CIC Services Files Second Lawsuit Against IRS over Micro-Captive Rules

Captive insurance manager CIC Services has filed a second lawsuit against the Internal Revenue Service (IRS) looking to invalidate an IRS rule targeting small captive insurance companies known as micro-captives.

In its suit, filed in the US District Court for the Eastern District of Tennessee, Knoxville, Tennessee-based CIC Services says the rule is a continued campaign of regulatory overreach by the IRS that harms legitimate business owners and that the new rule mirrors an earlier regulation that was struck down in court.

Along the way to a federal judge ruling in 2022 for CIC Services in vacating that earlier IRS rule, Notice 2016–66, the US Supreme Court ruled unanimously against an IRS effort attempting to block CIC Services from seeking an injunction barring the IRS from enforcing Notice 2016–66 under the Anti-Injunctions Act.

With the Supreme Court returning the case to the lower court for consideration, ultimately Judge Travis R. McDonough of the United States District Court Eastern District of Tennessee ruled in CIC Services LLC v. Internal Revenue Service, Department of Treasury, and The United States of America that, in enacting its Notice 2016–66 micro-captive reporting requirement, the IRS violated the federal Administrative Procedure Act (APA). "Notice 2016–66 is a legislative rule that is invalid because the IRS failed to observe notice-and-comment procedures required by the APA," the ruling said.

The judge also held that the federal agency's process of adopting the requirement—in which it deemed micro-captives "transactions of interest"—was arbitrary and capricious. "In this case, the administrative record fails to include relevant data and facts supporting the IRS's decision to designate micro-captive arrangements as transactions of interest, and, thus, reportable transactions," the judge found.

Despite the outcome of that earlier case, the IRS recently issued a final rule—Micro-Captive Listed Transactions and Micro-Captive Transactions of Interest—which again targets captive insurance companies that serve small and midsized businesses, CIC Services said. The captive manager argues the new rule imposes burdensome reporting requirements, creates reputational risk, and threatens both participants and advisors with potential penalties and criminal liability—without supporting evidence or compliance with administrative law.

Like its predecessor, the new rule is arbitrary, capricious, and contrary to law, CIC Services contends.

CIC Services' new lawsuit seeks to vacate the final rule and permanently bar its enforcement against the company, its clients, and its affiliated advisors.

So-called micro-captives, small captive insurance companies that elect to be taxed under section 831(b) of the Internal Revenue Code, which allows small insurance companies to be taxed only on their investment income, have long been the target of IRS scrutiny.