January 15, 2025
IRS Issues Final Regulations Related to Micro-Captive Insurance Transactions
On January 10, 2025, the IRS and U.S. Treasury Department finalized regulations regarding micro-captive transactions. These regulations classify certain micro-captive transactions as “listed transactions” and others as “transactions of interest” requiring additional disclosure from involved parties. Furthermore, these regulations mandate enhanced reporting requirements for taxpayers and related parties participating in such transactions.
Background
In 2016, IRS Notice 2016-66 (the Notice) identified certain 831(b) captives as “transactions of interest” necessitating increased disclosure. The IRS suspected that some of these transactions might not align with arm’s-length business practices and could be used to avoid or evade taxes. The Notice defined a “transaction of interest” as encompassing the following elements:
- A business purchases insurance from a captive, or the captive reinsures the risk through a third party,
- The captive has made an §831(b) election and is taxed solely on investment income,
- The owner of the insured entity owns, directly or indirectly, at least 20% of the voting power or the value of the captive, AND
- At least one of the following conditions applies:
- Captive’s liabilities incurred for insured losses and administrative costs are less than 70% of earned premiums, excluding any policyholder dividends paid by the captive during the five-year computation period, or
- Captive has provided or agreed to provide financing to the insured or related parties, through guarantees, loans, or investments that are not treated as taxable income by the recipient.
Then, the IRS issued proposed regulations on April 11, 2023, that apply to most captive insurance companies that have made an §831(b) election. The proposed regulations stemmed from a Sixth Circuit ruling that deemed the Notice lacked authority because the IRS failed to adhere to proper notice and comment procedures. The 2023 proposed regulations introduced the concept of classifying certain micro-captives as “listed transactions” in addition to “transactions of interest.”
The Final Regulations
On January 14, 2025, the IRS and U.S. Treasury Department issued the final regulations that establish specific requirements for classification as a “listed transaction” or “transaction of interest” for micro-captive transactions.
The table below highlights the key differences between the 2023 proposed regulations and the final regulations released in 2025:
| Proposed Regulations (2023) | Final Regulations (2025) | |
| Listed Transactions | An insured, or related party, must directly or indirectly own at least 20% of the voting power, the value of outstanding stock, or equity interest in the captive insurer, AND One of the following exists: A financing factor exists with a related party that does not generate taxable income for the recipient of the funds within the most recent five tax years; or An average loss ratio of less than 65% over the past ten tax years. | An insured, or related party, must directly or indirectly own at least 20% of the voting power, the value of outstanding stock, or equity interest in the captive insurer, AND Both of the following exist: A financing factor exists with a related party that does not generate taxable income for the recipient of the funds within the most recent five tax years; and An average loss ratio of less than 30% over the past ten tax years. A captive must be in existence for at least ten years to have listed transactions. |
| Transactions of Interest | An insured, or related party, must directly or indirectly own at least 20% of the voting power, the value of outstanding stock, or equity interest in the captive insurer, AND The captive has been in operation for less than ten years and exhibits a loss ratio of less than 65% throughout its existence. | An insured, or related party, must directly or indirectly own at least 20% of the voting power, the value of outstanding stock, or equity interest in the captive insurer, AND One of the following exists: A financing factor exists with a related party that does not generate taxable income for the recipient of the funds within the most recent five tax years; or The captive has a loss ratio of less than 60% for the ten-year computation period. If the captive has not been in existence for ten years, the computation period is for all tax years of existence. |
The final regulations serve to narrow the scope of the proposed regulations for both listed transactions and transactions of interest in the following ways:
- Listed transactions require both the financing factor and the average loss ratio, rather than just one,
- The loss ratio percentage for listed transactions and transactions of interest is lower in the final regulations, and
- The transaction of interest computation period increased from nine to ten years.
Disclosure Requirements
Micro-captives are required to file Form 8886, Reportable Transaction Disclosure Statement, if they are determined to be either a listed transaction or a transaction of interest under the final regulations. Disclosure filings are applicable for all open tax years a taxpayer has participated in either the listed transaction or transaction of interest. Impacted taxpayers will have 90 days from January 14, 2025, the date the regulations are published in the federal register, to comply with the regulations.
Taxpayers making an initial disclosure of reportable transactions, or changing the disclosure type, are required to file the initial Form 8886 with the Office of Tax Shelter Analysis (OTSA) to ensure that all information is collected in one place. The Form 8886 should then be filed with the income tax return for each tax year the Taxpayer has participated in the transaction.
Exclusion for Consumer Coverage Reinsurance
Both the 2023 proposed regulations and the 2025 final regulations exempt micro-captives that provide consumer coverage reinsurance arrangements (i.e. third-party risk) from classification as listed transactions or transactions of interest. This exemption is considered appropriate as long as the commissions paid for the consumer coverage by the captive are comparable to those paid for similar consumer coverage not issued by the captive.
The final regulations define a seller’s captive as a service provider, dealer (including an automobile dealer), lender, wholesaler, or retailer that sells products or services to customers who purchase insurance contracts in connection with those products or services, provided that at least 95% of the seller’s captive’s business is purchased by unrelated customers to the captive or persons related to the seller. If a seller’s captive meets the definitions in the final regulations, it is not required to file Form 8886.
Revoking the Section 831(b) Election
Commenters requested a streamlined method by which taxpayers could obtain the U.S. Treasury Secretary’s consent to revoke section 831(b) elections. The 831(b) election was previously irrevocable, requiring a request for letter ruling and consent of the Commissioner to revoke the election. In response to the comments, the IRS issued Rev. Proc 2025-13 on January 13, 2025 that allows for a simplified procedure to revoke an 831(b) election that was previously made.
Summary
In conclusion, the final regulations modified the 2023 proposed regulations in meaningful ways. The regulations are final as of January 14, 2025, and impacted taxpayers have 90 days to comply with the regulations. Reach out to your tax service providers to discuss the potential impact to your business and the best approach for your situation.
