Salvadore R. Salvo

Salvadore R. Salvo

By Salvadore R. Salvo

While radiologists make it their goal to safeguard the health of their patients, they can get so bogged down in their day to day routines that they neglect to safeguard their own financial health with respect to risk exposure and tax liability.

Enter the creation of a Captive Insurance Company, or the “Swiss Army Knife” of financial strategies.

If leveraged correctly, a radiologist can use a Captive to gain access to the following benefits:

  • Full Risk Protection
  • A Comprehensive Understanding of Unique Risk Profile
  • Current Income Tax Savings
  • Tax-Efficient Wealth Accumulation
  • Conversion of Ordinary Income to Capital Gains Tax Treatment
  • Estate Benefits for Heirs

It should be emphasized that a Captive’s primary function is to cover the holes of risk exposure found in commercially available insurance by serving as a replacement or a supplement to what a radiologist has in place. If a radiologist pursues the concept of a Captive with the intention of covering risks, they can enjoy a host of secondary benefits. Those solely looking to use a Captive as a tax shelter will face the scrutiny of the IRS.

Basic Requirements

For many years, the benefits of a Captive were mostly enjoyed by large public corporations. Recently, the implementation of a Captive has been simplified for smaller, closely held businesses. Nevertheless, it should be stated that there are a couple of basic requirements:

  1. The business has to face enough risk to justify the utilization of a Captive. Essentially, all practices face enough risk, even if they do not realize it.
  2. A radiologist(s) needs to have an annual free cash flow of $100,000 at a minimum. The more cash flow one has, the more one can maximize the benefits associated with having a Captive, making the associated costs not an issue.

The following explains some of the many benefits of a Captive.

Full Risk Protection

Almost every radiologist has somewhere between three and seven uninsured risks that can threaten their practice with potential financial ruin. These uninsured risks are usually the result of gaps in their commercially available insurance policies.

For example, when Hurricane Sandy hit New Jersey, we had a physician group that was forced to close their practice for 8 days because of the storm. They estimated a loss of $350,000 in revenue during that time. Having business interruption insurance, they put in a claim. The insurance company did not agree with the number and sent in a team of auditors. After two and a half hours of going through all the numbers, they settled on $253,000. The physician said, “Okay, at least we get some remuneration.” Two weeks later, they get a check in the mail for $25,000. Their coverage had a cap in it so that if the cause of business interruption was the loss of electricity from the power company, then $25,000 was the maximum allowed.

The first line of defense for an insurance company is the language used in the contract, meaning the contract an individual receives from an insurance company is written by the insurance company for the benefit of the insurance company. They work very diligently at limiting the actual risks they cover through their choice of contract language. Their second line of defense in paying claims is strict contract interpretation. In a situation like super storm Sandy, they’re looking at potentially billions of dollars in claims. So, it would appear that they are going to do whatever they can to limit their risk exposure. In contrast, a Captive can be written in broader contract language that applies to a wider range of circumstances and specialty risks so that in the event that something happens, radiologists can be indemnified for the loss they sustained.

There are several common areas of exposure for radiologists that are not included in commercially available insurance policies; examples include employee liability, employee fidelity, statutory/regulatory change, administrative actions, and accounts receivable defaults.

Awareness of Unique Risk Profile

By creating a Captive, radiologists can have the opportunity to understand the inherent risks involved with the operation of their practice. This awareness in and of itself provides radiologists with a competitive advantage over those who choose to ignore the risks surrounding the operation of their practice. Radiologists gain this knowledge during the actuarial analysis in the setup phase of the Captive.

Receive a tax deduction for $1,200,000 annually by paying this amount in insurance premiums to your Captive

The premium radiologists pay to their Captive is a deductible expense from a practice’s gross income. For example, if a radiologist makes $1,000,000 of income and can save $500,000 a year, instead of paying taxes on the $500,000 of savings, that money could possibly be put into a Captive as premium to cover liabilities that are not covered now. In this example with the Captive, the radiologist could save as much as $222,950 in federal income tax (assuming an effective top marginal tax bracket of 44.59%) plus whatever the state income tax would be on that $500,000 of earnings for the particular state where the radiologist resides. That’s a tax savings of $222,950 plus state income tax every year that this is done. That’s a cumulative tax savings of approximately $3.3 million over a 15-year period.

Again, this is all legal under section 831(b) of the tax code. This section of the tax code allows an insurance company to make an election to be taxed on its investment income rather than its gross income if the Captive has $1,200,000 or less in gross premiums.

Tax-Efficient Wealth Accumulation

To illustrate wealth accumulation, let’s assume the Captive is capitalized with $250,000 (must be kept liquid; but one could use a letter of credit for this requirement rather than cash), the radiologist pays an initial one-time setup fee that is under $30,000 (this would include an actuarial analysis, insurance policies, corporate documents, application fee, Captive license, written business plan, written investment policy), and the premium is $500,000 (the annual contribution from the previous example). Additionally, assume a 2% return on investment.

Generally, many Captives don’t pay a significant amount of claims, but for the sake of this example, let’s assume annual claims are $25,000 and there is a $50,000 cost in annual maintenance expenses, totaling $75,000 in expenses on an annual basis. As the tax code is written, under the election of 831(b), a radiologist pays tax on the net earnings of the Captive, not the premium income.

In this case, expenses offset investment income and no income tax is paid. Retained capital at the end of the first year is $690,000 in the Captive. This would grow each year, assuming the same rate of return and expenses. At the end of 15 years, the cumulative retained capital would be over $7.8 million!

Take money out of Captive at long term capital gains rates for retirement

The above example shows the effectiveness of wealth accumulation, but what about actually having the cash to spend? If the radiologist had taken the $7.8 million, they would have to pay taxes at the top federal tax rate of 44.59% (plus state). But if the $7.8 million were to accumulate in a Captive insurance company, the radiologist could save for retirement, dissolve the entity, take the accumulated retained capital, and be taxed at a more favorable federal long term capital gains rate of 24.99%, assuming these rates stay favorable every year (plus state tax)[Federal Long Term Capital Gains is 20%+ Pease+ 3.8% surtax]. This 19.60% difference in federal tax rates could amount to a tax savings of over $1.5 million.

When radiologists decide to retire and close down their Captive, they get capital gains treatment on the cumulative retained capital, in our example, $7.8 million.

Pass accumulated wealth from Captive onto heirs, avoiding estate taxes in the process

Assuming the accumulated funds of the Captive are not entirely used for retirement or claims, this is generally how it would be structured. The children of the owner contribute capital (or a letter of credit) to the formation of a Captive and are, therefore, shareholders of the Captive. It is best if they own the Captive through a trust to protect the shares from potential creditors’ claims. With time, the children receive the benefit of increased share prices caused by an increase in the Captive’s overall net worth. The Captive can act as a wealth accumulation vehicle and, consequently, the Captive would grow in value in the children’s names (or in the name of the trustee for the children’s benefit), avoiding any potential estate tax.

Final Thoughts

Despite the benefits, many radiologists will be discouraged from setting up a Captive because they may think that such a structure will create a significant amount of work. The reality is that a radiologist would be hiring an expert to set up and manage the Captive. This individual would take the administrative work, the policy building, and all of the complexity off the radiologist through a process called “Captive Management.” It is important to emphasize that Captive Management facilitates compliance with the law, and does not take control away from the radiologist.


Salvadore R. Salvo is Co-Founder of Summit Financial Resources. Mr. Salvo offers Securities and Investment Advisory Services through Summit Equities Inc, Member FINRA/SIPC, and financial planning services through Summit Equities Inc’s affiliate Summit Financial Resources Inc, in Parsippany, NJ.

Disclaimer: Any tax statements contained herein were not intended or written to be used, and cannot be used, for the purpose of avoiding US federal, state, or local tax penalties. The article is not intended as legal or tax advice. You should consult your legal counsel and tax professional before any action is taken. 20150126-0092


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