Ensuring that the IRS treats an insurer as an insurer for tax purposes is critically important for captive insurance companies. This may sound simple, but it can get complicated in certain captive situations.
A captive insurance company must be considered to be an insurer by the IRS for the premiums paid to be deductible. A summary article on the subject can be found at WebCPA (see here):
The IRS states that for a transaction to be considered insurance, both “risk shifting” and “risk distribution” must be present.
A prior revenue ruling, provided by Active Captive Mangement, disallowed premium deduction with insufficient risk distribution (see here):
Revenue Ruling 2005-40 disallows the premium deduction for a company that is the sole client of an insurance company. According to the IRS, such coverage does not spread risk among more than one policyholder and hence is not a bona fide insurance transaction.
Business Insurance summarizes a new ruling, Revenue Ruling 2009-26, which provides some detail on what structures do provide sufficient risk distribution (see here).
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