On January 14, 2025, Treasury and the IRS published final regulations (the “ Regulations”) that identify certain micro-captive insurance transactions, as well as transactions substantially similar thereto, as either listed transactions (“Micro-captive Listed Transactions”) or transactions of interests (“Micro-captive Transactions of Interest”). Generally, participants in, and material advisors to, Micro-captive Listed Transactions or Micro-captive Transactions of Interest must file disclosures with the IRS pursuant to the tax shelter rules or face penalties for failing to do so. As summarized below, the Regulations largely adopt the 2023 proposed regulations (the “ Proposed Regulations”) but narrow the scope of Micro-captive Listed Transactions.
- “Captive” entities are entities (i) that elect under Section 831(b) of the Code to include only investment income in their taxable income (thus, excluding premium payments from their taxable income), (ii) issue insurance contracts to insured persons, and (iii) whose assets, or voting power, are owned at least 20% by the insured or related persons.
- Micro-captive Listed Transactions are transactions in which, as determined at the end of each tax year, both (i) the Captive entity provided financing to the Captive entity's owner, the insured party, or a related party (each person, a “Recipient”) without triggering taxable income to the Recipient during the Captive entity's prior five tax years (the “Financing Factor”), and (ii) the Captive entity's liabilities for insured losses were less than 30% of the premiums earned minus dividends paid during the Captive entity's prior ten tax years (the “Loss Ratio Factor”). In contrast, the Proposed Regulations would have (i) utilized a 65% Loss Ratio Factor, and (ii) classified a transaction as a Micro-captive Listed Transaction if either the Financing Factor or the Loss Ratio Factor was triggered.
- Micro-captive Transactions of Interest are transactions in which, as determined at the end of each tax year, either (i) the Financing Factor is triggered, or (ii) the Captive entity's Loss Ratio Factor is less than 60%. The Proposed Regulations would have utilized a 65% Loss Ratio Factor.
- The Regulations exempt from Micro-captive Listed Transactions or Micro-captive Transactions of Interest status certain transactions between a seller and an unrelated customer who purchases products or services, and insurance thereon, from the seller or a related party (“Consumer Coverage Arrangements”). As discussed in the preamble to the Regulations, Consumer Coverage Arrangements generally are not Micro-captive Listed Transactions or Micro-captive Transactions of Interest as long as the insurer (e., the seller or a related party) is not owned by the insured person (i.e., the unrelated customer).
The Regulations are effective as of January 14, 2025; however, taxpayers must disclose Micro-captive Listed Transactions or Micro-captive Transactions of Interest from prior tax years for which the statute of limitations has not yet expired.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
