The Internal Revenue Service (IRS) has issued final regulations (TC 10029) that identify certain micro-captive transactions as listed transactions and transactions of interest, both of which are types of reportable transactions. These regulations, which are effective January 14, 2025, require material advisors and certain participants to file disclosures with the IRS, with penalties for non-compliance. This article provides an overview of these regulations and their implications for CPAs and their clients.

Authority for the Regulations

The regulations are issued under the authority of several sections of the Internal Revenue Code (Code):

• Section 6001: This section requires taxpayers to keep records, render statements, make returns, and comply with rules and regulations as deemed necessary by the Secretary of the Treasury to demonstrate tax liability.
• Section 6011: This section mandates that every taxpayer make a return or statement according to the forms and regulations prescribed by the Secretary, and include the information required by such forms or regulations.
• Section 6707A(c)(1): This section defines a “reportable transaction” as any transaction for which information is required to be included with a return or statement because it is a type that the Secretary determines as having a potential for tax avoidance or evasion.
• Section 6707A(c)(2): This section defines a “listed transaction” as a reportable transaction that is the same as or substantially similar to a transaction specifically identified by the Secretary as a tax avoidance transaction.
• Section 7805(a): This section grants the Secretary the authority to “prescribe all needful rules and regulations for the enforcement of” the Code.

Key Definitions The final regulations introduce important definitions to identify the transactions of interest:

• Captive: An insurance company that elects to be taxed under section 831(b) and is owned, directly or indirectly, by an insured, owner, or related person.
• Insured: A person who conducts a trade or business that enters into a contract with a Captive or enters into a contract with an intermediary that is directly or indirectly reinsured by a Captive.
• Owner: Any person who has direct or indirect ownership of the Insured.
• Related: Having a relationship described in sections 267(b), 707(b), 2701(b)(2)(C), and 2704(c)(2) of the Code.
• Seller: A service provider, dealer, lender, wholesaler, or retailer that sells products or services to customers who purchase insurance contracts in connection with those products or services and at least 95 percent of sales of products or services by Seller for the taxable

Micro-Captive Listed Transactions

A micro-captive transaction is identified as a listed transaction if it meets both of the following criteria:

• Financing Factor: The Captive has made its capital available to the Insured, an Owner, or a person Related to the Insured or the Owner.
• Loss Ratio Factor: The Captive’s loss ratio is 30% or less over a ten-year computation period. The loss ratio is determined by dividing the amount of liabilities incurred for insured losses and claim administration expenses, by the premiums earned, less policyholder dividends paid by the Captive.

Micro-Captive Transactions of Interest

A micro-captive transaction is identified as a transaction of interest if it meets the following criterion:

• Loss Ratio Factor: The Captive’s loss ratio is 60% or less over a period of up to ten years.

Disclosure Requirements

Participants in both Micro-Captive Listed Transactions and Micro-Captive Transactions of Interest must disclose their involvement to the IRS using Form 8886. A copy of the disclosure statement must be sent to the Office of Tax Shelter Analysis (OTSA) at the same time that any disclosure statement is first filed by the taxpayer.

• Participants: This includes, but is not limited to, any Owner, Insured, Captive, or Intermediary with respect to the transaction whose tax return reflects tax consequences or a tax strategy identified in the regulations.
• Information Required: Participants must provide detailed information about the transaction, including when, how, and from whom they became aware of the transaction, and how they participated in it.
  • Captives must disclose the types of policies issued or reinsured, the amounts treated as premiums written, and the identity of any person whose interest meets the 20 percent threshold.
  • Insureds must disclose the amounts treated as premiums paid and the identity of all Owners to whom they provided an acknowledgement that the Insured would comply with its disclosure obligation.

Exceptions and Safe Harbors

The regulations provide certain exceptions and safe harbors:

• Consumer Coverage Exception: Certain consumer coverage arrangements may be excluded from the definition of a Micro-Captive Listed Transaction and a Micro-Captive Transaction of Interest.
• Disclosure Safe Harbor for Owners: An Owner is not required to disclose participation if they receive acknowledgement from the Insured that the Insured has or will comply with its disclosure obligations, provided the Insured actually discloses the transaction in a timely manner.
• Settlement Agreements: Taxpayers who have finalized a settlement agreement with the IRS regarding the transaction, in examination or litigation, are not required to disclose the transaction for the years covered by the agreement.
• Revoked Section 831(b) Elections: If a Captive requests consent to revoke its section 831(b) election by the date disclosures are due, the transaction will not be treated as a listed transaction or transaction of interest for tax years ending before January 1, 2026. Also, taxpayers are provided a safe harbor from identification as participants in a transaction for any taxable year that the Captive’s 831(b) election was revoked, provided a successor Captive was not established.
• Prior Disclosure under Notice 2016-66: Taxpayers who disclosed their participation in a transaction under Notice 2016-66 will be treated as having met the disclosure requirements for a Micro-captive Transaction of Interest for tax years before January 14, 2025.

Implications for CPAs

• Client Education: CPAs need to educate their clients about these new regulations, especially those involved with micro-captive insurance arrangements, as well as the definitions of captive, insured, and related.
• Transaction Review: CPAs should help their clients assess their micro-captive transactions against the specific criteria outlined in the regulations to determine if they meet the definition of a reportable transaction.
• Disclosure Compliance: CPAs must ensure that clients who are participants in a Micro-Captive Listed Transaction or a Micro-Captive Transaction of Interest comply with the disclosure requirements, including filing Form 8886 and submitting a copy to the OTSA.
• Material Advisor Obligations: CPAs who act as material advisors should understand their disclosure and list maintenance obligations. Material advisors are required to disclose transactions if they have made a tax statement on or after the date that is six years before January 14, 2025.
• Amended Returns: CPAs should advise clients who have taken tax benefits from these transactions to consider filing amended returns, or AARs for certain partnerships, as the IRS may challenge those benefits.
• Documentation: CPAs should ensure that their clients maintain adequate documentation related to their micro-captive transactions for potential audit by the IRS.

Legal Challenges and IRS Response

The IRS anticipates that these regulations may be subject to legal challenges. Many commenters argued that the proposed regulations violate the McCarran-Ferguson Act, which prevents federal laws from invalidating, impairing or superseding State laws regarding the business of insurance. The IRS maintains that the regulations do not violate McCarran-Ferguson because they do not invalidate or interfere with state insurance laws and that the act of disclosing information to tax authorities is not part of the "business of insurance". The IRS also addressed arguments that these regulations violated the Administrative Procedure Act, or were unconstitutional, unfair, or retroactive in nature, and the IRS provided justifications for their position on each of these points.

Summarized with assistance from NotebookLM

Final regulations can be downloaded from the following link: https://public-inspection.federalregister.gov/2025-00393.pdf