelter yourself from the many complications that surround it.

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