The Captive Question
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Captive insurance estate planning is not a conversation most estate planners are having, and that gap is costing their business-owner clients options. A captive may belong in the succession plan long before anyone thinks to ask about one.

What a Captive Actually Is, in Plain Terms

A captive is a licensed insurance company a business owner forms to insure some of the business's own risk, instead of buying that coverage entirely from a commercial carrier. The business pays premiums the same way it always has. The difference is where the money goes. Premiums that would otherwise fund a carrier's balance sheet instead build reserves inside a company the owner controls. If claims run lower than premiums collected in a given year, that difference stays inside the business as equity, not as a carrier's profit.

Most captives elect treatment under Section 831(b) of the tax code, which taxes a qualifying captive on investment income only, up to a statutory premium cap, while the operating business still deducts the premiums it pays as a business expense. As a general guideline, this structure tends to make the most economic sense above roughly $250,000 in annual premium, though that is a guideline and not a hard rule. Higher-tax states can justify forming one at a lower premium level.

None of this is exotic. A captive is closer to a subsidiary the business owns than a specialty insurance product, and that is exactly why it belongs in front of an estate planner and not only an insurance broker.

Why This Belongs in a Succession or Estate Planning Conversation

A captive that has been running for several years accumulates reserves the way any profitable subsidiary accumulates retained earnings. That reserve is a real asset. If a client's business forms one before a succession event, it becomes part of what gets valued, transferred, and planned around from the start, instead of something discovered after the fact.

3F has written elsewhere about how a captive can fund a buy-sell obligation directly, letting a family build the cash for a future ownership transition instead of relying on a life insurance policy priced years before the business's value changed. That is one entry point. Another is coverage the commercial market prices conservatively or will not underwrite at all.

If a client's business already has a captive, the same principle applies in reverse. The succession or estate plan needs to name that entity specifically, since its ownership does not transfer automatically just because the operating company's does. But for most clients, the more common and more overlooked question is whether one should exist at all before the transition happens, not what to do with one that already does.

The Reputation Problem, and What's Actually True

Estate planners who have heard of captives at all have often heard about them the wrong way. Through the 2010s, some captives were marketed explicitly as wealth-transfer vehicles: gift the captive's shares to a trust for the next generation, let the reserves accumulate largely outside the parent's taxable estate, and deduct the premiums along the way. That structure has lost in Tax Court in nearly every case brought against it, including Avrahami, Keating, Swift, and Patel, all reaching the same conclusion in different fact patterns: the premiums being paid weren't for genuine insurance.

The IRS built a disclosure regime around that pattern, and it's more contested right now than most advisors realize. Final regulations issued in January 2025 created two separate designations. The stricter one, a "listed transaction," applied numeric thresholds, including a rule that a captive with claims paid below 30 percent of premiums earned over the past ten years was presumptively suspect. A federal court in Texas vacated that specific rule in April 2026, finding the IRS hadn't adequately justified it, and echoing what actuaries have said for years: a low loss ratio is often exactly what low-frequency, high-severity risk looks like in a quiet year, not evidence of abuse. A lighter, disclosure-only designation survived a separate ruling out of Tennessee the month before. Both rulings are now on appeal. The regulatory picture is unsettled, not resolved in either direction.

What matters more than either ruling is the substance test courts have actually applied for decades: does the arrangement genuinely shift and distribute risk, is it priced at arm's length by an independent actuary, does it pay real claims. A captive built and advised that way doesn't carry the exposure that made the Tax Court cases above losers. A captive whose primary purpose is moving reserves to a junior-generation trust does, regardless of which disclosure rule happens to be in force this year.

What Changed With the New Exemption, and What Didn't

The One Big Beautiful Bill Act permanently set the federal estate and gift tax exemption at 15 million dollars per individual, 30 million for a married couple, effective January 1, 2026, up from 13.99 million in 2025.

For many clients, that removes the acute estate-tax pressure that made aggressive wealth-shifting structures tempting for some advisors to consider in the first place. With less estate-tax urgency in the room, the reason to consider forming a captive is now almost entirely about risk management and building transferable equity, not about a tax outcome, which is a cleaner conversation for a cautious advisor to have with a client than it was a decade ago.

What This Means for How You Advise

• Ask about a captive earlier than you think you need to. If a client's business is already carrying high deductibles or thin excess coverage because commercial pricing doesn't fit its risk, that's worth raising well before a succession or estate plan is being finalized.
• Don't let a decade-old reputation problem rule it out by default. The abusive pattern that drove Tax Court losses and IRS scrutiny is a specific one: reserves moved to a junior-generation trust with no real underwriting behind them, not the existence of a captive itself.
• Loop in a captive manager and an independent, unconflicted CPA before recommending for or against one. Arm's-length pricing and real claims-paying substance are what the case law actually tests, not which disclosure rule happens to be in force this year.

Contact 3F Captive Services for a no-cost review of whether a captive belongs in a client's succession or estate plan.

This post is for informational purposes only and does not constitute insurance, legal, tax, or estate planning advice. Captive structures, succession outcomes, and IRS reporting requirements vary by entity, jurisdiction, and individual circumstances. Consult qualified legal, tax, and insurance advisors regarding your specific situation.

Sources

1. Internal Revenue Service, “What's New — Estate and Gift Tax,” irs.gov, reflecting the basic exclusion amount increase to $15,000,000 for calendar year 2026 under the One Big Beautiful Bill Act.

2. Morgan Lewis, “IRS Announces Increased Gift and Estate Tax Exemption for 2026,” October 28, 2025.

3. Gallup (Jonathan Rothwell), “Most Small-Business Owners Lack a Succession Plan,” March 24, 2025, analysis of U.S. Census Bureau data.

4. Avrahami v. Commissioner, 149 T.C. 144 (2017); Keating v. Commissioner, T.C. Memo. 2024-2; Swift v. Commissioner, T.C. Memo. 2024-13; Patel v. Commissioner, T.C. Memo. 2024-34.

5. Treasury Decision 10029, 90 Fed. Reg. 3534 (Jan. 14, 2025), final regulations under 26 U.S.C. § 6011 for microcaptive transactions, preamble acknowledging that low loss ratios may reflect coverage of low-frequency, high-severity risk.

6. CIC Services, LLC v. United States, No. 3:25-cv-146 (E.D. Tenn. Mar. 5, 2026), upholding the final regulations in full; Drake Plastics Ltd. Co. v. United States, No. 4:25-cv-02570 (S.D. Tex. Apr. 15, 2026), vacating the listed transaction designation under 26 C.F.R. § 1.6011-10 while upholding the transaction of interest designation under § 1.6011-11. Both decisions on appeal.

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