What’s Sweeter: Saving $100,000 in Taxes, or Maple Syrup?
CASE NUMBER 15, THE LAMBERT FAMILY: USE OF A CAPTIVE INSURANCE COMPANY FOR RISK MANAGEMENT AND ECONOMIC BENEFIT
Pierre Lambert, III is a third generation maple sugar farmer. His family “farm” consists of 1,400 acres of mostly sugar maple trees, and his company, Lambert Farm, Inc., has operating leases on another 2,400 acres of sugar maple forest. Pierre’s family has been in the sugaring business for over 50 years.
His grandfather, Pierre Sr., moved to St Albans, Vermont in 1962. It was romance that motivated the move as he met Sally in England at the end of his military service in the Canadian air force. He had been injured and Sally, a nurse in the United States military, was stationed at a hospital outside London where Pierre was recovering. It actually took several years for the romance to ripen into a long-term relationship.
After Pierre Sr. recovered and returned to his home in Sherbrook, Quebec, he stayed in contact with Sally who lived in Vermont. Initially, Pierre Sr. went back to work in Sherbrook for the Beaudry Family who owned sawmills and a sugaring operation. Pierre Sr. learned the sugaring business from them.
He initially worked in and later managed the forest part of the business. It was hard work. Thousands of trees were tapped in early spring, usually with lots of snow still in the woods. Each tree was tapped and a covered pail to hold the sap was attached. Workers had to retrieve the sap in large containers. Sometimes they used horses (later snowmobiles with trailers) to move from tree to tree and gather the sap, but often it was a man on snowshoes, pulling a toboggan with a large container attached to it up steep slopes, that was the means of gathering the sap.
Pierre Sr. was always trying to figure out easier and more efficient ways to gather the sap. He was creative and had the ability to match seemingly unrelated experiences to solve problems. He had remembered the long intravenous tubes that fed saline solution and medications into his veins when he was in the hospital in England. He wondered if such tubing using gravity flow and/or vacuum pumps could assist in his sugaring operation.
He first experimented in a mountainous area, where trees tapped at a high point on a maple ridge were attached with tubing running back and forth among the trees all the way to the bottom of the ridge. There he placed a large container on a trailer so that once full it could be attached to a snowmobile or four-wheeler. His experiment worked great. The result was a much more efficient system and had the important economic benefit of reducing the labor hours involved in the forest dramatically.
The Beaudry Family was very pleased and the experiment was duplicated wherever the topography had the necessary elevation change for the system. Later pumping techniques were added which increased the tubing capacity. Two years later Pierre Sr. and Sally decided that a long distance romance was not sufficient so Pierre decided to move to St. Albans. Sally’s family lived there and Pierre’s parents had both passed away. It was a difficult move as it involved complying with the immigration regulations. One such regulation at that time was that Pierre had to be able to show that he had a job in the United States. Pierre had little formal education and had only ever worked for the Beaudrys.
He tried but was just not able to find a job anywhere near St. Albans. He and Sally had planned a wedding; had set the date; and, were looking forward to their life together. They began to think that it was not to be. Pierre mentioned his problems to Robert Beaudry who smiled and said let’s go talk with my three brothers, all of whom worked in the Family business.
That talk resulted in the Beaudrys asking Pierre to research the St. Albans area to see if they could expand their sugaring operation into the United States with Pierre managing that new operation. Pierre was elated, as in his visits to St. Albans he had already discovered the maple forests in the area with only modest sugaring activity. It took almost a year but Pierre, Sr. was able to facilitate the purchase of an existing sugaring business with about 250 acres of maple forest.
He was able to add additional acreage, mostly with leases. It was a beginning and it was the job Pierre needed to fulfill his immigration requirements. He and Sally married and a year later, Pierre Jr. was born.
Pierre Jr. worked for the sugaring business starting as a young teenager, working summers and vacations even while attending the University of Vermont in Burlington. He majored in business administration. That pleased his father who liked the operating side of the business but detested all the paperwork and business regulations. When Pierre Jr. joined the business full time it was the beginning of a great partnership.
The first important step recommended by Jr. was to buyout the Beaudrys so that the Lambert Family could be the sole owner of the business. The Beaudrys had given Pierre, Sr. 55% of the ownership when they first formed the United States Company to meet some U. S. tax regulations so the Lamberts only had to buy the remaining 45%.
Pierre, Sr. was reluctant to approach the Beaudry’s about buying them out even though he knew that would help his family and simplify the business. Having a Canadian owner for a U. S. company added lots of paperwork and complications.
Pierre Sr. did finally make the approach and was pleased and surprised when the Beaudrys seemed happy to sell their interest especially if it could be for cash. Pierre had not previously known but the Beaudrys had built a large softwood sawmill outside Greenville, Maine, and just as it started operations a downturn in the housing market hit and the new mill could not manage its debt and had to shut down. The family needed cash to pay obligations that they had personally taken on for that mill.
Pierre Jr. negotiated the bank loan for the purchase but had to personally sign on the loan, as did his father. It worried both of them even though the purchase price was fair. Luckily the next few years witnessed great sap production and good markets for the resulting syrup. They paid off the bank loan in five years.
Over the next 20 years the father and son grew the business to be one of the largest in North America. Sr. continued to make innovations in the field. He changed the configuration of the traditional tap so it would not clog. Clogging had been a huge problem as one clogged tap could block the whole piping system.
Not only did Pierre’s tap invention almost eliminate clogging, he also figured out how to use additional piping to create bypasses so that one clogged or broken tap would not block a large number of trees from continuing to feed their sap to a collection point.
His collection innovations were just the beginning. In the early years he also tested using portable boilers for boiling the sap at the location of the sap harvesting to reduce the water content and to prevent having to haul the heavy sap to a central location. Over time he figured out that he could boil the sap on site to reduce the sap closer to the desired water content of 67%. Trucking the lighter loads to a central location for the finish boiling and processing was a substantial saving. He was always thinking.
He was also very clever in dealing with another difficult problem in the forest. Deer and moose coming through a sugaring operation at night sometimes got tangled in the plastic piping and in a couple of hours could rip apart a whole ridge of piping. Some owners tried bells, human hair strategically located, coyote urine and even having guns firing blanks every hour or so.
Radios seemed to only attract deer so that did not work. The family knew this risk was one that might never be able to be completely solved. Pierre Sr. did figure out a way to alleviate a catastrophe by a clever use of shut off mechanisms that would come to play automatically if a line was cut or detached from a tap.
When Pierre III entered the business he brought a slightly different set of skills. He had followed his father to the University of Vermont but majored in marketing. The Lambert sugaring business needed the cost control efficiencies brought to the forest by Pierre Sr.; the business expertise of Pierre Jr.; and now advanced further with a more sophisticated approach to marketing.
Roadside sales, bulk sales through distributors and direct sales to grocery chains were augmented by a whole new internet marketing system. The industry as a whole had done a good job of bringing to the market more ways to use syrup than just on pancakes.
The Lambert business did very well. On nearly $20 million in sales the business netted over $5 million. The family members who worked for the company did not take out huge salaries but they did have nice life styles. Pierre Sr. retired in 2005 at the age of 68 leaving Pierre Jr. to run the business along with Pierre III.
It was not all work for this family even though what might seem like a seasonal business really necessitated year round attention. On most weekends in the summer Pierre Jr. would be on his boat, the Maple Sugar, with his wife and other family members. He kept his boat in a marina in Colchester, Vt. on Lake Champlain.
One Saturday afternoon in July of 2014 the Lambert’s were grilling salmon on shore in a picnic area supplied by the marina. Pierre III and his wife and two young children were guests of dad and mom that day. Pierre III started a conversation with a family at the next table.
They had seen them before noting that their children, a boy and a girl, were about the same age as their children, also a boy and a girl. The two boys each had their fishing poles so they quickly found a sport in common. Pierre introduced himself, his wife, and his father.
He then met the Bailey Family including grandfather, David Reed, who was there visiting for a few days. Pierre Jr. remembered having been to a family business seminar where David Reed was the guest speaker and mentioned that.
Later in the evening as it was almost time for the Bailey Family to leave, Pierre Jr. asked David Reed if he still helped family businesses. David told him he did a few consulting engagements each year and served on 5 boards of directors. Pierre asked for David’s card and wanted to know if he would still be in Vermont the next Monday as he had some business issues he was concerned about.
Pierre Jr. made contact and arranged to meet David for lunch that Monday at the Windjammer Restaurant in Burlington. They had an interesting conversation mostly about their families and the sugaring business. Pierre asked if David would help him with one initial problem and then they might expand their professional relationship.
David liked the idea of being “tested” as to him it was a challenge and it also showed that Pierre Jr. was a very careful businessman. The “test” was easily expressed. Pierre, Jr. said he was sure his business was paying too much in income tax but his accountant said the business was using all the appropriate tax saving strategies. Pierre simply asked would you look to see if you could save us taxes?
David said he would certainly try. Pierre again surprised David when he put a large briefcase on the table and brought out all the files he thought David might need including three years of financial statements and tax returns, a copy of the company bylaws, a list of the owners and their percentage of ownership, and a list of business problems/risks the family worried about.
Pierre Jr. added one final request. Please just give me one idea that will save at least $100,000 a year and income tax without costing a lot of money. David then wondered if he had been too quick in his response of offering to help, as finding $100,000 in annual savings would be very difficult for a business run by a guy as sharp as Pierre. They agreed to talk on Friday afternoon as requested by Pierre. Luckily David could extend his family visit and would have time each day to work as his daughter and son-in-law both worked and the children attended a summer day camp.
David could not wait to get into the files Pierre, Jr. had provided. His first pass though the financial statements and tax returns clearly showed that they had been done professionally. There were no glaring errors and really no hint of a large, missed planning opportunity. David knew he could probably find opportunities for estate tax savings through creative ownership succession planning but Pierre had been specific –“Find one significant income tax planning idea.”
David started to think he was not going to be able to help Pierre as he went on to read a memo Pierre had written on the business risks of the sugaring business in preparation for a seminar he led for his industry association. It was several years old but apparently still applicable. The list included:
- Damage to the maple forests from fire.
- Damage to the maple forests from diseases like spruce budworm and damages from the ash borer.
- Damage to the collection systems from deer, moose or sabotage.
- Product liability occasioned by foreign or toxic substances getting into a batch of syrup.
- Lease renewal problems or landowners disrupting the system of having 54 over 10 inches in diameter maple trees per acre. Most leases were lucrative enough so that the landowners were happy and had no reason to mess with the system. In Maine, however, 4 prospectors found a very valuable tourmaline deposit on a ridge used for a sugaring operation and the extraction of the minerals created serious erosion, injuring many of the maple trees. Sugaring companies also worried about windmill farms and how the construction process and operating activities might hurt sugaring areas. Many of the leases done long ago never contemplated such activities and did not restrict the landowner from much more than harvesting the maple trees or the other species found in the leased acreage.
David went to bed that night thinking more about the risks to the business than about enhanced depreciation strategies, bad debt reserves, creative retirement plans, or a change of inventory methods. He hoped his mind would work better in slumber than it had fully awake.
It was one of those nights of tossing and turning on an unfamiliar bed with the anxiety of a difficult professional problem. He had failed assignments before but not in front of his children, the thought of which added to the stress.
At 4:00 AM a moment of vivid wakefulness occurred with an idea for the Lambert business. That successful business with under insured and uninsurable risks could benefit from establishing a captive insurance company. David had not actually been involved in setting one up before but was familiar with the concept so he spent the next morning doing some preliminary research. It became quite clear that creating a captive would be an endeavor necessitating the help of an insurance professional and an attorney experienced with the formation and operation of captives.
Selecting a team would come later after David thought this through and had a conversation with Pierre Jr. David prepared the following memorandum for his conversation with Pierre Jr.
PLANNING STRATEGY TO CONSIDER:
A CAPTIVE INSURANCE COMPANY FOR LAMBERT FARM, INC.
What is a captive insurance company?
A captive insurance company is an insurance company owned by the insured. It is a business strategy that has been around since the 1950’s but until the last 10 years was mostly used by very large businesses. (About 80% of the Fortune 500 have captives). The use of a captive has evolved to be simpler and less expensive. Many businesses now find that the benefits of having a captive greatly outweigh the cost.
Who should form a captive?
Any company with an above average risk profile and/or those with uninsurable risks should consider forming a captive. Professionals who advocate the use of a captive include manufacturers, product processors and commercial property owners in the categories of those having an above average risk profile for obvious reasons.
Are there practical and financial requirements?
A company or affiliated group of companies should have at least $1 million of annual net income and combined insurance premiums of at least $200,000. This premium threshold is just a guideline especially if a business is underinsured or has risks, which are not insured at all.
What are the benefits?
The company obtains an income tax deduction for the premium it pays to its captive. The company can accumulate wealth in a tax-favored vehicle (the captive). The captive only pays income tax itself on its investment income, not on the premiums it receives as long as the premiums are less than $1.2 million per year. Unused reserves distributed to captive owners are treated as capital gain.
There are also potential estate and gift tax benefits depending on who are the owners (the business, the current generation owners and/or younger generation owners). The insurance contract is an agreement between the owner and the captive so it can be tailored to the insured’s unique risk profile. The captive can be used to insure previously uninsured risks or underinsured risks including deductibles. The assets of the captive are protected from claims of business creditors.
What can be insured?
Lambert Farm, Inc. has some unique risks which might better be managed by having its own captive insurance company including:
- Product liability deductibles
- Fire loss coverage for trees (owned and leased)
- Losses from diseases affecting maple trees
- Losses from intruding deer and moose.
- Losses due to sabotage of tubing systems
- Losses due to deficiencies in lease protections
- Cyber risks
- Risks from employment practices
That Friday David and Pierre Jr. again met for lunch at The Windjammer Restaurant (they had a great Reuben sandwich). Pierre got right to the point asking, “What do you have for me?”
David started by saying: “You gave me a tough assignment and a short time to work on it. I did find that your accountant has done a good job with your financial statements and your tax returns. Even so I believe that there are areas of improvement. I have prepared a document explaining how you can save at least $100,000 a year in income taxes with the potential to save up to $350,000 a year. “
David then paused knowing he had Pierre’s full attention.
David went on to explain the strategy of creating a captive insurance company for Lambert Farm, Inc., the benefits in doing so and the risks that could be managed with tax-free dollars.
Pierre Jr. was probably a good poker player as he just listened with no expression as David gave him the whole explanation.
Pierre Jr. smiled and finally said, “I think we will be seeing a lot of each other in the next several years.”
TO BE CONTINUED