Over the past 20 years, many small businesses have begun to insure their own risks through a product called "Captive Insurance." Small captives (also known as single-parent captives) are insurance companies established by the owners of closely held businesses looking to insure risks that are either too costly or too difficult to insure through the traditional insurance marketplace. Brad Barros, an expert in the field of captive insurance, explains how "all captives are treated as corporations and must be managed in a method consistent with rules established with both the IRS and the appropriate insurance regulator." According to Barros, often single parent captives are owned by a trust, partnership or other structure established by the premium payer or his family. When properly designed and administered, a business can make tax-deductible premium payments to their related-party insurance company. Depending on circumstances, underwriting profits, if any, can be paid out to the owners as dividends, and profits from liquidation of the company may be taxed at capital gains. Premium payers and their captives may garner tax benefits only when the captive operates as a real insurance company. Alternatively, advisers and business owners who use captives as estate planning tools, asset protection vehicles, tax deferral or other benefits not related to the true business purpose of an insurance company may face grave regulatory and tax consequences. Many captive insurance companies are often formed by US businesses in jurisdictions outside of the United States. The reason for this is that foreign jurisdictions offer lower costs and greater flexibility than their US counterparts. As a rule, US businesses can use foreign-based insurance companies so long as the jurisdiction meets the insurance regulatory standards required by the Internal Revenue Service (IRS). There are several notable foreign jurisdictions whose insurance regulations are recognized as safe and effective. These include Bermuda and St. Lucia. Bermuda, while more expensive than other jurisdictions, is home to many of the largest insurance companies in the world. St. Lucia, a more reasonably priced location for smaller captives, is noteworthy for statutes that are both progressive and compliant. St. Lucia is also acclaimed for recently passing "Incorporated Cell" legislation, modeled after similar statutes in Washington, DC. Common Captive Insurance Abuses; While captives remain highly beneficial to many businesses, some industry professionals have begun to improperly market and misuse these structures for purposes other than those intended by Congress. The abuses include the following: 1. Improper risk shifting and risk distribution, aka "Bogus Risk Pools" 2. High deductibles in captive-pooled arrangements; Re insuring captives through private placement variable life insurance schemes 3. Improper marketing 4. Inappropriate life insurance integration Meeting the high standards imposed by the IRS and local insurance regulators can be a complex and expensive proposition and should only be done with the assistance of competent and experienced counsel. The ramifications of failing to be an insurance company can be devastating and may include the following penalties: 1. Loss of all deductions on premiums received by the insurance company 2. Loss of all deductions from the premium payer 3. Forced distribution or liquidation of all assets from the insurance company effectuating additional taxes for capital gains or dividends 4. Potential adverse tax treatment as a Controlled Foreign Corporation 5. Potential adverse tax treatment as a Personal Foreign Holding Company (PFHC) 6. Potential regulatory penalties imposed by the insuring jurisdiction 7. Potential penalties and interest imposed by the IRS. All in all, the tax consequences may be greater than 100% of the premiums paid to the captive. In addition, attorneys, CPA's wealth advisors and their clients may be treated as tax shelter promoters by the IRS, causing fines as great as $100,000 or more per transaction. Clearly, establishing a captive insurance company is not something that should be taken lightly. It is critical that businesses seeking to establish a captive work with competent attorneys and accountants who have the requisite knowledge and experience necessary to avoid the pitfalls associated with abusive or poorly designed insurance structures. A general rule of thumb is that a captive insurance product should have a legal opinion covering the essential elements of the program. It is well recognized that the opinion should be provided by an independent, regional or national law firm. Risk Shifting and Risk Distribution Abuses; Two key elements of insurance are those of shifting risk from the insured party to others (risk shifting) and subsequently allocating risk amongst a large pool of insured's (risk distribution). After many years of litigation, in 2005 the IRS released a Revenue Ruling (2005-40) describing the essential elements required in order to meet risk shifting and distribution requirements. For those who are self-insured, the use of the captive structure approved in Rev. Ruling 2005-40 has two advantages. First, the parent does not have to share risks with any other parties. In Ruling 2005-40, the IRS announced that the risks can be shared within the same economic family as long as the separate subsidiary companies ( a minimum of 7 are required) are formed for non-tax business reasons, and that the separateness of these subsidiaries also has a business reason. Furthermore, "risk distribution" is afforded so long as no insured subsidiary has provided more than 15% or less than 5% of the premiums held by the captive. Second, the special provisions of insurance law allowing captives to take a current deduction for an estimate of future losses, and in some circumstances shelter the income earned on the investment of the reserves, reduces the cash flow needed to fund future claims from about 25% to nearly 50%. In other words, a well-designed captive that meets the requirements of 2005-40 can bring about a cost savings of 25% or more. While some businesses can meet the requirements of 2005-40 within their own pool of related entities, most privately held companies cannot. Therefore, it is common for captives to purchase "third party risk" from other insurance companies, often spending 4% to 8% per year on the amount of coverage necessary to meet the IRS requirements. One of the essential elements of the purchased risk is that there is a reasonable likelihood of loss. Because of this exposure, some promoters have attempted to circumvent the intention of Revenue Ruling 2005-40 by directing their clients into "bogus risk pools." In this somewhat common scenario, an attorney or other promoter will have 10 or more of their clients' captives enter into a collective risk-sharing agreement. Included in the agreement is a written or unwritten agreement not to make claims on the pool. The clients like this arrangement because they get all of the tax benefits of owning a captive insurance company without the risk associated with insurance. Unfortunately for these businesses, the IRS views these types of arrangements as something other than insurance. Risk sharing agreements such as these are considered without merit and should be avoided at all costs. They amount to nothing more than a glorified pretax savings account. If it can be shown that a risk pool is bogus, the protective tax status of the captive can be denied and the severe tax ramifications described above will be enforced. It is well known that the IRS looks at arrangements between owners of captives with great suspicion. The gold standard in the industry is to purchase third party risk from an insurance company. Anything less opens the door to potentially catastrophic consequences. Abusively High Deductibles; Some promoters sell captives, and then have their captives participate in a large risk pool with a high deductible. Most losses fall within the deductible and are paid by the captive, not the risk pool. These promoters may advise their clients that since the deductible is so high, there is no real likelihood of third party claims. The problem with this type of arrangement is that the deductible is so high that the captive fails to meet the standards set forth by the IRS. The captive looks more like a sophisticated pre tax savings account: not an insurance company. A separate concern is that the clients may be advised that they can deduct all their premiums paid into the risk pool. In the case where the risk pool has few or no claims (compared to the losses retained by the participating captives using a high deductible), the premiums allocated to the risk pool are simply too high. If claims don't occur, then premiums should be reduced. In this scenario, if challenged, the IRS will disallow the deduction made by the captive for unnecessary premiums ceded to the risk pool. The IRS may also treat the captive as something other than an insurance company because it did not meet the standards set forth in 2005-40 and previous related rulings. Private Placement Variable Life Reinsurance Schemes; Over the years promoters have attempted to create captive solutions designed to provide abusive tax free benefits or "exit strategies" from captives. One of the more popular schemes is where a business establishes or works with a captive insurance company, and then remits to a Reinsurance Company that portion of the premium commensurate with the portion of the risk re-insured. Typically, the Reinsurance Company is wholly-owned by a foreign life insurance company. The legal owner of the reinsurance cell is a foreign property and casualty insurance company that is not subject to U.S. income taxation. Practically, ownership of the Reinsurance Company can be traced to the cash value of a life insurance policy a foreign life insurance company issued to the principal owner of the Business, or a related party, and which insures the principle owner or a related party. 1. The IRS may apply the sham-transaction doctrine. 2. The IRS may challenge the use of a reinsurance agreement as an improper attempt to divert income from a taxable entity to a tax-exempt entity and will reallocate income. 3. The life insurance policy issued to the Company may not qualify as life insurance for U.S. Federal income tax purposes because it violates the investor control restrictions. Investor Control; The IRS has reiterated in its published revenue rulings, its private letter rulings, and its other administrative pronouncements, that the owner of a life insurance policy will be considered the income tax owner of the assets legally owned by the life insurance policy if the policy owner possesses "incidents of ownership" in those assets. Generally, in order for the life insurance company to be considered the owner of the assets in a separate account, control over individual investment decisions must not be in the hands of the policy owner. The IRS prohibits the policy owner, or a party related to the policy holder, from having any right, either directly or indirectly, to require the insurance company, or the separate account, to acquire any particular asset with the funds in the separate account. In effect, the policy owner cannot tell the life insurance company what particular assets to invest in. And, the IRS has announced that there cannot be any prearranged plan or oral understanding as to what specific assets can be invested in by the separate account (commonly referred to as "indirect investor control"). And, in a continuing series of private letter rulings, the IRS consistently applies a look-through approach with respect to investments made by separate accounts of life insurance policies to find indirect investor control. Recently, the IRS issued published guidelines on when the investor control restriction is violated. This guidance discusses reasonable and unreasonable levels of policy owner participation, thereby establishing safe harbors and impermissible levels of investor control. The ultimate factual determination is straight-forward. Any court will ask whether there was an understanding, be it orally communicated or tacitly understood, that the separate account of the life insurance policy will invest its funds in a reinsurance company that issued reinsurance for a property and casualty policy that insured the risks of a business where the life insurance policy owner and the person insured under the life insurance policy are related to or are the same person as the owner of the business deducting the payment of the property and casualty insurance premiums? If this can be answered in the affirmative, then the IRS should be able to successfully convince the Tax Court that the investor control restriction is violated. It then follows that the income earned by the life insurance policy is taxable to the life insurance policy owner as it is earned. The investor control restriction is violated in the structure described above as these schemes generally provide that the Reinsurance Company will be owned by the segregated account of a life insurance policy insuring the life of the owner of the Business of a person related to the owner of the Business. If one draws a circle, all of the monies paid as premiums by the Business cannot become available for unrelated, third-parties. Therefore, any court looking at this structure could easily conclude that each step in the structure was prearranged, and that the investor control restriction is violated. Suffice it to say that the IRS announced in Notice 2002-70, 2002-2 C.B. 765, that it would apply both the sham transaction doctrine and §§ 482 or 845 to reallocate income from a non-taxable entity to a taxable entity to situations involving property and casualty reinsurance arrangements similar to the described reinsurance structure. Even if the property and casualty premiums are reasonable and satisfy the risk sharing and risk distribution requirements so that the payment of these premiums is deductible in full for U.S. income tax purposes, the ability of the Business to currently deduct its premium payments on its U.S. income tax returns is entirely separate from the question of whether the life insurance policy qualifies as life insurance for U.S. income tax purposes. Inappropriate Marketing; One of the ways in which captives are sold is through aggressive marketing designed to highlight benefits other than real business purpose. Captives are corporations. As such, they can offer valuable planning opportunities to shareholders. However, any potential benefits, including asset protection, estate planning, tax advantaged investing, etc., must be secondary to the real business purpose of the insurance company. Recently, a large regional bank began offering "business and estate planning captives" to customers of their trust department. Again, a rule of thumb with captives is that they must operate as real insurance companies. Real insurance companies sell insurance, not "estate planning" benefits. The IRS may use abusive sales promotion materials from a promoter to deny the compliance and subsequent deductions related to a captive. Given the substantial risks associated with improper promotion, a safe bet is to only work with captive promoters whose sales materials focus on captive insurance company ownership; not estate, asset protection and investment planning benefits. Better still would be for a promoter to have a large and independent regional or national law firm review their materials for compliance and confirm in writing that the materials meet the standards set forth by the IRS. The IRS can look back several years to abusive materials, and then suspecting that a promoter is marketing an abusive tax shelter, begin a costly and potentially devastating examination of the insured's and marketers. Abusive Life Insurance Arrangements; A recent concern is the integration of small captives with life insurance policies. Small captives treated under section 831(b) have no statutory authority to deduct life premiums. Also, if a small captive uses life insurance as an investment, the cash value of the life policy can be taxable to the captive, and then be taxable again when distributed to the ultimate beneficial owner. The consequence of this double taxation is to devastate the efficacy of the life insurance and, it extends serious levels of liability to any accountant recommends the plan or even signs the tax return of the business that pays premiums to the captive. The IRS is aware that several large insurance companies are promoting their life insurance policies as investments with small captives. The outcome looks eerily like that of the thousands of 419 and 412(I) plans that are currently under audit. All in all Captive insurance arrangements can be tremendously beneficial. Unlike in the past, there are now clear rules and case histories defining what constitutes a properly designed, marketed and managed insurance company. Unfortunately, some promoters abuse, bend and twist the rules in order to sell more captives. Often, the business owner who is purchasing a captive is unaware of the enormous risk he or she faces because the promoter acted improperly. Sadly, it is the insured and the beneficial owner of the captive who face painful consequences when their insurance company is deemed to be abusive or non-compliant. The captive industry has skilled professionals providing compliant services. Better to use an expert supported by a major law firm than a slick promoter who sells something that sounds

Brownie Baked Alaska

The start of summer can only mean 1 thing: ice cream!!! It was my goal to incorporate ice cream into one of the summer baking challenges, so baked Alaska was an easy choice. Along with many reader requests for the recipe, as well as my own desire to tackle this "difficult" retro dessert, I devoted some time in the kitchen to baked Alaska-ing. 3,845 quarts of ice cream and 2 emergency trips to the grocery store later, let me present you with baked Alaska and baked Alaska cupcakes!

Let's get one thing straight, though...
INGREDIENTS
  • Two 1.5 quarts any flavor ice cream*
  • enough brownie batter for 9-inch pan (I suggest this brownie recipe or this brownie recipe)
  • Meringue
  • 4 large egg whites, at room temperature
  • 1 cup (200g) granulated sugar
  • 1/2 teaspoon cream of tartar
  • 1/2 teaspoon pure vanilla extract
  • Special Equipment
  • Kitchen torch (if you don’t have one, use the oven as directed in step 10)
  • 9-inch 2.5 quart bowl (I recommend the one in this set)
  • Plastic wrap/cling wrap

DIRECTIONS
  1. Please watch the video tutorial in the blog post to help guide you. Read the recipe in full before beginning as the ice cream is time sensitive.
  2. Remove ice cream from the freezer and allow to soften on the counter for 10 minutes. As it softens, line a 9-inch 2.5 quart bowl (I recommend the one in this set) with plastic wrap with enough overhang to easily remove the ice cream as a whole once it’s frozen.
  3. Scoop softened ice cream into another large bowl and using a handheld or stand mixer fitted with a paddle attachment, beat until creamy. Spread ice cream into prepared lined bowl. Cover with plastic wrap and freeze for 8 hours and up to 3 days. I freeze it overnight. The longer it's frozen, the sturdier the cake and neater the slices.
  4. Preheat oven to 350°F (177°C). Grease a 9-inch round cake pan, then line with parchment paper. Grease the parchment paper as well. The brownie is difficult to remove from the cake pan as a whole without the parchment.
  5. Pour brownie batter into prepared cake pan and bake for 32-38 minutes or until a toothpick inserted in the center comes out mostly clean without any wet batter. (This brownie recipe is thick and could take a little longer in your oven.) Allow to cool completely in the pan. Once cool, run a knife around the brownie edges, then invert the pan to fully release the brownie as a whole.
  6. Remove bowl of ice cream from the freezer. Peel back the plastic wrap and place the brownie layer on top (which will be the base of the baked Alaska). Cover back up with plastic wrap and freeze for 30 minutes. (Make the meringue while you wait.)
  7. Make the meringue: Place egg whites, sugar, and cream of tartar in a heatproof bowl. Set bowl over a saucepan filled with two inches of simmering water. Do not let it touch the water. (You can use a double boiler if you have one.) Whisk constantly until sugar is dissolved, about 4 minutes. Transfer the mixing bowl to an electric mixer fitted with a whisk attachment. Add the vanilla. (FYI I forgot to add it in the video!) Beat on high speed for 5-6 minutes until stiff glossy peaks form.
  8. If using the oven in step 10, preheat oven to 450°F (232°C) now.
  9. Remove ice cream/brownie from the freezer. Carefully remove from the bowl and peel off the plastic wrap. If using a kitchen torch, invert onto a heatproof serving plate or cake stand. If using the oven, invert onto a baking sheet lined with aluminum foil.
  10. Spread meringue all over the ice cream, completely enclosing it. Use a spoon to create big peaks and swirls. Make sure there is absolutely no ice cream peeking out. If using the kitchen torch, toast the entire meringue topping. If using the oven, bake in preheated oven for 4-5 minutes until toasted.
  11. Use a sharp knife (I suggest a serrated knife) to cut thin slices and serve immediately. Store leftovers in the freezer.
  12. Make ahead tip: Step 3 can be prepared up to 3 days in advance. Brownie base can be prepared up to 3 days in advance as well. Cover and store at room temperature. My recommendation for making ahead is to assemble the entire brownie baked Alaska with meringue topping, freezing for up to 1-2 days, then torching or baking right before serving. The meringue covered Alaska holds up wonderfully in the freezer and your guests will love to watch the meringue toast! The brownie will be pretty hard, but warms up quickly as you begin slicing.

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