Disability Trust

Discussion in 'Professional Trading' started by DayTraderNYC, May 23, 2002.

  1. Is anyone familiar with a tax shelter called Disability Trust? A buddy of mine who is a doctor uses 4 tax shelters: (1) Pension Plan (similar to Keogh or 401K I guess...contribute up to $30,000 per year (2) Malpractice Trust - which we wont qualify for, (3) VEBA/ Sec 419 Death Benefit Plan - Ted Tesser and others have written about this & (4) Disability Trust.

    Disability Trust is bascially a vehicle where you can contribute into your own disability fund. It is supposedly tax dedcutible and grows tax deferred..Im not 100% sure of the details. I went to IRS website but could not find anything on the subject. If this is legitimate, it seems this is something trtaders can utilize to cut taxes with.............
  2. trdrmac


    I don't know if this is what your friend is doing, but it appears to be close. There are several factors, one of which is he needs to be selling insurance to others.

    As a general rule, either the trust pays tax or the person pays the tax, there is really no have your cake and eat it too trusts. except those that are being illegally promoted.


    Favorable Tax Treatment

    To promote the use of insurance companies, Congress has given insurance companies -- and especially "small" property & casualty companies -- very favorable tax treatment.

    The very best tax treatment given by Congress comes in the form of the IRC § 501(c)(15) company. Essentially, so long as an insurance company is: (1) primarily in the business of insurance; and (2) receives less than $350,000 in annual insurance premiums, the company is tax exempt, subject to certain restrictions. This means that the insurance company may obtain the following tax benefits:

    Premium Income Received Is Not Taxed – All insurance premiums are received by the company tax-free.

    Passive Investment Income Received Is Not Taxed -- This is the really Big Bang for qualifying 501(c)(15) insurance companies. So long as the company continues to qualify under the Internal Revenue Code, its passive investment income is NOT taxed. What this means for qualifying insurance companies, under certain circumstances is that:

    Capital gains are not taxed. This means that if a person has a large appreciated asset, whether a large bloc of IPO stock or appreciated real estate, that they could transfer those assets to the insurance company as reserves and surplus, and the insurance company could liquidate and diversify those assets with NO tax immediately payable.

    Short-term capital gains, dividends earned by stock held by the company, etc., as reserves and surplus, are not taxed.

    Royalty streams, such as income streams from patents, copyrights, and trademarks which have been contributed to the insurance company as reserves and surplus, are not taxed. [Caution: There are very complicated rules for contributing such income streams or intangibles to the insurance company, and the failure to follow these rules correctly can lead to unfavorable results.]

    All Taxes Deferred -- Although the 501(c)(15) insurance company typically pays no taxes, the owner of the company will pay taxes: (1) whenever a distribution is made or a salary or management fee paid, at ordinary income tax rates; and (2) when the insurance company is sold or liquidated long-term capital gains rates will be paid (assuming the insurance company has been held for a significant amount of time. But note that, at worst, the owner of a 501(c)(15) insurance company has converted ordinary income (premiums received) and non-long term capital gains investment income, into long-term capital gains which are deferred until the company is sold, etc.


    The insurance company tax rules are full of “tax landmines”, which you can easily explode if you or your planner are not familiar with this area of the Internal Revenue Code (very few planners have any experience with insurance company taxation). If you hit a “tax landmine” you may end up with worse tax consequences than if you had done nothing at all.

    In particular, the 501(c)(15) insurance company is an oddity, because it is a for-profit insurance company which falls into rules for the tax-exempt organizations (such as charities and other non-profit organizations). This creates some additional tax traps, including the following:

    It limits the types of assets which can be placed into the insurance company, and the methods of placing them there.

    A 501(c)(15) company will be taxed on income from a non-qualifying subsidiary or on other "active" income, i.e., you cannot put an active business into a 501(c)(15) and claim that the income from the business is tax exempt.

    The primary business purpose of the insurance company must be insurance, and not some other purpose, such as investing.

    The surplus and reserves must make sense based upon actuarial calculations. Simply declaring that the policy premium will be "X" doesn’t work.

    There are a myriad of state and federal regulatory issues that must be addressed.

    CHICs vs. Captives

    Certain insurance companies are called "captive" insurance companies because most of the insurance they underwrite is exclusively that of a related business, i.e., the insurance company is "captive" to the insurance needs of the related business.

    CHICs are not restricted to underwriting insurance for any related company, except in the sole discretion of the common owner, and certain tax and regulatory restrictions. Many CHICs are formed to be stand-alone insurance companies, and intended to grow into separate and valuable profit centers for their owners. Some CHICs may never underwrite so-called related party risks.

    Self-Insuring & Third-Party Insurance

    An insurance company which shares common ownership with another business may typically underwrite the other business's insurance needs so long as the premiums charged are actuarially (read: statistically) reasonable. The business that is purchasing insurance from the insurance company should -- if the insurance is real and the premiums are reasonable -- get a deduction for the premiums paid.

    However, for the premiums to be deductible to the other business, the insurance company must also sell some insurance to other unrelated third-parties.

    The premiums charged must also be reasonable, which is usually proven by way of actuarial assessments. If the premiums are not reasonable, the arrangement is subject to challenge. In the famous UPS case, UPS's captive insurance company charged three times the going rate for a particular type of commonly-available insurance. The Tax Court ruled that the premiums in this context were not reasonable, and disallowed the deduction for the premiums paid.
  3. trdrmac