Treasury, IRS Propose Regulations Targeting Micro-Captive Transactions

The US Treasury Department and the Internal Revenue Service (IRS) have issued proposed regulations identifying certain micro-captive transactions as "listed transactions" and certain other micro-captive transactions as "transactions of interest."

Listed transactions are abusive tax transactions that must be reported to the IRS, an IRS statement said, while transactions of interest are tax transactions that have the potential for tax avoidance or evasion that must also be reported to the IRS.

The move comes days after the IRS released its 2023 Dirty Dozen list, which included abusive micro-captive transactions.

In abusive micro-captive structures, promoters, accountants, or wealth planners persuade owners of closely held entities to participate in schemes that lack many of the attributes of genuine insurance, the IRS statement announcing the proposed regulations said.

So-called micro-captives are 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. They have been the target of IRS scrutiny in recent years.

The IRS noted that it previously identified certain micro-captive transactions as transactions of interest in its Notice 2016-66. Recent court decisions in the Sixth Circuit and the US Tax Court found that the IRS lacks authority to identify listed transactions and transactions of interest by notices such as Notice 2016-66, however, and must instead follow notice and public comment procedures applying to regulations in order to identify such transactions.

"Treasury and the IRS disagree with these decisions that the IRS lacks authority to identify listed transactions by notice and continue to defend listing notices in litigation except in the Sixth Circuit," the IRS said in its April 10 statement. "Treasury and the IRS will, however, no longer take the position that transactions of interest can be identified without complying with notice and public comment procedures. Treasury and the IRS 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."

The IRS said that it has consistently disallowed the tax benefits claimed by taxpayers in abusive micro-captive structures. "Some taxpayers have challenged the IRS position disallowing these micro-captive tax benefits in court, but none has been successful," the IRS said. "To the contrary, the Tax Court has now sustained the IRS'[s] disallowance of the claimed tax benefits in three different cases."

The IRS said that the agency and the Treasury Department intend to finalize the proposed regulations "after due consideration of public comments in 2023" and that they intend to issue proposed regulations identifying additional listed transactions in the near future.