Hotel Lawyer: What you need to know about the "ancillary benefits" of setting up a captive insurance company
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By Jim Butler and the Global Hospitality Group®
Hotel Lawyers | Authors of www.HotelLawBlog.com
27 June 2011
Hotel Lawyer: Why people set up captive insurance companies.
Our recent blog post, Captive Insurance for Hotel Owners, described how hotel owners can protect their business and save money by forming a captive insurance company.
That is enough for many people, but there are additional "ancillary" benefits that can also be very attractive, enabling owners of the captive to achieve certain business and personal objectives.
These ancillary benefits can be quite compelling. They include estate planning, business succession planning and management benefits.
My partner, Gordon Schaller -- one of the top experts in the country advising clients on setting up captive insurance companies -- explores some of those benefits in today's post on the Hotel Law Blog.
Gordon Schaller | Hotel Lawyer, JMBM Global Hospitality Group®
As explained in an earlier article, a captive insurance company is a subsidiary or affiliate of a closely-held business entity formed to insure or reinsure certain risks of those entities.
The primary reasons hotel owners form a captive insurance company is to effectively manage the uninsured and under-insured risks of their business and to save money on certain types of coverage. But the captive also provides owners a number of ancillary opportunities to achieve business and personal goals.
A hotel owner who has decided to establish a captive insurance company and has qualified as an appropriate candidate, should then ask, "Given my specific circumstances and goals, what is the best way to own the captive"?
Benefits of Ownership by or in Trust for Children and Grandchildren
If the captive is owned directly or indirectly by or in trust for the hotel owner's children or grandchildren, there will be a net wealth transfer without gift, estate, or generation-skipping transfer tax consequences if the captive's reserves are not used to pay claims. Insurance premiums are business expenses, if reasonable -- not gifts. Since the captive's assets would be outside the hotel owner's taxable estate it is an asset that is ideal for a generation-skipping dynasty trust.
Benefits of Ownership by Family Limited Partnerships or LLCs
As with many estate planning structures, the captive insurance company could be owned by a family limited partnership (FLP) or limited liability company (LLC). The FLP or LLC could in turn be owned by various family members or trusts with differing classes of interests and rights. This could provide a continuing ability for the hotel owner to control and invest funds received as distributions from the captive insurance company. Caution must be used in structuring family partnerships and LLCs in light of the IRS' recent aggressive litigation positions in this area.
Benefits of Ownership by Key Management
Another common ownership structure involves creating restricted shares for key management. Since the captive is taxed as a "C corporation" for income tax purposes, it can have multiple classes of stock. The classes could have vesting and transfer restrictions that would provide incentive and retention features for management. This also provides incentives for employees to manage business risk more effectively. Insurance premiums paid to the captive should not be deemed compensation to the employee-owners for income tax purposes.
Benefits for Asset Protection
Generally, the assets of the captive insurance company should not be subject to claims by creditors of the hotel business. This assumes that the insurance premiums are reasonable and justified, the captive is not a sham, and that it was properly formed and operated.
Benefits for Shareholders
To the extent that claims against the captive's reserves are less than projected by actuaries and reflected in premiums, reserves grow and the captive stock becomes more valuable. Dividends can be paid to the shareholders from excess reserves which are subject to capital gain tax rates today. When the captive is liquidated, the proceeds received by shareholders is also treated as capital gain.
Gordon Schaller is a partner in JMBM's Taxation, Trusts & Estates Department, and a senior member of JMBM's Global Hospitality Group®. Gordon helps businesses set up captive insurance companies and advises them in a full range of strategies to achieve tax efficiencies. For more information, please contact Gordon Schaller at 949.623.7222 or GSchaller@jmbm.com.
This is Jim Butler, author of www.HotelLawBlog.com and hotel lawyer, signing off. We've done more than $60 billion of hotel transactions and have developed innovative solutions to unlock value from troubled hotel transactions. Who's your hotel lawyer?
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