On Jan. 14, 2025, the IRS and Treasury Department finalized regulations regarding micro-captive insurance transactions. These regulations reinstitute the reportable transaction treatment for certain micro-captive transactions that were previously withdrawn after several courts concluded that the previous rules under Notice 2016-66 were invalid.
Micro-captive transactions
The final regulations break the micro-captive transactions into two categories: a listed transaction and a transaction of interest. While each category requires additional reporting, a listed transaction is a tax avoidance transaction, so this is a much more serious designation, which goes beyond the previous designations in Notice 2016-66. The following are definitions of the two micro-captive transaction categories:
- Transaction of interest. This includes a captive insurance arrangement (a) with a loss ratio of less than 60% over the past 10 years (or less if it doesn’t have a 10-year history) or (b) where the captive has made financing available to the insured who is a related party at any point over the past five years.
- Listed transaction. This includes a captive insurance arrangement (a) that has been in existence for at least 10 years and has a loss ratio of less than 30% over the most recent 10 years and (b) has made financing available to the insured who is a related party at any point over the past five years.
Based on the definitions above, a captive arrangement without a 10-year history can’t be in the listed transaction category but can be a transaction of interest. Similarly, a captive arrangement that hasn’t made financing available to a related party over the past five years can’t be in the listed transaction category but can be a transaction of interest.
As compared to Notice 2016-66 and the proposed regulations, each of these categories in the final regulations have been narrowed to exclude far more captive arrangements from the reporting requirements. For example, the proposed regulations would have included as a listed transaction a captive arrangement with a loss ratio of less than 65% or one that had previously provided financing to a related party. A 65% threshold also applied to the transaction of interest category in the proposed regulations.
One additional change in the final regulations are exceptions for certain employee benefit captives and for certain “Consumer Coverage Arrangement” (CCA) transactions. A CCA arrangement is focused on circumstances where a service provider, dealer, retailer, lender, or wholesaler sells products or services to unrelated customers and those customers purchase insurance from a captive owned by that seller. If 100% of the seller’s captive business is either insuring or reinsuring these arrangements, among a few other requirements, then the CCA captive will be excluded from the micro-captive reporting requirements listed above.
Reporting requirements
A wider variety of micro-captives have been required to file Form 8886 Reportable Transaction Disclosure Statement since Notice 2016-66. Upon the issuance of final regulations, only micro-captives that fall into either of the two categories above will need to file Form 8886. That filing is due by April 14, 2025, to the extent it relates to a tax year that’s open under the statute of limitations and where a previous Form 8886 hasn’t already been filed under previous rules Form 8886 must be filed with The Office of Tax Shelter Analysis (OTSA) upon first filing or amending previous filings. Material advisors to these transactions may also have reporting requirements.
What to do now
All captive insurance companies or taxpayers related to captive insurance companies should review the final regulations to determine if they have a filing obligation that needs to be met on or before April 14, 2025. These same taxpayers should consider what reporting obligations may exist into the future, either because of the continued existence of the arrangement, changes in loss ratios, crossing the 10-year threshold in the listed transaction definition, or other similar events.
For taxpayers with potential reporting requirements, documentation should be reviewed to ensure that appropriate records exist to support the underlying insurance policies and the determination of premiums. If financing arrangements exist, consideration should be given to whether those should continue. To the extent that a captive insurance company would consider revoking its Section 831(b) election in order to no longer be classified as a micro-captive, the IRS has provided a streamlined process under Rev. Proc. 2025-13.
These types of steps are critical to ensure both that the appropriate reporting requirements are being followed but also to ensure that the captive insurance arrangement still makes sense in light of any changes to the underlying costs and risks associated with maintaining the arrangement. Even in light of these regulations, micro-captive insurance arrangements can still make sense for many taxpayers.
