District court upholds final microcaptive reporting regulations

The U.S. District Court for the Eastern District of Tennessee held that the IRS did not exceed its statutory authority or act in an arbitrary and capricious manner when it promulgated final regulations requiring the disclosure of certain microcaptive insurance arrangements. The court therefore granted the IRS’s motion for summary judgment in the case.

Facts: The IRS has been concerned about the potential for tax abuse by businesses’ arrangements with captive insurers since at least 2015, the year captives first appeared on the Service’s “Dirty Dozen” list of tax scams. To further combat these perceived abuses, in 2016, the IRS issued Notice 2016-66, which classified certain microcaptive transactions as “transactions of interest” requiring disclosure on Form 8886, Reportable Transaction Disclosure Statement.

CIC Services, a Tennessee limited liability company that assists businesses in forming and managing captive insurance companies, filed suit in the District Court for the Eastern District of Tennessee, claiming that the IRS’s issuance of Notice 2016-66 violated the Administrative Procedure Act (APA) by failing to follow the APA’s requirements to first provide public notice and opportunity to comment. Furthermore, CIC Services claimed, the notice’s provisions were arbitrary and capricious and therefore should be held invalid under the APA.

The IRS claimed the notice could not be challenged due to the Tax Anti-Injunction Act (Sec. 7421), which bars any “suit for the purpose of restraining the assessment or collection of any tax.” The district court agreed with the IRS, dismissing the suit (CIC Services, LLC, No. 3:17-cv-110 (E.D. Tenn. 11/2/17)). That decision was affirmed by the Sixth Circuit (CIC Services, LLC, 925 F.3d 247 (6th Cir. 2019)).

CIC Services appealed the case to the Supreme Court, which reversed the Sixth Circuit’s decision (CIC Services, LLC, 593 U.S. 209 (2021)). The Supreme Court held the Anti-Injunction Act did not bar a pre-enforcement challenge to the reporting requirements, allowing taxpayers to contest the notice under the APA.

On remand, the District Court for the Eastern District of Tennessee invalidated Notice 2016-66, holding the IRS had failed to comply with the APA’s notice-and-comment requirements. The court also held the notice was arbitrary and capricious due to the lack of an adequate administrative record supporting the agency’s conclusions (CIC Services, LLC, 592 F. Supp. 3d 677 (E.D. Tenn. 2022); see Newkirk and Webber, “Microcaptive Insurance Arrangements After CIC Services,” 53-9 The Tax Adviser 18 (September 2022)).

Following the district court’s decision, the IRS pivoted to formal rulemaking. It issued proposed regulations in 2023 and, after receiving over 100 public comments, published final regulations on Jan. 14, 2025 (T.D. 10029; 90 Fed. Reg. 3534). Under the final Sec. 6011 regulations, a microcaptive transaction qualifies as a listed transaction (i.e., a tax-avoidance transaction) if the captive elects Sec. 831(b) taxation and fails the following three objective tests:

• The 20% relationship test: This test is failed if at least 20% of the captive’s assets or the voting power or value of its stock or equity interests is owned, directly or indirectly, by an insured, an owner, or a related party of either (Regs. Sec. 1.6011-10(b)(1)(iii)).
• The financing factor: This factor is failed if the captive made funds available as financing (such as nontaxable loans) to a policyholder, a policyholder’s owner, or a related party in a transaction that did not result in taxable income or gain on any portion of the amounts the captive earned from insurance contracts (Regs. Sec. 1.6011-10(c)(1)(i)).
• The loss–ratio factor: This factor is failed if the liabilities for insured losses and claims expenses are less than 30% of premiums earned minus policyholder dividends over the most recent 10 tax years (Regs. Secs. 1.6011-10(b)(2)(ii) and 10(c)(2)). 

Additionally, the regulations designated microcaptive transactions as “transactions of interest” if the captive elects Sec. 831 tax treatment, fails the 20% relationship test, and fails either the financing factor or loss-ratio factor with an adjusted loss ratio of 60%.

In April 2025, CIC Services challenged the IRS again, asserting the new regulations also violated the APA as contrary to law and were arbitrary and capricious. CIC argued the regulations impose recordkeeping and reporting requirements on material advisers, resulting in significant costs and the threat of potential civil and criminal liability. CIC and the IRS filed cross-motions for summary judgment in the case.

Issues: Microcaptives are small insurance companies, typically owned by an affiliate or owner of its insured business, electing to be taxed under Sec. 831(b). This section allows qualifying insurers to be taxed only on investment income, excluding up to $2.9 million (for the 2026 tax year) of premium income from their taxable income, while the insured party deducts those same premiums as a business expense. The IRS has long expressed concerns that these arrangements are frequently used for tax avoidance rather than bona fide insurance, particularly when they insure implausible risks or charge excessive premiums.

The district court addressed two arguments made by CIC: (1) whether Treasury and the IRS exceeded their statutory authority by imposing reporting requirements that effectively added new conditions to obtain Sec. 831(b) tax benefits and (2) whether the final regulations are arbitrary and capricious under the APA. Regarding its second argument, CIC specifically claimed that the administrative record lacks facts or data to support the final regulations’ conclusions, the IRS had not provided a reasonable explanation of the final regulations, and the IRS’s abuse-detection rationale for the final regulations was a pretext for eliminating microcaptives’ ability to claim Sec. 831(b) tax benefits.

In evaluating the scope of statutory authority, the district court noted Section 706(2)(C) of the APA empowers courts to set aside agency actions found to exceed statutory jurisdiction. As noted, CIC Services contended that by creating tests not found in the Code, the IRS was adding requirements for a taxpayer to qualify for Sec. 831(b). The court did not agree, emphasizing that the regulations only specify that captives that engage in listed transactions or transactions of interest are subject to recordkeeping and reporting requirements. Taxpayers are still “free to engage in any captive transaction” and can still qualify for the tax benefits of Sec. 831(b) even if they are required to disclose the transaction (preamble, T.D. 10029). The district court cited the Supreme Court’s recognition that the IRS has “broad power to require the submission of tax-related information” helpful in assessing and collecting taxes (CIC Services, 593 U.S. at 212).

Regarding the arbitrary-and-capricious argument, the district court found that the administrative record for the new regulations was more robust than in the case’s previous litigation. In particular, the court pointed out that it included multiple recent Tax Court decisions where courts determined that a taxpayer in a microcaptive transaction remitted amounts treated as insurance premiums for something other than insurance (e.g., Avrahami, 149 T.C. 144 (2017); Keating, T.C. Memo. 2024-2; Swift, T.C. Memo. 2024-13; and Patel, T.C. Memo. 2024-34). The court concluded that these cases provided “sufficient facts and data” for the IRS to conclude that such arrangements are potentially used for tax avoidance.

The district court also found that the IRS provided a reasonable explanation for the final regulations, determining that it had provided a “reasonably discernable path” for including each objective factor. For the loss-ratio factor, the IRS explained that pricing premiums far exceeding what is needed to fund operations is a “strong indicator” of tax avoidance. The IRS justified its inclusion of the financing factor by pointing to cases where premiums were returned to the insured via nontaxable loans or other transfers, allowing the insured to deduct payments while maintaining control of the cash. Finally, the IRS explained that the purpose of the relationship test was to exclude arrangements with less potential for tax avoidance, such as small mutual insurers with diversified ownership.

The district court further found that even if the factors are overinclusive and trigger reporting requirements for microcaptive transactions that are legitimately for insurance, this did not render the regulations arbitrary and capricious because the IRS had explained how these factors aid in identifying potentially tax-avoidant transactions.

Finally, the district court determined that the final regulations were not a pretext for limiting microcaptives’ use of Sec. 831(b)’s tax benefits. While commentators had suggested that the regulations would impermissibly “chill” the captive insurance industry, particularly for small and midsize businesses, the IRS had stated in the preamble to T.D. 10029 that it did not intend to discourage the use of Sec. 831(b) by qualifying entities. According to the court, the administrative record reflected that the final regulations were the result of reasoned decision-making and a long-standing concern that captive transactions may be used for tax avoidance. Thus, the final regulations were not a pretext for discouraging legitimate captives from using Sec. 831(b).

Holding: The district court denied CIC Services’ motion for summary judgment and granted the IRS’s motion. It concluded that the IRS satisfied its obligation to provide a reasonably discerned path for its decision-making that was supported by the administrative record. Under the decision, the final regulations remain in effect, and taxpayers involved in reportable microcaptive arrangements must comply with disclosure requirements on Form 8886.

Following the decision, on March 16, 2026, CIC Services filed a notice of appeal to the Sixth Circuit, which docketed it the following day (CIC Services, No. 26-5210 (6th Cir. 3/17/26) (appeal filed)).

In Drake Plastics Ltd. Co, No. 4:25-cv-02570 (S.D. Tex. 4/15/16), the District Court for the Southern District of Texas held that the IRS had appropriately designated microcaptive transactions as transactions of interest, allowing disclosure requirements with respect to those transactions to remain in place. However, the court held the IRS had improperly designated microcaptive transactions as listed transactions and vacated Regs. Sec. 1.6011-10. The resulting court split further complicates the regulatory regime for microcaptive arrangements.

• CIC Services, LLC, No. 3:25-cv-146 (E.D. Tenn. 3/5/26)

— Kaitlin Newkirk, CPA, MST, M.Acc., is an assistant professor in the Williams College of Business at Xavier University in Cincinnati. Sarah Webber, CPA, J.D., LL.M., is an associate professor in the School of Business Administration at the University of Dayton in Dayton, Ohio. To comment on this column, contact Paul Bonner, the JofA’s tax editor.