Weather the retirement storm by strengthening your business with an 831(b) plan. It’s legal and highly effective for tax deferral today to address tomorrow’s risks.
Today, Toby Mathis of Anderson Business Advisors talks to Ed Bryan, Director of Business Development at SRA. Ed has more than 20 years of sales and operations management experience and brings a consistent history of leading high-performing sales teams and operational excellence.
Ed is responsible for developing business strategies to improve representative and client relationships. He works closely with Field Marketing Representatives to identify opportunities and provide education to keep them abreast of industry news and latest product knowledge.
Discussed in the Episode
- 831(b): What it is and how it compares to 401(k) and other retirement accounts
- Options: Allow money to grow, declare a qualified dividend, or realize investment gains
- COVID Claims: Making employee retention credit retroactive has hurt businesses
- Where people go wrong – they don’t share risk and/or operating principles of insurance
- Typical Clients: From builders to doctors – there’s no shortage of risk in any industry
- What can be insured? Threats to business cash flow (brand, cyber security, other risks)
Links
Captive Insurance: The BIG Business Tactic YOU Want To KNOW!
Internal Revenue Service (IRS)
FAQs: Employee Retention Credit under the CARES Act
Full Episode Transcript:
Toby: Hey, guys. This is Toby Mathis with the Anderson Business Advisors Podcast. Today, I have Ed Bryan on. I’m just going to preface this. The IRS hates what Ed does, but they can’t stop what Ed does because it’s so effective. But if you go up, and I’ll let Ed explain what he does, it is so effective when you meet the criteria to use a company like Ed. I never get to start like that. Ed, first off, welcome.
Ed: Thank you.
Toby: Do you think I’m exaggerating when I say that? Is that a fair statement?
Ed: It’s a very fair statement.
Toby: All right. So then the big question is, what do you do and why are they mad at you guys?
Ed: Thanks, Toby. Appreciate it. What we do is we help taxpayers, business owners, and entrepreneurs take advantage of the tax code. It’s been around since 1986. The tax code is called 831(b). Everybody’s heard of 401(k). Businesses understand the benefits of a 401(k), the tax advantages, et cetera, setting aside money for retirement.
831(b) allows a small to midsize business owner or an entrepreneur to set aside money for self-insured risks down the road for future liabilities. Those premiums that they pay into basically an insurance company that they own are a tax deduction. That’s why the IRS, they have a little bit of heartburn about that. That’s what we do.
Our website’s 831b.com. We’re not hiding from it. We’re stepping right into the storm, if you will. We’ve been doing this for 12 years, but really, it’s a big business tool. It’s been around for almost 40 years.
Like a lot of things like the 401(k), when it first started, it was big business. Fortune 500 companies were taking advantage of it. Now anybody can have a 401(k). We’re part of what we feel is kind of a similar migration with 831(b). It was big business, Fortune 500s, and now, most small to midsize businesses and entrepreneurs can have their own 831(b) plan and take advantage of the tax efficiencies and also the risk mitigation that it offers. That’s really what we do.
Toby: All right, so what’s the benefit? What’s the downside? Why are people going and using 831(b)? Who does this apply to?
Ed: Let’s start with what the benefit is. If you own a business, if you’re a small business owner and let’s say that you have a business that generates $5 million a year in gross revenue, that’s a pretty decent sized business. Let’s say that you can set aside up to 10% to 12% of your gross revenue into a captive insurance or micro captive insurance company. All of a sudden, you just took a half a million dollars of profit off your books.
You don’t pay taxes on it, you expense it out of your business. It goes into this entity that you own. You control and the money can be managed. It can make money and you also have a layer of insurance, a protection that you don’t have with your traditional insurance.
Let’s go back to the last year, especially the last two years, the crazy world that we live in with COVID. A lot of businesses last year filed business interruption claims with their traditional insurance carriers. I can tell you, they were denied. Most of them, if not all of them were told, unless you had an earthquake, flood, or fire, et cetera, you can’t even file a claim, and by the way, there are exemptions in your traditional commercial policy for pandemics.
Toby: Yup. I see that over and over and over again. Everybody’s trying. They sue them. They do everything they can, but the insurance companies are standing strong saying, hold on for a second. We literally said this is an excluded coverage.
Ed: Exactly. To that point, out of necessity, business owners looked at things last year and said, okay, I’m going to have to address this with after-tax money. I hope I have a rainy day fund, but odds are, it’s after-tax money. With our program what happens is you set money aside for those types of things, and then if they happen, you have pre-tax money to go fight that fight.
The hope is it doesn’t happen. The hope is that you put the money into the program, policies are one year in length—just like ordinary insurance policies, and the things we help you insure for are things like that: third party business interruption, political risk—that’s a real hot button right now, dispute resolution, and supply chain interruption is one that is just really, really popular.
Those are things that either a) you can’t get coverage for on the open market or b) you’re underinsured for. And if you have insurance, there are gaps in your coverage. It’s like that business […].
Toby: Because they’ll let you have it, but maybe they’ll say, hey, we’ll let you do business interruption but it’s going to be a $25,000 deductible and it’s maxed at $100,00 or something. It’s just really limited. I just want to make sure that I’m being very, very clear for people that are listening out there. From a layman’s standpoint, this is a tax deductible insurance program.
I’m putting the money aside, but if I just put it aside in a savings plan, I don’t get any benefit. But if I meet the requirements of 831(b), I get a tax deduction for it. Then when I pay tax when I use it, if I made a claim against my own insurance policy—
Ed: That’s a good question. While that policy is in place during the year, and you said it very well, Toby, that tax deduction is obviously the incentive. That’s part of the reason why Congress put it into place in 1986. There had to be an incentive to save money, and that incentive was a tax deduction.
During the year, if you have a claim, you can access those funds. It works just like ordinary insurance. You file a claim, we go through, we determine the loss. As the 831(b) plan administrator or the captive manager, we handle all those things for our business owner clients. You can access it via a claim during the year, and depending on the type of loss you suffer or expense you suffer, it may be taxable, it may not be taxable, it depends. We always say to talk to your CPA to verify, or you can always give us a call and we can talk about an individual situation.
But that money can grow during the year. It’s invested in stocks, bonds, and mutual funds. It’s fairly conservative traditional insurance-type investments. Without any investment gain to […] the clients. It’s your own insurance company. We’re kind of flipping that paradigm, if you will. It’s a paradigm shift to instead of paying premiums to a third-party insurance carrier and never getting any of them back, if you make no claims, you don’t get your premiums back under ordinary insurance.
With captive insurance, with micro-captive, at the end of the year when the policy expires, all of that underwriting profit, all those premiums that weren’t used for claims are underwriting profits to your insurance company, and any good insurance company loves underwriting profits.
That’s the reason why insurance companies have their names on every single building, stadium, you name it across the world. They love that surplus or that underwriting profit. What happens is when those policies expire, you have three different options. One, you can leave the money there and allow it to continue to grow. The second option is you can declare a dividend and it would come out as a qualified dividend. Instead of ordinary income tax, you’re going to pay qualified dividend tax.
Toby: Does it have to pay tax at the corporate level first or can it just distribute those?
Ed: Yeah, that’s the beautiful thing. When you pay premiums into your micro-captive over your 831(b), it does not recognize those premiums as taxable income. That’s the sweetener of this. If you put half a million dollars into your captive, it’s not going to pay taxes on those. The only taxes that the captive pays for micro-captive is on investment gains, and I should say realized investment gains. But other than that, at the end of the year, when the policies expire—
Toby: What level would it be taxed at, corporate rate?
Ed: C-corp, yeah. They’re C-corp. They’re standalone separate C-corps. Right now it’s 21%. Who knows down the road what it might be. I’ve seen some different proposals. I have a sneaking suspicion when I say something—
Toby: It’s all off the table right now. They had it up to 26.5%, they had it going down, and then they just removed it. The existing proposals as we sit here today at the end of 2021, nothing includes a capital gain, hike increase, or a corporate tax increase.
Ed: That’s what we had seen as well, Toby. Like I said, you can take a qualified dividend. You can loan yourself the bulk of the funds as well, which is a really efficient way to access. Think about it this way, you write the funds off on the front end. They go through this mechanism. You have a good underwriting year. At the end of the year, all of a sudden, you say, hey, I need a loan, I want a shareholder loan. We don’t care what the loan is for. You can use it to go reinvest or you can go put it into your business.
Toby: But this is where the IRS comes in and they say that’s actually a disguised distribution. This is probably why they’re losing their […].
Ed: Good question. And that’s where we come in. As an administrator or a manager, what we do is we make sure it’s a performing note because to be honest with you, that’s the key. Anytime anybody’s got—
Toby: AFR rates, you do the minimum rate, and you make sure that you’re actually paying on it, right?
Ed: Yeah, principals and interest. Anytime anybody’s gotten sideways with the IRS, especially with loans in these types of vehicles, it’s because they’re not performing notes. That’s where you have us to lean on. We make it very easy and very turnkey. We perform all of the duties to make sure that you’re in compliance with those types of things.
Toby: All right, here’s the big question. How much can you deduct each year? And is this per individual or per business? Can your business have two or three? What are the amounts?
Ed: Let’s start at the top. The tax code right now says you can set aside up to $2.4 million a year into one of these captives. There’s an inflation rider attached to this tax code. The truth of the matter is, we anticipate. Yeah, you’re going to see that go up.
Toby: It’s going to go like crazy. Inflation’s absolutely on fire right now.
Ed: Exactly. It might jump $200,000, $300,000, $400,000, we’ll see. But as it stands today, at the end of 2021, it’s $2.4 million going into 2022. That’s the max that you could set aside. We have some internal control mechanisms from a compliance standpoint that says 10% to 12% of your gross revenue is kind of a number to look at, and there are variables in there that’s just a very general assumption, but it helps people kind of wrap their head around, hey, this might be a fit and this might be something I want to look at.
Those are the mechanisms right there that we use. Obviously, we got the tax code and then our internal mechanism.
Toby: Right. So to get a $2 million deduction, what is it going to cost you?
Ed: We have two types of fees. We have a fixed annual fee that covers the bare minimum with the program. It covers us doing the tax returns, all of the day-to-day operations, et cetera. That’s $5000.
Toby: You’re setting up an insurance company. For $5000, you’re setting up an insurance company. You’re the administrators for it so it’s going to be a professional office. I know you guys. You have a separate insurance company that does all the claims, but the client is setting up an insurance company, and I’m sure it has to have pooled risk and all that. It’s like you’re probably going to have to lump it in with a bunch of others, take at least a portion of the money, and put it in a pooled account. But let’s say that you set this up, I can literally get a $2 million deduction for $5000?
Ed: That’s a good question. So $5000 fixed and then we’re going to retain a percentage of your premium. It’s 3%, but we also retain risk with all our clients. We retain 3% of your premium on the high end. We have a graduated scale-up, basically. We retain anywhere from 10% to 3%.
On the low end, it’s 10%. As you move up, that number steps down. But if you have a claim in a given year, whatever percentage of your premium we retain, we’re on the hook for your claim. Our frontline insurance company that you referenced is on the hook for that percentage of your claim.
Toby: You’re creating an incentive to make claims against your own insurance company. So you don’t just play around and just leave.
Ed: Right. It’s got to be a valid claim. We don’t want casual claims, and at the same time, if you have a claim and it’s valid, absolutely we need it made. That’s what these vehicles are set up for from a risk mitigation standpoint. Your cash benefit is great and we’re not naive enough to think that that’s not what business owners look at a lot of times. But I can tell you, over the last two years, I’ve got more than probably 40 or 50 business owners that will tell you the only reason they’re still in business is because they had one of these things prior to COVID.
Toby: Let’s look at it this way. It’s things that you can’t get insurance for. You’re underinsured or you can’t be insured. Pandemic insurance, you’re not going to be able to get it. Nobody’s going to give it to you.
You could set up your own pandemic insurance policy, and let’s say you’re worried about PPP money, employee retention. Hey, I don’t know what the government’s doing. They just did this retroactive nonsense where they made companies give back a whole bunch of the employee retention credit. They talked about doing this bizarre stuff just to make it harder to run a business because it’s not hard enough already in the middle of a pandemic. They want to make sure you got some hurdles you got to jump over.
I know I have a bunch of clients, and they’re worried. Let’s say they got a million dollars on the hook and they’re like, I don’t know if they’re going to forgive it or come back after me. Can I take that million dollars set aside and put it into this type of vehicle? Let’s go over the numbers real quick. It costs me $5000 to put it together and it’s going to cost me 3%. Do I have to write a check for the 3%?
Ed: Great question. Whatever we retain, we just retain when premiums are paid. You’re going to get a premium invoice. Yes, to that point, we offer political risk coverage. That speaks exactly to what you talked about—
Toby: Retroactive tax breaks removed. This would have actually just impacted us because last month, they made it retroactive on the fourth quarter for the employee retention credit. I know I have clients, I know people that had over a million dollars of payback simply because Congress decided to do something and said, hey, retroactive, boom. They didn’t think about it. I was going to say a special word, but they really hurt some businesses out there.
Ed: Yeah, it’s true. To your point, any of the policies that we set up now would be for 2022 and forward or if you started one in 2022. But yeah, you’re right. Hindsight is 2020. It’s so cliche to say, but the truth of the matter is—
Toby: We just went through it.
Ed: Yes.
Toby: And they keep saying they’re going to do it again. They say, oh, we can make retroactive tax law changes.
Ed: Right, and you almost can’t predict the types of things to your point that businesses are going to face. If you have excess funds, if you had a good year, or if you had a run of good years, it makes sense to set a little bit on the side, let’s write it off the books, take advantage of the tax benefit, and self-insured for this risks that frankly we can’t make up. We know they’re out there, you know it.
As any business owner knows, there are things that keep you up at night. You lay in bed and you just think of what else could happen, especially over the last two years. That’s what this is designed for.
Toby: All right. Let’s go back to my example of a million-dollar premium payout. It’s going to cost me $5000 to put it together, it’s going to cost me 3% of that premium.
Ed: Good question. Remember, I talked about that sliding scale. On a million bucks, it’s 5%. So it’s $50,000. It’s going to cost $5000 to set it up, $50,000 in retaining the premium that we retain with that risk. It’s going to be $55,000, but you’re going to write off the millions.
Toby: The million dollars, let’s say it was an S-corp. So it’s a dentist, doctor, or somebody. That’s going to be tax savings of at least $370,000 plus state tax, right?
Ed: Yes, exactly.
Toby: I always use a seven to one rule. I want seven times the tax savings for any dollar I spend. This seems like it’d be right in that ballpark of about seven to one. Now it’s in there and I have a policy for a year that says, hey, if they shut me down again, I can make a claim against the insurance. It sounds like it’s a real insurance policy. I would have to prove what my damages are and all that stuff, and you have a claims adjuster.
Ed: Absolutely.
Toby: And they say, all right. Let’s just say scenario, doctor gets shut down again, dentist gets shut down again because of some new variant—very real possibility of this, guys. Let’s say that it pays you out $500,000. You’re going to have a taxable income of $500,000, but you’re going to get back the 3% premium charge or 5% premium charge.
Ed: Yeah, from us. Yeah, absolutely. One important point, Toby, is for every $1 that goes into the program, you actually get $2 in coverage. There is a true principle of insurance here, if you will. Every dollar in there’s $2 in coverage.
Toby: Where is that risk?
Ed: Good question. What happens is the clients can own the first half of their risk because that’s the money they set aside. Then what happens is you get the risks that we retain, our frontline insurance company retains, so we have risk, and then we pool risk. You alluded to that earlier.
What we do is let’s say everybody is at political risk for a year, they own a pro-rata share of that policy or that pool based on the premiums they put in. There is an element of risk-sharing here, which, as you know, the IRS says you have to have to participate in a transaction like this.
Toby: In reality, do you ever reinsure that? Do you ever go out and get a reinsurance policy to cover some of that?
Ed: We do, yeah. We do have stop-loss policies out there. Truthfully, Cardinal Point is involved in this as well, our frontline insurance company. I should tell you this, Toby. In essence, what we really form is they looked at as micro captives by the IRS, but they really are reinsurance companies themselves. They’re actually reinsuring the risk with Cardinal Point, not to get too much into the weeds. That’s how it works.
To give you an idea, just real general numbers, this year, somebody that put in say $100,000 into the program, it’s probably going to pay somewhere between $100,000 and $500,000 total across multiple claims that they participated in if they don’t have their own. The risk-sharing is there, it’s real. But by utilizing the law of large numbers, we mitigate that risk as much as we can.
Toby: Worst case scenario, let’s just say, I put it in there, I’m getting pretty good-sized tax savings, and I do have a policy that covers me. If I exhaust my policy, if I make a full-on claim and I get it back, I’m just undoing my tax deduction, in essence. Then if there is no claim and it’s a bunch of profit, under these numbers, we’d have $5000+ and an additional $55,000 of expenses. I’d have a profit of about $945,000 that then would get distributed out to me. It would be treated as long-term capital gains.
Ed: Absolutely. I should say as well, while the money’s in there during that year, it can be invested. Our hope is that—
Toby: Hopefully it grows.
Ed: Yeah, it grows, even if it’s conservative. Even if it’s 3%, 4%, or 5%, that can offset our fees very quickly.
Toby: How much has to be pooled for the risk pool? Is it like a percentage of the total premium paid? Is it a dollar amount? What is it?
Ed: Good question. A couple of things. One, we ask that the client set aside 30% in a loss reserve account. It could still be managed.
Toby: You still make income on it, but it’s in the risk pool.
Ed: Right, and that’s where we pull claims from. But as I mentioned, most years the claims are sub 3%. Even last year in COVID claims, we saw an uptick, but still fairly minimal. That’s why I give you that number.
I think that last year—I’ll give you just an example—one of our biggest clients who did $2.3 million into the program. They didn’t have a claim of their own. In unaffiliated third-party claims, I think they ended up paying around $18,000–$20,000, which sounds like a lot, but they wrote $2.3 million off. The investment advisor went out and got a 5% or 6% on their money.
Toby: But they still came out ahead. They actually put in $2.4 million, they ended up paying $20,000 plus probably $60,000, $70,000, $80,000, or whatever plus the costs. Let’s just say they’re out $120,000, X savings was $740,000+, plus their state taxes. They may be more than $800,000. Why is the IRS attacking this, and what are people doing wrong that’s getting them burned?
Ed: That’s a very good question, Toby. Here’s why, and I say this all the time. Anytime there’s a tax incentive attached to something, the IRS is going to look at it really closely because it’s lost tax revenue. Whether it’s R&D credits, whether it’s conservation easements, opportunity zones, micro-captive insurance, which is what we do, they look at that closely.
Here’s the unfortunate thing about it. Previously—and when I say previous, I’m talking 10, 15, 20 years ago—there were some actors that got into the space that was starting to misuse the tax code. They were only selling the tax code. They weren’t looking at it from a risk mitigation standpoint.
Truthfully, where people go wrong—I alluded to it earlier—where they don’t share risk and/or they’re not operating the principles of insurance. Meaning, there aren’t policies that are generated. There’s not a claims process. There’s no risk pool. Those types of things, to be honest with you, the problems are fairly elementary.
That’s where, as a manager, where we come in and say this is how our program is designed from a compliance standpoint, from a risk mitigation standpoint, we’re going to check all those boxes. The IRS references something called a four-part test to participate in a transaction like this. We’ve been doing that for the last 12 years before they actually officially started talking about it. That has to do with transfer risk and that risk pooling, operating under the principles of insurance, and all those things.
Toby: I’ve seen it. Am I incorrect but the ones that they’re really hitting the hardest don’t actually have an insurance company as a component. You’re just setting it up and then it’s pretending I’m going to make a claim against myself, so you make a claim. You do this?
Ed: Yeah. That’s what it is. They’re either not paying the premiums or they never issue policies. Could you imagine an insurance company, you pay them premiums and they never send you a policy. That’s not what a real insurance company would do. For the IRS, it’s easy to say, well, that’s tax fraud.
Toby: So you actually have Cardinal Point?
Ed: Yeah, Cardinal Point. They issue the policies. Like I said, we use third-party licensed adjusters. This runs, acts, and operates as an insurance company as it should in order to elect under this tax code.
Toby: Okay. Who uses these? Who’s your typical client? If you’re talking to people out there, is this, hey, if you’re a builder; hey, if you’re a dentist; hey, if you’re a doctor; hey, if you’re running a traditional business; hey, if you have a bunch of employees; hey, you have a physical location; or hey, you’re a restaurant? Is this who you’re talking to or who’s your typical client?
Ed: Our typical client, first of all, you can apply this in any industry. Let me say that upfront. There’s no shortage of risk. Our typical clients are usually closely held family businesses or partnerships. Our clients gross anywhere from a million dollars in revenue to $200–$300 million. I realize that’s a massive delta.
I will tell you, our typical client is a family business or closely-held business. It doesn’t matter the industry because we are in all industries. Our average client probably does somewhere between $3 million and $6 million in revenue. We have that huge delta, but I would say our typical client is somewhere right in there.
In a lot of times, they’re past what we call their spending phase. They made some money. They bought the house, they bought the boat, they’ve done these things, and now they’re sitting here with this business saying, okay, there are things keeping me up at night. I’m looking at the big picture, what can I do to mitigate some of this risk that I can insure, and/or what can I do to set myself up, the next generation, or the key employees that I want to take the business over down the road?
Toby: What type of things can I insure? Let’s just go over it.
Ed: Yeah, let’s talk about that. Really, we offer about 13–14 different coverages that are there—risks that will help you cover. Think about it this way, everything that we help you insure really is something that would potentially threaten the cash flow of the business. Your traditional insurance does a great job insuring tangible assets—buildings, inventory, fleets, homes, and all of those types of things.
Where we step in is we have what we call Enterprise Risk Management coverages. They’re things like your brand. Dispute resolution, if someone brings legal action against you and you have to respond and potentially pay a settlement. Employer liability practices and political risk, and you dive into those.
They’re written very broadly to capture all of the types of things that may happen under one of those coverages. Whereas traditional commercial insurance policies are fairly narrow and there are exclusions in there. We try to capture as many things because we want these to be an asset. That’s just a taste. Unauthorized access is another, think about cybersecurity.
Toby: Somebody shuts you down and says, hey, I want a big chunk of money to give you back your data, you could insure that?
Ed: Absolutely. Or for example, let’s say you store customer data and someone breaks into your system or a disgruntled former employee does, and all of a sudden you have to pay for credit monitoring. Those are insurable risks.
Supply chain. Our supply chain coverage doesn’t just cover what happens within the four walls of the manufacturer or fabricator. It will go all the way across the globe. For example, you can’t get a part from somewhere in Asia or somewhere in South America, then you have to go find another supplier and it costs you X number of dollars more, that’s an insurable risk.
Toby: What about I’m a builder and you know you’re going to get sued at some point because somebody is mad because your roof starts leaking, something goofy like that, or you have warranty claims, can I actually insure that?
Ed: Absolutely. That’s a great question, Toby. Yes, we have a lot of builders that utilize our program. They’re self-insuring, to that point, dispute resolution. Subcontractor default is another one. Let’s say you’re a general contractor and you have a subcontractor that goes out and does a job, then they disappear, they didn’t do their job right, and you’re on the hook as a general contractor. Well, this is a way to offset that.
Then warranties. To your point, we offer what we call safe harbor plans as well that allows you to insure your warranties. Basically set up a warranty program and service agreement programs. In the self-storage space, let’s talk self-storage real quick. Think about tenet insurance where we offer a protection plan alternative where the self-storage owner of the facility actually can offer their own and they can charge for it. We can use an 831(b) for that as well.
We offer a lot of customized products as well. It’s one of those things where if someone has something unique enough, a lot of times we can address that.
Toby: Interesting. How about the type of business? Let’s say that I’m a C-corp and I do one of these. I’m going to be maxed really at 21%, right? That’s going to be my total benefit.
Ed: Yeah.
Toby: And if it pays out dividends, is it coming back to the corp, or should I always do this to flow through the entity?
Ed: Yeah. What I’ll tell you is this. There are no restrictions on the front-end entity. Obviously, we want to make sure that it makes sense for you from a numbers perspective because we understand that you got to win as the business owner, but we have C-corps. We have S-corps, LLC, sole proprietors, partnerships, you name it. We have them all in the program.
We’re careful to make sure that the numbers make sense. When dividends are declared, a qualified dividend comes out the back end of one of these vehicles, it comes out to the individual. Usually, unless a business on its own that you can send back to a business, you’ve got a lot of options and that’s where advisors come in. People like you, Toby. You come in, you step and say, here’s what—
Toby: You probably want to have it to where it flows down to the individual. If you’re doing this, you might want to have your C-corp have a contract outside S-corp to actually put this in place, and then you’re deducting from the C-corp. The S-corp is then deducting it, so you have a zero, probably. You’re zeroing it out. Then when the dividends come out of flow, it retains its character and goes to the individual shareholders.
Ed: Absolutely.
Toby: Hey, that’s all fun stuff. Can I ask you a really uncomfortable question?
Ed: Sure.
Toby: Have you guys had any issues with the IRS, and if so, how has that come out? Because my understanding is that they weren’t going after every single micro-cap. I know there was a case decided in the micro-caps favor very recently that they beat the IRS, and that’s having repercussions throughout the industry. The IRS was really mad for some reason. Were they just out over their skis? What was the IRS doing, then how is it resolved and how have you guys dealt with it?
Ed: Great question. First of all, what I’ll tell you is we haven’t had any issues with the IRS. We’re very conservative in our approach. The IRS is aware of our program. Frankly, they’ve looked at our program a handful of times. Let me give you an example real quick.
A client, maybe their main business, let’s say they own a marketing firm and they get audited for whatever reason. The IRS auditors come in and they look for the biggest deduction. They say, oh, you own a captive, a micro-captive. Then they ask for premium invoices, how claims are paid, et cetera. We provide all of that. Not once has an auditor disallowed the deduction with our program.
Toby: Fantastic. They’re looking at these things closely.
Ed: Yes, absolutely. To that point, we haven’t had any issues. We actually view the IRS scrutiny as—believe it or not—a good thing. I know that sounds kind of like an oxymoron, but the truth of the matter is, we look at it as it’s cleaning the tax code up. It’s getting rid of abusive practices.
To that point, about this most recent court case in tax court, we’ve been watching. We’ve been aware of this since late last year or early this year. We’re hearing in the legal circles very positive things early on saying, hey, there are really good facts for this taxpayer. It was interesting to watch, and then finally the IRS conceded. Basically, they walked away. Our understanding is that the IRS wanted them to settle because then, the IRS could point to the fact […] and settle.
This taxpayer, our understanding was, they were going to go all the way because they knew it was insurance. When the IRS brought in insurance professionals to look at this, they very quickly were advised, this is legitimate insurance and you may not have a case here. Ultimately, rather than losing tax court, they conceded and walked away.
Toby: The moral of the story is have a separate insurance company, have actual premiums, have an actual policy, run it like an insurance company, and have pooled risk. Don’t play cowboy, don’t go out there and do anything crazy. If it sounds too good to be true, it probably is. If somebody’s making a claim, you guys are on the hook. You’re probably going to push back saying, no willy-nilly claims. It needs to actually fit underneath this policy. You just can’t make stuff up.
Ed: Absolutely. That’s exactly right, Toby. One thing I’ll add to that is something somewhat unique to us in this space is that we offer a written guarantee. It’s in one of our contracts with all of our clients that if you’re ever to be audited as a result of owning an 831(b) with us—and as long as you’re in compliance with us and you’re following the rules, et cetera—that we’ll provide a legal team and a legal defense on our dime. Our attorneys that we have on retainer are all former IRS prosecuting attorneys or chief counsel in the micro-captive space.
Toby: Nice.
Ed: They’re in private practice now. We feel like we’ve got some of the best and brightest legal minds in the space. From a compliance standpoint, our program runs through them. They mock audit us on a regular basis to make sure we’re within the balance. Because of that, everybody says, has anybody ever had to use that guarantee? The answer in 12 years is no. It’s out there, we’re very confident in our program, but no one has had to use it today.
Toby: Okay. Let’s say somebody is listening to this—we’re doing it at the end of 2021. But let’s say that it’s anytime towards the end of the year. Can I prepay premiums? If I was really aggressive, can I set up a company, prepay the premium, and take a deduction this year?
Ed: Absolutely. Yeah. You got to think this way. A lot of businesses prepay their insurance for the next year. Absolutely.
Toby: Twelve months in advance. I think it has to be a contract that’s 12 months. Is it 12 months or is it a calendar year?
Ed: Twelve months. To that point, we do have a lot of business owners this time of year that are sitting down and saying, hey, we barely survived or we had a good year, but I’m really worried about X. Is this something we can do this year? We can actually get one of these things set up within 7–10 business days, and sometimes even shorter.
If someone was interested, they wanted to do it or wanted to pursue it, there is time at the end of the year. If it pushes into next year, that’s fine. But if somebody is looking to take advantage of the full benefit, we actually did a podcast the other day where we talked about getting one set up for next year and/or taking advantage of the tax deferral aspect as well. There is time to get something done if someone wants to do something this year.
Toby: And then next year, do we know what the amount that they’ll be able to put in? Do you know when that will be?
Ed: Good question. We’ll probably see something in early spring. The thought is somewhere between $2.5 million and $2.6 million based on inflation. It’s at $2.4 million right now.
Toby: Six percent, 8%. Eight percent of $2 million is going to be another $200,000.
Ed: Yeah. It’s going to be interesting to see. We’ll see early spring, but it is going up. The other thing is more businesses are paying attention to it. It’s becoming an important enough or a big enough number to say, hey, we can set this money aside and it’s meaningful down the road to us.
Toby: Yeah, absolutely. I really appreciate you coming on, Ed. You’ve been very transparent. We’ve worked together for years, and I really appreciate what you do for our clients and the fact that you’re doing it right. I think that we’re pretty good about picking the winning horse. In this space, there wasn’t anybody else that we felt like we could talk to. They were doing it for the wrong reasons and you guys do it for the right reasons, ao I really appreciate that.
Ed: Thanks, Toby. I appreciate it. If anybody’s interested, 831b.com is our website. Obviously, you can reach out to Toby and he can put you in contact with us. That’s great. We love working with you, Toby. You guys do great things and I appreciate the opportunity to be on your platform.
Toby: Perfect, and we’ll share out their information so you guys all have it. If it’s something that might fit your bill, just go straight to them. You don’t need to talk to us. You just say, hey, Ed, help me out, I’d love to get a nice deduction, but I also like to take action against some things that may happen in the future, especially with this nasty pandemic and the government showing an inclination to shut things down repeatedly.
If it’s affecting you, then this might be your safety net to make sure you have a pot of cash there instead of paying it to the treasury. Keep it in your realm. Perfect. Thanks, Ed.
Ed: Yeah. Thanks, Toby. We’ll talk to you soon.
As always, take advantage of our free educational content and every other Tuesday we have Toby’s Tax Tuesday, a great educational series. Our Structure Implementation Series answers your questions about how to structure your business entities to protect you and your assets.
Additional Resources:
- Claim your FREE Strategy Session
- Join our next Tax & Asset Protection event to learn more advanced tax minimization & entity structuring strategies
- For all things investing, check out the Infinity Investing YouTube channel
- Subscribe to our YouTube channel to make sure you never miss the latest strategies & updates
