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Captive insurance companies are often used by large corporations to lower their insurance costs and are often created in offshore tax havens. However, small, closely held companies can take advantage of a number of tax and business benefits if they set up their own captives. These captives can be set up in the jurisdiction that makes the most sense for the captives business.

Captive insurance companies are formed for both economic and risk management purposes. For example, by forming a captive insurance company, a business can dramatically lower insurance costs in comparison to premiums paid to a conventional property and casualty insurance company. By establishing ones own insurance vehicle, costs for overhead, marketing, agent commissions, advertising, etc., may result in significant savings in the form of underwriting profits, which can be retained by the owner of the captive company.

Additionally, a captive insurance company can provide protection against risks which prove to be too costly in commercial markets or may be generally unavailable. The inability to obtain specialized types of coverage from commercial third-party insurers is another reason why clients may choose to establish a captive insurance company. With a captive insurance company, a business owner can address their self-insured risks by paying tax deductible premium payments to their captive insurance company. To the extent the captive generates profits, those dollars belong to the owner of the captive.

In general, your captive insurance company will be capable of delivering better service to your operating company than a commercial insurance company can

The formation of a captive insurance company is a lengthy process including feasibility studies, financial projections, determining domicile, and, finally, preparing and submitting the application for an insurance license. A professional captive manager, risk management expert and actuary should be engaged to help you to determine the best balance between coverage retained from commercial carriers and your captive insurance carrier, and an appropriate amount of premium to be paid for the coverage being provided. Premium payments made by the operating company to the captive insurance company for property and casualty insurance coverage should be tax-deductible as an ordinary and necessary business expense, just as they would be treated had they been made to a traditional insurance company.

The use of a captive should be considered for entities that meet the following criteria:

  • Profitable business entities seeking substantial annual adjustable tax deductions;
  • Businesses with multiple entities or those that can create multiple operating subsidiaries or affiliates;
  • Businesses with $500,000 or more in sustainable operating profits;
  • Businesses with requisite risk currently uninsured or underinsured;
  • Business owners interested in personal wealth accumulation and/or family wealth transfer strategies;
  • Businesses where owner(s) are looking for asset protection.

The tax benefits associated with captives can sometimes cause business owners to forget that the captive must operate as a true insurance company. The use of an experienced and capable captive management company is an essential element of the normal operations of such an entity. The need for annual actuarial reviews, annual financial statement audits, continuing tax compliance oversight, claims management, and other regulatory compliance needs puts the day-to-day management of a captive insurance company beyond the skills of most general business people. Likewise, the involvement of the management company in the investment activities of the captive is essential from a planning perspective to assure that the captives liquidity needs are met.

Tax Benefits

A properly structured and managed captive insurance company could provide the following tax and nontax benefits:

  • Tax deduction for the parent company for the insurance premium paid to the captive;
  • Various other tax savings opportunities, including gift and estate tax savings for the shareholders and income tax savings for both the captive and the parent;
  • Opportunity to accumulate wealth in a tax-favored vehicle;
  • Distributions to captive owners at favorable income tax rates.

For the premium payment to the captive to be deductible as an insurance expense, the captive must be able to prove that it is a valid insurance company (payments for self-insurance generally are not). Besides obtaining an insurance license from a state or a foreign jurisdiction, the captive must provide insurance to the operating company or its affiliates. Insurance is defined for tax purposes as including elements of risk shifting and risk distribution. To meet the risk-shifting requirement, the operating company must show that it has transferred specific risks to the captive insurance company in exchange for a reasonable premium.

Internal Revenue Code Section 831(b) provides that captive insurance companies are taxed only on their investment income, and do not pay income taxes on the premiums they collect, providing premiums to the captive do not exceed $1.2 million per year. Legislation signed into law on December 18, 2015 has increased the premium limitation from $1.2 million to $2.2 million per year for taxable years beginning after December 31, 2016. This new limit will be indexed for inflation annually.

The higher limit is an opportunity for captive owners to place more risks in their captives, such as cyber, earthquake, wind and flood, pollution liability and cleanup, and property mold. While the new law increases the premium income that is exempt from taxation, it also imposes stricter rules on the ownership structures of 831(b) captives.

Captive that try to massage their premium income need to be very careful because they are putting their tax election at risk as well as potentially putting the captive in jeopardy and the subject of potential scrutiny by the IRS.

As discussed above the captive may retain surplus from underwriting profits within reserve accounts, free from income tax. It can also generate profits by controlling or eliminating costs for overhead, marketing, advertising, agent commissions, profits, etc., items normally built into the premiums charged by traditional insurance companies. After adjustment for expenses and claim payments, net underwriting profits are retained within the captive insurance company. Over the years, profits and surplus may accumulate to sizeable amounts, and may be distributed to the owners of the captive company, under favorable income tax rates as either dividends or long-term capital gains.

Amounts set aside as reserves for potential claims payments, plus capital surplus, should be maintained in safe, liquid asset classes so that the captive has adequate solvency to pay claims when called upon. The formation of the captive and eventual issuance of a certificate of authority to do business, are subject to approval by the insurance regulators in the jurisdiction where the insurance captive is formed. The insurance regulators will also oversee the organization and ongoing operation of the captive insurance company to assure ongoing compliance with the rules for that jurisdiction.

The planning, formation, and management of a captive are complex undertakings, and compliance with the formalities of running a true insurance company is mandatory. Establishing a captive insurance company is not feasible for all companies but, where appropriate, it can provide substantial tax and nontax benefits to successful shareholders and their families.

 

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Richard Levychin
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Richard Levychin, CPA Featured Speaker With Joseph Romano, CPA
on Tax Cuts and Jobs Act and How it Impacts Businesses

Richard Levychin, CPA and Joseph Romano, CPA teamed up to discuss the key business components of the Tax Cuts and Jobs Act at a recent Morning MOJO. Included in the session was a detailed discussion of the 20% deduction for pass through entities, and a discussion of expenses that are no longer deductible

Please click on link below to view:
http://kbl.com/video/kbl_MorningMojo.mp4

Why Your CQ is Just as Important as Your IQ (and EQ)

Cultural intelligence is increasingly important for business success.

By Richard Levychin, CPA, CGMA

Many factors contribute to professional success. Hard work is one, but it is not enough. Having a high IQ combined with hard work is no longer enough.

Having a high EQ, which stands for emotional quotient and measures one's ability to connect to people on an emotional level, combined with hard work and a high IQ used to be enough, but it is also no longer sufficient to lead to professional success.

Today's and tomorrow's professionals will also have to own a high CQ, a measure of cultural intelligence and the ability to interact comfortably and successfully with other cultures. Studies have shown that people with a high CQ perform better on multicultural work teams than those with a low CQ. A study published in 2011 in the Journal of Social Issues found that cultural intelligence was a stronger predictor of the cross-border effectiveness of Swiss military leaders than either general intelligence or emotional intelligence.

The person deciding whether you get access to your next opportunity, be it a job offer, project, financing, or something else, may have a different cultural background than yours. Do you possess a high enough CQ to engage with him or her in such a way that distinguishes you from your competition and gets you the opportunity?

As business becomes more global, CPA firms and other business entities will begin to measure a prospective candidate's cultural intelligence as a way of determining if he or she can engage with clients or customers who are from different cultures.

The primary purpose for improving CQ is to increase a firm's revenue. To implement a platform that encourages increasing the CQ of a firm's professionals for any purpose other than one that is directly tied to a significant positive impact on the firm's profit-and-loss statement will run out of steam quickly. The business case for CQ ends with a positive return on investment.

FINDING COMMON GROUND

Several years ago I was referred to a well-known and powerful synagogue in Stamford, Conn. When I went to the synagogue, I was the only person of color in the building. I went to meet with the synagogue's rabbi and financial officer and before entering the rabbi's offices donned a yarmulke. The three of us then engaged in a 30- to 45-minute conversation on Jewish culture and the history of the synagogue before discussing the synagogue's specific business issues. I ended up closing the business.

A few weeks later I met with the managing partner of a midsize law firm who had been born in Israel and had served in the Israeli army. I happened to mention that that synagogue was a client. That literally was the icebreaker of the meeting. I ended up with a referral to a client of theirs in the airline industry that became a public company audit client of our firm, as well as a technology company whose principals were also from Israel and also became an audit client.

Possessing cultural intelligence, particularly as it relates to Jewish culture, was probably the differentiating factor that put me ahead of my competition in securing that business. I have had similar success meeting with decision-makers who were black, Asian, female, gay, Hispanic, or combinations of the above.

Having a high CQ also comes into play when attracting quality talent. Today's up-and-coming professionals want more cultural diversity in both their personal and business lives. And they also want their places of work to be culturally diverse. To attract and retain the quality of talent that can interact in a global marketplace, firms will need to increase their CQ so that they can speak to and attract a larger number of quality professionals. The more people you are exposed to, the better chance you have to hire the right staff members.

So how does one develop and improve his or her CQ?

Accounting is a profession that combines continued learning and application of that learning. Cultural intelligence cannot be learned. The road to cultural intelligence starts with unlearning the unconscious biases that we have developed and embedded into our belief systems over time as they relate to other cultures (see "How to Counteract Unconscious Biases"). Unlearning involves creating a state called "no mind," which is based on being able to interact with others without having assumptions about who you think they are playing in the background of your thoughts while you engage with them.

PRACTICE INTERACTIONS

I believe that to authentically engage in the practice of "no mind" one needs to first acknowledge that maintaining such a state permanently is impossible. In other words, you cannot just simply flip an "off" switch and have unconscious biases go away forever. You can only maintain this state for periods of time.

Despite its name, the concept of "no mind" is a form of mindfulness. As you probably know, the practice of mindfulness has been around for a while. However, it is a practice. It is not a "perfect." And when you don't practice the state of "no mind," all you can do is work harder to do better next time. Even the most evolved person has unconscious biases. Realize that you have unconscious biases and there are times that they will influence your actions and decisions, and that is part of being human. Acknowledge it when it happens from a very human space, and then learn the lesson that the opportunity of screwing it up afforded you, and then move forward. 

I recently served on the AICPA's National Commission on Diversity & Inclusion. I introduced a session called "Conversations About Race" that was led by an interracial married couple. Within the session participants were matched with other accounting professionals from different cultures. Within these groups they were put through a series of exercises that allowed everyone to interact from this place of "no mind." After the exercises the session leaders engaged in a conversation about cultural diversity. The participants were highly engaged in the conversation and participated enthusiastically. By first actually engaging with someone of a different culture from the space of "no mind," participants had the physical experience of what this felt like. This provided the necessary relativity of what the opposite would look like.

The concepts of cultural intelligence discussed here focus on creating a platform of experiential learning where all cultures participate together and interact directly. These platforms create experiences of what it feels like to be in diverse environments and, for those who choose to engage in these types of practices in their firm, recommend that measurement of success be tied directly to the firm's profit-and-loss statement, specifically to how increased CQ contributes to increased revenue, increased staff retention rates, and lower labor costs.

Soft skills and team-building courses combined with content that focuses on cultural diversity are good starts toward the unlearning process and developing a higher CQ. But, like anything else, mastery comes from practice. And practice consists of a professional's willingness to consistently enter situations that include people from different cultures and engage in deep conversations and interactions with them, with an eye toward creating the state of "no mind." The more you engage in these types of interactions, the more key cultural nuances you will learn and the higher your CQ will become.

 

The Tax Consequences of Dealing in Cryptocurrency

The coolness factor of digital currency is being closely scrutinized by one of the least coolest agencies on the planet: The Internal Revenue Service. Given the speed at which these currencies have caught on — Bitcoin was released only in 2009 — the IRS hasn’t quite kept pace. They issued basic guidelines in 2014 for digital currencies, but tax experts say some of the rules are subject to interpretation.

In 2016 the IRS made it clear that it was searching for cryptocurrency tax evaders: The agency sent a broad request to Coinbase, one of the larger cryptocurrency exchanges in the United States, requesting records for all customers who bought digital currency from the company from 2013 to 2015. Coinbase balked, but a court ruled that it had to provide the records of roughly 14,000 customers, fewer than 1 percent of its patrons, who made transactions involving more than $20,000 of virtual currencies.

So, come April people who have bought and sold cryptocurrency such as Bitcoin will be expected to report any profits on their federal tax returns. And considering digital currency’s wild increases in value in 2017, there are probably many people who incurred gains or losses for the first time. But how much tax you owe will depend on how and when you acquired the digital currency.

Here are some basics about the tax implications of virtual currency:

I sold digital currency last year. What does that do to my tax return?

If you are holding digital currency as an investment, any gains or losses on the sale are treated as capital assets like a stock or bond. The gain or loss is calculated against the market value of the currency when you acquired it (your basis).

If you held the currency for more than a year, you qualify for the less onerous long-term capital gains rates (generally 0, 15 or 20 percent). Short-term gains, from digital coins held for a year or less, are taxed as ordinary income.

As on the stock market, losses can be used to offset capital gains, subject to certain rules, and losses that are not used to offset gains can be deducted — up to $3,000 — from other kinds of income. Unused losses can be carried over to future years.

I’ve successfully ‘mined’ digital currency. Now what?

All cryptocurrency transactions are recorded in a public ledger, which is maintained by a decentralized network of computers. Mining refers to the process in which new digital currency coins are created and then awarded to the computers that are the first to process these transactions coming onto the network. The people whose computers do this most quickly collect a fresh helping of cryptocurrency.

These virtual miners must report the fair market value of the currency (on the day they received it) as gross income and are ultimately required to pay federal, state and most likely self -employment taxes, assuming that the mining constitutes a trade or business.

What are the tax consequences of being paid in digital currency?

Receiving wages from an employer in a virtual currency is like being paid in dollars: it is taxable to the employee, must be reported by the employer on a Form W-2 and is subject to FICA, and federal and state income tax withholding. Independent contractors paid in digital currency must also treat that as gross income and pay self-employment taxes.

What if I paid someone in cryptocurrency for their services?

When you pay an independent contractor in excess of $600 for services performed for your “trade or business,” that should be reported to the IRS and the person receiving the payment for an amount equal to the value of the cryptocurrency when paid.

Can I reduce my tax bill by donating my cryptocoins?

Only people who itemize their tax returns can deduct their charitable donations.

For those who itemize their deductions it may be possible to directly donate their cryto currency just as they can directly donate, for example, highly appreciated stock. Just as long as the charity accepts it.

For example, Fidelity Charitable, a donor-advised fund, allows people to give money, take a tax deduction in the same year, and then invest and allocate the money to select charities over time. Fidelity Charitable works with Coinbase, the exchange, to immediately turn the Bitcoin or Ether into cash, which is then invested as its donor wishes.

Will I receive any tax forms such as 1099s from my exchange?

Generally speaking, brokers and exchanges are not yet required to report cryptocurrency transactions to the IRS., as they do when you sell a stock at a profit or loss (and you receive a 1099-B or a 1099-DIV for a mutual fund).

But you will need to keep track of every move you make. Coinbase, for example, refers you to your account transaction history for records to compute your gains and losses; it also provides customers a “cost basis for taxes” report.

How did the new tax bill affect digital currency?

The bill eliminated what some interpreted to be a tax break for virtual currency holders. Under the old rules, some cryptocoin investors applied a legal maneuver often used with real estate investments to defer their capital gains. Under what is called a 1031 exchange, taxpayers can sell one property and defer taxes as long as the proceeds were reinvested in a similar, or “like-kind,” property and met certain requirements.

The IRS didn’t say this strategy could be used with virtual currencies, but some tax experts argued that it was a reasonable — albeit debatable — interpretation since the coins were considered property. Now that the tax legislation limits the use of 1031 exchanges to real estate, this strategy no longer applies. That is if it ever did.