Regs. identify microcaptive transactions as reportable transactions

The IRS issued final regulations (T.D. 10029) that identify certain transactions that are the same as, or substantially similar to, certain microcaptive insurance transactions as listed transactions and certain other microcaptive transactions as transactions of interest, both of which are types of reportable transactions.

The final regulations, published Tuesday in the Federal Register, require material advisers and certain participants in the listed transactions and transactions of interest to file disclosures with the IRS and be subject to penalties for failure to disclose. The final regulations affect participants in these transactions as well as material advisers.

The final regulations make some changes to the proposed regulations (REG-109309-22) that the IRS issued in April 2023 in response to court decisions that went against the agency.

Commenters said the proposed 65% modified loss ratio was too high, and the IRS responded by lowering the loss ratio factor percentage for identification of a transaction of interest to 60%, which the IRS said is a discount from the lowest loss ratio supported by available data. The loss ratio factor percentage for identification as a listed transaction was reduced to 30%.

In addition, the final regulations add sections to clarify when a transaction is considered “substantially similar” and reference Regs. Sec. 1.6011-4(c)(4) to define the phrase.

Under the tax laws, a business generally can create a captive insurance company to protect against certain risks. A provision in the Code allows small non–life insurers (those receiving $2.65 million or less of premium payments per year), which are commonly called microcaptives, to be taxable on investment income only and thus avoid paying tax on their premium income.

Some who commented on the proposed regulations suggested that their purpose was “to harass otherwise valid businesses,” the IRS said in the preamble to the final regulations. The IRS stated that this was not the case and that the purpose of the regulations is simply to require disclosures, in the interest of tax administration, for microcaptive listed transactions and transactions of interest.

The factors used to decide on regulations of microcaptives “are objective and reasonably determined, based on relevant factors in existing statutory provisions, on available industry data, and on a careful review of case law and examination information,” the IRS said.

The final regulations are effective as of Jan. 14.

— To comment on this article or to suggest an idea for another article, contact Martha Waggoner at Martha.Waggoner@aicpa-cima.com.