If the Captive qualifies and makes the required election under Sec. 831(b), the Captive insurance company will not pay federal income tax on its net premium income. It will pay income tax on its investment income only at regular corporate tax rates. As long as the insurance premium qualifies as “ordinary and necessary”, the insurance payment will be deductible by the sponsoring organization.
As a result of its successful operation, if the Captive were to distribute dividends to its shareholders, those payments would constitute “qualified dividends” and be eligible for taxation at the favorable 15% or 20% tax rate for Federal purposes. In addition, any payments made by the Captive to redeem common stock or preferred shares held by its stockholders would be treated as payments in exchange for the shares and thus qualify for capital gain treatment.
Gift and Estate Tax:
The initial ownership of the Captive can be structured using any eligible taxpayer, including but not limited to the owners of the operating business, family members or other beneficiaries of those owners, trusts established by those owners, key employees of the operating business, or virtually anyone that the owners of the business wish to designate as shareholders of the Captive. The operating company’s transactions with the Captive are at arm’s length, therefore the increase in wealth occasioned by the increase in the value of the Captive’s shares can be transferred to the Captive’s shareholders free of any gift or estate tax.