The IRS, in response to court decisions that went against the agency, issued proposed regulations (REG-109309-22) that identify certain microcaptive insurance transactions as listed transactions and certain other microcaptive transactions as transactions of interest. The proposed regulations were published in the Federal Register on April 11.
The proposed regulations are in response to recent court decisions that have held that the IRS's practice of issuing notices to identify listed transactions and transactions of interest does not comply with the Administrative Procedure Act (APA) because the IRS issued the notices without following the notice-and-comment procedures required by the APA. A Tennessee federal district court in March 2022 (CIC Services, LLC, No. 3:17-cv-110 (E.D. Tenn. 3/21/22)) vacated Notice 2016-66, which identified certain microcaptive transactions as reportable transactions of interest.
In Announcement 2023-11, which accompanied the regulations, the IRS and Treasury said they disagreed with the court decisions but "will no longer take the position that transactions of interest can be identified without complying with APA notice-and-comment procedures."
The IRS said it was obsoleting Notice 2016-66 and proposing regulations that identify some microcaptive transactions as listed transactions and others as transactions of interest. The IRS describes listed transactions as abusive tax transactions that must be reported to the IRS. Transactions of interest are tax transactions that have the potential for tax avoidance or evasion that must also be reported.
Treasury and the IRS said in a news release that they issued the proposed regulations "to ensure that these decisions do not disrupt the IRS's ongoing efforts to combat abusive tax shelters throughout the nation."
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.
"If these arrangements are used for real insurance purposes, the Code permits them," a September 2022 article in the Tax Adviser explained (see Newkirk and Webber, "Microcaptive Insurance Arrangements After CIC Services," 53-9 The Tax Adviser 18 (September 2022)). "However, the arrangements set up by business owners (often on the advice of unscrupulous promoters or advisers), frequently lack the true attributes of insurance, for example, by insuring implausible risks, failing to address genuine business needs, duplicating the business's commercial insurance coverage, or charging excessively high 'premiums.'"
The proposed regulations affect both participants in these transactions as well as material advisers.
The IRS has consistently disallowed the tax benefits claimed by taxpayers in abusive microcaptive structures. And while some taxpayers have challenged the IRS's position in court, the agency said the Tax Court has now sustained the IRS's disallowance of the claimed tax benefits in three cases.
Comments on the proposed rules are due June 12, and a public hearing is scheduled for July 19. "After due consideration of public comments," Treasury and the IRS said they plan to finalize the proposed regulations in 2023. They also plan to issue more proposed regulations that will identify additional listed transactions "in the near future."
— To comment on this article or to suggest an idea for another article, contact Martha Waggoner at Martha.Waggoner@aicpa-cima.com.