Navigating the New IRS Rules for 831(b) Captives: Insights from the World Captive Forum

At the 2025 World Captive Forum (WCF), industry experts took the stage to dissect the latest Internal Revenue Service (IRS) regulatory crackdown on 831(b) captives. Panelists Nate Reznicek, president of Captives.Insure; Jeff Simpson, partner at Womble Dickinson (US); and Rob Walling, principal at Pinnacle Actuarial Resources, provided insights into the evolving compliance landscape, the IRS's motivations, and how the captive industry is responding.

Evolving IRS Oversight and Industry Response

The IRS has intensified its focus on captives electing the 831(b) tax treatment, moving from prior guidance under Notice 2016–66 to a more structured classification system. Under the final regulations, the IRS has introduced two categories of reportable transactions.

• Transactions of Interest (TOI): Arrangements the IRS believes have the potential for tax avoidance but lack sufficient information to make a definitive determination. These transactions require reporting so the IRS can evaluate their tax implications.
• Listed Transactions: Arrangements the IRS has already determined to have the potential for tax avoidance or evasion, requiring stricter reporting rules and potential penalties for noncompliance.

Panelists noted that this shift reflects the IRS's increasing scrutiny of certain captives electing the 831(b) tax treatment, particularly those involving loanbacks and similar financial transactions as well as persistently low loss ratios. Mr. Simpson explained that with listed transactions, the IRS is essentially saying, "We don't think there's something going on here. We're very confident that there's something going on here, and we want it to stop."

Loanbacks and Financing Transactions: A Key IRS Concern

The IRS targets loanbacks and other financing transactions, particularly when captive assets fund affiliated businesses in ways that undermine a genuine insurance purpose. Panelists noted that the IRS views these transactions as problematic when they lack meaningful risk transfer or proper underwriting.

Captive loanbacks come under scrutiny when a captive insurance company provides financing to related parties, such as the insured business, its owners, or affiliates. The IRS is concerned that these transactions may effectively cycle funds back to the insured while still claiming tax benefits, especially when they fail to meet arm's-length standards or serve no legitimate risk management purpose.

Under the final rules, a captive is classified as a transaction of interest if it has engaged in a financing transaction within the last 5 years or has a loss ratio below 60 percent. However, it is considered a listed transaction if it has engaged in a financing transaction within the last 5 years and has a loss ratio below 30 percent.

Panelists emphasized that captives involved in financing transactions should ensure loan arrangements follow arm's-length principles and are defensible as legitimate risk management tools.

A key concern raised was that, based on past IRS scrutiny, the agency does not differentiate between loans made to the operating company versus those made to an individual owner. Mr. Walling noted that, from the IRS's perspective, any loanback to a related party, regardless of form, signals a financing transaction rather than legitimate insurance activity.

Since the IRS applies the same level of scrutiny to both types of loanbacks, captive owners should not assume that loans structured for business purposes will avoid classification as a financing transaction. To reduce regulatory exposure, captives must ensure all loan arrangements are properly underwritten, comply with arm's-length standards, and are defensible as risk management tools.

Another significant aspect of the discussion was how captives might respond to these rules. Some strategies mentioned included the following.

• Following National Association of Insurance Commissioners (NAIC) guidance on loans, ensuring they meet acceptable regulatory requirements and do not impair claims-paying liquidity. Mr. Walling noted that loans involving affiliates and other related parties are not unique to captives—traditional insurance companies also use them under established NAIC rules. The NAIC provides specific guidance on transactions with affiliates, emphasizing the importance of proper accounting, transparency, and disclosure. These rules outline structuring requirements, acceptable collateral, and the impact on risk-based capital calculations.
• Considering alternative fund distribution methods, such as taxable shareholder or policyholder dividends, which the IRS acknowledged in response to public comments but did not explicitly endorse as a preferred alternative to loanbacks and similar financial transactions. While the IRS maintains scrutiny over loanback arrangements, it has not provided definitive guidance on whether alternative distribution methods would be viewed more favorably in all cases.
• Ensuring loan transactions adhere to arm's-length standards to reduce IRS scrutiny and demonstrate legitimate risk management practices. NAIC guidelines emphasize that transactions with affiliates should be properly disclosed and structured in a way that does not compromise financial stability. Mr. Walling emphasized that loans can make good business sense when structured properly and in compliance with NAIC and state regulations. However, indirect loans—where funds are funneled through nonaffiliates to ultimately benefit an affiliate—may receive additional regulatory scrutiny under NAIC standards.

Balancing Act: The 30 Percent Loss Ratio and Industry Realities

The 30 percent threshold has raised concerns within the industry, particularly for captives covering low-frequency, high-severity risks. These programs often experience periods of low claims activity followed by significant losses, making it difficult to maintain a consistent loss ratio above the IRS's threshold. Some panelists pointed out that this rigid benchmark does not fully reflect the nature of captive insurance, where risk pooling and long-term claims development can create loss patterns that diverge from traditional market expectations.

Mr. Walling highlighted concerns raised by the American Academy of Actuaries regarding the IRS's use of a fixed 30 percent loss ratio threshold. The Academy noted that this approach is problematic for captives insuring long-tail exposures, where claims may not materialize for several years. Mr. Walling pointed out that many insurers, including those well above the 831(b) premium threshold, have maintained loss ratios below 30 percent over extended periods. In fact, the California Earthquake Authority has operated for a 10-year period with loss ratios below 1 percent, underscoring that a low loss ratio does not inherently indicate tax avoidance.

Public comments from the American Academy of Actuaries further emphasized that traditional commercial insurers—particularly those covering catastrophic risks—often operate with low loss ratios, yet the IRS appears to hold certain captives electing the 831(b) tax treatment to a different standard. These assumptions, they argued, may not fully account for the unique nature of these specialized insurance arrangements.

The discussion also touched on how captives might respond to the 30 percent loss ratio threshold.

Mr. Walling explained that under the IRS's new regulations, loss ratios are calculated by including losses and claims administration expenses in the numerator, while earned premiums minus policyholder dividends make up the denominator. He noted that policyholder dividends could become a tool for captives adjusting to these requirements. For example, a captive that has accumulated investment income over multiple years might issue a policyholder dividend in year 7 to adjust its reported loss ratio while maintaining financial stability.

More broadly, captives may look to either increase the numerator or decrease the denominator to align with the regulatory threshold. Some may choose to expand their risk portfolios by adding coverages with inherently higher loss ratios, such as workers compensation or auto liability. Others may focus on increasing claims administration expenses to demonstrate active risk management. As Mr. Walling suggested, adjusting premium structures and strategically utilizing policyholder dividends could help captives smooth out reported loss ratios over time, ensuring compliance while preserving financial strength.

Successor Captives: The Risk of "Rebooting"

Another IRS concern is successor captives, where owners dissolve one captive and form a new one in a way that could be viewed as an attempt to avoid reporting obligations. Under the final regulations, a captive may be considered a successor if it meets either of the following criteria.

• Acquires the assets of another entity and takes into account the other entity's earnings and profits or deficit in earnings and profits.
• Receives assets from another entity where its basis in those assets is determined, in whole or in part, by reference to the prior entity's basis in such assets.

If a captive meets either of these conditions, the IRS may treat it as a continuation of the prior captive, subjecting it to the same regulatory scrutiny and reporting requirements.

Mr. Simpson reiterated that if a captive is shut down and its surplus is transferred to a new captive, the IRS is likely to classify the new entity as a successor. This classification depends on whether the new captive inherits the earnings, profits, or basis of the prior captive.

Mr. Walling noted that some offshore captives have attempted to shut down and convert into noninsurance entities rather than forming direct successors, but this strategy has not been successful.

As an exception, Mr. Walling explained that some states allow 831(b) captives to merge into a newly formed 831(a). Mr. Walling observed that many captives are converting from 831(b) to 831(a), particularly to switch from claims-made policies to occurrence-based coverage, allowing them to retain reserves and better manage long-tail risks.

Mr. Simpson advised that captive owners should not rush into shutting down and forming a new captive without legal counsel. Restructuring decisions should be carefully reviewed with tax and legal professionals to avoid unintentionally creating a successor captive and triggering additional compliance requirements.

Legal Challenges and the Post-Chevron Landscape

The impact of the US Supreme Court's ruling in Loper Bright Enters. v. Raimondo, 144 S. Ct. 2244 (2024), where the Court overruled the Chevron doctrine, remains uncertain. The decision eliminates automatic deference to agency interpretations of ambiguous statutes, and while some in the industry believe this may limit the IRS's ability to broadly interpret tax regulations, the full effect will depend on how courts apply this new precedent in cases like Ryan LLC v. IRS.

The Path Forward: Caution, Compliance, and Strategy

Despite the new hurdles, the panelists emphasized that the captive industry remains resilient. While the full impact of these regulations remains to be seen, captives making an 831(b) election must be more strategic than ever to navigate this evolving regulatory landscape.