- Captive Insurance Alert: New Tax Act Affects Captive Insurance Planning
- July 16, 2003
- Law Firm: Thompson Hine LLP - Cleveland Office
On May 28, 2003, President Bush signed the Jobs and Growth Tax Relief Reconciliation Act of 2003 (the Act). As explained below, the Act contains provisions that may affect owners of offshore captive insurance companies, including provisions that:
- Reduce the maximum rate on "qualified dividend income" from 38.6% to 15%, effective for dividends received in tax years beginning in 2003 through 2008. This rate applies for both regular tax and alternative minimum tax purposes. Individuals may instead elect to treat such dividends as "investment income" for purposes of deducting investment interest.
- Reduce the maximum rate on "net capital gains" from 20% to 15%, effective for sales and exchanges on or after May 6, 2003, through 2008. This rate applies for both regular tax and alternative minimum tax purposes.
- Reduce the maximum individual tax rate from 38.6% to 35%, effective for tax years beginning in 2003 through 2010.
Planning Opportunities for Owners of Offshore Captive Insurance Companies
At this point, it is too early to identify all of the possible planning opportunities presented by these provisions of the Act. It appears, however, that owners of offshore captive insurance companies are eligible to receive the following benefits:
- Dividends paid by an offshore captive insurance company to its individual shareholders should qualify for the new 15% tax rate, provided that the company has elected to be treated as a domestic corporation under Section 953(d) of the Internal Revenue Code of 1986 (the Code).
- Long-term capital gains recognized by individuals on liquidation of an offshore captive insurance company should qualify for the 15% tax rate; short-term capital gains and ordinary income qualify for the 35% tax rate.
Impact of Special Tax Status of Certain Offshore Captive Insurance Companies
Some captive insurance companies with annual premiums of $350,000 or less are exempt from federal income tax under Section 501(c)(15) of the Code. Any dividends paid by these types of captive insurance companies are not eligible for the new 15% tax rate, apparently because the earnings related to the dividends are not subject to a corporate-level tax.
Some captive insurance companies with annual premiums of more than $350,000 (but not exceeding $1.2 million) elect to be taxed only on certain investment income under Section 831(b) of the Code. The Act does not address whether a company's "Section 831(b) election" prevents its dividends from qualifying for the new 15% tax rate. Therefore, we believe that the election should have no impact on whether a dividend qualifies for the new lower rates. The government, however, may take a different view because only a portion of the company's earnings is subject to a corporate-level tax. We are monitoring developments in this area of the law and will advise you as soon as we know more.
For More Information
The foregoing is a general discussion of certain provisions of the Act. It will take time to assess the true impact of the Act, and many questions will need to be addressed by administrative and legislative guidance.