Micro-Captive Listed Transactions and Micro-Captive Transactions of Interest, 3534-3563 [2025-00393]

Download as PDF 3534 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 [TD 10029] RIN 1545–BQ44 Micro-Captive Listed Transactions and Micro-Captive Transactions of Interest Internal Revenue Service (IRS), Treasury. ACTION: Final rule. AGENCY: This document contains final regulations that identify transactions that are the same as, or substantially similar to, certain micro-captive transactions as listed transactions, a type of reportable transaction, and certain other micro-captive transactions as transactions of interest, another type of reportable transaction. Material advisors and certain participants in these listed transactions and transactions of interest are required to file disclosures with the IRS and are subject to penalties for failure to disclose. The final regulations affect participants in these transactions as well as material advisors. DATES: Effective date: These regulations are effective on January 14, 2025. Applicability date: For dates of applicability, see §§ 1.6011–10(h) and 1.6011–11(h). FOR FURTHER INFORMATION CONTACT: Allan H. Sakaue, (202) 317–6995 (not a toll-free number). SUPPLEMENTARY INFORMATION: SUMMARY: khammond on DSK9W7S144PROD with RULES5 Authority This document amends the Income Tax Regulations (26 CFR part 1) by adding final regulations under section 6011 of the Internal Revenue Code (Code) to identify certain micro-captive transactions and substantially similar transactions as listed transactions and certain other micro-captive transactions as transactions of interest, each a type of reportable transaction (final regulations). These regulations are issued pursuant to the authority conferred on the Secretary of the Treasury or her delegate (Secretary) under the following provisions of the Code: Section 6001, which requires every taxpayer to keep the records, render the statements, make the returns, and comply with the rules and regulations that the Secretary deems necessary to demonstrate tax liability and prescribes, either by notice served or by regulations; VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 Section 6011, which requires every taxpayer to ‘‘make a return or statement according to the forms and regulations prescribed by the Secretary’’ and ‘‘include therein the information required by such forms or regulations’’; Section 6707A(c)(1), which states that ‘‘[t]he term ‘reportable transaction’ means any transaction with respect to which information is required to be included with a return or statement because, as determined under regulations prescribed under section 6011, such transaction is of a type which the Secretary determines as having a potential for tax avoidance or evasion’’; and Section 6707A(c)(2), which states that, ‘‘[t]he term ‘listed transaction’ means a reportable transaction which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of section 6011.’’ Reportable transactions are described in § 1.6011–4 and include listed transactions, confidential transactions, transactions with contractual protection, loss transactions, and transactions of interest. See § 1.6011–4(b)(2) through (6). Section 1.6011–4(b)(2) defines a ‘‘listed transaction’’ as a transaction that is the same as or substantially similar to one of the types of transactions that the IRS has determined to be a tax avoidance transaction and identified by notice, regulation, or other form of published guidance as a listed transaction. Section 1.6011–4(b)(6) defines a ‘‘transaction of interest’’ as a transaction that is the same as or substantially similar to one of the types of transactions that the IRS has identified by notice, regulation, or other form of published guidance as a transaction of interest. The final regulations are also issued under the express delegation of authority under section 7805(a) of the Code. Background I. Section 831(b) As enacted by section 1024 of the Tax Reform Act of 1986, Public Law 99–514, 100 Stat. 2085, 2405 (October 22, 1986), section 831(a) of the Code generally imposes tax on the taxable income (determined under the special rules for calculating taxable income of insurance companies in part II of subchapter L of chapter 1 of the Code) of every insurance company other than a life insurance company (nonlife insurance company), for each taxable year computed as provided in section 11 of the Code. However, certain small PO 00000 Frm 00002 Fmt 4701 Sfmt 4700 nonlife insurance companies may elect to be subject to the alternative tax imposed by section 831(b). Upon election by an eligible nonlife insurance company (eligible electing company) to be taxed under section 831(b), in lieu of the tax otherwise imposed by section 831(a), section 831(b) imposes tax on the company’s income computed by multiplying the taxable investment income of the eligible electing company (determined under section 834 of the Code) for the taxable year by the rates provided in section 11(b) of the Code. Thus, an eligible electing company pays no tax on its underwriting income, including amounts paid as premiums, for taxable years for which its election is in effect. Congress enacted section 333 of the Protecting Americans from Tax Hikes Act of 2015 (PATH Act), div. Q. of Public Law 114–113, 129 Stat. 2242, 3040 (December 18, 2015), to both tighten and expand the requirements for qualifying under section 831(b), effective for taxable years beginning after December 31, 2016. As amended by the PATH Act, section 831(b) requires an eligible electing company to be an insurance company (within the meaning of section 816(a) of the Code) having net written premiums or, if greater, direct written premiums, for the taxable year not exceeding $2.2 million as adjusted for inflation (net written premium limitation) and to meet the diversification requirements of section 831(b)(2)(B). The last sentence of section 831(b)(2)(A) provides that an election under section 831(b) applies to the taxable year for which it is made and all subsequent taxable years for which the net written premium limitation and the diversification requirements are met and may be revoked only with the Secretary’s consent. In addition, section 831(d) requires every eligible electing company that has a section 831(b) election in effect to furnish to the Secretary ‘‘at such time and in such manner as the Secretary shall prescribe such information for such taxable year as the Secretary shall require with respect to’’ the diversification requirements of section 831(b)(2)(B). To qualify as an insurance company pursuant to section 816(a), a requirement to elect section 831(b) taxation, more than half of the business of the entity during the taxable year must be the issuing of insurance or annuity contracts or the reinsuring of risks underwritten by insurance companies. An insurance contract must meet all four prongs of the test for insurance set forth by the courts: risk shifting, risk distribution, insurable risks, and insurance in the commonly E:\FR\FM\14JAR5.SGM 14JAR5 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations accepted sense. See Helvering v. Le Gierse, 312 U.S. 531, 539 (1941) (both risk shifting and risk distribution must be present); Allied Fidelity Corp. v. Commissioner, 572 F.2d 1190, 1193 (7th Cir. 1978) (the risk transferred must be risk of economic loss); Commissioner v. Treganowan, 183 F.2d 288, 290–91 (2d Cir. 1950) (the risk must contemplate the fortuitous occurrence of a stated contingency); Rent-A-Center, Inc. v. Commissioner, 142 T.C. 1, 13 (2014) (the arrangement must constitute insurance in the commonly accepted sense); see also Rev. Rul. 2007–47, 2007–2 C.B. 127 (the risk must not be merely an investment or a business risk). To determine whether an arrangement is insurance in the commonly accepted sense, courts consider several nonexclusive factors including (1) whether the company was organized, operated, and regulated as an insurance company; (2) whether the company was adequately capitalized; (3) whether the policies were valid and binding; (4) whether premiums were reasonable and the result of arm’s length transactions; (5) whether claims were paid; (6) whether the policies cover typical insurance risks; and (7) whether there was a legitimate business reason for acquiring insurance from the captive. Avrahami v. Commissioner, 149 T.C. 144, 191 (2017). khammond on DSK9W7S144PROD with RULES5 II. Notice 2016–66 and Notice of Proposed Rulemaking (‘‘NPRM’’) On November 21, 2016, the Treasury Department and the IRS published Notice 2016–66, 2016–47 I.R.B. 745, which identified certain micro-captive transactions as transactions of interest. On January 17, 2017, the Treasury Department and the IRS published Notice 2017–08, 2017–3 I.R.B. 423, which modified Notice 2016–66 by providing for an extension of time for participants and material advisors to file their disclosures. Notice 2016–66 alerted taxpayers and their representatives pursuant to § 1.6011–4(b)(6) and for purposes of § 1.6011–4(b)(6) and sections 6111 and 6112, that the Treasury Department and the IRS identified as transactions of interest certain micro-captive transactions in which a taxpayer attempts to reduce the aggregate taxable income of the taxpayer, related persons, or both, using contracts that the parties treat as insurance contracts and a related company that the parties treat as an insurance company. Notice 2016–66 also alerted persons involved with the identified transactions that certain responsibilities may arise from their involvement. VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 The Treasury Department and the IRS issued proposed regulations under section 6011 (REG–109309–22) in an NPRM published in the Federal Register (88 FR 21547) on April 11, 2023 (proposed regulations). That NPRM obsoleted Notice 2016–66. The Treasury Department and the IRS considered comments received in response to Notice 2016–66 in developing the proposed regulations. The proposed regulations would identify taxpayers who file returns reflecting the tax benefits of a transaction described at § 1.6011–10(a) as participants in a listed transaction (‘‘Micro-captive Listed Transaction’’). The proposed regulations would identify taxpayers who file returns reflecting the tax benefits of a transaction described at § 1.6011–11(a) as participants in a transaction of interest (‘‘Micro-captive Transaction of Interest’’). Generally, a Micro-captive Listed Transaction is a transaction in which an Owner (as defined in proposed § 1.6011–10(b)(6)) of an Insured (as defined in proposed § 1.6011–10(b)(4)) holds the necessary interest described in proposed § 1.6011– 10(b)(1)(iii) (the ‘‘20 Percent Relationship Test’’) in Captive (as defined in proposed § 1.6011–10(b)(1)), Captive meets the definition provided in proposed § 1.6011–10(b)(1), and Captive provides financing as described in proposed § 1.6011–10(c)(1) (the ‘‘Financing Factor’’), determined over the Financing Computation Period defined in proposed § 1.6011– 10(b)(2)(i), or has less than a 65 percent loss ratio (the ‘‘Loss Ratio Factor’’) as described in proposed § 1.6011–10(c)(2), determined over the Loss Ratio Computation Period defined in proposed § 1.6011–10(b)(2)(ii). A Micro-captive Transaction of Interest is a transaction in which an Owner (as defined in proposed § 1.6011–11(b)(6)) of an Insured (as defined in proposed § 1.6011–11(b)(4)) holds the necessary interest in Captive (as defined in proposed § 1.6011– 11(b)(1)), Captive meets the definition provided in proposed § 1.6011–11(b)(1), and Captive has less than a 65 percent loss ratio, as described in proposed § 1.6011–11(c), determined over the Transaction of Interest Computation Period defined in proposed § 1.6011– 11(b)(2). Participants in a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest, and material advisors with respect to Micro-captive Listed Transactions and Micro-captive Transactions of Interest, would be required file disclosure statements as set forth in proposed §§ 1.6011–10(f) and PO 00000 Frm 00003 Fmt 4701 Sfmt 4700 3535 1.6011–11(f). The Treasury Department and the IRS developed these objective factors to ensure administrability and clarity for taxpayers whose transactions are identified in the regulations, so taxpayers can clearly determine whether they are participants or material advisors, and thus be on clear notice of their obligations. The Treasury Department and the IRS received 110 public comments in response to the proposed regulations and notice of public hearing that are the subject of this final rulemaking. The comments are available for public inspection at https:// www.regulations.gov or upon request. A public hearing on the proposed regulations was held by teleconference on July 19, 2023, at 10 a.m. Eastern Time, at which six speakers provided testimony. The Summary of Comments and Explanation of Revisions of these final regulations summarizes the proposed regulations, which are described in greater detail in the preamble to the proposed regulations. After full consideration of all the comments received and the testimony provided, these final regulations adopt the proposed regulations with the modifications described in this Summary of Comments and Explanation of Revisions. Summary of Comments and Explanation of Revisions This Summary of Comments and Explanation of Revisions summarizes all significant comments addressing the proposed regulations, and describes and responds to comments concerning: (1) the authority to issue the proposed and final regulations generally; (2) the Loss Ratio Factor described in proposed §§ 1.6011–10(c)(2) and 1.6011–11(c); (3) the Financing Factor described in proposed § 1.6011–10(c)(1); (4) the exception for certain consumer coverage arrangements described in proposed §§ 1.6011–10(d)(2) and 1.6011–11(d)(2); (5) requests for safe harbors from either identification as a reportable transaction or from the reporting requirements upon identification as a reportable transaction; and (6) other matters including clarifications and changes not specifically related to the identified factors already addressed. This Summary of Comments and Explanation of Revisions also explains revisions adopted by the final regulations in response to those comments. Comments outside the scope of this rulemaking are generally not addressed. As an initial matter, the final regulations incorporate non-substantive changes to the description of the E:\FR\FM\14JAR5.SGM 14JAR5 3536 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations election under section 831(b) at proposed § 1.6011–10(b)(1)(i) (defining in part the term Captive) to better reflect the text of the statute. See § 1.6011– 10(b)(1)(i) of the final regulations. Furthermore, §§ 1.6011–10(e) and 1.6011–11(e) are added to the final regulations, to provide more clarity on when a transaction is considered substantially similar as defined in § 1.6011–4(c)(4) to the identified transactions. The term ‘‘Substantially Similar’’ has also been defined in the final regulations by cross-reference to § 1.6011–4(c)(4). I. Comments on Authority To Issue the Proposed Regulations khammond on DSK9W7S144PROD with RULES5 A. The McCarran-Ferguson Act Several commenters argued that the proposed regulations implicate ‘‘the business of insurance’’ under the McCarran-Ferguson Act, 15 U.S.C. 1011 et seq. (‘‘McCarran-Ferguson’’). In addition, commenters argued that sections 6011, 6111, and 6112 do not explicitly reference insurance, and thus McCarran-Ferguson prohibits the application of the proposed regulations thereunder. Commenters also asserted that the inclusion of a Loss Ratio Factor and a Financing Factor in the proposed regulations will invalidate, impair, or supersede State law governing insurance companies. For example, commenters contended that because State regulators must approve relatedparty financing transactions entered into by insurance companies, State law to that effect will preempt identification of a captive insurance transaction involving related-party financing as a reportable transaction. Similarly, commenters contended that because State regulators establish solvency requirements for insurers licensed in their domicile, State laws regarding premium pricing will preempt identification of a captive insurance transaction as a reportable transaction based on the Loss Ratio Factor. Commenters also asserted that the Loss Ratio Factor, by encouraging payment of policyholder dividends, impacts the insurer and policyholder relationship and therefore implicates McCarranFerguson. Contrary to the commenters’ arguments, and as discussed in more detail in the following paragraphs, McCarran-Ferguson does not apply to these regulations for two primary reasons: first, because the regulations do not invalidate, impair, or supersede State law, and second, because the regulations do not implicate the business of insurance. VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 First, the proposed regulations do not ‘‘invalidate, impair, or supersede’’ any State law. As relevant here, McCarranFerguson provides that ‘‘[n]o Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance, or which imposes a fee or tax upon such business, unless such Act specifically relates to the business of insurance.’’ 15 U.S.C. 1012(b). In other words, McCarran-Ferguson prohibits application of Federal law not specifically relating to the business of insurance if it would invalidate, impair, or supersede State laws enacted for the purpose of regulating the business of insurance. Humana Inc. v. Forsyth, 525 U.S. 299, 307 (1999). Courts have uniformly upheld Tax Code provisions pertaining to the taxation of insurance companies in the face of a McCarranFerguson challenge. See, e.g., Modern Life & Acc. Ins. Co. v. Commissioner, 420 F.2d 36, 37 (7th Cir. 1969) (holding that taxpayer did not show that Commissioner’s determination of taxpayer’s status under the Internal Revenue Code ‘‘will interfere with the choice made by [State].’’); Indust. Life Ins. Co. v. United States, 344 F. Supp. 870, 875 (D.S.C. 1972), aff’d, 481 F.2d 609 (4th Cir. 1973) (holding that Congress did not give up the right to tax by passing McCarran-Ferguson); Hanover Ins. Co. v. Commissioner, 65 T.C. 715, 722 (1976) (‘‘Congress did not, under the McCarran-Ferguson Act, surrender to the States the power of the Federal Government to tax insurance companies and to issue regulations implementing the taxing statute.’’). Moreover, McCarran-Ferguson was enacted to prevent inadvertent Federal intrusion on the State’s rights to regulate insurance. See Barnett Bank of Marion Cty. v. Nelson, 517 U.S. 25, 39. McCarran-Ferguson does not prevent the Federal Government from issuing insurance regulations. Id. The Supreme Court has stated that McCarranFerguson does not ‘‘cede the field of insurance regulation to the States, saving only instances in which Congress expressly orders otherwise.’’ Humana, 525 U.S. at 308; see also SEC v. Nat’l Sec., Inc., 393 U.S. 453, 459–60 (1969) (‘‘The [McCarran-Ferguson Act] did not purport to make the States supreme in regulating all the activities of insurance companies.’’); Modern Life & Acc. Ins. Co., 420 F.2d at 37–38; Indust. Life Ins. Co., 344 F. Supp. at 875; Hanover Ins. Co., 66 T.C. at 721–22. The Supreme Court also stated that ‘‘[t]he term ‘invalidate’ ordinarily means ‘to render ineffective, generally without providing PO 00000 Frm 00004 Fmt 4701 Sfmt 4700 a replacement rule or law . . . [a]nd the term ‘supersede’ ordinarily means ‘to displace (and thus render ineffective) while providing a substitute rule.’’ Humana, 525 U.S. at 307 (citations omitted). The Supreme Court relied on the dictionary definition of ‘‘impair,’’ which is ‘‘[t]o weaken, to make worse, to lessen in power, diminish, or relax, or otherwise affect in an injurious manner.’’ Humana, 525 U.S. at 309–10 (citing Black’s Law Dictionary 752 (6th ed. 1990)). Thus, ‘‘[w]hen federal law does not directly conflict with state regulation, and when the application of federal law would not frustrate any declared state policy or interfere with a State’s administrative regime, the McCarran-Ferguson Act does not preclude its application.’’ Humana, 525 U.S. at 310. The proposed regulations do not render ineffective any State law, nor do they displace or diminish any State regulator’s ability to regulate the insurers within their jurisdiction. Rather, the proposed regulations run parallel to the State laws. Identification of a transaction as a listed transaction or a transaction of interest, solely for Federal tax purposes, does not in any way invalidate, impair, supersede, or affect State insurance laws. As in United States v. Redcorn, ‘‘state insurance regulations remain fully in force.’’ 528 F.3d 727, 736 (10th Cir. 2008) (holding that prosecution under 18 U.S.C. 669 (‘‘Theft or embezzlement in connection with health care’’) did not conflict in any way with state insurance law for purposes of McCarran-Ferguson); see also United States v. Del. Dep’t of Ins., 66 F.4th 114, 132 (3d Cir. 2023) (holding that Delaware State law prohibiting the Delaware Department of Insurance from disclosing certain information about captive insurance companies to anyone, including the Federal Government, did not, under McCarran-Ferguson, override the IRS’s statutory authority to issue summonses to the Department and have them enforced). Commenters cite to United States Dep’t of Treasury v. Fabe, 508 U.S. 491 (1993), to support their argument that the proposed regulations violate the McCarran-Ferguson Act, but the proposed regulations can be readily distinguished from the Federal statute at issue in Fabe. In Fabe, a State preference for distributions to policyholders for claims and expenses incurred in the administration of insolvency proceedings was found to be the ‘‘business of insurance.’’ The Supreme Court found that the Ohio statute at issue in Fabe was ‘‘aimed at protecting or regulating, directly or indirectly, the relationship between the E:\FR\FM\14JAR5.SGM 14JAR5 khammond on DSK9W7S144PROD with RULES5 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations insurance company and its policyholders.’’ Fabe, 508 U.S. at 491– 92 (citing SEC v. Nat’l Sec., Inc., 393 U.S. at 460). Considering the relationship between the insurer and the insured, the Supreme Court held that, to the extent (1) the State law at issue in Fabe protected policyholders and (2) the Federal priority statute under 31 U.S.C. 3713(a)(1)(A)(iii) would impair that relationship, Federal law did not preempt State law. The Court in Fabe had to choose between Federal and State statutes because they were in direct conflict. Conversely, the proposed regulations are not in conflict with any State regulations; the relationship between insurer and insured is in no way impacted. Taxpayers remain free to enter into captive insurance transactions in any State and to structure such transactions within the confines of State regulations, and States remain free to regulate such transactions. However, if such structure is described in § 1.6011– 10 or § 1.6011–11, participants must disclose information about the arrangement to the IRS. In other words, the proposed regulations attach specific tax obligations (in the form of disclosure) to specific acts (in the form of participating in a transaction described in § 1.6011–10 or § 1.6011– 11), but the proposed regulations do not change how those acts are done. Second, the act of disclosing a transaction to the tax authorities is not the ‘‘business of insurance.’’ The threshold question under 15 U.S.C. 1012(a), in determining whether the anti-preemption mandate of 15 U.S.C. 1012(b) applies, is whether the challenged conduct broadly constitutes the ‘‘business of insurance’’ in the first place. If the contested activities are wholly unrelated to the insurance business, then McCarran-Ferguson has no place in analyzing Federal regulation because only when ‘‘[insurance companies] are engaged in the ‘business of insurance’ does the act apply.’’ Sabo v. Metropolitan Life Ins. Co., 137 F.3d 185, 190 (3d Cir. 1998) (citing SEC v. Nat’l Sec., Inc., 393 U.S. at 459–60); see also United States v. Del. Dep’t of Ins., 66 F.4th at 125 (reaffirming the threshold inquiry precedent set in Sabo). The ‘‘core of ‘the business of insurance’’ is ‘‘[t]he relationship between insurer and insured, the type of policy which could be issued, its reliability, interpretation and enforcement.’’ United States v. Del. Dep’t of Ins., 66 F.4th at 130 (citing SEC v. Nat’l Sec., Inc., 393 U.S. at 460). The ‘‘business of insurance’’ is also understood to be ‘‘[an]other activity of insurance companies [that] relate[s] so VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 closely to [their] status as reliable insurers that [it] must be placed in the same class.’’ Id. The conduct at issue in the proposed regulations is the filing of disclosure statements upon identification as participants in or material advisors of a transaction that, for Federal tax purposes, either is a listed transaction or a transaction of interest. Like the information gathering conduct via the summonses at issue in the United States v. Del. Dep’t of Ins., the disclosure requirements in the proposed regulations are not ‘‘the business of insurance.’’ The final regulations do not adopt any changes based on these comments. B. Federalism Implications Commenters also argued that the proposed regulations have federalism implications and fail to satisfy Executive Order 13132 (Federalism). Executive Order 13132 generally provides that an agency is prohibited from publishing any rule that has federalism implications if the rule imposes substantial, direct compliance costs on State and local governments, and is not required by statute, or if the rule preempts State law, unless the agency satisfies, among other things, the consultation and federalism summary impact statement requirements of section 6 of the Executive order. The proposed regulations do not have federalism implications, and the requirements in section 6 of Executive Order 13132 to consult with State and local officials and issue a federalism impact statement do not apply. As described in this preamble, the proposed regulations do not preempt State law, nor do they impose substantial, direct compliance costs on State and local governments, as there is no obligation created by the regulations with which any State or local agency may need to comply. The final regulations do not adopt any changes based on these comments. C. Constitutionality, Fairness, and Retroactivity Commenters contended that the proposed regulations are unconstitutional for a number of reasons. First, commenters argued that requiring participants to disclose transactions they participated in, even if such taxpayers were examined for one or more years for which reporting would be required and for which the IRS did not make any adjustments to the taxpayers’ returns, is unconstitutional and retroactive in nature. Second, commenters argued that the proposed regulations are intended to shut down the captive insurance industry and may PO 00000 Frm 00005 Fmt 4701 Sfmt 4700 3537 constitute a ‘‘taking’’ under the Fifth Amendment of the U.S. Constitution, by restricting the rights of taxpayers to engage in captive insurance transactions. With respect to the first argument, commenters did not specify what provision of the Constitution is allegedly violated by the potential need to disclose participation in a transaction after an examination resulted in no change to the examined returns, and we are not aware of any Constitutional provision that would be violated. In addition, any such disclosure requirement in these regulations is not retroactive in nature; the final regulations will be effective January 14, 2025. To the extent the final regulations result in a disclosure obligation with respect to transactions occurring in prior taxable years for which the statute of limitations on assessment has not expired, such obligation is a current reporting obligation that arises after January 14, 2025. With respect to the comment about reporting requirements for taxpayers whose returns have been examined, the reporting rules are outside the scope of these final regulations, which merely identify a listed transaction and a transaction of interest, respectively. The reporting rules for listed transactions and transactions of interest are found in § 1.6011–4, which was issued pursuant to notice and comment and finalized most recently on August 3, 2007, in TD 9350 (72 FR 43146), and which is not amended by these regulations. However, there are tax administration reasons to maintain these reporting requirements. Most importantly, initial disclosures of reportable transactions are filed with the Office of Tax Shelter Analysis (OTSA) to ensure that all information is collected in one place. The OTSA’s mission is, among other things, to ensure that the IRS has the information necessary to detect abusive tax shelters and identify issues of significant compliance risk to tax administration. The OTSA collects and analyzes information about abusive tax shelters and reportable transactions to identify trends and disseminates the results to those in a position to take appropriate action. In order to identify participants and promoters of tax avoidance transactions, the OTSA needs to receive and review Forms 8886 in a timely and efficient manner. Limiting disclosure to a subset of transaction participants (such as taxpayers whose examinations have been closed) would provide an incomplete picture of the transaction and hinder the OTSA’s efforts. Accordingly, the final regulations do not E:\FR\FM\14JAR5.SGM 14JAR5 3538 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations khammond on DSK9W7S144PROD with RULES5 adopt any changes based on these comments. The commenters’ second Constitutional argument, under the Fifth Amendment, is also without merit. As relevant here, the Fifth Amendment provides, in addition to the other limitations on government power, that ‘‘private property [shall not] be taken for public use, without just compensation.’’ The proposed regulations identify a transaction as a listed transaction or a transaction of interest for Federal tax purposes and require the filing of disclosures with the IRS and the OTSA. Requiring disclosure of participation in these transactions does not implicate the Fifth Amendment; no property interest is taken for public use by the government under the proposed regulations necessitating compensation. Taxpayers remain free to engage in any captive insurance transaction, regardless of whether such transaction is identified in § 1.6011–10 or § 1.6011– 11, respectively; however, there may be Federal tax consequences if the transaction is not a valid captive insurance transaction. As there is no limitation on participation in any transaction by operation of the proposed regulations, there is no ‘‘taking’’ for Fifth Amendment purposes. D. The Administrative Procedure Act Commenters argued that the proposed regulations lack legal foundation and assert that the regulations will be challenged and set aside just as Notice 2016–66 was set aside in CIC Services, LLC v. IRS, 592 F.Supp.3d 677 (E.D. Tenn. 2022). In CIC Services, the district court followed the analysis in Mann Construction, Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022), rev’g 539 F.Supp.3d 745 (E.D. Mich. 2021), which held that the identification of a listed transaction must follow the notice-andcomment procedures of the Administrative Procedure Act (‘‘APA’’). The district court in CIC Services held that Notice 2016–66 should be vacated because the IRS did not follow the APA’s notice-and-comment procedures. The district court held in the alternative that the IRS acted arbitrarily and capriciously based on the administrative record. CIC Services, 592 F.Supp.3d at 687. In light of the decision by the district court in CIC Services and other judicial decisions, the Treasury Department and the IRS published the proposed regulations and obsoleted Notice 2016– 66. The NPRM provided for a comment period from April 11, 2023, through June 12, 2023, and more than 100 comment letters were received. The Treasury Department and the IRS VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 conducted a public hearing on July 19, 2023, providing further opportunity for taxpayers to comment on the proposed regulations. The APA notice-andcomment procedures have been followed. Some commenters suggested that the IRS’s purpose for publishing the proposed regulations is to harass otherwise valid businesses, but the purpose is simply to require disclosures with respect to transactions described in §§ 1.6011–10 and 1.6011–11, in the interest of tax administration. Examinations of taxpayers and promoters have helped to clarify the Treasury Department’s and the IRS’s understanding of micro-captive transactions, including the scope of participation. The factors used to identify the Micro-captive Listed Transaction and the Micro-captive Transaction of Interest are neither arbitrary nor capricious. They reflect the IRS’s long-standing positions with respect to abusive micro-captives as made public in annual Dirty Dozen tax schemes publications and case law. The factors 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 objectivity and reasonableness of each factor is discussed more fully throughout this Summary of Comments and Explanation of Revisions, notably in part II. (Loss Ratio Factor); part III. (Financing Factor); and part VI.B. (20 Percent Relationship Test). The existing case law with respect to micro-captives demonstrates the commonalities in the fact patterns in these transactions, which is relevant to the development of the transaction fact patterns identified in these regulations. The Tax Court has consistently determined in its section 831(b) decisions issued to date that taxpayers in the relevant micro-captive transactions remitted amounts treated as premiums for something other than insurance. See Avrahami, 149 T.C. at 197–98; Syzygy v. Commissioner, T.C. Memo. 2019–34, at *45; Caylor Land & Dev., Inc. v. Commissioner, T.C. Memo. 2021–30, at *48–49; Keating v. Commissioner, T.C. Memo. 2024–2, at *64; Swift v. Commissioner, T.C. Memo. 2024–13, at *44–45; Patel v. Commissioner, T.C. Memo. 2024–34, at *51–52, and Royalty Mgmt. Ins. Co., Ltd. v. Commissioner, T.C. Memo. 2024–87, at *49–50. Current examinations and litigation also are relevant, as they demonstrate consistency with the transaction fact patterns identified in these regulations. PO 00000 Frm 00006 Fmt 4701 Sfmt 4700 Section 6707A(c) delegates to the IRS the authority to promulgate regulations pursuant to section 6011 identifying reportable transactions. Specifically, section 6707A(c)(1) states that ‘‘[t]he term ‘reportable transaction’ means any transaction with respect to which information is required to be included with a return or statement because, as determined under regulations prescribed under section 6011, such transaction is of a type which the Secretary determines as having a potential for tax avoidance or evasion.’’ Section 6707A(c)(2) defines the term ‘‘listed transaction’’ as ‘‘a reportable transaction which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of section 6011.’’ Section 6707A(a) provides that ‘‘[a]ny person who fails to include on any return or statement any information with respect to a reportable transaction which is required under section 6011 to be included with such return or statement shall pay a penalty in the amount determined under subsection (b)’’ (emphasis added). Under section 6011(a), returns and statements, including disclosures, should be filed ‘‘according to the forms and regulations prescribed by the Secretary.’’ The proposed regulations do not create any law that is contrary to any statute; rather, the proposed regulations identify transactions that must be disclosed per the existing rules under the Code with respect to reportable transactions, as sections 6707A(c) and 6011 prescribe. In addition, the Secretary has general regulatory authority under section 7805(a) to ‘‘prescribe all needful rules and regulations for the enforcement of’’ the Code. The Treasury Department and the IRS have clear authority to issue the proposed regulations and have followed the procedural requirements of the APA. As explained more fully throughout this Summary of Comments and Explanation of Revisions, these final regulations are based on consideration of comments in response to the proposed regulations, case law, and the IRS’s years of experience with abusive micro-captives. E. Definition of Insurance for Federal Tax Purposes Commenters also argued that by identifying a micro-captive transaction as a listed transaction or a transaction of interest on the basis of a Loss Ratio Factor, a Financing Factor, or both, the proposed regulations define insurance for Federal tax purposes in a manner inconsistent with case law. Commenters cited a number of cases, including Reserve Mech. Corp. v. Commissioner, E:\FR\FM\14JAR5.SGM 14JAR5 khammond on DSK9W7S144PROD with RULES5 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations 34 F.4th 881 (10th Cir. 2022), aff’g, T.C. Memo. 2018–86; United Parcel Service of America, Inc. v. Commissioner, 254 F.3d 1014 (11th Cir. 2001); Harper Grp. v. Commissioner, 979 F.2d 1341 (9th Cir. 1992), aff’g, 96 T.C. 45 (1991); Sears Roebuck & Co. v. Commissioner, 972 F.2d 858 (7th Cir. 1992); AMERCO v. Commissioner, 96 T.C. 18 (1991); Humana, Inc. v. Commissioner, 881 F.2d 247 (6th Cir. 1989); Caylor, T.C. Memo. 2021–30; Syzygy, T.C. Memo. 2019–34; Avrahami, 149 T.C. 144 (2017); R.V.I. Guar. Co. v. Commissioner, 145 T.C. 209 (2015); Rent-A-Center, 142 T.C. 1 (2014); and Securitas Holdings, Inc. v. Commissioner, T.C. Memo. 2014–225. Additionally, several commenters pointed to the IRS’s concession in Puglisi v. Commissioner, 2021 WL 7162530 (T.C. Oct. 29, 2021), as proof that the IRS has accepted facts similar to those described in the proposed regulations as insurance for Federal tax purposes, and therefore, the apparent attempt by the proposed regulations to redefine insurance for Federal tax purposes is contrary to established precedent. The proposed regulations do not redefine insurance for Federal tax purposes by identifying the specific fact patterns set forth in §§ 1.6011–10 and 1.6011–11 as listed transactions or transactions of interest, respectively. The proposed regulations identify fact patterns that are consistently present in the micro-captive cases tried on their merits and the examined cases with respect to which the IRS has determined that the transaction at issue lacked the necessary characteristics, based on the specific facts in each case, to qualify as insurance for Federal tax purposes under existing caselaw. (Although section 6103 prohibits the IRS from disclosing specific taxpayer information, it does not preclude the IRS from identifying consistent fact patterns based on specific taxpayer information.) For specific cases with respect to which the IRS received comments, section 6103 of the Code prohibits the IRS from discussing taxpayer return information. However, section 6103(b)(2) clarifies that the IRS is not prohibited from disclosing information to the extent it is ‘‘in a form which cannot be associated with, or otherwise identify, directly or indirectly, a particular taxpayer,’’ such as, for example, fact patterns based on specific taxpayer return information. In general, there are a variety of reasons why certain examined cases may have conceded an otherwise valid challenge to the taxpayer’s position, either by the VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 IRS Independent Office of Appeals (Appeals) or in litigation. Several commenters incorrectly assumed that the proposed regulations declare all entities electing the alternative tax under section 831(b) as tax avoidant or potentially tax avoidant, contrary to Congressional intent to encourage the use of small captives by enacting section 831(b) and subsequent amendments thereof, including section 333 of the PATH Act. This assumption is incorrect for several reasons. First, the proposed regulations identify a specific fact pattern involving related parties, including a Captive, at least 20 percent of the voting power or the value of the outstanding stock or equity interest of which is owned, directly or indirectly, by an Insured, an Owner, or persons Related to Insured or an Owner (as such terms are defined in § 1.6011–10(b)). The definition of Captive includes the section 831(b) election, but there are several other factors that must be met before the transaction is described as a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest. The closely held nature of the arrangement coupled with the section 831(b) election and the use of premiums for personal investments or for relatedparty financing and not to pay losses are what renders these transactions appropriate subjects of disclosure as tax avoidance transactions or transactions of interest. Second, Congress enacted section 831(b) in the interest of simplifying the Code, not to encourage the use of small captive insurance companies. H.R. Rep. No. 99–426, at 678 (1985) (‘‘The present law applicable to small and certain ordinary mutual companies is inordinately complex and should be simplified.’’). Congress amended section 831(b) to provide that the election may be revoked only with the consent of the Secretary, with the clear intent ‘‘that the election not be used as a means of eliminating tax liability (e.g., by making the election only for years when the taxpayer does not have net operating losses), but rather as a simplification for small companies.’’ H.R. Rep. No. 100– 795, at 121 (1988); S. Rep. 100–445, at 127 (1988). Nothing in the statutory language or the legislative history of section 831(b) suggests that Congress intended to provide the benefits of section 831(b) to companies that do not qualify as insurance companies for Federal tax purposes. Third, the Code does not permit a current deduction for amounts set aside for self-funding of future losses. See, e.g., Harper Grp, 96 T.C. at 46 n.2 (1991) (‘‘Losses incurred by the self-insured taxpayer are deductible (if at all) only in PO 00000 Frm 00007 Fmt 4701 Sfmt 4700 3539 the year paid out from the reserve fund.’’), aff’d, 979 F.2d 1341 (9th Cir. 1992); Stearns-Roger Corp. v. United States, 774 F.2d 414, 415 (10th Cir. 1985) (‘‘Payments [for self-insurance] are not deductible as insurance premiums’’). The transactions described in § 1.6011–11 have many of the characteristics of self-insurance, and as such, taxpayers who deduct amounts paid to captives in such transactions may be engaged, as a matter of substance, in self-insurance, but more information is needed to determine if that is the case. F. Small and Mid-Sized Businesses and the Captive Industry A number of commenters suggested that the proposed regulations discriminate against small and midsized businesses by designating certain micro-captive transactions as listed transactions, and certain other microcaptive transactions as transactions of interest. Commenters also stated that the proposed regulations will impermissibly chill the captive insurance industry. Although it may be the case that many small and mid-sized businesses utilize captive insurance entities that make an election under section 831(b), the proposed regulations do not discriminate against such businesses on the basis of their size by identifying their captive as a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest. Regarding Insureds, there is no specific size of company at issue; large and small businesses alike may engage in a captive insurance transaction, but if such transaction meets the description of a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest, the participants in and material advisors thereof must file disclosure statements. The Treasury Department and the IRS do not intend to discourage the use of section 831(b) by entities that qualify for the election, nor should these regulations be construed as intending to discourage the use of section 831(b) by such entities. These regulations do not hinder the formation of valid captive insurance companies, as discussed more fully at parts VI.C. and H. of the Summary of Comments and Explanation of Revisions. II. Comments and Changes Relating to the Loss Ratio Factors as Described in Proposed §§ 1.6011–10(c)(2) and 1.6011–11(c) A. Overview of Comments Relating to the Loss Ratio Factors Commenters expressed a number of concerns about the Loss Ratio Factors E:\FR\FM\14JAR5.SGM 14JAR5 3540 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations khammond on DSK9W7S144PROD with RULES5 and Computation Periods. In response to these concerns, the final regulations significantly narrow the scope of the Micro-captive Listed Transaction description by providing that transactions are identified as listed transactions under the final regulations only if both the Financing Factor and the Loss Ratio Factor tests are met. The final regulations also lower the Loss Ratio Factors for both Micro-captive Listed Transactions and Micro-captive Transactions of Interest in response to comments. With respect to the proposed Loss Ratio Computation Period set forth at proposed § 1.6011–10(b)(2)(ii) and the proposed Transaction of Interest Computation Period set forth at proposed § 1.6011–11(b)(2) (collectively, the ‘‘Computation Periods’’), as further discussed in this part II. of the Summary of Comments and Explanation of Revisions, the final regulations make no substantive changes to the Loss Ratio Computation Period but do extend the Transaction of Interest Computation Period to a period of up to ten years. Many of the comments related to the Loss Ratio Factors in the proposed regulations raised multiple concerns that were not clearly delineated from other comments or recommendations. For clarity, comments received with respect to the Loss Ratio Factors are addressed categorically in the remaining subparts of this part II. of the Summary of Comments and Explanation of Revisions. B. Tax Avoidance or Potential for Tax Avoidance Identified by Loss Ratio Factors Several commenters suggested that the Loss Ratio Factors as set forth at proposed §§ 1.6011–10(c)(2) and 1.6011–11(c) are inappropriate metrics for the captive insurance industry and should not be determinative of whether a transaction is a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest. Some cited Puglisi, 2021 WL 7162530, for support, suggesting that the IRS conceded the case because the captive at issue, which had a loss ratio below 65 percent, was not participating in a tax avoidance transaction. Commenters also argued that the IRS is treating similarly situated taxpayers differently, by predicating whether a micro-captive transaction involving an entity electing the alternative tax under section 831(b) is a reportable transaction using the Loss Ratio Factors but not doing the same for entities that do not make the section 831(b) election. Other commenters asserted that the Loss Ratio Factors were inappropriate because captives may recover funds through reinsurance, VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 which would have the effect of lowering loss ratios. In the context of closely held section 831(b) entities, the Loss Ratio Factors generally identify transactions involving circumstances inconsistent with insurance for Federal tax purposes, including excessive pricing of premiums and artificially low or nonexistent claims activity. The Loss Ratio Factor measures whether the amount of liabilities incurred for insured losses and claims administration expenses is significantly less than the amount of premiums earned, adjusted for policyholder dividends. The primary purpose of premium pricing is to ensure funds are available should a claim arise. The pricing of premiums should naturally reflect the economic reality of insurance operations, to ensure that policies are ‘‘price[d] in such a way that the premiums brought in cover losses and the insurer’s business expenses with enough profit left over to keep investors happy.’’ Avrahami, 149 T.C. at 152. Typically, actuaries establish a policy rating scheme and classify risks ‘‘‘to allow credible statistical inferences regarding expected outcomes.’’’ Id. (quoting Actuarial Standard of Practice No. 12: Risk Classification (for All Practice Areas), sec. 3.3 (Actuarial Standards Bd. 2005). The work should be reproducible and permit ‘‘another actuary qualified in the same practice area [to] make an objective appraisal of the reasonableness of the actuary’s work.’’ Actuarial Standard of Practice No. 41: Actuarial Communications, sec. 3.2 (Actuarial Standards Bd. 2010), https://www.actuarial standardsboard.org/standards-ofpractice/ (last visited Jan. 6, 2025). Pricing premiums far in excess of what is reasonably needed to fund insurance operations results in a lower loss ratio and remains a strong indicator of tax avoidance. Further, while amounts paid for insurance may be deductible business expenses, amounts set aside in a loss reserve as a form of self-insurance are not. See, e.g., Harper Grp., 96 T.C. at 46 n.2; Stearns-Roger Corp., 774 F.2d at 415. With respect to comments suggesting that the outcome of specific examined cases (such as Puglisi, 2021 WL 7162530) demonstrates the impropriety of using Loss Ratio Factors generally, or that determinations in such cases demonstrate that the Service is treating similarly situated taxpayers differently, section 6103 prohibits the IRS from disclosing specific taxpayer information. However, as discussed in part I.E. of this Summary of Comments and Explanation of Revisions, section PO 00000 Frm 00008 Fmt 4701 Sfmt 4700 6103 does not preclude the IRS from identifying consistent fact patterns based on specific taxpayer information. The IRS’s decision to concede or settle a given case in no way alters these findings and conclusions, nor are these findings and conclusions altered by the examination of entities that do not fit the identified fact pattern. Further, commenters suggested that the inclusion of a section 831(b) election as an identifying factor in the proposed regulations but not doing the same for entities that do not make a section 831(b) election means similarly situated taxpayers are being treated differently. However, an entity that does not make a section 831(b) election is not similarly situated. An insurance company taxed under section 831(a) has a corresponding income recognition for amounts paid as insurance premiums, lessening the potential of ongoing tax deferral present in the transactions identified by these regulations. In response to the commenters who asserted that reinsurance would have the effect of lowering loss ratios, the Treasury Department and the IRS respectfully disagree. Any reinsurance obtained by the Captive for risks attributable to direct written coverage would tend to reduce the premiums earned by the Captive (as most if not all amounts attributable to the reinsurance would typically be ceded to the reinsurer and deducted from premiums earned), thereby increasing the Captive’s Loss Ratio Factor percentage and making it less likely that such transaction would be described in the regulations. The final regulations do not eliminate the Loss Ratio Factors based on these and similar comments. C. Potential To Capture Transactions That Are Not Tax Avoidance Transactions as Listed Transactions Commenters asserted that microcaptive transactions that are not tax avoidance transactions may have loss ratios that fall below the threshold established by the Loss Ratio Factors. Commenters opined that a loss ratio factor of 65 percent leaves determination of whether a transaction is a listed transaction up to ‘‘random chance,’’ because future loss experience cannot be known when premiums are set, which makes the Loss Ratio Factors inappropriate for identifying tax avoidance transactions or transactions of interest. Commenters stated that premiums are intentionally set at high rates for long periods of time to ensure that there are adequate reserves to pay claims in case of catastrophic loss. Some suggested that transactions meeting the proposed 65 percent Loss Ratio Factor E:\FR\FM\14JAR5.SGM 14JAR5 khammond on DSK9W7S144PROD with RULES5 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations using a ten-year Loss Ratio Computation Period be identified as Micro-captive Transactions of Interest instead of Micro-captive Listed Transactions. Commenters expressed concern that transactions that are not tax avoidance transactions would be captured if the Loss Ratio Factors are retained, arguing that limited loss history does not mean that risks are not present, or that premiums are overpriced. Commenters pointed to a governmental program that provides reimbursement coverage for certain losses attributable to acts of terrorism set forth in the Terrorism Risk Insurance Act of 2002 (‘‘TRIA’’) as an example for why a loss ratio well below the proposed 65 percent is not inherently indicative of tax avoidance. Several commenters pointed to the Tax Court’s holdings in R.V.I. Guar. Co., Ltd. & Subs. v. Commissioner, 145 T.C. 209 (2015), as support for why the proposed 65 percent for a loss ratio is too high. With respect to concerns that transactions that are not tax avoidance transactions could be identified as Micro-captive Listed Transactions based on a ten-year Loss Ratio Computation Period and proposed 65 percent Loss Ratio Factor, the IRS recognizes that low loss ratios may be the result of coverage of low-frequency, high-severity risks. Inherent in insurance underwriting is the concept that by assuming numerous independent risks that will occur randomly, losses will become more predictable over time, and pricing should reflect those anticipated losses. See, e.g., Clougherty Packing Co., Inc. v. Commissioner, 811 F.2d 1297, 1306 (9th Cir. 1987) (‘‘The likelihood that a loss will occur is of uncertain but predictable magnitude; the size of the loss is similarly uncertain but predictable.’’). This concept is notably absent from the micro-captive cases tried to date, as premiums were consistently priced to meet the target threshold under section 831(b) without regard to reasonable estimates for loss experience. See Avrahami, 149 T.C. at 194–198; Syzygy, T.C. Memo. 2019–34, at *33–34; Caylor, T.C. Memo. 2021–30, at *45–47; Keating, T.C. Memo. 2024–2, at *59–61; Swift, T.C. Memo. 2024–13, at *40–42; Patel, T.C Memo. 2024–34, at *48–50; and Royalty Mgmt., T.C. Memo. 2024–87, at *23, 46–48; see also Reserve Mech., 34 F.4th at 891–94. The Loss Ratio Factor percentage is not intended to act as a proxy for the actuarial basis of premium pricing, as such a basis would be too fact specific to establish an administrable test that would adequately put all relevant taxpayers on notice of their obligations under the Code in accordance with every VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 taxpayer’s right to be informed. See Taxpayer Bill of Rights, https:// www.irs.gov/taxpayer-bill-of-rights (last visited Jan. 6, 2025). Commenters identifying loss ratios at issue in specific Tax Court cases did not specify what the loss ratios would be in those cases if computed as set forth in the proposed regulations over the proposed ten-year Loss Ratio Computation Period, nor did they specify an administrable metric that would enable better identification of tax avoidance transactions. The inclusion of a ten-year Loss Ratio Computation Period is intended to allow a Captive significant time to develop a reasonable loss history that supports the use of a micro-captive for legitimate insurance purposes. The final regulations retain the ten-year Loss Ratio Computation Period in the proposed listed transaction regulations, but in response to concerns that the proposed Loss Ratio Factors are nevertheless set too high and will capture transactions that are not tax avoidance transactions, the final regulations lower the Loss Ratio Factor for purposes of designating a listed transaction under § 1.6011–10 to 30 percent. The percentage was selected in response to comments indicating that the Tax Court’s holding in R.V.I. supports a lower loss ratio. R.V.I. is the one case cited by commenters that analyzed loss ratios for time periods corresponding to the Loss Ratio Computation Period for the Microcaptive Listed Transaction. In R.V.I., the Tax Court listed the captive’s loss ratios from 2000 through 2013. R.V.I., 145 T.C. at 216. The listed loss ratios ranged from a low of 0.2 percent (2012) to a high of 97.9 percent (2008). Id. As the Tax Court found, when considered in their totality, these ratios reflect ‘‘significant claims and . . . . significant insurance losses.’’ Id. at 215. The average loss ratio in R.V.I. for the five ten-year periods analyzed by the Tax Court (2000 through 2009; 2001 through 2010; 2002 through 2011; 2003 through 2012; and 2004 through 2013) themselves ranged from a low of 28 percent (2000 through 2009) to a high of 35 percent (2004 through 2013). Taking the average of those five ten-year periods, the average ten-year loss ratio in the R.V.I. case was 32 percent. This amount is rounded down to 30 percent in the final regulations. Further, to better target those transactions that are properly identified as listed transactions rather than as transactions of interest, the final regulations require that the transaction meet both the Loss Ratio Factor and the Financing Factor (a conjunctive test) to PO 00000 Frm 00009 Fmt 4701 Sfmt 4700 3541 be designated as a listed transaction, as explained more fully in part III. of this Summary of Comments and Explanation of Revisions. This change to a conjunctive test, coupled with the lower Loss Ratio Factor percentage for Microcaptive Listed Transactions, significantly narrows the scope of the Micro-captive Listed Transaction in the final regulations and should provide adequate relief for taxpayers who suggested comparisons to specific business line loss ratios, as well as for taxpayers who expressed concerns about the breadth of the Micro-captive Listed Transaction under the proposed regulations or who requested that transactions that would have met the proposed 65 percent Loss Ratio Factor be identified as transactions of interest instead. Although the example of the TRIA’s loss experience is not strictly relevant (that is, because the TRIA is a governmental relief program, not an insurance company) the significantly narrowed scope of the Micro-captive Listed Transaction is intended to respond to concerns that lower losses do not necessarily mean risks were not present or that premiums were overpriced. For clarity, the proposed Loss Ratio Computation Period is retitled as the ‘‘Listed Transaction Loss Ratio Computation Period’’ and the proposed Transaction of Interest Computation Period is retitled as the ‘‘Transaction of Interest Loss Ratio Computation Period’’. The final regulations generally retain the substance of the proposed Computation Periods except the Transaction of Interest Loss Ratio Computation Period is increased in the final regulations from a Captive’s nine most recent taxable years to its ten most recent taxable years (or all taxable years of the Captive’s existence if it has been in existence for less than ten taxable years) as discussed more fully in part II.D. of this Summary of Comments and Explanation of Revisions. If an established transaction that is otherwise described in the final regulations has not had adequate time to develop a tenyear loss history, the transaction may only be designated as a transaction of interest rather than a listed transaction. In addition, the Loss Ratio Factor for identification as a transaction of interest is also lowered from 65 percent to 60 percent in the final regulations, as described in part II.D. of this Summary of Comments and Explanation of Revisions. D. Comparison to National Averages The proposed Loss Ratio Factors were generally formulated by using the medical loss ratio in section 833 of the E:\FR\FM\14JAR5.SGM 14JAR5 khammond on DSK9W7S144PROD with RULES5 3542 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations Code, to inform the original loss ratio factor in Notice 2016–66, and by using national data for commercial property and casualty insurers, to inform the proposed regulations. A number of commenters contended that these metrics are inappropriate because section 831(b) captive insurers are materially different from commercial insurers due to the different types of coverage offered by commercial and captive insurers. For example, several commenters asserted that the inclusion in national averages of certain lines of coverage (identified by one commenter as private passenger auto liability, commercial auto liability, and accident and health coverage lines) that captives do not typically write, or may not be permitted to write, may tend to skew industry-wide loss ratios higher. Another commenter relatedly suggested that the Loss Ratio Factor’s reliance on data from the National Association of Insurance Commissioners (NAIC) as a benchmark was inappropriate because the data does not include the experience of the vast majority of captive insurance companies, including those which have elected to be taxed under section 831(b). One commenter asserted that the national industry average relied upon in the proposed regulations lacks an actuarial basis, and another commenter stated that aggregated data of the U.S. property-casualty insurance industry would reflect more risk diversification and geographic diversity than would be present in a typical micro-captive arrangement. As noted in the preamble to the proposed regulations, the Loss Ratio Factors are modified loss ratios spread out over the course of many years, unlike the single-year NAIC averages, and are also lower than the NAIC industry averages. The NAIC industry averages ranged between 67.2 and 76.2 percent per year from 2012 to 2021. See Insurance Industry Snapshots and Analysis Reports, https:// naic.soutronglobal.net/Portal/Public/enUS/RecordView/Index/26555 (last visited Jan. 6, 2025). In the latest published NAIC industry report, national averages ranged between 69.0 and 76.4 percent per year from 2014 to 2023. See 2023 Annual Property & Casualty Insurance and Title Insurance Industries Analysis Report, https:// naic.soutronglobal.net/Portal/Public/enUS/RecordView/Index/26555 (last visited Jan. 6, 2025). Accordingly, even a Captive electing the alternative tax under section 831(b) that has a loss ratio below the industry-wide average for property and casualty companies in a given year will not necessarily have a VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 loss ratio that causes it to be a participant to a transaction identified by the regulations. With respect to concerns that the use of NAIC data as a benchmark for the Loss Ratio Factor is inappropriate because the NAIC does not capture micro-captive data, the commenter did not identify any alternative published data set that would capture the experience of ‘‘the vast majority of captive insurance companies, including micro-captive insurance companies,’’ nor is the IRS aware of one. The commenter included a table illustrating the distribution of AM Best Company’s average loss and loss administration expenses ratios for small insurance companies, described as insurers grouped by capital and surplus up to $10 million, but this data set is inappropriate. As the commenter noted, the AM Best Company’s data set includes ‘‘vastly different claims characteristics than micro-captives’’ covering risks that micro-captives are not generally permitted to cover, such as personal automobile liability and homeowner’s liability. The NAIC data, conversely, represents industry averages generally applicable to all nonlife insurers, and, accordingly, was relied upon in the proposed regulations as a starting point, which was modified by the inclusion of policyholder dividends in the computation and by the application of an extended Computation Period. Further, as previously discussed in part II.C. of this Summary of Comments and Explanation of Revisions, the threshold for the Loss Ratio Factor for identification of a Micro-captive Listed Transaction has been lowered significantly in the final regulations. The comments regarding the lines of coverage included in the NAIC averages provide support for a reduction to the proposed Loss Ratio Factor for identification as a transaction of interest. The specific business lines identified by the commenters would, based on the NAIC Profitability Study provided by one of the commenters, result in an average nine-year loss ratio of approximately 59 percent. However, there are other high frequency, low severity coverages and other business lines that captives are unlikely to cover in the data provided by the commenter that the commenter failed to mention: private passenger auto physical damage, homeowners’ multiple peril, and mortgage guaranty lines. Removing these lines from the data set provided by the commenter would reduce the average nine-year loss ratio percentage from 65 percent identified in the PO 00000 Frm 00010 Fmt 4701 Sfmt 4700 proposed regulations to slightly over 60 percent. However, this relies on the national average computation of loss ratios, which as commenters pointed out, is not the modified computation set forth in the proposed regulations. The modified computation ratio in the final regulations would potentially be lower, in part because policyholder dividend payments reduce the ratio. To determine what the average loss ratio would be using the modified loss ratio computation set forth in the proposed regulations, the IRS considered the annual NAIC Report on Profitability by Line by State for each year from 2013 through 2022 to understand a typical property and casualty company loss ratio. See, e.g., 2013 Report on Profitability by Line by State, Center for Insurance Policy & Research, https:// naic.soutronglobal.net/Portal/Public/enUS/RecordView/Index/7008 (last visited Jan. 6, 2025). By removing the high frequency, low severity coverages that captives are unlikely to cover for each year from 2013 through 2022 from the annual data and computing the comparison of liabilities incurred for insured losses and claim administration expenses to premiums earned less policyholder dividends as set forth in the regulations, the average nine-year modified loss ratio is approximately 66 percent, which is slightly higher than the proposed 65 percent established in the proposed regulations. The average ten-year modified loss ratio is also slightly higher, at approximately 67 percent. In light of commenters’ concerns that the proposed 65 percent modified loss ratio is still too high, the Loss Ratio Factor percentage for identification of a transaction of interest in these regulations is lowered to 60 percent. This amount represents a discount from the lowest loss ratio supported by available data. The Loss Ratio Factor percentage for identification as a listed transaction has been reduced much more substantially to 30 percent, for other reasons, as described in part II.C. of this Summary of Comments and Explanation of Revisions. In the interest of ensuring all taxpayers can easily determine their status under the regulations, the Loss Ratio Factor remains based on the aggregated NAIC average as modified in the final regulations; although commenters were critical of the aggregated data provided by the NAIC, commenters did not point to, and the IRS is not aware of, an alternative publicly-available data set that would be more appropriate. Further, the Treasury Department and the IRS considered alternative E:\FR\FM\14JAR5.SGM 14JAR5 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations Computation Periods and determined that a difference of one year in the Computation Periods between the Micro-captive Listed Transaction and the Micro-captive Transaction of Interest when the loss ratio thresholds are different adds unnecessary complexity and burden to affected taxpayers. The Transaction of Interest Loss Ratio Computation Period is accordingly increased to a period of up to ten years, or if the Captive has not been existence for ten full years, all years of the Captive’s existence. This change will afford affected taxpayers more time to develop a loss history and will enable the computation of one ratio when affected taxpayers are considering if they need to report under § 1.6011–10 or § 1.6011–11. khammond on DSK9W7S144PROD with RULES5 E. Proposed Alternatives to the Loss Ratio Factors Commenters suggested alternatives to the Loss Ratio Factors including: (1) evaluating the methodology used to price premiums to ensure the premiums either are priced commensurate with commercial insurance market premiums, or are priced at arm’s length, given that several Code sections (such as section 482) and the regulations thereunder place strict limitations on what may be considered arm’s length in a given industry; (2) applying the definition of a qualified insurance company (QIC) set forth in the passive foreign investment company rules; (3) comparing micro-captives to commercial carriers and special markets, such as commercial excess and surplus lines (‘‘E&S’’) carriers; (4) comparing micro-captives to county mutual insurance companies, which commenters said have loss ratios of 40 percent and frequently make section 831(b) elections; or (5) establishing variations of the Loss Ratio Factors for specific regions or States. These recommendations are addressed in turn in this part II.E. of the Summary of Comments and Explanation of Revisions. 1. Premium Pricing Methodology Many commenters stated that they believe a better standard for assessing whether a micro-captive transaction should be identified as a listed transaction is to evaluate whether an independent, licensed actuary annually determines the premiums. Some commenters suggested that the IRS’s real concern is whether premiums are priced fairly, and that if taxpayers can demonstrate that the premiums were priced by a credentialed actuary, employing actuarial techniques to establish premium rates that VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 appropriately reflect the risk of loss and applicable costs, the transaction should be of no concern to the IRS. The determination of whether a transaction is insurance for Federal tax purposes is based on the totality of the circumstances, but these regulations are not defining insurance for either Federal or State law purposes. Rather, these regulations identify a set of recurring and consistent fact patterns indicating the lack of a non-tax business purpose in related-party transactions that purport to offer insurance for Federal tax purposes. In related party transactions, the lack of arm’s length dealing is often a source of abuse. In the micro-captive cases tried to date, the participation of an actuary or other professional in the computation of the premiums (and the taxpayer’s insistence that pricing was at arm’s length) was not sufficient to make the premiums reasonable, as is necessary for a valid insurance transaction for Federal tax purposes. See, e.g., Avrahami, 149 T.C. at 196; Syzygy, T.C. Memo. 2019–34, at *34–36; Caylor, T.C. Memo. 2021–30, at *45–47; Keating, T.C. Memo. 2024–2, at *61–62; Swift, T.C. Memo. 2024–13, at *41–44; Patel, T.C. Memo. 2024–34, at *49–50; and Royalty Mgmt., T.C. Memo. 2024–87, at *46–47; see also Reserve Mech., T.C. Memo. 2018–86, at *55–56, 61; cf. Harper Grp., 96 T.C. at 59 (premiums were stipulated to be priced at arm’s length); Securitas, T.C. Memo. 2014–225, at *12 n.4 (‘‘Respondent does not challenge the reasonableness of premiums.’’). For example, in Avrahami, the premiums were priced by a credentialed actuary. The Tax Court was unpersuaded that the actuary’s involvement resulted in reasonable premiums and found that the actuary’s ‘‘calculations [were] aimed not at actuarially sound decision-making but at justifying total premiums as close as possible to $1.2 million—the target— without going over.’’ 149 T.C. at 196. The Tax Court expressed similar skepticism in subsequent micro-captive cases. See, e.g., Syzygy, T.C. Memo. 2019–34, at *17–18, 34–36 (finding that premiums were not actuarially determined after concluding that there was no evidence demonstrating that actuarial methods were followed; that a feasibility study completed by an actuarial consulting firm and an actuarial review completed by the State of Delaware Department of Insurance were focused on solvency, not the reasonableness of premiums; and that the advice of a credentialed actuary was ignored regarding the allocation of premiums between layers in a layered reinsurance arrangement); Caylor, T.C. PO 00000 Frm 00011 Fmt 4701 Sfmt 4700 3543 Memo. 2021–30, at *45–47 (finding that a captive manager’s pricing methodology was not actuarially sound); Keating, T.C. Memo. 2024–2, at *30 n.30 (actuary’s opinion that pricing methodology was reasonable did not address specific policies). Further, while section 482 and the regulations thereunder provide standards for when a transaction between related parties is considered arm’s length, such determination is wholly fact specific to each arrangement and thus inappropriate as a metric for identifying reportable transactions. Accordingly, the final regulations do not adopt the commenters’ recommendation to replace the Loss Ratio Factors with a metric evaluating pricing methodology. While commenters were critical of the Loss Ratio Factors and suggested that the IRS evaluate pricing methodology, they provided no specific pricing methodology or reliable commercial market source that would enable the IRS to better distinguish between transactions that are or may be tax avoidance transactions and those that are not. The final regulations do not adopt any changes based on this recommendation. 2. Qualified Insurance Company Rules Section 1297 of the Code sets forth the rules for determining whether a foreign corporation is a passive foreign investment company (PFIC), which can result in adverse Federal tax consequences to a U.S. shareholder of that corporation. Generally, pursuant to section 1297(a), a foreign corporation is a PFIC if: (1) 75 percent or more of its gross income for the taxable year is passive income or (2) the average percentage of assets held by such corporation during the taxable year which produce passive income or which are held for the production of passive income is at least 50 percent. However, section 1297(b)(2)(B) provides that passive income does not include income derived in the active conduct of an insurance business by a QIC. Generally, to be a QIC, the foreign insurer must: (1) be a corporation that would be subject to tax under Subpart L if it were a domestic corporation and (2) have ‘‘applicable insurance liabilities’’ (AILs) that exceed 25 percent of its total assets, as provided in section 1297(f)(1), which is referred to as the ‘‘AIL test’’ in this preamble. The commenter stated that QIC status creates a rebuttable presumption that the purported insurer is a bona fide insurance company and that applying the same QIC test to domestic insurers that have elected to be taxed under E:\FR\FM\14JAR5.SGM 14JAR5 khammond on DSK9W7S144PROD with RULES5 3544 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations section 831(b) should create a similar rebuttable presumption in these regulations. The Treasury Department and the IRS have determined that QIC status is not appropriate for determining whether a micro-captive transaction is a tax avoidance transaction or has the potential to be a tax avoidance transaction. Foremost, QIC status does not create a rebuttable presumption that the foreign company is a bona fide insurance company. Rather, QIC status depends on the foreign company being a bona fide insurance company, as that is a prerequisite to satisfying the first prong of the QIC test, that it would be subject to tax under subchapter L (that is, would be taxable as an insurance company for Federal tax purposes) if it were a domestic corporation. The commenter’s proposed test is unworkable because it is circular. Further, the entities identified as Captives by the proposed and final regulations claim eligibility to be taxed under section 831(b) of subchapter L and therefore would presumably take the position that they are subject to tax under subchapter L. However, as discussed more fully in parts I.E. and VI.C. of this Summary of Comments and Explanation of Revisions, litigation and audit experience demonstrate that many micro-captive transactions do not meet the requirements for taxation as insurance under the Code. Nor is the second prong of the QIC test, the AIL test, suitable for determining whether a company is a bona fide insurance company or for identifying micro-captive listed transactions or transactions of interest. The AIL test is based on the ratio of a foreign corporation’s applicable insurance liabilities to its total assets as reported on the foreign insurance company’s applicable financial statement for a taxable year, as those terms are defined in § 1.1297–4. The AIL test is appropriate in the PFIC context because the objective of the PFIC provisions generally, that is, independent of insurance considerations, is identifying foreign companies with U.S. shareholders that are predominately passive investment vehicles focused on holding investment assets and earning investment income. The AIL test achieves this objective by identifying foreign insurance companies that, though they are engaged in the active conduct of an insurance business, are nevertheless predominantly passive investment vehicles because they have a very large amount of total assets compared to their insurance liabilities. By failing the AIL test, such foreign insurance companies do not constitute VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 QICs and therefore do not qualify for the PFIC insurance exception under section 1297(b)(2)(B). The AIL test is not part of the determination of whether a foreign corporation would be an insurance company taxable under subchapter L if it were a domestic company. Further, a foreign insurance company that fails the AIL test would still be a PFIC even if it is a bona fide insurance company and is engaged in the active conduct of an insurance business. It is thus inappropriate to use the AIL test in determining if a company is a bona fide insurance company or to identify microcaptive listed transactions or transactions of interest. Instead, the Loss Ratio Factors are appropriate for this purpose, in part because one indicium of tax avoidance in a micro-captive transaction is excessive premium payments (which taxpayers claim are deductible to the Insured and not taxable to the Captive pursuant to the section 831(b) election) when compared to liabilities incurred for insured losses and claim administration expenses. 3. Commercial and Special Markets Comparison Commenters compared micro-captives to commercial carriers and special markets, such as commercial E&S (excess and surplus lines) carriers. Commenters pointed out that many commercial insurance business lines and geographical locations consistently have loss ratios of less than 65 percent, and some recommended the loss ratio percentage be based on each line of coverage written by the Captive or similar coverages written by commercial carriers. One commenter identified specific commercial lines of coverage, including Boiler & Machinery, Burglary & Theft, Earthquake, Fidelity, Surety, and Other Liability-Claims Made, as examples of lines of coverage that many micro-captives offer and stated that micro-captives therefore have similar loss and loss ratio distributions to these commercial lines. Generally, commercial E&S carriers cover risks that are too uncommon, too large, or too unquantifiable to be insured by admitted carriers. In a commercial E&S market, multiple financial backers, grouped in syndicates, come together to pool and spread diversified risks that are placed with the syndicates through authorized brokers. Certain Captives may share some similarities with a commercial E&S carrier, but as a general matter, a typical micro-captive does not comport itself consistently with insurers operating in the commercial E&S market. For example, the risks covered PO 00000 Frm 00012 Fmt 4701 Sfmt 4700 by a micro-captive are often those of relatively few insureds who are concentrated in a small geographic region. See, e.g., Caylor, T.C. Memo. 2021–30, at *38 (risks were concentrated in a group operating in a specific geographic location); Swift, T.C. Memo. 2024–13, at *31 (risks were concentrated in a specific industry in a small geographical area). Commenters did not explain what aspect of a commercial E&S carrier’s loss ratio is substantially comparable to the average loss ratio for a typical micro-captive or how a more reliable metric to identify tax avoidant micro-captives can be derived from a commercial E&S carrier’s loss ratio. Thus, loss ratio comparisons between micro-captives and commercial E&S carriers would not constitute an improvement over the current Loss Ratio Factors. With respect to comments suggesting alternatives based on comparable commercial lines, the Treasury Department and the IRS have determined sufficient relief is afforded by the reductions to the Loss Ratio Factors for both Micro-captive Listed Transactions and Micro-captive Transactions of Interest, as discussed further in parts II.C. and II.D. of this Summary of Comments and Explanation of Revisions. With respect to comments suggesting comparison to certain business lines, the Treasury Department and the IRS are not persuaded that the few specific lines identified by the commenters better represent the variety of lines offered by micro-captives than the case law and national averages for property and casualty companies (excluding certain consumer and business lines), as discussed further in parts II.C. and II.D. of this Summary of Comments and Explanation of Revisions. The final regulations do not adopt any changes based on these recommendations. 4. County Mutual Insurance Company Comparisons A commenter suggested comparing micro-captives to county mutual insurance companies, which the commenter said have loss ratios of 40 percent and frequently make section 831(b) elections. Like commercial E&S and special markets, county mutual insurance companies are similarly inappropriate for comparison. Although they may also cover risks concentrated in a small geographical area, county mutual insurance companies are subject to different incentives and constraints compared to micro-captive insurance companies because they are wholly owned by their many unrelated policyholders in a manner that does not E:\FR\FM\14JAR5.SGM 14JAR5 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations resemble the closely held nature of micro-captive insurance companies. For example, if premiums collected by a county mutual insurance company are not used to pay claims, the unrelated policyholders would expect that the county mutual insurance company will reduce future premiums or return some portion of the excess funds to the owners as a dividend or return premiums. Micro-captive insurance companies, on the other hand, face no such expectation. The final regulations do not adopt any changes based on this recommendation. However, for the reasons described in part II.C. of this Summary of Comments and Explanation of Revisions, and consistent with the request by commenters regarding the loss ratios of county mutual insurance companies, the final regulations lower the Loss Ratio Factor for purposes of identification as a listed transaction under § 1.6011–10 to 30 percent. khammond on DSK9W7S144PROD with RULES5 5. Variations for Regions or States Some commenters recommended establishing variations of the Loss Ratio Factors for specific regions or States. Accounting for disparities in loss experience from region to region would not be administrable, and, within a given region, different coverages would be subject to different disparities, which would further complicate the analysis. The final regulations do not adopt any changes based on this recommendation because the Treasury Department and the IRS have determined that sufficient relief is afforded by the changes to the Loss Ratio Factors described in parts II.C. and II.D. of this Summary of Comments and Explanation of Revisions. F. Inclusion of Policyholder Dividends in Loss Ratio Factor Computation Commenters expressed concerns about the inclusion of policyholder dividends in the computation, indicating that issuance of policyholder dividends may require regulatory approval and is not a common practice of micro-captives, thereby situating a micro-captive to fail the test for insurance in the commonly accepted sense. The Loss Ratio Factors are modified loss ratios, determined for Federal tax purposes, and the inclusion of policyholder dividends in the computation is intended to afford taxpayers a means of correcting inappropriately accumulated premiums, thereby avoiding characterization of their micro-captive arrangements as ‘‘transactions of interest’’ or ‘‘listed transactions.’’ The Loss Ratio Factors have no other purpose or relevance and do not in any way affect or impede the VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 functioning of a Captive. Further, removing policyholder dividends from the computation would unfairly disadvantage Captives that choose to use policyholder dividends to correct overpriced policies. The Treasury Department and the IRS are not persuaded that the issuance of policyholder dividends by itself would cause a transaction to fail the commonly accepted sense prong of the four-prong test for insurance for Federal tax purposes described in part I. of the Background of this Preamble. Courts consider many factors to determine whether an arrangement constitutes insurance in the commonly accepted sense, including whether policies are valid and binding, whether premiums were reasonable and the result of arm’s length transactions, and whether claims were paid, and no one factor within the commonly accepted sense prong is dispositive. See, e.g., Avrahami, 149 T.C. at 191–97; Caylor, T.C. Memo. 2021–30, at *41–48; and Keating, T.C. Memo. 2024–2, at *53–64. The final regulations do not modify the Loss Ratio Factors in response to these comments. G. Solvency Concerns Some commenters protested that establishing a minimum loss threshold by application of the Loss Ratio Factors would negatively impact solvency for captives, by requiring artificially low premiums or imprudent issuance of policyholder dividends. This concern is misplaced. Captive insurers would avoid insolvency in the same way they always have; that is, by insuring risks that are selected and duly reserved for in accordance with sound business judgement and the regulatory requirements of their domicile. Nothing in these regulations requires, encourages, or allows micro-captives to make contractual promises that exceed risk-bearing capabilities. The final regulations do not modify the Loss Ratio Factors in response to these comments. H. Clarifications Regarding Computation of Loss Ratio Factors Commenters argued that it may not be possible to calculate a loss ratio applicable to a given taxable year because losses under a policy may not be resolved for years (for example, longtail coverage), and sought some clarification in the computation of the Loss Ratio Factors. For example, commenters asked whether the ‘‘liabilities incurred for insured losses’’ amount used in the Loss Ratio Factors computations includes losses incurred through participation in pooling arrangements, reinsurance agreements, and retrocession agreements, how PO 00000 Frm 00013 Fmt 4701 Sfmt 4700 3545 micro-captives should compute the applicable loss ratio for long-tail coverage, and whether the current taxable year is included in the number of years being counted for the Computation Periods. The Computation Periods of ten years for Micro-captive Listed Transactions and up to ten years for Micro-captive Transactions of Interest, respectively, are intended to accommodate the existence of potential long-tail coverage. These commenters appear to contemplate situations in which a Captive incurs losses but for which claims have not been reported (incurred but not reported, or IBNR) or are undergoing further development (incurred but not enough reported, or IBNER). To clarify, the Loss Ratio Factor is computed using the amount of liabilities incurred for insured losses as such term is applied under the relevant accounting method used by the participant taxpayer, as of the end of the relevant taxable year(s). See, e.g., § 1.446–1(c)(1)(ii) (defining when a liability is considered incurred for accrual method taxpayers). The final regulations do not adopt any changes based on these comments. With respect to whether the Loss Ratio Factors include losses incurred through pooling arrangements, reinsurance agreements, and retrocession agreements, the final regulations place no limitation on the source of losses incurred by the Captive. The Computation Periods as set forth in §§ 1.6011–10(b)(2)(i) and (ii) and 1.6011–11(b)(2)(i) and (ii) include the most recent concluded taxable year in accordance with § 1.6011–4(e)(2), Rev. Proc. 2005–26, 2005–17 I.R.B. 965, and the Instructions to Form 8886. III. Comments and Changes Relating to the Financing Factor as Described in Proposed § 1.6011–10(c)(1) A few commenters argued that the Financing Factor should be removed as a factor for identifying listed transactions and transactions of interest. As proposed, such commenters assert that the Financing Factor fails to consider the circumstances for the financing, suggesting that a better measure of a transaction’s potential for tax avoidance is whether the financing reflects an overconcentration in illiquid assets. One commenter stated that nothing in the Code or existing precedent treats related-party financing that is arm’s length as abusive. Commenters noted that State regulators generally must approve financing in related-party transactions, and if approved by the State, financing should not be of concern to the IRS. E:\FR\FM\14JAR5.SGM 14JAR5 khammond on DSK9W7S144PROD with RULES5 3546 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations One of the key abuses seen in microcaptive transactions is the indefinite deferral of tax. Such abuses may be compounded by the use of tax-deferred income for the personal benefit of the related persons involved. See, e.g., Avrahami, T.C. 149 at 169–71 (portions of premiums paid made available as loans to related real estate holding company); Swift, T.C. Memo. 2024–13, at *18–19 (portions of premiums paid made available to invest in real estate and limited liability companies for the direct or indirect benefit of petitioners); and Patel, T.C. Memo. 2024–34, at *11 (portions of premiums paid made available to invest in life insurance for the direct or indirect benefit of petitioners). In an abusive micro-captive transaction, an Insured entity deducts amounts paid directly or indirectly to the Captive that the parties treat as insurance premiums in an arrangement that does not constitute insurance for Federal tax purposes. Captives then exclude those amounts from taxable income under section 831(b). When a financing arrangement is involved, such Captives return some portion of those tax-deferred amounts directly or indirectly to the Insured or related parties via a loan, capital contributions to a special purpose vehicle, or other financing arrangement for which a current tax does not apply. Thus, in a financing arrangement involving an abusive micro-captive transaction, amounts paid as premiums have not only avoided ordinary taxation but have continued to avoid tax while back in the hands of the related parties who caused the premiums to be paid and deducted. This deliberate, continuing avoidance of income tax using benefits to which the participants are not entitled is abusive and identifying transactions with similar fact patterns as listed transactions is consistent with the IRS’s pronouncements with respect to microcaptives since before the publication of Notice 2016–66. See, e.g., ‘‘Captive Insurance,’’ IR–2015–19 (Feb. 3, 2015), https://www.irs.gov/newsroom/abusivetax-shelters-again-on-the-irs-dirtydozen-list-of-tax-scams-for-the-2015filing-season (last visited Jan. 6, 2025.) Several commenters noted that related-party financing such as the arrangements described by the Financing Factor can be subject to substantial scrutiny, to the extent that State insurance regulators will permit such financing only after an extensive approval process. See, e.g., Avrahami, 149 T.C. at 170 (‘‘Insurance regulators often raise bureaucratic eyebrows at related-party dealings.’’). Even so, the IRS has seen multiple transactions for VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 which approval was required but not sought, or for which approval may have been granted but, nevertheless, the parties’ treatment of the financing arrangement did not comport with industry standards. Based on its experience, the IRS maintains that, in transactions structured as described in the proposed regulations, financing arrangements that create a tax-deferred circular flow of funds are indicative of tax avoidance. One commenter argued that inclusion of specific factors, such as the Loss Ratio Factor and the Financing Factor, improperly assumes insurance company status can be determined by reference to a single factor. However, the proposed regulations neither define insurance for Federal tax purposes nor identify transactions by a single factor. As discussed more fully in part I.E. of this Summary of Comments and Explanation of Revisions, these regulations do not presume to define insurance for Federal tax purposes; rather, the regulations identify fact patterns that are consistently associated with transactions that are or may be tax avoidance transactions. Regarding commenters’ suggestions that the liquidity of a captive is a better measure than the Financing Factor, the commenters did not specify what potential measure of liquidity (such as the character of assets, amount of assets, or comparison of assets to Captive’s liabilities) would better identify microcaptive transactions that are or may be tax avoidance transactions. Further, regardless of the specific measure of liquidity used, determinations thereof would be too fact-specific (and dependent upon individual policy terms and jurisdictional requirements) to be administrable. The use of amounts paid as premiums in a tax-preferred manner, and the return of such amounts directly or indirectly to the related parties who benefitted from the original tax deduction, is the tax avoidance addressed by the Financing Factor. While some participants may have obtained regulatory approval to issue the related-party financing, from a Federal tax perspective, the approval of a regulatory body does not answer the question of whether the transaction as a whole should be respected for Federal tax purposes. The final regulations therefore retain the Financing Factor. However, the Treasury Department and the IRS agree that the presence of related-party financing in a microcaptive transaction by itself may not rise to the level of tax avoidance, as it may be that such financing was determined at arm’s length or otherwise treated as a bona fide financing arrangement PO 00000 Frm 00014 Fmt 4701 Sfmt 4700 between the related parties. See Avrahami, 149 T.C. at 199–204 (finding that the economic reality of the relatedparty financing at issue, while a close question, could be treated as a bona fide debt obligation, notwithstanding the court’s determination that the Avrahami’s captive transaction was not insurance for Federal tax purposes). The concern with respect to financing arrangements is the continuing deferral of tax. Such deferral should not be considered tax avoidance unless coupled with the continued accumulation of tax-deferred amounts in a transaction involving circumstances inconsistent with insurance for Federal tax purposes, including the excessive pricing of premiums and artificially low or nonexistent claims activity. Accordingly, the final regulations have revised the factors identifying a listed transaction to reflect a conjunctive test: taxpayers who are engaged in a transaction described by the regulations that meets the Financing Factor as described in § 1.6011–10(c)(1), in conjunction with the Loss Ratio Factor as described in § 1.6011–10(c)(2), are identified as listed transactions in the final regulations. This change, to require both the Financing Factor and the Loss Ratio Factor in the identification of Micro-captive Listed Transactions, should provide substantial relief to taxpayers participating in transactions with loss ratios below 30 percent but for which the Financing Factor is not met. Because the potential for tax avoidance still exists when there is related-party financing, the final regulations include the Financing Factor in the identification of a Micro-captive Transaction of Interest. Taxpayers who are engaged in a transaction described by the regulations that meets the Financing Factor as described in § 1.6011–11(c)(1), the Loss Ratio Factor as described in § 1.6011–11(c)(2), or both, are identified as participating in a transaction of interest in the final regulations. The Financing Computation Period for Micro-captive Transactions of Interest is the same as the Financing Computation Period for Micro-captive Listed Transactions. IV. Comments and Changes Relating to the Consumer Coverage Exception as Described in § 1.6011–10(d)(2) A ‘‘Consumer Coverage Arrangement’’ as described in the proposed regulations includes certain arrangements in which a service provider, automobile dealer, lender, or retailer (‘‘Seller’’) sells contracts that the parties treat as insurance contracts (‘‘Contracts’’ as defined in proposed § 1.6011–10(b)(3)) either issued or reinsured by a Captive E:\FR\FM\14JAR5.SGM 14JAR5 khammond on DSK9W7S144PROD with RULES5 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations related to the Seller (‘‘Seller’s Captive’’) to its Unrelated Customers (as defined in proposed § 1.6011–10(b)(11)) in connection with the products or services being sold. As noted in the preamble to the proposed regulations, as a general matter, participation in this type of reinsurance arrangement is neither a Micro-captive Listed Transaction nor a Micro-captive Transaction of Interest under the proposed regulations because the insured is not sufficiently related to the Seller’s Captive. Generally, in a Consumer Coverage Arrangement, the Insureds under the Contracts that are issued or reinsured by the Seller’s Captive are Unrelated Customers of Seller, and these Unrelated Customers, their owners, and persons related to the Unrelated Customers or their owners do not directly or indirectly own at least 20 percent of the voting power or value of the outstanding stock of any entity issuing or reinsuring the Contract. Nonetheless, the proposed regulations would provide relief from identification as either a Micro-captive Listed Transaction or as a Micro-captive Transaction of Interest under §§ 1.6011– 10(d)(2) and 1.6011–11(d)(2) (‘‘Consumer Coverage Exception’’) for certain Consumer Coverage Arrangements that would otherwise be Micro-captive Listed Transactions or Micro-captive Transactions of Interest. The proposed exception would apply to arrangements in which the following criteria are met: (1) the arrangement involves a Seller’s Captive (meaning a Captive related to Seller as defined in proposed § 1.6011–10(b)(10)); (2) Seller’s Captive insures or reinsures some or all of the Contracts sold by Seller; (3) 100 percent of the business of the Seller’s Captive is insuring or reinsuring Contracts in connection with products or services being sold by the Seller or persons related to Seller; and (4) commissions or remunerations paid for the sale of such Contracts, as a percentage of the premiums paid by the Seller’s customers, is at least the greater of: (a) 50 percent; or (b) the unrelated commission percentage (meaning the highest commission for the sale of Contracts connected to Seller’s products that are not issued or reinsured by Seller’s Captive). Proposed § 1.6011– 10(d)(2)(iv)(B) is referred to as the ‘‘Unrelated Commissions Test’’; proposed § 1.6011–10(d)(2)(iv)(A) and (B) are collectively referred to as the ‘‘Commissions Test.’’ As further discussed in this part IV. of the Summary of Comments and Explanation of Revisions, commenters expressed appreciation for the inclusion of the Consumer Coverage Exception but VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 requested clarification of the Consumer Coverage Exception provisions and recommended changes to the exception, particularly with respect to the Commissions Test. A. The Commissions Test Several commenters recommended that the Commissions Test be eliminated from the Consumer Coverage Exception. One commenter recommended that if the Commissions Test is not eliminated from the Consumer Coverage Exception altogether, it should at least be eliminated for commercial insurers acting as Intermediaries (as such term is defined in proposed § 1.6011–10(b)(5)). Several commenters specifically requested the elimination of the Unrelated Commissions Test set forth at proposed § 1.6011–10(d)(2)(iv)(B), expressing concern about the ability of taxpayers to comply with the provision as written. To explain why the Commissions Test should be eliminated, one commenter argued that commissions seemingly have no applicability to the validity of the insurance arrangement. Two commenters remarked on the lack of a basis for the 50 percent threshold in the Commissions Test, as set forth in proposed § 1.6011–10(d)(2)(iv)(A). The commenters suggested that use of this percentage to determine ‘‘abusiveness’’ of the transactions does not necessarily have any substantive connection to the economic realities of the transaction, which is negotiated at arm’s length between customers and Sellers. Commenters noted that customers negotiate the purchase price of consumer coverage with Sellers without regard to the tax implications of Sellers’ participation in the underwriting profit of the consumer coverage, and Sellers sometimes agree to lower prices and lower commissions, not for any taxmotivated reason, but because otherwise the customer will not buy the product. One of these commenters said that, as a result, the Commissions Test sets an ‘‘arbitrary’’ standard. The other commenter suggested that the proposed regulations would injure consumers by essentially requiring Sellers to caution their salespeople not to offer discounts, for fear of losing the Consumer Coverage Exception and triggering ‘‘transaction of interest’’ status. A third commenter noted that, for standard types of coverage written by commercial insurers, such as automobile service contracts, the market is strongly competitive, and the effect of the proposed regulations would be to reduce that competition by requiring consumers to pay a commission mark- PO 00000 Frm 00015 Fmt 4701 Sfmt 4700 3547 up on consumer coverage of at least 100 percent of the net premium charged by the insurer. One of the commenters remarked that the 50 percent threshold in the Commissions Test would only make sense if the IRS had reason to believe that the sale of products at a lower rate is an indication of a non-market driven effort to artificially transfer otherwise taxable revenue to the micro-captive. The commenter asserted that, in over 30 years, the commenter had never seen this issue raised in examination, read cases of this happening, or heard that the IRS has actual evidence that it in fact occurs. The commenter further asserted that Consumer Coverage Arrangements ‘‘have already been examined, and deemed not to justify listed transaction treatment,’’ as evidenced by the listing of certain consumer coverage transactions in Notice 2002–70, 2002–2 C.B. 765, and subsequent ‘‘de-listing’’ of those transactions in Notice 2004–65, 2004–2 C.B. 599. The commenter distinguished Consumer Coverage Arrangements from the micro-captive transactions determined by the Tax Court in recent cases not to be insurance for Federal tax purposes. To the extent the IRS has had successful Tax Court outcomes in the micro-captive area, the commenter asserted, those cases all concerned enterprise risk; none were concerned with unrelated third-party consumer risk arrangements. Another commenter called the Commissions Test ‘‘vague, unworkable, anti-consumer and anti-competitive,’’ asserting that the IRS should not be requiring, or even encouraging, payment of high commission rates as a condition of the exception. The commenter observed that the Commissions Test seems to be based upon section 482 of the Code transfer-pricing concerns rather than failure of risk transfer and risk distribution and lack of arm’slength dealing and sound business practices, the issues identified by the preamble to the proposed regulations as the focus of the proposed regulations. The commenter asserted that the real concern of the regulations should be to ensure that the net premiums paid to the Captive are not excessive. The commenter observed that commercial insurers writing consumer coverage for sale through dealers typically specify a schedule listing various products and the applicable net premium for each (that is, after the dealer’s withheld commission) payable to the insurer for each, and that these net premiums are set by the commercial insurer based upon actuarial analysis of the risks to be covered. The commenter further E:\FR\FM\14JAR5.SGM 14JAR5 khammond on DSK9W7S144PROD with RULES5 3548 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations observed that the gross amount paid by the customer (including the amount above the specified net premium that the dealer retains as a commission) is subject to negotiation by each customer, and the commercial insurer may not be informed of the commission or who earns it. To address this commercial insurer scenario, the commenter proposed a safe harbor from material advisor and participant status for commercial insurers acting as Intermediaries (as defined in proposed § 1.6011–10(b)(5)) in transactions that do not involve the payment of excessive premiums to the captive. However, because the proposed safe harbor would be for any commercial insurer acting as an Intermediary in a micro-captive transaction, unless the commercial insurer (or related company) retrocedes risks with respect to consumer products and pays a reinsurance premium in excess of an arm’s length amount, the effect of this safe harbor would not be limited to Consumer Coverage Arrangements. Because the proposed safe harbor has implications beyond Consumer Coverage Arrangements, it is discussed in part V.B. of this Summary of Comments and Explanation of Revisions. Commenters also remarked that elimination of the Commissions Test would make application of the Consumer Coverage Exception more streamlined and efficient and less burdensome. One of the commenters expressed concern that not all Sellers capture information about sales and commissions in a way that will facilitate calculation of ‘‘the fee, commission, or other remuneration earned by any person or persons, in the aggregate, for the sale of the Contracts, described as a percentage of the premiums paid by the Seller’s customers.’’ The commenter asserted that this additional cost and effort is not justified ‘‘to guard against a theoretical abuse in an industry where the Service has already found that insufficient evidence of abuse exists to justify listed transaction treatment.’’ After careful consideration of the comments received generally requesting the elimination of the Commissions Test and specifically requesting the elimination of the Unrelated Commissions Test, the Treasury Department and the IRS are persuaded that elimination of the Commissions Test in the Consumer Coverage Exception is appropriate. The tax avoidance or potential for tax avoidance that the Commissions Test intended to identify is distinguishable from the closely held arrangements associated with the fact patterns identified in VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 §§ 1.6011–10(a) and 1.6011–11(a); for example, the ultimate policyholders are commonly Unrelated Customers in Consumer Coverage Arrangements. Accordingly, the Commissions Test is eliminated from the Consumer Coverage Exception in the final regulations. One commenter also sought clarification of certain aspects of the Commissions Test. However, because the Commissions Test is eliminated from the Consumer Coverage Exception in the final regulations, no further explanation is necessary. B. Restricting Consumer Coverage Arrangements Identified as Reportable Transactions Through Clarification of Defined Terms The definition of ‘‘Insured’’ set forth in proposed § 1.6011–10(b)(4) and incorporated in proposed § 1.6011– 11(b)(4) is ‘‘any person that conducts a trade or business, enters into a Contract with a Captive or enters into a Contract with an Intermediary that is directly or indirectly reinsured by a Captive, and treats amounts paid under the Contract as insurance premiums for Federal income tax purposes.’’ One commenter on the Consumer Coverage Exception recommended that the final regulations clarify that this definition is not intended to include someone who is only covered by the policy for a momentary period of time during which the underlying sales transaction is being finalized. The commenter noted that the preamble appears to indicate that guaranteed asset protection (GAP) products are an example of a ‘‘dealer obligor’’ arrangement in which a Seller could be considered the Insured for a short transitory time period occurring between the time the covered product is delivered to the Unrelated Customer of Seller and the financing to purchase the product is finalized for the Unrelated Customer. The commenter asserted that such situations should not trigger a reporting obligation since this is a temporary condition arising solely from an administrative need to allow third parties to process paperwork. Another commenter asked that the final regulations clarify that a Seller that only directly or indirectly reinsures Contracts that ultimately benefit Unrelated Customers, such as GAP contracts, is not an Insured, even if the Seller is technically a transitory or residual obligor under the contract. The commenter suggested that if this recommendation is not adopted, the definition of ‘‘Captive’’ set forth in proposed § 1.6011–10(b)(1) and incorporated in proposed § 1.6011– 11(b)(1), should be modified to exclude any entity that only issues Contracts to PO 00000 Frm 00016 Fmt 4701 Sfmt 4700 Insureds, where the ultimate beneficiaries of such contracts are Unrelated Customers, to the extent that the total percentage of issued and reinsured GAP and similar Contracts provided to Insureds of such entity do not exceed 25 percent of the total issued and reinsured Contracts for such entity. The commenter noted that this definition would remove burdensome compliance data collection from what is essentially a minority of the entity’s contracts and would permit the IRS to focus on situations where there is greater potential for tax avoidance. The final regulations make no change to the definitions of Insured and Captive in response to these comments. A Seller is an Insured only if it ‘‘enters into a Contract with a Captive or enters into a Contract with an Intermediary that is directly or indirectly reinsured by a Captive.’’ A Seller is not an Insured if it facilitates an Unrelated Customer entering into a Contract with Seller’s Captive or an Intermediary but is not itself a party to the Contract. A Seller is an Insured only if it treats amounts paid under the Contract as insurance premiums for Federal tax purposes. To the extent a Seller receives and makes payments under a Contract as an agent of a party or parties to the Contract, the Seller would not treat amounts paid under a Contract as insurance premiums for Federal tax purposes. As a general matter, therefore, a Seller that only facilitates the direct or indirect insurance or reinsurance of Contracts that ultimately benefit Unrelated Customers, such as GAP contracts, and does not reflect the tax benefits of participating in a purported insurance transaction in its filed returns, will not be an Insured that is a participant under these regulations. A Seller that satisfies all the requirements of the definition of Insured is appropriately considered an Insured. However, in recognition of concerns expressed by commenters that such situations could potentially arise, the final regulations retain the Consumer Coverage Exception, which may prevent a Consumer Coverage Arrangement in which a Seller (or related person) is an Insured from being identified as a Micro-captive Listed Transaction or Micro-Captive Transaction of Interest. C. Revising Definition of Seller To Permit De Minimis Sales to Related Persons The definition of ‘‘Seller’’ set forth in proposed § 1.6011–10(b)(9) and incorporated in proposed § 1.6011– 11(b)(8) is ‘‘a service provider, automobile dealer, lender, or retailer that sells products or services to E:\FR\FM\14JAR5.SGM 14JAR5 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations khammond on DSK9W7S144PROD with RULES5 Unrelated Customers who purchase insurance contracts in connection with those products or services.’’ A commenter recommended modification of this definition to prevent an occasional sale of an automobile and insurance contract to a related party from disqualifying a Seller’s Captive from the Consumer Coverage Exception. The commenter also stated it is important to clarify that it is not a requirement for all purchasers of insurance contracts to be Unrelated Customers for the dealer to be a Seller. The commenter asserted that there is a low risk of tax avoidance if a majority of the Contracts being insured or reinsured by a Seller’s Captive are either directly sold to an Unrelated Customer or are for the ultimate benefit of an Unrelated Customer. The commenter suggested a de minimis exception for related party sales by establishing a five percent threshold for such transactions. In response to these comments, § 1.6011–10(b)(9) of the final regulations clarify that a Seller is a service provider, dealer (including an automobile dealer), lender, wholesaler, or retailer that sells products or services to customers who purchase insurance contracts in connection with those products or services provided no more than five percent of all its sales of products or services to persons who purchase insurance contracts in connection with those products or services are to customers other than Unrelated Customers. Additionally, the Consumer Coverage Exception in §§ 1.6011– 10(d)(2) and 1.6011–11(d)(2) of the final regulations is modified to require that no more than five percent of the Seller’s Captive’s business is issuing or reinsuring Contracts purchased by persons other than Unrelated Customers in connection with products or services sold by the Seller or persons Related (as defined in § 1.6011–10(b)(8) of the final regulations) to the Seller. D. Other Requests for Clarification A commenter asked for clarification of whether the Consumer Coverage Exception applies when the Seller’s Captive neither assumes reinsurance from an unrelated fronting company, nor cedes reinsurance to an unrelated insurer. The Consumer Coverage Exception set forth in proposed § 1.6011–10(d)(2) and incorporated in proposed § 1.6011–11(d)(2) requires that ‘‘Seller’s Captive issue or reinsure some or all of the Contracts sold to Unrelated Customers in connection with the products or services being sold by the Seller,’’ that ‘‘100 percent of the business of the Seller’s Captive is insuring or reinsuring Contracts in VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 connection with products or services being sold by the Seller or persons Related to the Seller,’’ and that the Commissions Test set forth in proposed § 1.6011–10(d)(2)(iv) is met with respect to ‘‘the Contracts issued or reinsured by the Seller’s Captive.’’ The involvement of an unrelated fronting company or other unrelated insurer is not required. The commenter also asked if the Consumer Coverage Exception is intended to apply if Seller’s Captive directly insures an entity related to or affiliated with Seller for certain contracts described in the proposed regulations but without fronting or reinsurance attached. The Consumer Coverage Exception set forth in the proposed regulations would not apply in these circumstances because the Seller’s Captive is insuring an entity related to or affiliated with Seller (rather than Unrelated Customers of Seller). This would be the case whether or not a fronting company or reinsurer were involved. However, as discussed in part IV.C. of this Summary of Comments and Explanation of Revisions, under §§ 1.6011–10(d)(2)(iv) and 1.6011– 11(d)(2) of the final regulations, the Consumer Coverage Exception may apply when a Seller’s Captive issues or reinsures Contracts purchased by persons other than Unrelated Customers in connection with products or services sold by the Seller or persons related to Seller, provided that no more than five percent of the Seller’s Captive’s business is issuing or reinsuring such Contracts. Accordingly, the Consumer Coverage Exception set forth in the final regulations would potentially apply in the circumstances described by the commenter. A commenter suggested that ‘‘coverage for incurring diminished value’’ should be considered a type of consumer coverage. The preamble to the proposed regulations explains that a ‘‘Consumer Coverage contract generally provides coverage for repair or replacement costs if the product breaks down or is lost, stolen, or damaged; coverage for the customer’s payment obligations if the customer dies or becomes disabled or unemployed; coverage for the difference between all or a portion of the value of the product and the amount owed on the product’s financing, including a lease, if the product suffers a covered peril; or a combination of one or more of the foregoing types of coverage.’’ However, this is a non-exclusive list. The Consumer Coverage Exception may apply when a Seller’s Captive issues or reinsures Contracts in connection with the products or services being sold by the Seller. Such Contracts could include PO 00000 Frm 00017 Fmt 4701 Sfmt 4700 3549 those providing coverage for incurring diminished value. Another commenter noted that warranty products are also widely sold and reinsured outside the automotive space and often in the business-tobusiness environment, suggesting that this should be taken into account when drafting terminology in the final regulations related to consumer products and seller captive concepts. The description of the Consumer Coverage Exception and related definitions use generic terms intended to encompass a broad range of products and services, not limited to automotive products and services. Nonetheless, in response to this commenter’s apparent concern that the Consumer Coverage Exception as proposed may exclude arrangements ‘‘in the business to business environment,’’ the final regulations clarify that the term Seller includes a wholesaler that sells products or services to customers who purchase insurance contracts in connection with those products or services. Finally, one commenter asked that the final regulations apply prospectively to Seller’s Captives, meaning reporting would be required with respect to Seller’s Captives only for taxable years subsequent to the effective date of the final regulations, because otherwise a number of legitimate captives would be subjected to very burdensome information gathering, testing, and reporting for a very small amount of premium income per captive. The commenter suggested that changes such as a 50 percent commission threshold should be applied on a prospective basis only to provide notice to taxpayers. As discussed in the preamble to the proposed regulations, as a general matter, participation in Consumer Coverage Arrangements is neither a Micro-captive Listed Transaction nor a Micro-captive Transaction of Interest because the insured is not sufficiently related to the insurer or any reinsurer. The proposed regulations were not intended to change this, but nonetheless provide a potential exception for taxpayers considered to be participating in a reportable Consumer Coverage Arrangement. The clarifications and changes to the proposed regulations described in this part of the Summary of Comments and Explanation of Revisions are only intended to provide further reassurance that Consumer Coverage Arrangements generally do not give rise to a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest. Further, if the Consumer Coverage Exception for Seller’s Captives applied only to taxable E:\FR\FM\14JAR5.SGM 14JAR5 3550 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations years after the regulations are effective as suggested by the commenter, then the exception would not apply to otherwise open taxable years for which reporting would be required. This would disadvantage taxpayers who otherwise may have qualified for the Consumer Coverage Exception in open taxable years. Consequently, the final regulations do not adopt any changes in response to this comment. V. Comments and Changes Relating to Identification as Reportable Transactions and Reporting Requirements khammond on DSK9W7S144PROD with RULES5 A. Comments Relating to Safe Harbors From Identification as Reportable Transactions 1. Proposed Safe Harbors for Amended Returns A commenter requested a change to the proposed regulations that would allow taxpayers who file amended returns that remove tax benefits previously recognized from participation in the micro-captive transaction to not be designated as participating in a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest. Taxpayers who file amended returns after the due date, including extensions, are considered participants in the transaction if their transaction otherwise meets the description of a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest because their original return reflects the tax benefits of participation. In order for the IRS to obtain a complete picture of participation in these transactions, such taxpayers must file disclosures. However, a taxpayer whose timely-filed amended return is treated as the original return for the taxable year (that is, a superseding return) is not considered to have filed a return reflecting the tax benefits of participation in the transaction and would not be required to file disclosures under the final regulations. Further, whether amended returns determine participation is outside the scope of these regulations and the final regulations do not adopt any changes based on this request. Several commenters expressed concern that the proposed regulations would require taxpayers to amend returns for approximately three to four taxable years prior to the promulgation of these regulations as final regulations. The regulations do not require taxpayers to file an amended return or an Administrative Adjustment Request (AAR) for certain partnerships. The proposed regulations would require taxpayers whose transactions are VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 described in either § 1.6011–10(c) or § 1.6011–11(c) to file a disclosure statement in the form and manner prescribed by § 1.6011–4. The preamble to the proposed regulations acknowledged that because the IRS will take or may take a position that taxpayers are not entitled to the purported tax benefits, taxpayers who have filed tax returns taking such positions should consider filing an amended return or AAR. The preamble to the proposed regulations provided a method for filing such amended returns or AARs, if so desired. The final regulations do not adopt any changes pursuant to these comments. 2. Proposed Safe Harbors for Captives With Certain Features Commenters requested that the IRS clarify whether taxpayers who issue premium refunds or policyholder dividends to meet the Loss Ratio Factor will be designated as participating in a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest. As described more fully in part II. of this Summary of Comments and Explanation of Revisions, the Loss Ratio Factors compare the amount of liabilities incurred for insured losses and claim administration expenses to the premiums earned less policyholder dividends paid by the Captive, over the course of the defined Computation Periods. Thus, if a taxpayer issues premium refunds or policyholder dividends, either of which would reduce the amount to which liabilities for insured losses and claim administration expenses over the relevant Computation Period are compared, the relevant loss ratio for purposes of identification as a Microcaptive Listed Transaction or Microcaptive Transaction of Interest will be higher. Further, as described more fully in parts II.B. and III. of this Summary of Comments and Explanation of Revisions and as clarified in the bright-line rules of § 1.6011–10(e) of the final regulations, only taxpayers participating in a transaction that (1) involves a Captive that elects under section 831(b) to include in taxable income only taxable investment income (defined in section 834) in lieu of the tax imposed under section 831(a) (that is, to exclude premiums from taxable income) and (2) meets both the Financing Factor and the Loss Ratio Factor, will be designated as participating in a Micro-captive Listed Transaction under the final regulations. That is, if Captive’s loss ratio is 30 percent or more for the Listed Transaction Loss Ratio Computation Period, or if the Captive does not meet the Financing Factor, the transaction is PO 00000 Frm 00018 Fmt 4701 Sfmt 4700 not identified as a Micro-captive Listed Transaction. With respect to Microcaptive Transactions of Interest, if the taxpayer does not meet the Financing Factor, and has effectively lowered the percentage of premiums earned as compared to liabilities incurred for claims and administration by issuing policyholder dividends, the transaction is not identified as a Micro-captive Transaction of Interest under the final regulations. That is, if Captive’s loss ratio is 60 percent or more for the Transaction of Interest Loss Ratio Computation Period as set forth in § 1.6011–11(b)(2) and Captive has not made Captive’s capital available in a way that furthers the deferral of tax, the taxpayer is already not a participant in a Micro-captive Transaction of Interest. This is clarified in the final regulations setting forth the bright-line rules at § 1.6011–11(e). One commenter recommended that a transaction should not be designated as a Micro-captive Listed Transaction or Micro-captive Transaction of Interest if the Captive has paid claims in any amount, there is an annual rate and reserve study conducted by a qualified actuary, and there is commercial coverage available for the risks covered by the Captive. The commenter indicated that all of these factors together should be sufficient to demonstrate that a micro-captive transaction was not entered into for tax avoidance purposes. Several other commenters asserted that taxpayers who can demonstrate that the premiums charged in their transaction were actuarially determined by a credentialed actuary should not be designated as participating in a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest. Additional commenters suggested that the existence of a feasibility study prepared by a credentialed actuary, or a third-party transfer pricing memorandum certifying the transaction, would provide better metrics for identification as a listed transaction or transaction of interest, and transactions for which such feasibility studies or third-party transfer pricing memoranda have been prepared should not be designated as participating in a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest. With respect to proposed safe harbors involving claims, the Treasury Department and the IRS are aware of promoters encouraging the filing of claims under contracts that the parties treat as insurance contracts to establish the appearance of a legitimate insurance arrangement, regardless of business need. Because these transactions E:\FR\FM\14JAR5.SGM 14JAR5 khammond on DSK9W7S144PROD with RULES5 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations involve closely held related entities, there is little to no barrier to the manufacture of claims in these arrangements. Further, in many of the micro-captive cases tried to date, the handling of claims was atypical of valid insurance arrangements, with claims paid despite lacking in substantiation and under the direction of the Insured or its Owners without regard to the validity of the claim. See, e.g., Caylor, T.C. Memo. 2021–30, at *42–43; Keating, T.C. Memo. 2024–2, at *63–64. The existence of paid claims in any amount is therefore not a viable metric for distinguishing between transactions that are or may be tax avoidance transactions and those that are not. With respect to the involvement of an actuary or other professional in the transaction, as observed in Avrahami and discussed more fully at part II.E.1. of this Summary of Comments and Explanation of Revisions, such involvement does not establish that the arrangement is not, and does not have the potential to be, a tax avoidance transaction, and further is not dispositive of a valid transaction for Federal tax purposes. Similarly, with respect to Captives covering risks for which commercial coverage is available, the presence of such risks is not dispositive of the validity of a transaction. Many abusive micro-captive transactions involve purported risks that would be a typical insurance risk for another company but would be inappropriate for the Insured to purchase given the nature of the Insured’s business, such as construction coverage for an entity that ‘‘wasn’t constructing anything.’’ Avrahami, 149 T.C. at *196. In all micro-captive cases tried to date, courts have found the arrangement at issue not to be insurance for Federal tax purposes even though the factors identified by the commenters as appropriate for safe harbors were present—claims were paid; an actuary or other professional prepared pricing reports, feasibility studies, or the like in the transaction; and the captive covered some typical insurance-type risks. See Avrahami, 149 T.C. at *149–52, 167, 186–87, 195–97; Syzygy, T.C. Memo. 2019–34, at *15–17, 35, 44; Caylor, T.C. Memo. 2021–30, at *14, 19–23, 25–26, 48–49; Keating, T.C. Memo. 2024–2, at *14, 20–25, 30, 33, 35, 63–64; Swift, T.C. Memo. 2024–13, at *12, 15–17, 44; Patel, T.C. Memo. 2024–34, at *9, 14– 22, 29–30, 50–51; Royalty Mgmt., T.C. Memo. 2024–87, at *16–17, 21, 47; see also Reserve Mech., T.C. Memo. 2018– 86, at *9, 11–20, 47–48, 61. Accordingly, the final regulations provide no exclusion from identification VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 as a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest in response to these comments. One commenter argued that if the following facts are present, the transaction should be excepted from identification as either a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest: (a) 90 percent of the coverage written is coverage that is commercially available, (b) Insureds purchase or have purchased such coverage from commercial carriers in a similar amount to what is now purchased from the Captive, (c) the commercial carrier has credible loss experience for the types of coverage in the Insured’s location, and (d) commercial rates are used to extrapolate the Captive’s premiums, taking into account the Captive’s expenses and layers written. As discussed in this part V.A.2. of the Summary of Comments and Explanation of Revisions, the coverage of risks for which commercial coverage is available does not guarantee the validity of the transaction. The Tax Court has held multiple arrangements did not qualify as insurance arrangements for Federal tax purposes despite purporting to cover such risks. See, e.g., Avrahami, 149 T.C. at 150, 153–56, 159, 197 (administrative actions and employee fidelity); Keating, T.C. Memo. 2024–2, at *20–27, 64 (workers’ compensation); Swift, T.C. Memo. 2024–13, at *7–8, 12, 14–15, 44 (medical malpractice and terrorism); Patel, T.C. Memo. 2024–34, at *15–20, 51 (business interruption and regulatory). Further, Insureds’ purchase of such coverage from commercial carriers in a similar amount to what is now purchased from the Captive does not guarantee the validity of the transaction. The availability of commercial coverage may indicate a lack of a business need for captive coverage. See, e.g., Keating, T.C. Memo. 2024–2, at *59–60 (petitioners provided no credible evidence of a business need for captive coverage in light of comprehensive commercial coverage). Additionally, the commenter did not clarify whether the purchase of coverage from commercial carriers in a similar amount to what is now purchased from the Captive would include duplicative coverage, coverage of different layers of risk, or both. The commenter did not specify what commercial markets or rates are relevant nor what constitutes a ‘‘similar amount’’ or a ‘‘credible loss experience’’ sufficient to exempt the participant’s identification under these regulations. Nor did the commenter explain how the experience of a commercial insurer would be known to the participants in the micro-captive PO 00000 Frm 00019 Fmt 4701 Sfmt 4700 3551 transaction. The suggested factors are too subjective and complex to be administrable, and sufficient relief is afforded by the changes to the Loss Ratio Factors described in parts II.B. and II.C. of this Summary of Comments and Explanation of Revisions. One commenter recommended that transactions with Captives that have been rated highly by an independent third-party credit or rating agency specializing in insurance should not be designated as a Micro-captive Listed Transaction or Micro-captive Transaction of Interest. In general, such agencies rate the financial strength of Captives, that is, the ability to pay claims should they arise. Thus, their ratings are not informative regarding the nature of an entity or a transaction for Federal tax purposes. This recommendation is not adopted in the final regulations. A commenter suggested that transactions with Captives that are licensed or domiciled in a jurisdiction that regulates many Captives should not be designated as a Micro-captive Listed Transaction or Micro-captive Transaction of Interest. The commenter also suggested that taxpayers whose Captive uses template insurance policies accepted by the State regulator, or whose Captive offers coverage that has been accepted as adequate proof of insurance by other State or Federal agencies, should not be designated as a Micro-captive Listed Transaction or Micro-captive Transaction of Interest. Another commenter recommended a broader exception for all State-licensed domestic captives. However, whether a captive is regulated in a given domicile does not determine whether a transaction is abusive or has the potential for abuse for Federal tax purposes. See, e.g., Avrahami, 149 T.C. at 192 (captive regulated in St. Kitts); Syzygy, T.C. Memo. 2019–34, at *38 (captive regulated in Delaware); Caylor, T.C. Memo. 2021–30, at *41 (captive regulated in Anguilla); Keating, T.C. Memo. 2024–2, at *53 (captive regulated in Anguilla); Swift, T.C. Memo. 2024– 13, at *37 (captive regulated in St. Kitts); Patel, T.C. Memo. 2024–34, at *46 (captives regulated in St. Kitts and Tennessee, respectively); cf. Royalty Mgmt., T.C. Memo. 2024–87, at *43–44 (no regulatory oversight in Tribal domicile). As each micro-captive case describes, whether a company is organized and regulated as an insurance company is not the end of the inquiry, as courts ‘‘must look beyond the formalities and consider the realities of the purported insurance transaction.’’ Hospital Corp. of Am. v. Commissioner, E:\FR\FM\14JAR5.SGM 14JAR5 3552 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations khammond on DSK9W7S144PROD with RULES5 T.C. Memo. 1997–482, 1997 WL 663283, at *24 (citing Malone & Hyde, Inc. v. Commissioner, 62 F.3d 835, 842–43 (6th Cir. 1995)). In the micro-captive transactions identified as transactions that are or may be tax avoidance transactions, the realities of the purported insurance transaction, including the closely held nature of the arrangement, the section 831(b) election, and the use of premiums primarily for investment or related-party financing (rather than to pay losses) indicate tax avoidance or the potential for tax avoidance. Further, a safe harbor identifying a specific domicile or specific domiciles would require the IRS to evaluate the manner in which the respective domicile regulates insurance, which would be administratively burdensome and inject uncertainty. Accordingly, the final regulations do not adopt these suggestions. A commenter indicated that taxpayers whose Captive covers risks with a specified number of Insureds or risk units, or pools risk with a specified distribution of the risk of loss, should not be designated as participating in a Micro-captive Listed Transaction or Micro-captive Transaction of Interest. However, these aforementioned factors only relate to the degree to which a transaction distributes risk. Risk distribution is just one of the four prongs used by the courts in determining whether an arrangement qualifies as insurance for Federal tax purposes and does not alone establish that a transaction has no potential for tax avoidance. See part I. of the Background section of this Preamble for further explanation of the four-prong test. The final regulations do not adopt these suggestions. 3. Captives Providing Certain Types of Coverage or Serving Certain Industries Other commenters suggested that taxpayers who can demonstrate that the Captive directly or indirectly reinsures contracts issued by a commercial carrier should not be designated as participants in a Micro-captive Listed Transaction or Micro-captive Transaction of Interest. The final regulations do not adopt this suggestion. First, as discussed in part V.A.2. of this Summary of Comments and Explanation of Revisions, the involvement of commercially covered risks in the transaction does not guarantee the validity of the transaction. The commenter did not specify what commercial carriers are relevant nor what portion of reinsurance would be sufficiently significant to exempt the participants from identification under these regulations. Second, if the entirety of a captive’s business is the reinsurance VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 of a commercially rated program, it is less likely that the transaction would be described by these regulations, as the individuals or entities insured would not be sufficiently related to the captive to meet the 20 Percent Relationship Test. Accordingly, a safe harbor based on a Captive’s direct or indirect reinsurance of contracts issued by a commercial carrier is not appropriate. A commenter recommended that taxpayers who operate as risk retention groups pursuant to the Federal Liability Risk Retention Act (FLRRA), 15 U.S.C. 3901, et. seq., should not be designated as participating in a Micro-captive Listed Transaction or Micro-captive Transaction of Interest because the FLRRA establishes that a risk retention group licensed in one State can transact business as an insurance company in every State, and the IRS does not have the authority to repeal the FLRRA. A risk retention group is ‘‘a group-owned insurer organized for the purpose of assuming and spreading the liability risks to its members.’’ NAIC Glossary of Insurance Terms, https://content. naic.org/glossary-insurance-terms (last visited Jan. 6, 2025). Risk retention groups formed pursuant to the FLRRA are unlikely to be described by the proposed regulations as they would have too many member-owners to satisfy the 20 Percent Relationship Test. Further, the proposed regulations do not repeal the FLRRA. By identifying certain micro-captive transactions as reportable transactions, the proposed regulations impose disclosure requirements and provide notice that the tax treatment of the transactions will or may be challenged by the IRS. They do not in any way prevent any taxpayer from transacting business as an insurance company. The final regulations do not adopt this recommendation. Commenters expressed concern that community banks in particular will be negatively impacted by the proposed regulations to the detriment of their communities. Commenters recommended that community banks as a whole be exempted from identification as a Micro-captive Listed Transaction. Regardless of the industry, taxpayers engaged in transactions identified as listed transactions or transactions of interest in the final regulations must disclose such participation. There is no one industry whose constituents should be categorically exempted from identification as a Micro-captive Listed Transaction or as a Micro-captive Transaction of Interest. Adverse impacts to individual taxpayers or specific industries consequent to implementation of these regulations are PO 00000 Frm 00020 Fmt 4701 Sfmt 4700 limited to disclosure and recordkeeping requirements and are outweighed by the public interest in sound tax administration. Accordingly, the final regulations do not adopt any changes in response to this concern. A commenter argued for an exception for any micro-captive that ‘‘writes ‘deductible reimbursement’ policies for the deductible or self-insured retention (‘SIR’) layer(s) underlying policies issued by Licensed Insurers and uses comparable rates taking into account the layer written and [the] micro-captive’s expenses.’’ The commenter did not provide any additional explanation, including why such an exception was appropriate. To the extent a transaction involving a Captive writing such policies otherwise falls within the description of Micro-Captive Listed Transaction or Micro-Captive Transaction of Interest, the transaction remains one that is or may be a tax avoidance transaction. The final regulations do not adopt any changes based on this comment. B. Comments Relating to Reporting Required Under Proposed §§ 1.6011– 10(g) and 1.6011–11(g), Pursuant to § 1.6011–4(d) and (e) With respect to Micro-captive Listed Transactions, proposed § 1.6011–10(g) would provide that participants must disclose their participation in the transaction pursuant to § 1.6011–4(d) and (e). Similarly, with respect to Micro-captive Transactions of Interest, proposed § 1.6011–11(g) would provide that participants must disclose their participation in the transaction pursuant to § 1.6011–4(d) and (e). Section 1.6011–4(d) and (e) provides that the disclosure statement—Form 8886 (or successor form)—must be attached to the taxpayer’s tax return for each taxable year for which a taxpayer participates in a reportable transaction. A copy of the disclosure statement must be sent to the OTSA at the same time that any disclosure statement is first filed by the taxpayer pertaining to a particular reportable transaction. Section 1.6011–4(e)(2)(i) provides that if a transaction becomes a listed transaction or a transaction of interest after the filing of a taxpayer’s tax return reflecting the taxpayer’s participation in the transaction and before the end of the period of limitations for assessment for any taxable year in which the taxpayer participated in the transaction, then a disclosure statement must be filed with the OTSA within 90 calendar days after the date on which the transaction becomes a listed transaction or transaction of interest. This requirement extends to an amended return and exists E:\FR\FM\14JAR5.SGM 14JAR5 khammond on DSK9W7S144PROD with RULES5 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations regardless of whether the taxpayer participated in the transaction in the year the transaction became a listed transaction or transaction of interest. Proposed §§ 1.6011–10(g)(2) and 1.6011–11(g)(2) would provide relief from disclosure for participants in Micro-captive Listed Transactions and Micro-captive Transactions of Interest, respectively, who have finalized settlement agreements with the IRS with respect to the transaction. Such taxpayers do not need to disclose their participation in the transaction for years covered by the settlement agreement. Proposed § 1.6011–11(g)(2) provides similar relief for participants in a Microcaptive Transaction of Interest who disclosed their participation in the transaction under Notice 2016–66 and file no more returns reflecting participation in the transaction after the final regulations are finalized. One commenter expressed concern that settlements in litigation are not covered by the disclosure relief for taxpayers who have finalized settlement agreements that would be provided in proposed §§ 1.6011–10(g)(2) and 1.6011–11(g)(2). This provision in the proposed regulations is intended to cover settlement agreements with respect to the transaction reached in litigation or during the course of examination. The final regulations clarify this provision by explicitly referencing litigation. See §§ 1.6011– 10(h)(2) and 1.6011–11(h)(2) of the final regulations. Another commenter argued that excusing taxpayers from filing disclosure statements if they have finalized a settlement agreement with the IRS is an illusory reporting exemption because the IRS effectively requires Captives to wind up and liquidate as part of certain private settlement agreements. However, if this provision was removed from the regulations, taxpayers who had conclusively settled taxable years under audit that would otherwise be subject to the reporting requirements in the regulations would be forced to disclose for those years. It may not be clear that such disclosure would be unnecessary and, accordingly, the final regulations retain the exception. One commenter stated that reporting more than once is unjust to taxpayers and suggested that Form 8886 should only have to be filed with the IRS once with respect to each Micro-captive Listed Transaction or Micro-captive Transaction of Interest. Consistent with § 1.6011–4, participation in a listed transaction that involves a purported insurance arrangement means that the taxpayer is claiming tax benefits each VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 year to which the taxpayer is not entitled. Similarly, participation in a transaction of interest that involves a purported insurance arrangement means that the taxpayer may be claiming tax benefits each year to which the taxpayer may not be entitled (that is, the IRS needs more information to determine whether the transaction is a tax avoidance transaction). As discussed in part I.C. of this Summary of Comments and Explanation of Revisions, the reporting rules for listed transactions and transactions of interest under § 1.6011–4 are outside the scope of these final regulations. The final regulations do not adopt any changes based on this comment; taxpayers must disclose their participation for each year in which such tax benefits are claimed unless otherwise relieved of the obligation in the regulations. A commenter requested an expansion of the proposed safe harbors set forth at §§ 1.6011–10(e)(2) and 1.6011–11(e)(2) (‘‘Disclosure Safe Harbor for Owners’’), which provide that an Owner of an Insured is not required under § 1.6011– 4 to file a disclosure statement with respect to a Micro-captive Listed Transaction or Micro-captive Transaction of Interest provided that person receives written or electronic acknowledgment that Insured has or will comply with its separate disclosure obligation under § 1.6011–4(a) with respect to the transaction. The preamble to the proposed regulations explained that the receipt of an acknowledgment that Insured has or will comply with its disclosure obligation does not relieve the Owners of Insured of their disclosure obligations if Insured fails to disclose the transaction in a timely manner. The commenter requested that an Owner that relies on an acknowledgement pursuant to this safe harbor should be allowed to rely solely on the acknowledgement and should not also need to confirm that the Insured actually timely disclosed the transaction. However, such a position could result in non-filing by both an Owner and the Insured. To ensure that Insureds file, or Owners file if the Insured fails to do so, the final regulations do not adopt this recommendation. Commenters also requested that the final regulations expand the Disclosure Safe Harbor for Owners to all Insured entities for transactions in which the Captive entity reported, or to all Captive entities for transactions in which the Insured reported. The final regulations do not adopt this request because unlike Owners, who must only disclose the information required by § 1.6011– 10(g)(1), Captives and Insureds must PO 00000 Frm 00021 Fmt 4701 Sfmt 4700 3553 also provide the information required by § 1.6011–10(g)(2) and (3), respectively. See §§ 1.6011–10(g) and 1.6011–11(g) of the final regulations. Commenters suggested that transactions for which disclosure statements were filed under Notice 2016–66 should not be required to report under the proposed regulations. Proposed §§ 1.6011–10(g)(2) and 1.6011–11(g)(2) already limit the disclosure requirements to taxpayers who have filed a tax return (including an amended return) reflecting their participation in a Micro-captive Listed Transaction or Micro-Captive Transaction of Interest prior to January 14, 2025, and who have not finalized a settlement agreement with the IRS with respect to the transaction. Additionally, proposed § 1.6011–11(g)(2) already provides that taxpayers who have filed a disclosure statement regarding their participation in a transaction identified by the proposed regulations as a Microcaptive Transaction of Interest with the OTSA pursuant to Notice 2016–66, will be treated as having made the disclosure pursuant to the final regulations for the taxable years for which the taxpayer filed returns before the January 14, 2025. Similar relief should not be extended with respect to any transaction identified by the proposed regulations as a Micro-captive Listed Transaction because disclosure statements filed under Notice 2016–66 do not identify participation in a listed transaction. The final regulations do not adopt any changes based on this comment. One commenter stated that the requirement that taxpayers participating in transactions that become listed transactions under the proposed regulations must file again under the final regulations, even if they already filed Forms 8886 pursuant to Notice 2016–66, is duplicative and a waste of taxpayers’ time because the IRS already has most of the necessary information about these transactions, and there is little marginal value to the IRS in obtaining another round of filings. The commenter suggested that there is no justification for this other than a transparent effort by the Treasury Department and the IRS to extend the applicable statute of limitations period under section 6501(c)(10) unilaterally for years where the limitations period has expired or is about to (such as 2021, for instance) and that requiring material advisors to file Forms 8918 with the OTSA, again irrespective of whether they previously filed under Notice 2016–66, is similarly unnecessary. The commenter asserts that both these duplicate filing requirements run contrary to the Paperwork Reduction E:\FR\FM\14JAR5.SGM 14JAR5 khammond on DSK9W7S144PROD with RULES5 3554 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations Act (44 U.S.C. 3507(c)) and are themselves abusive. This additional disclosure for listed transactions is needed because Notice 2016–66 only identified transactions of interest, so disclosure pursuant to Notice 2016–66 does not disclose that a transaction meets the threshold for listed transactions under the proposed regulations. Further, for Micro-captive Transactions of Interest, there are differences between the proposed regulations and Notice 2016–66 in both the scope of transactions identified and the information required to be disclosed. The final regulations also significantly narrow the scope of transactions identified as Micro-captive Listed Transactions compared to the proposed regulations, as further discussed in part II. of this Summary of Comments and Explanation of Revisions. Accordingly, disclosure under the final regulations will provide the IRS with new information, including identifying transactions that are now listed, and will not create unnecessary duplicative reporting requirements. The final regulations do not adopt any changes based on this comment. Commenters asserted that the requirement in § 1.6011–4(e)(2)(i) (to report to the OTSA) is unfair because it will require some taxpayers who were already subject to audits that closed without adjustment (to Captive) to report under this provision. Similarly, other commenters suggested that taxpayers who are under examination should not have to disclose because the IRS will have access to detailed taxpayer records through the examination process and should not need Form 8886 disclosures to identify participation in the transaction. The Form 8886 disclosure statements to the OTSA and the IRS are necessary, even if a taxpayer is in examination for the reporting year or was examined in an earlier year. While the IRS endeavors to resolve all tax issues in a given examination, examination may be specific to a given issue or return that does not clearly address the tax benefits of participating in a Micro-captive Listed Transaction or a Micro-captive Transaction of interest. The final regulations do not adopt these suggested changes. A commenter requested that taxpayers who are commercial insurers acting as Intermediaries (as defined in proposed § 1.6011–10(b)(5)) and material advisors to such commercial insurers be excepted from reporting because commercial insurers ceding risks to a reinsurer need to be certain that the reinsurer will satisfy its financial obligations to the ceding company, a VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 need that is generally met by requiring that the reinsurer provide security. With security in place, the commenter states that there is no business reason for the ceding company to investigate the reinsurer’s ownership, tax status, overall loss ratio (including any other business the reinsurer may write), or financing practices. The final regulations do not adopt this suggestion. Commercial insurers acting as Intermediaries should know as part of their due diligence the nature of the entity with which they have contracted. The material advisors to such commercial insurers, similarly, should know as part of their due diligence the nature of the transaction about which they are providing advice. Also, as a general matter, the most likely type of micro-captive transaction involving a commercial insurer is a Consumer Coverage Arrangement. The final regulations have significantly broadened the reporting exception set forth in the proposed regulations for Consumer Coverage Arrangements to eliminate their possible identification as a Micro-captive Listed Transaction, as discussed more fully at part IV. of this Summary of Comments and Explanation of Revisions, which should afford sufficient relief to commercial insurers acting as Intermediaries. VI. Other Comments and Requested Changes to the Proposed Regulations In addition to comments on the authority of the Treasury Department and the IRS to issue the proposed regulations, specific comments on the Loss Ratio Factor and the Financing Factor, comments on the Consumer Coverage Exception, and comments seeking safe harbors from identification as or disclosure of a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest, commenters expressed additional concerns, sought clarification, and recommended additional changes to the proposed regulations. A. Request for Clarification Regarding Effect on Cannabis Businesses One commenter stated that because the sale of cannabis constitutes ‘‘trafficking in controlled substances’’ under section 280E, cannabis businesses may not claim deductions for amounts paid or incurred during the taxable year, including amounts paid for insurance premiums. The commenter asked for guidance on how the proposed regulations will impact the cannabis industry. A cannabis business that enters into a Contract with a Captive would be an Insured under the proposed regulations if it treats amounts paid under the Contract as insurance PO 00000 Frm 00022 Fmt 4701 Sfmt 4700 premiums for Federal income tax purposes, even if it cannot deduct such amounts. Accordingly, a transaction between a cannabis business and Captive may meet the definition of a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest under the proposed regulations. Any taxpayer engaged in such a transaction would be subject to the disclosure requirements set forth in the proposed regulations, except as otherwise provided therein, if their returns reflect the tax consequences of participation in the transaction. The tax return of an Insured that cannot deduct an amount paid or incurred for purported insurance payments by operation of section 280E is not likely to reflect the tax consequences of participation in a Micro-captive Listed Transaction or Micro-captive Transaction of Interest, and therefore, the Insured will likely not be a ‘‘participant’’ in the transaction under these regulations. However, others involved in the transaction, such as Captive, which generally will exclude amounts received as premiums from income based on the position that it is an insurance company, would therefore reflect the tax consequences of participation in their returns, and may nonetheless be considered ‘‘participants’’ subject to the disclosure requirements set forth in these regulations. B. Comments Regarding the 20 Percent Relationship Test Some commenters suggested that the 20 Percent Relationship Test set forth in proposed § 1.6011–10(b)(1)(iii) and incorporated in proposed § 1.6011– 11(b)(1) is inconsistent with the diversification requirements of section 831(b)(2)(B) as enacted pursuant to the PATH Act. One part of the PATH Act diversification requirements is based on the percentage of premiums from related insureds, requiring that no more than 20 percent of net written premiums (or if greater, direct written premiums) for a taxable year is attributable to any one policyholder. The other part is based on the relative concentration of ownership in an insurance company and its policyholders. An insurance company must meet one of the PATH Act diversification requirements to make a section 831(b) election. However, the PATH Act diversification requirements are not sufficient to eliminate the possibility that a transaction is or may be a tax avoidance transaction. The final regulations describe fact patterns that strongly indicate tax avoidance or the potential for tax avoidance by entities that make a section 831(b) election and share a concentration in ownership with E:\FR\FM\14JAR5.SGM 14JAR5 khammond on DSK9W7S144PROD with RULES5 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations any policyholder that exceeds the 20 Percent Relationship Test. The final regulations do not adopt any changes based on these comments. Another commenter requested clarification regarding what kinds of derivatives will cause a taxpayer to meet the 20 Percent Relationship Test. The commenter expressed concern that as risk management vehicles, derivatives are not comparable to ownership of an entity through stock. To be clear, any derivative that is derived from a direct or indirect interest in the assets held by the Captive or the Captive’s stock is included in the definition of Owner for the Captive. Any derivative that is derived from a direct or indirect interest in the assets held by the Insured or the Insured’s stock is included in the definition of Owner for the Insured. While the commenter asserted that derivatives are generally used for risk management, the Treasury Department and the IRS are aware of promoters of abusive micro-captive transactions using derivatives to replicate ownership interests, specifically in response to Notice 2016–66. For example, a taxpayer may enter into a derivative contract such as a tracking stock warrant with respect to a Captive’s stock. Such a contract would lack the voting rights or equity interest considered ownership under Notice 2016–66, but the taxpayer is provided with the same or similar economic benefits as owning the Captive directly through its eligibility to exercise the warrant to obtain one or more shares in the Captive. The final regulations do not adopt any changes based on this comment. One commenter argued that the 20 Percent Relationship Test is contrary to the micro-captive concept, asserting that micro-captives are typically structured with a single owner, who has a single business, that is also the sole policyholder of the micro-captive. The commenter appeared to suggest that section 831(b) was intended specifically for the benefit of such micro-captives, but this is not consistent with the history of section 831(b). Section 831(b) arose out of tax laws specific to certain small and mutual insurers, which are traditionally held by their members in a given geographical location ‘‘solely for the protection of their own property and not for profit.’’ Revenue Act of 1914, Public Law 63–217, 38 Stat. 745, 762. These small insurers, including groups of farmers and fire associations, were exempt from ordinary income tax laws and were understood to collect funds only up to what was needed for losses and expenses. See H.R. Rep. No. 69–1, at 9 (1925). Under the current Code, these and other types of small insurers VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 use section 831(b) to exclude premiums from taxable income. Accordingly, while the Code does contemplate small insurers, such contemplation is not specific to a single captive covering a sole policyholder. The inclusion of the 20 Percent Relationship Test in the proposed regulations was intended to exclude entities such as the mutual insurers, which are more likely to have diversified ownership and thus have significantly reduced potential for tax avoidance. The final regulations do not adopt any changes based on this comment. C. Recommendations To Eliminate or Delay Some or All of the Proposed Regulations Commenters recommended that the proposed regulations identifying MicroCaptive Listed Transactions should not be finalized. Commenters noted that captive transactions can differ significantly from one transaction to the next and because the test for whether a transaction is insurance for Federal tax purposes is a totality of the circumstances inquiry, it is unreasonable to designate any category of transactions as transactions known to be abusive. The final regulations do not adopt this recommendation. However, the final regulations significantly narrow the scope of § 1.6011–10 to decrease the likelihood that transactions that are not tax avoidance transactions are identified as listed transactions. As commenters noted, the IRS has received information on micro-captive transactions, whether in response to Notice 2016–66 or as part of examinations or litigation, for many years. The IRS is confident from its review of examinations and case law that the fact pattern described in the final regulations is a fact pattern that consistently gives rise to tax avoidance. Commenters recommended that finalization of these regulations be postponed until a decision is reached in Loper Bright Enterprises v. Raimondo, Sup. Ct. Dkt. No. 22–451 (certiorari granted on the question of ‘‘[w]hether the Court should overrule Chevron or at least clarify that statutory silence concerning controversial powers expressly but narrowly granted elsewhere in the statute does not constitute an ambiguity requiring deference to the agency’’). The Supreme Court issued its decision in this case on June 28, 2024, and as such, this recommendation is moot. Loper Bright Enterprises v. Raimondo, 144 S.Ct. 2244 (2024). Further, as described more fully in the Authority section of this preamble, sections 6011 and 7805(a) provide express delegations of authority PO 00000 Frm 00023 Fmt 4701 Sfmt 4700 3555 to the Secretary to identify the form and manner of taxpayer filing requirements and make rules, respectively. Section 6707A provides an express delegation of authority to identify reportable transactions. The final regulations do not adopt any changes based on these comments. Commenters recommended modification of Form 1120–PC, U.S. Property and Casualty Insurance Company Tax Return, to capture the information required to be reported by Captives in the proposed regulations, in lieu of finalizing the proposed regulations. This recommendation was not adopted for the reasons explained in the preamble to the proposed regulations. Changes to the Form 1120– PC would at a minimum impact all nonlife insurance companies that make section 831(b) elections, not only participants in the micro-captive transactions described in these regulations. Some of the requested information is not readily available from filed Forms 1120–PC, such as the descriptions of the types of coverages provided by a Captive and the name and contact information of any actuary or underwriter who assisted Captive in the determination of amounts treated as premiums. Additionally, limiting the collection of information to only those entities filing the Form 1120–PC would be insufficient to gather relevant information, including information regarding Insureds and promoters of the transactions. Reporting for the specific transactions identified in these regulations is best captured in the manner of all reportable transactions, by requiring disclosure on Form 8886, for consistency in enforcement of the reportable transaction regime. Commenters expressed concern that the IRS should have sufficient information on micro-captives in the responses filed to Notice 2016–66 and thus the regulations are not needed. Commenters stated the IRS should not require any further reporting. As commenters also noted, the IRS has received information on micro-captive transactions for several years. The IRS is confident from its review of examinations and case law that the fact pattern described in the regulations is a fact pattern that consistently gives rise to tax avoidance or otherwise potentially gives rise to tax avoidance. However, promoters continue to promote participation in these transactions, and the IRS is aware of new entrants to these transactions. Thus, despite information collected to date, the IRS needs to continue collecting information to identify who the participants are and the nature of E:\FR\FM\14JAR5.SGM 14JAR5 3556 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations khammond on DSK9W7S144PROD with RULES5 their transactions. The final regulations do not adopt any changes based on these comments. Commenters recommended that the proposed regulations be withdrawn in their entirety and that guidance be issued instead on what would make a micro-captive arrangement an insurance arrangement for Federal tax purposes in the IRS’s estimation. As the Tax Court explained in Syzygy, ‘‘[a]n inherent requirement for a company to make a valid section 831(b) election is that it must transact in insurance.’’ T.C. Memo. 2019–34, at *28; see also Reserve Mech., 34 F.4th at 904. Like any insurance transaction, a valid micro-captive arrangement for Federal tax purposes is one that meets the four-prong test of insurance as detailed by the courts in a significant body of case law. See Le Gierse, 312 U.S. at 539; see also Avrahami, 149 T.C. at 181 (citing RentA-Center, 142 T.C. at 13–14) (additional citations omitted); Syzygy, T.C. Memo. 2019–34, at *29; Caylor, T.C. Memo. 2021–30, at *31–32; Keating, T.C. Memo. 2024–2, at *51–52; Swift, T.C. Memo. 2024–13, at *27; Patel, T.C. Memo. 2024–34, at *37–38; Royalty Mgmt., T.C. Memo. 2024–87, at *35. The IRS has issued guidance regarding what makes a captive insurance arrangement an insurance arrangement for Federal tax purposes that is applicable to all insurance companies, including those making section 831(b) elections. See, e.g., Rev. Rul. 2002–89, 2002–2 C.B. 984; Rev. Rul. 2002–90, 2002–2 C.B. 985; Rev. Rul. 2002–91, 2002–2 C.B. 991; Rev. Rul. 2005–40, 2005–2 C.B. 4; Rev. Rul. 2007–47, 2007–2 C.B. 127; Rev. Rul. 2008–8, 2008–1 C.B. 340; and Rev. Rul. 2009–26, 2009–38 I.R.B. 366. Nonetheless, in many micro-captive transactions, the manner in which the contracts are interpreted, administered, and applied is inconsistent with arm’s length transactions, actuarial standards, and sound business practices. The captive typically does not behave as an insurance company commonly would, indicating that the captive is not issuing insurance contracts and the transaction does not constitute insurance for Federal tax purposes. The final regulations therefore do not adopt any changes based on these comments. D. Requests for Clarification Regarding Revoked or Inapplicable Section 831(b) Elections Commenters requested clarification whether reporting is still required for years in which a Captive’s section 831(b) election has been revoked or is otherwise inapplicable for a given taxable year. Under section 831(b)(2)(A), a section 831(b) election, once made, VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 may be revoked only with the consent of the Secretary. Once an election is made, the alternative tax under section 831(b) applies only if the net written premiums (or, if greater, the direct written premiums) for the taxable year do not exceed the threshold set forth in section 831(b)(2)(A)(i) (as adjusted for inflation) and if the electing entity meets the diversification requirements set forth in section 831(b)(2)(B), for that taxable year. Under proposed §§ 1.6011–10(b)(1)(i) and 1.6011–11(b)(1), an entity would be a Captive only if it elects under section 831(b) to exclude premiums from taxable income. Under proposed §§ 1.6011–10(a) and 1.6011–11(a), a transaction would be a Micro-Captive Listed Transaction or Micro-captive Transaction of Interest only if it involves a Captive. Separately, pursuant to § 1.6011–4(a), the disclosure requirements for reportable transactions apply to a taxpayer that is a participant in a reportable transaction for taxable years in which the taxpayer’s filed return reflects the tax consequences of participation in the transaction, as set forth in § 1.6011–4(c)(3)(i)(A). An entity that revokes its section 831(b) election would not be a Captive under the proposed regulations beginning in the year of revocation. Similarly, for taxable years after a Captive has filed its final return, it has effectively revoked its section 831(b) election. See § 1.6011–10(b)(1)(i); but see §§ 1.6011–10(b)(2)(iv) and 1.6011– 11(b)(2)(iii) (regarding successor corporations). Accordingly, for taxable years in which a Captive’s section 831(b) election has been revoked or the Captive has previously filed its final return, the arrangement generally is not a Micro-Captive Listed Transaction or Micro-Captive Transaction of Interest under the proposed regulations in that taxable year. However, if the alternative tax under section 831(b) is inapplicable (either because premiums exceed the threshold or the entity fails the diversification requirements set forth in section 831(b)(2)(B) for that year), because the section 831(b) election remains in effect, the entity may still be a Captive under the proposed regulations. Thus, in taxable years in which a Captive’s section 831(b) election is inapplicable but has not been revoked, and the arrangement is otherwise described in the regulations, the arrangement would still be a Micro-Captive Listed Transaction or Micro-Captive Transaction of Interest under the proposed regulations. The potential of using of the section 831(b) election for tax avoidance is not eliminated until the PO 00000 Frm 00024 Fmt 4701 Sfmt 4700 election is revoked. Taxpayers must disclose the transaction in such years if their returns reflect the tax consequences of participation. The effect of revocation or inapplicability of the section 831(b) election, as described with respect to the proposed regulations, is retained in the final regulations. However, in the interest of limiting the reporting required by these regulations, the final regulations provide transition relief for section 831(b) revocations. Specifically, if the Captive in a transaction identified as a Micro-captive Listed Transaction or Micro-captive Transaction of Interest in §§ 1.6011–10(a) and 1.6011–11(a) of the final regulations requests the Secretary’s consent to revoke its section 831(b) election on or before the date by which the participants’ disclosures must be filed with the OTSA, the transaction will not be identified as a Micro-captive Listed Transaction or Micro-captive Transaction of Interest for taxable years ending before January 1, 2026, pursuant to §§ 1.6011–10(h)(1) and 1.6011– 11(h)(1). Additionally, the final regulations provide certainty regarding the disclosure obligations of taxpayers who have participated in a Micro-captive Listed Transaction or Micro-captive Transaction of Interest involving a Captive that has subsequently revoked its section 831(b) election and therefore ceased to be a Captive. With respect to taxable years in which the section 831(b) revocation is effective, §§ 1.6011– 10(f)(3) and 1.6011–11(f)(3) of the final regulations provide taxpayers involved in the transaction with a safe harbor from identification as participants in that transaction. Commenters also requested a streamlined method by which taxpayers could obtain the Secretary’s consent to revoke section 831(b) elections. Currently, consent is obtained through the private letter ruling procedures, published annually. See, e.g., Rev. Proc. 2024–1, 2024–1 I.R.B. 1. The IRS intends to issue a Revenue Procedure that describes a simplified process for revocation of section 831(b) elections. E. Request for Clarification Regarding the Definition of Intermediary A commenter requested clarification on whether the defined term ‘‘Intermediary,’’ as described in proposed §§ 1.6011–10(b)(5) and 1.6011–11(b)(5), includes fronting companies. Generally, ‘‘fronting’’ is ‘‘an arrangement in which a primary insurer acts as the insurer of record by issuing a policy, but then passes the entire risk to a reinsurer in exchange for a commission. Often, the fronting insurer E:\FR\FM\14JAR5.SGM 14JAR5 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations is licensed to do business in a state or country where the risk is located, but the reinsurer is not.’’ NAIC Glossary of Insurance Terms, https://content. naic.org/glossary-insurance-terms (last visited Jan. 6, 2025). The term ‘‘Intermediary’’ as defined in the proposed regulations means an entity that issues Contracts to an Insured, which are then reinsured, directly or indirectly, by a Captive. A ‘‘fronting’’ company would fall within the definition of ‘‘Intermediary’’ if it issues Contracts to an Insured, which are then reinsured, directly or indirectly, by a Captive. khammond on DSK9W7S144PROD with RULES5 F. Recommendation To Limit the Effective Period of Section 831(b) Elections for Companies That Do Not Meet Loss Ratio Threshold A commenter recommended that no loss ratio factor apply for the first five years of a section 831(b) election, after which any entity that elected the alternative tax under section 831(b) would automatically revert to an entity taxable under section 831(a) unless it meets a loss ratio threshold. The commenter did not specify what an appropriate loss ratio threshold would be, but implied that the loss ratio threshold should be lower than the Loss Ratio Factor percentages set forth in the proposed regulations. An automatic conversion to a taxable insurance company under section 831(a) would be inconsistent with the statutory language of section 831(b). Valid insurers who rely on the section 831(b) election would be impermissibly harmed by this recommendation. To the extent the commenter intended to recommend a five-year grace period from formation of a Captive to identification as either a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest, this could enable participants in micro-captive arrangements that are or may be tax avoidance transactions to permanently avoid reporting that would otherwise be required by, for instance, setting up a new Captive every five years. The final regulations do not adopt any changes based on this comment. G. Comments Regarding Constitutionality of Potential Adjustments if Transaction Examined Commenters expressed concern that the potential adjustments applicable to abusive transactions, as described in the preamble to the proposed regulations, are unconstitutional as double tax. Specifically, the preamble to the proposed regulations noted that examinations may result in adjustments including full disallowance of claimed VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 micro-captive insurance premium deductions and the inclusion in income of amounts received by the Captive. These adjustments are consistent with the adjustments sustained against taxpayers in the relevant micro-captive court cases. See Avrahami, 149 T.C. at 199 (disallowed premium deductions), Syzygy, T.C. Memo. 2019–34, at *45–46 (disallowed premium deductions and required income inclusion by the Captive), Caylor, T.C. Memo. 2021–30, at *48–53 (disallowed premium deductions and penalties); Keating, T.C. Memo. 2024–2, at *65–66, 77 (disallowed premium deductions and penalties); Swift, T.C. Memo. 2024–13, at *44–50 (disallowed premium deductions and penalties); Patel, T.C. Memo. 2024–34, at *52 (disallowed premium deductions), and Royalty Mgmt., T.C. Memo. 2024–87, at *49–50, 52–53 (disallowed premium deductions and required income inclusion by the Captive); see also Reserve Mech., T.C. Memo. 2018–86, at *62–64 (income to a tax-exempt entity under section 501(c)(15)). Further, while the IRS may challenge the tax benefits claimed in these transactions, adjustments will be asserted only to the extent warranted by the facts, following examination by the IRS. The final regulations do not adopt any changes based on these comments. H. Comments Regarding Impact on the Captive Insurance Industry Commenters expressed concern that the proposed regulations will negatively impact the captive insurance industry and would eliminate many benefits to its participants. Commenters stated that the benefits of captives include the following: providing coverage that is either unavailable or prohibitively expensive commercially, providing entry to reinsurance markets that are otherwise unavailable to participants, allowing for competition with commercial insurers, and serving to manage catastrophic risks for many businesses, such as the risks arising under the Coronavirus Disease 2019 (COVID–19) pandemic. These benefits are available to all section 831(a) captives and to those section 831(b) captives that are not engaged in transactions that are tax avoidance transactions. These regulations do not hinder the formation of valid captives. Accordingly, the final regulations do not adopt any changes based on these comments. I. Comments Regarding Compliance Concerns Some commenters argued that the proposed regulations are retroactive in nature, that there would be no way for PO 00000 Frm 00025 Fmt 4701 Sfmt 4700 3557 an existing micro-captive to ‘‘come into compliance with the proposed regulation,’’ and that there would be no way for a taxpayer to know whether they are entering into a reportable transaction. As previously stated in part I.C. of this Summary of Comments and Explanation of Revisions, the proposed regulations are not retroactive in nature; the final regulations will be effective as of January 14, 2025. Section 1.6011– 4(e)(2)(i) is clear that reporting is required for transactions entered into and reflected on a tax return for a year prior to the publication of guidance identifying a transaction as a listed transaction or a transaction of interest, if the statute of limitations is still open on the effective date of the listing. While the disclosures mandated by § 1.6011–4 may be with respect to prior periods, if the period of limitations on assessment for such periods has not expired, the disclosure obligation is itself not retroactive—it is a current reporting obligation. The comments regarding an impermissible retroactive burden are without merit and outside the scope of these final regulations. Moreover, existing participants in transactions identified under the final regulations as a Micro-Captive Listed Transaction or a Micro-Captive Transaction of Interest may successfully comply by fulfilling their reporting obligations as set forth in the final regulations at §§ 1.6011–10(g) and 1.6011–11(g). Lastly, taxpayers are encouraged to make informed decisions and seek independent tax advice before entering into any transaction. Taxpayers have been placed on notice of the IRS’s concern with abuse of the section 831(b) election since at least 2015 when the IRS first identified micro-captive transactions on its annual Dirty Dozen list. The final regulations do not adopt any changes based on these comments. J. Comment Expressing Concerns About Access to Administrative Appeals Finally, a commenter expressed concern that taxpayers whose microcaptive transactions are examined do not have access to good faith administrative appeals. Appeals is an independent office of the IRS. Section 7803(e)(3) of the Code provides that it is the function of Appeals to resolve Federal tax controversies without litigation on a basis which is fair and impartial to both the Government and the taxpayer, and promotes a consistent application and interpretation of, and voluntary compliance with, the Federal tax laws. The Appeals resolution process is generally available to all taxpayers. Appeals endeavors to be consistent in its approach with the goal E:\FR\FM\14JAR5.SGM 14JAR5 3558 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations of making a fair and reasoned determination on each case presented to it, considering the facts of the case and existing case law. Taxpayers concerned about their specific case and the handling thereof should raise the matter to the appropriate authorities within Appeals. following chart sets forth the gross receipts of respondents to Notice 2016– 66, based on data for taxable year 2022: NOTICE 2016–66—RESPONDENTS BY SIZE Receipts Special Analyses I. Regulatory Planning and Review Pursuant to the Memorandum of Agreement, Review of Treasury Regulations under Executive Order 12866 (June 9, 2023), tax regulatory actions issued by the IRS are not subject to the requirements of section 6 of Executive Order 12866, as amended. Therefore, a regulatory impact assessment is not required. II. Paperwork Reduction Act The collection of information contained in the final regulations is reflected in the collection of information for Forms 8886 and 8918 that have been reviewed and approved by OMB in accordance with the Paperwork Reduction Act (44 U.S.C. 3507(c)) under control numbers 1545–1800 and 1545– 0865. To the extent there is a change in burden as a result of these regulations, the change in burden will be reflected in the updated burden estimates for the Forms 8886 and 8918. The requirement to maintain records to substantiate information on Forms 8886 and 8918 is already contained in the burden associated with the control numbers for the forms and is unchanged. An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number assigned by OMB. khammond on DSK9W7S144PROD with RULES5 III. Regulatory Flexibility Act The Regulatory Flexibility Act (RFA) (5 U.S.C. part I, chapter 6) requires agencies to ‘‘prepare and make available for public comment an initial regulatory flexibility analysis,’’ which will ‘‘describe the impact of the rule on small entities.’’ 5 U.S.C. 603(a). Section 605(b) of the RFA allows an agency to certify a rule if the rulemaking is not expected to have a significant economic impact on a substantial number of small entities. The Secretary of the Treasury hereby certifies that the final regulations will not have a significant economic impact on a substantial number of small entities pursuant to the RFA. The basis for these final regulations is Notice 2016–66, 2016–47 I.R.B. 745 (as modified by Notice 2017–08, 2017–3 I.R.B. 423). The VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 Firms (%) Filings (%) Under 5M .................. 5M to 10M ................ 10M to 15M .............. 15M to 20M .............. 20M to 25M .............. Over 25M .................. 74.45 7.17 4.36 2.49 1.87 9.66 70.87 7.56 4.76 2.80 2.24 11.76 Total ................... 100 100 This chart shows that the majority of respondents to Notice 2016–66 reported gross receipts under $5 million. Even assuming that these respondents constitute a substantial number of small entities, the final regulations will not have a significant economic impact on these entities because the final regulations implement sections 6111 and 6112 and § 1.6011–4 by specifying the manner in which and time at which an identified Micro-captive Listed Transaction or Micro-captive Transaction of Interest must be reported. Accordingly, because the regulations are limited in scope to time and manner of information reporting and definitional information, the economic impact of the final regulations is expected to be minimal. Further, the Treasury Department and the IRS expect the reporting burden to be low; the information sought is necessary for regular annual return preparation and ordinary recordkeeping. The estimated burden for any entity required to file Form 8886 (as revised Oct. 2022) is approximately 10 hours, 16 minutes for recordkeeping; 4 hours, 50 minutes for learning about the law or the form; and 6 hours, 25 minutes for preparing, copying, assembling, and sending the form to the IRS. The IRS’s Research, Applied Analytics, and Statistics division estimates that the appropriate wage rate for this set of taxpayers is $73.48 (2022 dollars) per hour. Thus, it is estimated that a respondent will incur costs of approximately $1,581.05 per filing. Disclosures received to date by the Treasury Department and the IRS in response to the reporting requirements of Notice 2016–66 indicate that this small amount will not pose any significant economic impact for those taxpayers now required to disclose under the final regulations. The Treasury Department and the IRS have concluded that the cost of filing the disclosure statements required by these PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 regulations will not pose any significant economic impact. Some commenters expressed concern that the cost of filing disclosure statements is too onerous for taxpayers. Specifically, commenters stated that they incurred significant costs in responding to Notice 2016–66 and will again face those costs if new disclosures are required. In response to comments on Notice 2016–66 and the proposed regulations, the final regulations narrow the scope of transactions described in §§ 1.6011–10(h) and 1.6011–11(h). New disclosures are needed to identify participants in these transactions, but the final regulations provide in § 1.6011–11(h)(2) that taxpayers who have filed a disclosure statement regarding their participation in a transaction that is the same as, or substantially similar to, the transaction described in § 1.6011–11(a) with the OTSA pursuant to Notice 2016–66, will be treated as having made the disclosure pursuant to the final regulations for the taxable years for which the taxpayer filed returns before January 14, 2025. One commenter asserted that the reporting obligations would be particularly onerous for arrangements using a pooled reinsurance structure with numerous participants and likened the cost of filling out a Form 8886 to effectively imposing a tax on the entire community of captive insurers electing the alternative tax under section 831(b). Taxpayer compliance burden is not equivalent to a tax, and the Instructions to Forms 8886 and 8918 make clear that the time needed to complete and file such forms will vary depending on individual circumstances. Two commenters indicated that the $77.50 (2020 dollars) wage rate per hour used to approximate the total cost of preparing and filing a Form 8886, as referenced in the proposed regulations, is too low. One of these commenters implied that the applicable average wage rate per hour is closer to $268.50. Given the availability of more recent data, the hourly rate estimate is revised in the final regulations to $73.48 (2022 dollars). This updated figure does not address the substantial difference from the commenter’s estimate. The difference is likely attributable to the different methodologies used. The commenter likely used the hourly rate that an independent professional would charge a retail customer to prepare a Form 8886. These commenters also expressed disagreement with the estimated average amounts of time required to complete Forms 8886 and 8918, as indicated in the instructions to each of those forms. One commenter described the estimate E:\FR\FM\14JAR5.SGM 14JAR5 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations khammond on DSK9W7S144PROD with RULES5 of 21.5 hours to comply as ‘‘significantly underestimated.’’ However, the commenter did not elaborate on the amount of time actually required for the commenter. Additionally, the Instructions to Forms 8886 and 8918 make clear that the time needed to complete and file such forms will vary depending on individual circumstances. One of the commenters stated that based on a survey of 2,397 respondents, the average amount of time spent by each respondent ‘‘for compliance’’ under Notice 2016–66 (using it as a proxy for these final regulations) was 50.97 hours, which the commenter noted is above the estimated average amounts of time for completion indicated in the instructions to each of those forms. However, based on the information provided by this commenter regarding the same survey, the total number of hours spent on ‘‘compliance’’ by all respondents was 121,755 hours, and the total number of Forms 8886 and 8918 completed by respondents for this ‘‘compliance’’ was 15,021. Consequently, the average amount of time spent per form by these respondents appears to be approximately 8.11 hours (that is, approximately 8 hours, 6 minutes). This amount falls below the estimated average time of 21 hours, 31 minutes for Form 8886 (as revised Oct. 2022) and 14 hours, 31 minutes for Form 8918 (as revised Nov. 2021) as provided in the instructions to those forms, respectively. For the reasons stated, a regulatory flexibility analysis under the RFA is not required. Pursuant to section 7805(f)(1), the notice of proposed rulemaking preceding the final regulations was submitted to the Chief Counsel for the Office of Advocacy of the Small Business Administration for comment on its impact on small business, and no comments were received. IV. Unfunded Mandates Reform Act Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA) requires that agencies assess anticipated costs and benefits and take certain other actions before issuing a final rule that includes any Federal mandate that may result in expenditures in any one year by a State, local, or Tribal government, in the aggregate, or by the private sector, of $100 million in 1995 dollars, updated annually for inflation. This final rule does not include any Federal mandate that may result in expenditures by State, local, or Tribal governments, or by the private sector in excess of that threshold. V. Executive Order 13132: Federalism Executive Order 13132 (Federalism) prohibits an agency from publishing any VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 rule that has federalism implications if the rule either imposes substantial, direct compliance costs on State and local governments, and is not required by statute, or preempts State law, unless the agency meets the consultation and funding requirements of section 6 of the Executive order. This final rule does not have federalism implications and does not impose substantial direct compliance costs on State and local governments or preempt State law within the meaning of the Executive order. See also part I.B. of the Summary of Comments and Explanation of Revisions. VI. Congressional Review Act Pursuant to the Congressional Review Act (5 U.S.C. 801 et seq.), the Office of Information and Regulatory Affairs has designated this rule as not a ‘‘major rule,’’ as defined by 5 U.S.C. 804(2). Drafting Information The principal author of these regulations is Allan H. Sakaue, Office of Associate Chief Counsel (Financial Institutions and Products), IRS. However, other personnel from the Treasury Department and the IRS participated in their development. Availability of IRS Documents The notices cited in this preamble are published in the Internal Revenue Bulletin and are available from the Superintendent of Documents, U.S. Government Publishing Office, Washington, DC 20402, or by visiting the IRS website at https://www.irs.gov. List of Subjects in 26 CFR Part 1 Income taxes, Reporting and recordkeeping requirements. Amendments to the Regulations Accordingly, the Treasury Department and the IRS amend 26 CFR part 1 as follows: PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 is amended by adding entries for §§ 1.6011–10 and 1.6011–11 in numerical order to read in part as follows: ■ Authority: 26 U.S.C. 7805 * * * * * * * * Section 1.6011–10 also issued under 26 U.S.C. 6001 and 6011. Section 1.6011–11 also issued under 26 U.S.C. 6001 and 6011. * * * * * Par. 2. Section 1.6011–10 is added to read as follows: ■ PO 00000 Frm 00027 Fmt 4701 Sfmt 4700 3559 § 1.6011–10 Micro-captive listed transaction. (a) Identification as listed transaction. Transactions that are the same as, or Substantially Similar to, transactions described in paragraph (c) of this section are identified as listed transactions for purposes of § 1.6011– 4(b)(2), except as provided in paragraph (d) of this section. (b) Definitions. The definitions in this paragraph (b) apply for purposes of this section: (1) Captive. The term Captive means any entity that is described in each of the paragraphs (b)(1)(i), (ii), and (iii) of this section. (i) The entity elects under section 831(b) of the Internal Revenue Code (Code) to include in taxable income only taxable investment income (defined in section 834 of the Code) in lieu of the tax imposed under section 831(a). (ii) The entity issues a Contract to an Insured, reinsures a Contract of an Insured issued by an Intermediary, or both. (iii) At least 20 percent of the entity’s assets or the voting power or value of its outstanding stock or equity interests is directly or indirectly owned, individually or collectively, by an Insured, an Owner, or persons Related to an Insured or an Owner. For purposes of this paragraph (b)(1)(iii), the rules of paragraph (b)(1)(iii)(A) or (B) of this section apply to the extent application of a rule (or rules) would increase such direct or indirect ownership. (A) A person that holds a derivative is treated as indirectly owning the assets referenced by the derivative. (B) The interest of each beneficiary of a trust or estate in the assets of such trust or estate must be determined by assuming the maximum exercise of discretion by the fiduciary in favor of such beneficiary and the maximum use of the trust’s or estate’s interest in the company to satisfy the interests of such beneficiary. (2) Computation periods—(i) Financing Computation Period. The term Financing Computation Period means the most recent five taxable years (including the most recent concluded taxable year) of a Captive (or all taxable years of a Captive if the Captive has been in existence for less than five taxable years). (ii) Listed Transaction Loss Ratio Computation Period. The term Listed Transaction Loss Ratio Computation Period is the most recent ten taxable years (including the most recent concluded taxable year) of Captive. A Captive that does not have at least ten taxable years cannot have a Listed E:\FR\FM\14JAR5.SGM 14JAR5 khammond on DSK9W7S144PROD with RULES5 3560 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations Transaction Loss Ratio Computation Period, and therefore is not described in paragraph (c)(2) of this section. (iii) Taxable years. For purposes of paragraphs (b)(2)(i) and (ii) of this section: (A) Each short taxable year is a separate taxable year. (B) If the Captive is a successor to one or more other Captives, taxable years of each such other Captive are treated as taxable years of the Captive. (iv) Successors. The term successor means any entity described in paragraph (b)(2)(iv)(A), (B), or (C) of this section. (A) A successor corporation as defined in § 1.382–2(a)(5). (B) An entity that, directly or indirectly, acquires (or is deemed to acquire) the assets of another entity and succeeds to and takes into account the other entity’s earnings and profits or deficit in earnings and profits. (C) An entity that receives (or is deemed to receive) any assets from another entity if such entity’s basis in such assets is determined, directly or indirectly, in whole or in part, by reference to the other entity’s basis in such assets. (3) Contract. The term Contract means any contract that is treated by a party to the contract as an insurance contract or reinsurance contract for Federal income tax purposes. (4) Insured. The term Insured means any person that conducts a trade or business, enters into a Contract with a Captive or enters into a Contract with an Intermediary that is directly or indirectly reinsured by a Captive, and treats amounts paid under the Contract as insurance premiums for Federal income tax purposes. (5) Intermediary. The term Intermediary means any entity that issues a Contract to an Insured or reinsures a Contract that is issued to an Insured, and such Contract is reinsured, directly or indirectly, by a Captive. A transaction may have more than one Intermediary. (6) Owner. The term Owner means any person who, directly or indirectly, holds an ownership interest in an Insured or its assets. For purposes of this paragraph (b)(6), the rules of paragraph (b)(6)(i) or (ii) of this section apply to the extent application of a rule (or rules) would increase such direct or indirect ownership. (i) The interest of a person that holds a derivative must be determined as provided in paragraph (b)(1)(iii)(A) of this section. (ii) The interest of each beneficiary of a trust or estate in the assets of such trust or estate must be determined as VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 provided in paragraph (b)(1)(iii)(B) of this section. (7) Recipient. The term Recipient means any Owner, Insured, or person Related to an Owner or an Insured engaged in a transaction described in paragraph (c)(1) of this section. (8) Related. The term Related means having a relationship described in one or more of sections 267(b), 707(b), 2701(b)(2)(C), and 2704(c)(2) of the Code. (9) Seller. The term Seller means a service provider, dealer (including an automobile dealer), lender, wholesaler, or retailer that sells products or services to customers who purchase insurance contracts in connection with those products or services and at least 95 percent of sales of products or services by Seller for the taxable year to persons who purchase such insurance contracts are sales to Unrelated Customers. (10) Seller’s Captive. The term Seller’s Captive means a Captive Related to Seller, an owner of Seller, or individuals or entities Related to Seller or owners of Seller. (11) Substantially Similar. The term Substantially Similar is defined in § 1.6011–4(c)(4). (12) Unrelated Customers. The term Unrelated Customers means persons who do not own an interest in, and are not wholly or partially owned by, Seller, an owner of Seller, or individuals or entities Related to Seller or owners of Seller. (c) Transaction description. A transaction is described in this paragraph (c) if the transaction is described in both paragraphs (c)(1) and (2) of this section. (1) The transaction involves a Captive that, at any time during the Captive’s Financing Computation Period, directly or indirectly, engages in a transaction described in paragraph (c)(1)(i) of this section, taking into account paragraph (c)(1)(ii) of this section. (i) The Captive made available as financing or otherwise conveyed or agreed to make available or convey to a Recipient, in a transaction that did not result in taxable income or gain to the Recipient, in whole or in part, any portion of the amounts received under a Contract, such as through a guarantee, a loan, or other transfer of Captive’s capital, or made such financings or conveyances prior to the Financing Computation Period that remain outstanding or in effect at any point in the taxable year for which disclosure is required. (ii) Any amounts that a Captive made available as financing or otherwise conveyed or agreed to make available or convey to a Recipient are presumed to PO 00000 Frm 00028 Fmt 4701 Sfmt 4700 be portions of the amounts received under a Contract to the extent that such amounts, when made available or conveyed, are in excess of Captive’s cumulative after-tax net investment earnings minus any outstanding financings or conveyances. (2) The transaction involves a Captive for which the amount described in paragraph (c)(2)(i) of this section is less than 30 percent of the amount described in paragraph (c)(2)(ii) of this section. (i) The amount of liabilities incurred for insured losses and claim administration expenses during the Listed Transaction Loss Ratio Computation Period. (ii) The amount equal to premiums earned by the Captive during the Listed Transaction Loss Ratio Computation Period, less policyholder dividends paid by the Captive during the Listed Transaction Loss Ratio Computation Period. (d) Exceptions. A transaction described in paragraph (c) of this section is not identified as a listed transaction for purposes of this section and § 1.6011–4(b)(2) if the transaction: (1) Provides insurance for employee compensation or benefits and is one for which the Employee Benefits Security Administration of the U.S. Department of Labor has issued a Prohibited Transaction Exemption under the procedures provided at 29 CFR 2570.30 through 2570.52; or (2) Is an arrangement in which a Captive meets all of the requirements described in this paragraph (d)(2). (i) The Captive is a Seller’s Captive. (ii) The Seller’s Captive issues or reinsures some or all of the Contracts purchased by Unrelated Customers in connection with the products or services being sold by the Seller. (iii) 100 percent of the business of the Seller’s Captive is issuing or reinsuring Contracts in connection with products or services being sold by the Seller or persons Related to the Seller. (iv) At least 95 percent of the Seller’s Captive’s business for the taxable year is issuing or reinsuring Contracts purchased by Unrelated Customers in connection with products or services sold by Seller or persons Related to Seller. (e) Bright-line rules. A transaction is not considered Substantially Similar (as defined in paragraph (b)(11) of this section) to the listed transaction identified in this section if the transaction: (1) Does not involve an entity that has elected under section 831(b) to include in taxable income only taxable investment income (defined in section E:\FR\FM\14JAR5.SGM 14JAR5 khammond on DSK9W7S144PROD with RULES5 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations 834) in lieu of the tax imposed under section 831(a); or (2) Involves a Captive for which the amount described in paragraph (c)(2)(i) of this section is 30 percent or more of the amount described in paragraph (c)(2)(ii) of this section. (f) Special participation rules—(1) In general. Whether a taxpayer has participated in the listed transaction identified in paragraph (a) of this section, including Substantially Similar transactions, will be determined under § 1.6011–4(c)(3)(i)(A). Participants include, but are not limited to, any Owner, Insured, Captive, or Intermediary with respect to the transaction whose tax return reflects tax consequences or a tax strategy identified in paragraph (a), except as otherwise provided in paragraphs (f)(2) and (3) of this section. (2) Disclosure safe harbor for Owners. An Owner who, solely by reason of the Owner’s direct or indirect ownership interest in an Insured, has participated in the listed transaction described in this section will not be required to disclose participation in the transaction under section 6011(a) of the Code, notwithstanding § 1.6011–4(c)(3), if the Owner receives acknowledgement, in writing or electronically, from the Insured that the Insured has or will comply with the Insured’s separate disclosure obligation under § 1.6011–4 with respect to the transaction and the Insured discloses the transaction in a timely manner. The acknowledgment can be a copy of the Form 8886, Reportable Transaction Disclosure Statement (or successor form), filed (or to be filed) by the Insured and must be received by the Owner prior to the time set forth in § 1.6011–4(e) in which the Owner would otherwise be required to provide disclosure. Owners who meet the requirements of the safe harbor in this paragraph (f)(2) will not be treated as having participated in an undisclosed listed transaction for purposes of § 1.6664–2(c)(3)(ii) or as having failed to include information on any return or statement with respect to a listed transaction for purposes of section 6501(c)(10) of the Code. (3) Disclosure safe harbor for taxpayers in transactions with revoked section 831(b) elections. If the Captive has revoked its section 831(b) election, taxpayers who participated in the listed transaction with respect to that Captive, including any Insureds, Owners, and Intermediaries, will not be considered participants in the transaction under section 6011(a), notwithstanding § 1.6011–4(c)(3), for any taxable year in which the section 831(b) revocation is effective, provided that a successor VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 Captive has not been established as described in paragraph (b)(2)(iv) of this section. In addition, if the Captive has revoked its section 831(b) election, taxpayers who meet the requirements of this safe harbor, for any taxable year in which the section 831(b) revocation is effective, will not be treated as having participated in an undisclosed listed transaction for purposes of § 1.6664– 2(c)(3)(ii) or as having failed to include information on any return or statement with respect to a listed transaction for purposes of section 6501(c)(10). (g) Disclosure requirements—(1) Information required of all participants. Participants must provide the information required under § 1.6011– 4(d) and the Instructions to Form 8886 (or successor form). For all participants, describing the transaction in sufficient detail includes, but is not limited to, describing on Form 8886 (or successor form) when, how, and from whom the participant became aware of the transaction, and how the participant participated in the transaction (for example, as an Insured, a Captive, or other participant). Paragraphs (g)(2) and (3) of this section describe additional information required of a Captive and an Insured, respectively. (2) Additional information required of a Captive. For a Captive, describing the transaction in sufficient detail includes, but is not limited to, describing on Form 8886 (or successor form) the items described in each of the paragraphs (g)(2)(i) through (v) of this section. (i) All the type(s) of policies issued or reinsured by the Captive during the year of participation or each year of participation (if disclosure pertains to multiple years). (ii) The amounts treated by the Captive as premiums written for coverage provided by Captive during the year of participation or each year of participation (if disclosure pertains to multiple years). (iii) The name and contact information of each and every actuary or underwriter who assisted in the determination of the amounts treated as premiums for coverage provided by the Captive during the year or each year of participation (if disclosure pertains to multiple years). (iv) The total amounts of claims paid by the Captive during the year of participation or each year of participation (if disclosure pertains to multiple years). (v) The name and percentage of interest directly or indirectly held by each person whose interest in the Captive meets the 20 percent threshold or is taken into account in meeting the PO 00000 Frm 00029 Fmt 4701 Sfmt 4700 3561 20 percent threshold under paragraph (b)(1)(iii) of this section. (3) Additional information required of Insured. For Insured, describing the transaction in sufficient detail includes, but is not limited to, describing on Form 8886 (or successor form) the amounts treated by Insured as premiums paid for coverage provided to Insured, directly or indirectly, by the Captive or by each Captive (if disclosure pertains to multiple Captives) during the year or each year of participation (if disclosure pertains to multiple years), as well as the identity of all persons identified as Owners to whom the Insured provided an acknowledgment described in paragraph (f)(2) of this section. (h) Applicability date—(1) In general. This section identifies transactions that are the same as, or Substantially Similar to, the transactions identified in paragraph (a) of this section as listed transactions for purposes of § 1.6011– 4(b)(2), effective January 14, 2025, except as otherwise provided in this paragraph (h)(1). If, on or before the date prescribed for filing disclosure statements with the Office of Tax Shelter Analysis under § 1.6011–4(e), the Captive involved in the transaction has requested the consent of the Secretary to revoke its section 831(b) election, the transaction is not identified as a listed transaction for purposes of this section and § 1.6011–4(b)(2) for taxable years ending before January 1, 2026. (2) Obligations of participants with respect to prior periods. Pursuant to § 1.6011–4(d) and (e), taxpayers who have filed a tax return (including an amended return) reflecting their participation in transactions described in paragraph (a) of this section prior to January 14, 2025, must disclose the transactions as required by § 1.6011– 4(d) and (e) provided that the period of limitations for assessment of tax (as determined under section 6501, including section 6501(c)) for any taxable year in which the taxpayer participated has not ended on or before January 14, 2025, except as otherwise provided in this paragraph (h)(2). Taxpayers who have finalized a settlement agreement with the Internal Revenue Service with respect to the transaction, in examination or litigation, will be treated as having made the disclosure for years subject to that agreement. (3) Obligations of material advisors with respect to prior periods. Material advisors defined in § 301.6111–3(b) of this chapter who have previously made a tax statement with respect to a transaction described in paragraph (a) of this section have disclosure and list E:\FR\FM\14JAR5.SGM 14JAR5 3562 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations maintenance obligations as described in §§ 301.6111–3 and 301.6112–1 of this chapter, respectively. Notwithstanding § 301.6111–3(b)(4)(i) and (iii) of this chapter, material advisors are required to disclose only if they have made a tax statement on or after the date that is six years before January 14, 2025. Material advisors that are uncertain whether the transaction they are required to disclose should be reported under this section or § 1.6011–11 should disclose under this section and will not be required to disclose a second time if it is later determined that the transaction should have been disclosed under § 1.6011–11. ■ Par. 3. Section 1.6011–11 is added to read as follows: khammond on DSK9W7S144PROD with RULES5 § 1.6011–11 interest. Micro-captive transaction of (a) Identification as transaction of interest. Transactions that are the same as, or Substantially Similar to, transactions described in paragraph (c) of this section are identified as transactions of interest for purposes of § 1.6011–4(b)(6), except as provided in paragraph (d) of this section. (b) Definitions. The definitions in this paragraph (b) apply for purposes of this section. (1) Captive. Captive has the same meaning as provided in § 1.6011– 10(b)(1). (2) Computation periods—(i) Financing Computation Period. Financing Computation Period has the same meaning as provided in § 1.6011– 10(b)(2)(i). (ii) Transaction of Interest Loss Ratio Computation Period. The term Transaction of Interest Loss Ratio Computation Period means— (A) The most recent ten taxable years of a Captive; or (B) In the case of a Captive that has been in existence for less than ten taxable years, all taxable year(s) of the Captive. (iii) Rules for computation periods. The rules provided in § 1.6011– 10(b)(2)(iii) and (iv) for computation periods apply for purposes of this paragraph (b)(2). (3) Contract. Contract has the same meaning as provided in § 1.6011– 10(b)(3). (4) Insured. Insured has the same meaning as provided in § 1.6011– 10(b)(4). (5) Intermediary. Intermediary has the same meaning as provided in § 1.6011– 10(b)(5). (6) Owner. Owner has the same meaning as provided in § 1.6011– 10(b)(6). VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 (7) Recipient. Recipient has the same meaning as provided in § 1.6011– 10(b)(7). (8) Related. Related has the same meaning as provided in § 1.6011– 10(b)(8). (9) Seller. Seller has the same meaning as provided in § 1.6011–10(b)(9). (10) Seller’s Captive. Seller’s Captive has the same meaning as provided in § 1.6011–10(b)(10). (11) Substantially Similar. Substantially Similar has the same meaning as provided in § 1.6011– 10(b)(11). (12) Unrelated Customers. Unrelated Customers has the same meaning as provided in § 1.6011–10(b)(12). (c) Transaction description. A transaction is described in this paragraph (c) if the transaction is described in paragraph (c)(1) of this section, paragraph (c)(2) of this section, or both. (1) The transaction involves a Captive that, at any time during the Captive’s Financing Computation Period, directly or indirectly, engages in a transaction described in paragraph (c)(1)(i) of this section, taking into account paragraph (c)(1)(ii) of this section. (i) The Captive made available as financing or otherwise conveyed or agreed to make available or convey to a Recipient, in a transaction that did not result in taxable income or gain to the Recipient, in whole or in part, any portion of the amounts received under a Contract, such as through a guarantee, a loan, or other transfer of Captive’s capital, or made such financings or conveyances prior to the Financing Computation Period that remain outstanding or in effect at any point in the taxable year for which disclosure is required. (ii) Any amounts that a Captive made available as financing or otherwise conveyed or agreed to make available or convey to a Recipient are presumed to be portions of the amounts received under a Contract to the extent such amounts, when made available or conveyed are in excess of a Captive’s cumulative after-tax net investment earnings minus any outstanding financings or conveyances. (2) The transaction involves a Captive for which the amount described in paragraph (c)(2)(i) of this section is less than 60 percent of the amount described in paragraph (c)(2)(ii) of this section. (i) The amount of liabilities incurred for insured losses and claim administration expenses during the Transaction of Interest Loss Ratio Computation Period. (ii) The amount equal to premiums earned by the Captive during the PO 00000 Frm 00030 Fmt 4701 Sfmt 4700 Transaction of Interest Loss Ratio Computation Period, less policyholder dividends paid by the Captive during the Transaction of Interest Loss Ratio Computation Period. (d) Exceptions. A transaction described in paragraph (c) of this section is not identified as a transaction of interest for purposes of this section and § 1.6011–4(b)(6) if the transaction: (1) Is described in § 1.6011–10(d)(1); (2) Is described in § 1.6011–10(d)(2); or (3) Is identified as a listed transaction in § 1.6011–10(a), in which case the transaction must be reported as a listed transaction under § 1.6011–10. (e) Bright-line rules. A transaction is not considered Substantially Similar (as defined in paragraph (b)(11) of this section) to the transaction of interest identified in this section if the transaction: (1) Does not involve an entity that has elected under section 831(b) of the Internal Revenue Code (Code) to include in taxable income only taxable investment income (defined in section 834 of the Code) in lieu of the tax imposed under section 831(a); or (2) Involves a Captive for which the amount described in paragraph (c)(2)(i) of this section is 60 percent or more of the amount described in paragraph (c)(2)(ii) of this section. (f) Special participation rules—(1) In general. Whether a taxpayer has participated in the transaction of interest identified in paragraph (a) of this section, including Substantially Similar transactions, will be determined under § 1.6011–4(c)(3)(i)(E). Participants include, but are not limited to, any Owner, Insured, Captive, or Intermediary with respect to the transaction whose tax return reflects tax consequences or a tax strategy identified in paragraph (a), except as otherwise provided in paragraphs (f)(2) and (3) of this section. (2) Disclosure safe harbor for Owners. An Owner who, solely by reason of the Owner’s direct or indirect ownership interest in an Insured, has participated in the transaction of interest described in this section will not be required to disclose participation in the transaction under section 6011(a), notwithstanding § 1.6011–4(c)(3), if the Owner receives acknowledgment, in writing or electronically, from the Insured that the Insured has or will comply with Insured’s separate disclosure obligation under § 1.6011–4 with respect to the transaction and the Insured discloses the transaction in a timely manner. The acknowledgment can be a copy of the Form 8886, Reportable Transaction Disclosure Statement (or successor E:\FR\FM\14JAR5.SGM 14JAR5 Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules and Regulations khammond on DSK9W7S144PROD with RULES5 form), filed (or to be filed) by the Insured and must be received by the Owner prior to the time set forth in § 1.6011–4(e) in which the Owner would otherwise be required to provide disclosure. (3) Disclosure safe harbor for taxpayers in transactions with revoked section 831(b) elections. If the Captive has revoked its section 831(b) election, taxpayers who participated in the transaction of interest with respect to that Captive, including any Insureds, Owners, and Intermediaries, will not be considered participants in the transaction under section 6011(a), notwithstanding § 1.6011–4(c)(3), for any taxable year in which the section 831(b) revocation is effective, provided that a successor Captive has not been established as described in paragraph (b)(2)(iii) of this section (referencing § 1.6011–10(b)(2)(iii) and (iv)). (g) Disclosure requirements. Participants must provide the information required under § 1.6011– 4(d) and the Instructions to Form 8886 (or successor form). For all participants, describing the transaction in sufficient detail includes, but is not limited to, describing on Form 8886 (or successor form) when, how, and from whom the participant became aware of the transaction, and how the participant participated in the transaction (for example, as an Insured, a Captive, or other participant). A Captive and an Insured must also provide the information required in § 1.6011– 10(g)(2) and (3), respectively. (h) Applicability date—(1) In general. This section identifies transactions that are the same as, or Substantially Similar to, the transaction identified in paragraph (a) of this section as VerDate Sep<11>2014 18:14 Jan 13, 2025 Jkt 265001 transactions of interest for purposes of § 1.6011–4(b)(6) effective January 14, 2025, except as otherwise provided in this paragraph (h)(1). If, on or before the date prescribed for filing disclosure statements with the Office of Tax Shelter Analysis under § 1.6011–4(e), the Captive involved in the transaction has requested the consent of the Secretary to revoke its section 831(b) election, the transaction is not identified as a transaction of interest for purposes of this section and § 1.6011–4(b)(6) for participants with respect to that Captive for taxable years ending before January 1, 2026. (2) Obligations of participants with respect to prior periods. Pursuant to § 1.6011–4(d) and (e), taxpayers who have filed a tax return (including an amended return) reflecting their participation in transactions described in paragraph (a) of this section prior to January 14, 2025, must disclose the transactions as required by § 1.6011– 4(d) and (e) provided that the period of limitations for assessment of tax (as determined under section 6501 of the Code, including section 6501(c)) for any taxable year in which the taxpayer participated has not ended on or before January 14, 2025, except as otherwise provided in this paragraph (h)(2). Taxpayers who have finalized a settlement agreement with the Internal Revenue Service with respect to the transaction, in examination or litigation, will be treated as having made the disclosure for years subject to that agreement. Taxpayers who have filed a disclosure statement regarding their participation in the transaction with the Office of Tax Shelter Analysis pursuant to Notice 2016–66, 2016–47 I.R.B. 745, will be treated as having made the PO 00000 Frm 00031 Fmt 4701 Sfmt 9990 3563 disclosure pursuant to the final regulations for the taxable years for which the taxpayer filed returns before January 14, 2025. If a taxpayer described in the preceding sentence participates in the Micro-captive Transaction of Interest in a taxable year for which the taxpayer files a return on or after January 14, 2025, the taxpayer must file a disclosure statement with the Office of Tax Shelter Analysis at the same time the taxpayer files their return for the first such taxable year. (3) Obligations of material advisors with respect to prior periods. Material advisors defined in § 301.6111–3(b) of this chapter who have previously made a tax statement with respect to a transaction described in paragraph (a) of this section have disclosure and list maintenance obligations as described in §§ 301.6111–3 and 301.6112–1 of this chapter, respectively. Notwithstanding § 301.6111–3(b)(4)(i) and (iii) of this chapter, material advisors are required to disclose only if they have made a tax statement on or after the date that is six years before January 14, 2025. Material advisors that are uncertain whether the transaction they are required to disclose should be reported under this section or § 1.6011–10 should disclose under § 1.6011–10 and will not be required to disclose a second time if it is later determined that the transaction should have been disclosed under this section. Douglas W. O’Donnell, Deputy Commissioner. Approved: January 3, 2025. Aviva R. Aron-Dine, Deputy Assistant Secretary of the Treasury (Tax Policy). [FR Doc. 2025–00393 Filed 1–10–25; 4:15 pm] BILLING CODE 4830–01–P E:\FR\FM\14JAR5.SGM 14JAR5

Agencies

[Federal Register Volume 90, Number 8 (Tuesday, January 14, 2025)]
[Rules and Regulations]
[Pages 3534-3563]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2025-00393]

[[Page 3533]]

Vol. 90

Tuesday,

No. 8

January 14, 2025

Part VII

Department of the Treasury

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Internal Revenue Service

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26 CFR Part 1

Micro-Captive Listed Transactions and Micro-Captive Transactions of
Interest; Final Rule

Federal Register / Vol. 90, No. 8 / Tuesday, January 14, 2025 / Rules
and Regulations

[[Page 3534]]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 10029]
RIN 1545-BQ44

Micro-Captive Listed Transactions and Micro-Captive Transactions
of Interest

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final rule.

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SUMMARY: This document contains final regulations that identify
transactions that are the same as, or substantially similar to, certain
micro-captive transactions as listed transactions, a type of reportable
transaction, and certain other micro-captive transactions as
transactions of interest, another type of reportable transaction.
Material advisors and certain participants in these listed transactions
and transactions of interest are required to file disclosures with the
IRS and are subject to penalties for failure to disclose. The final
regulations affect participants in these transactions as well as
material advisors.

DATES:
Effective date: These regulations are effective on January 14,
2025.
Applicability date: For dates of applicability, see Sec. Sec.
1.6011-10(h) and 1.6011-11(h).

FOR FURTHER INFORMATION CONTACT: Allan H. Sakaue, (202) 317-6995 (not a
toll-free number).

SUPPLEMENTARY INFORMATION:

Authority

This document amends the Income Tax Regulations (26 CFR part 1) by
adding final regulations under section 6011 of the Internal Revenue
Code (Code) to identify certain micro-captive transactions and
substantially similar transactions as listed transactions and certain
other micro-captive transactions as transactions of interest, each a
type of reportable transaction (final regulations). These regulations
are issued pursuant to the authority conferred on the Secretary of the
Treasury or her delegate (Secretary) under the following provisions of
the Code:
Section 6001, which requires every taxpayer to keep the records,
render the statements, make the returns, and comply with the rules and
regulations that the Secretary deems necessary to demonstrate tax
liability and prescribes, either by notice served or by regulations;
Section 6011, which requires every taxpayer to ``make a return or
statement according to the forms and regulations prescribed by the
Secretary'' and ``include therein the information required by such
forms or regulations'';
Section 6707A(c)(1), which states that ``[t]he term `reportable
transaction' means any transaction with respect to which information is
required to be included with a return or statement because, as
determined under regulations prescribed under section 6011, such
transaction is of a type which the Secretary determines as having a
potential for tax avoidance or evasion''; and
Section 6707A(c)(2), which states that, ``[t]he term `listed
transaction' means a reportable transaction which is the same as, or
substantially similar to, a transaction specifically identified by the
Secretary as a tax avoidance transaction for purposes of section
6011.''
Reportable transactions are described in Sec. 1.6011-4 and include
listed transactions, confidential transactions, transactions with
contractual protection, loss transactions, and transactions of
interest. See Sec. 1.6011-4(b)(2) through (6). Section 1.6011-4(b)(2)
defines a ``listed transaction'' as a transaction that is the same as
or substantially similar to one of the types of transactions that the
IRS has determined to be a tax avoidance transaction and identified by
notice, regulation, or other form of published guidance as a listed
transaction. Section 1.6011-4(b)(6) defines a ``transaction of
interest'' as a transaction that is the same as or substantially
similar to one of the types of transactions that the IRS has identified
by notice, regulation, or other form of published guidance as a
transaction of interest.
The final regulations are also issued under the express delegation
of authority under section 7805(a) of the Code.

Background

I. Section 831(b)

As enacted by section 1024 of the Tax Reform Act of 1986, Public
Law 99-514, 100 Stat. 2085, 2405 (October 22, 1986), section 831(a) of
the Code generally imposes tax on the taxable income (determined under
the special rules for calculating taxable income of insurance companies
in part II of subchapter L of chapter 1 of the Code) of every insurance
company other than a life insurance company (nonlife insurance
company), for each taxable year computed as provided in section 11 of
the Code. However, certain small nonlife insurance companies may elect
to be subject to the alternative tax imposed by section 831(b).
Upon election by an eligible nonlife insurance company (eligible
electing company) to be taxed under section 831(b), in lieu of the tax
otherwise imposed by section 831(a), section 831(b) imposes tax on the
company's income computed by multiplying the taxable investment income
of the eligible electing company (determined under section 834 of the
Code) for the taxable year by the rates provided in section 11(b) of
the Code. Thus, an eligible electing company pays no tax on its
underwriting income, including amounts paid as premiums, for taxable
years for which its election is in effect.
Congress enacted section 333 of the Protecting Americans from Tax
Hikes Act of 2015 (PATH Act), div. Q. of Public Law 114-113, 129 Stat.
2242, 3040 (December 18, 2015), to both tighten and expand the
requirements for qualifying under section 831(b), effective for taxable
years beginning after December 31, 2016. As amended by the PATH Act,
section 831(b) requires an eligible electing company to be an insurance
company (within the meaning of section 816(a) of the Code) having net
written premiums or, if greater, direct written premiums, for the
taxable year not exceeding $2.2 million as adjusted for inflation (net
written premium limitation) and to meet the diversification
requirements of section 831(b)(2)(B). The last sentence of section
831(b)(2)(A) provides that an election under section 831(b) applies to
the taxable year for which it is made and all subsequent taxable years
for which the net written premium limitation and the diversification
requirements are met and may be revoked only with the Secretary's
consent. In addition, section 831(d) requires every eligible electing
company that has a section 831(b) election in effect to furnish to the
Secretary ``at such time and in such manner as the Secretary shall
prescribe such information for such taxable year as the Secretary shall
require with respect to'' the diversification requirements of section
831(b)(2)(B).
To qualify as an insurance company pursuant to section 816(a), a
requirement to elect section 831(b) taxation, more than half of the
business of the entity during the taxable year must be the issuing of
insurance or annuity contracts or the reinsuring of risks underwritten
by insurance companies. An insurance contract must meet all four prongs
of the test for insurance set forth by the courts: risk shifting, risk
distribution, insurable risks, and insurance in the commonly

[[Page 3535]]

accepted sense. See Helvering v. Le Gierse, 312 U.S. 531, 539 (1941)
(both risk shifting and risk distribution must be present); Allied
Fidelity Corp. v. Commissioner, 572 F.2d 1190, 1193 (7th Cir. 1978)
(the risk transferred must be risk of economic loss); Commissioner v.
Treganowan, 183 F.2d 288, 290-91 (2d Cir. 1950) (the risk must
contemplate the fortuitous occurrence of a stated contingency); Rent-A-
Center, Inc. v. Commissioner, 142 T.C. 1, 13 (2014) (the arrangement
must constitute insurance in the commonly accepted sense); see also
Rev. Rul. 2007-47, 2007-2 C.B. 127 (the risk must not be merely an
investment or a business risk). To determine whether an arrangement is
insurance in the commonly accepted sense, courts consider several non-
exclusive factors including (1) whether the company was organized,
operated, and regulated as an insurance company; (2) whether the
company was adequately capitalized; (3) whether the policies were valid
and binding; (4) whether premiums were reasonable and the result of
arm's length transactions; (5) whether claims were paid; (6) whether
the policies cover typical insurance risks; and (7) whether there was a
legitimate business reason for acquiring insurance from the captive.
Avrahami v. Commissioner, 149 T.C. 144, 191 (2017).

II. Notice 2016-66 and Notice of Proposed Rulemaking (``NPRM'')

On November 21, 2016, the Treasury Department and the IRS published
Notice 2016-66, 2016-47 I.R.B. 745, which identified certain micro-
captive transactions as transactions of interest. On January 17, 2017,
the Treasury Department and the IRS published Notice 2017-08, 2017-3
I.R.B. 423, which modified Notice 2016-66 by providing for an extension
of time for participants and material advisors to file their
disclosures.
Notice 2016-66 alerted taxpayers and their representatives pursuant
to Sec. 1.6011-4(b)(6) and for purposes of Sec. 1.6011-4(b)(6) and
sections 6111 and 6112, that the Treasury Department and the IRS
identified as transactions of interest certain micro-captive
transactions in which a taxpayer attempts to reduce the aggregate
taxable income of the taxpayer, related persons, or both, using
contracts that the parties treat as insurance contracts and a related
company that the parties treat as an insurance company. Notice 2016-66
also alerted persons involved with the identified transactions that
certain responsibilities may arise from their involvement.
The Treasury Department and the IRS issued proposed regulations
under section 6011 (REG-109309-22) in an NPRM published in the Federal
Register (88 FR 21547) on April 11, 2023 (proposed regulations). That
NPRM obsoleted Notice 2016-66. The Treasury Department and the IRS
considered comments received in response to Notice 2016-66 in
developing the proposed regulations.
The proposed regulations would identify taxpayers who file returns
reflecting the tax benefits of a transaction described at Sec. 1.6011-
10(a) as participants in a listed transaction (``Micro-captive Listed
Transaction''). The proposed regulations would identify taxpayers who
file returns reflecting the tax benefits of a transaction described at
Sec. 1.6011-11(a) as participants in a transaction of interest
(``Micro-captive Transaction of Interest''). Generally, a Micro-captive
Listed Transaction is a transaction in which an Owner (as defined in
proposed Sec. 1.6011-10(b)(6)) of an Insured (as defined in proposed
Sec. 1.6011-10(b)(4)) holds the necessary interest described in
proposed Sec. 1.6011-10(b)(1)(iii) (the ``20 Percent Relationship
Test'') in Captive (as defined in proposed Sec. 1.6011-10(b)(1)),
Captive meets the definition provided in proposed Sec. 1.6011-
10(b)(1), and Captive provides financing as described in proposed Sec.
1.6011-10(c)(1) (the ``Financing Factor''), determined over the
Financing Computation Period defined in proposed Sec. 1.6011-
10(b)(2)(i), or has less than a 65 percent loss ratio (the ``Loss Ratio
Factor'') as described in proposed Sec. 1.6011-10(c)(2), determined
over the Loss Ratio Computation Period defined in proposed Sec.
1.6011-10(b)(2)(ii).
A Micro-captive Transaction of Interest is a transaction in which
an Owner (as defined in proposed Sec. 1.6011-11(b)(6)) of an Insured
(as defined in proposed Sec. 1.6011-11(b)(4)) holds the necessary
interest in Captive (as defined in proposed Sec. 1.6011-11(b)(1)),
Captive meets the definition provided in proposed Sec. 1.6011-
11(b)(1), and Captive has less than a 65 percent loss ratio, as
described in proposed Sec. 1.6011-11(c), determined over the
Transaction of Interest Computation Period defined in proposed Sec.
1.6011-11(b)(2).
Participants in a Micro-captive Listed Transaction or a Micro-
captive Transaction of Interest, and material advisors with respect to
Micro-captive Listed Transactions and Micro-captive Transactions of
Interest, would be required file disclosure statements as set forth in
proposed Sec. Sec. 1.6011-10(f) and 1.6011-11(f). The Treasury
Department and the IRS developed these objective factors to ensure
administrability and clarity for taxpayers whose transactions are
identified in the regulations, so taxpayers can clearly determine
whether they are participants or material advisors, and thus be on
clear notice of their obligations.
The Treasury Department and the IRS received 110 public comments in
response to the proposed regulations and notice of public hearing that
are the subject of this final rulemaking. The comments are available
for public inspection at https://www.regulations.gov or upon request. A
public hearing on the proposed regulations was held by teleconference
on July 19, 2023, at 10 a.m. Eastern Time, at which six speakers
provided testimony.
The Summary of Comments and Explanation of Revisions of these final
regulations summarizes the proposed regulations, which are described in
greater detail in the preamble to the proposed regulations. After full
consideration of all the comments received and the testimony provided,
these final regulations adopt the proposed regulations with the
modifications described in this Summary of Comments and Explanation of
Revisions.

Summary of Comments and Explanation of Revisions

This Summary of Comments and Explanation of Revisions summarizes
all significant comments addressing the proposed regulations, and
describes and responds to comments concerning: (1) the authority to
issue the proposed and final regulations generally; (2) the Loss Ratio
Factor described in proposed Sec. Sec. 1.6011-10(c)(2) and 1.6011-
11(c); (3) the Financing Factor described in proposed Sec. 1.6011-
10(c)(1); (4) the exception for certain consumer coverage arrangements
described in proposed Sec. Sec. 1.6011-10(d)(2) and 1.6011-11(d)(2);
(5) requests for safe harbors from either identification as a
reportable transaction or from the reporting requirements upon
identification as a reportable transaction; and (6) other matters
including clarifications and changes not specifically related to the
identified factors already addressed. This Summary of Comments and
Explanation of Revisions also explains revisions adopted by the final
regulations in response to those comments. Comments outside the scope
of this rulemaking are generally not addressed.
As an initial matter, the final regulations incorporate non-
substantive changes to the description of the

[[Page 3536]]

election under section 831(b) at proposed Sec. 1.6011-10(b)(1)(i)
(defining in part the term Captive) to better reflect the text of the
statute. See Sec. 1.6011-10(b)(1)(i) of the final regulations.
Furthermore, Sec. Sec. 1.6011-10(e) and 1.6011-11(e) are added to
the final regulations, to provide more clarity on when a transaction is
considered substantially similar as defined in Sec. 1.6011-4(c)(4) to
the identified transactions. The term ``Substantially Similar'' has
also been defined in the final regulations by cross-reference to Sec.
1.6011-4(c)(4).

I. Comments on Authority To Issue the Proposed Regulations

A. The McCarran-Ferguson Act
Several commenters argued that the proposed regulations implicate
``the business of insurance'' under the McCarran-Ferguson Act, 15
U.S.C. 1011 et seq. (``McCarran-Ferguson''). In addition, commenters
argued that sections 6011, 6111, and 6112 do not explicitly reference
insurance, and thus McCarran-Ferguson prohibits the application of the
proposed regulations thereunder. Commenters also asserted that the
inclusion of a Loss Ratio Factor and a Financing Factor in the proposed
regulations will invalidate, impair, or supersede State law governing
insurance companies. For example, commenters contended that because
State regulators must approve related-party financing transactions
entered into by insurance companies, State law to that effect will
preempt identification of a captive insurance transaction involving
related-party financing as a reportable transaction. Similarly,
commenters contended that because State regulators establish solvency
requirements for insurers licensed in their domicile, State laws
regarding premium pricing will preempt identification of a captive
insurance transaction as a reportable transaction based on the Loss
Ratio Factor. Commenters also asserted that the Loss Ratio Factor, by
encouraging payment of policyholder dividends, impacts the insurer and
policyholder relationship and therefore implicates McCarran-Ferguson.
Contrary to the commenters' arguments, and as discussed in more
detail in the following paragraphs, McCarran-Ferguson does not apply to
these regulations for two primary reasons: first, because the
regulations do not invalidate, impair, or supersede State law, and
second, because the regulations do not implicate the business of
insurance.
First, the proposed regulations do not ``invalidate, impair, or
supersede'' any State law. As relevant here, McCarran-Ferguson provides
that ``[n]o Act of Congress shall be construed to invalidate, impair,
or supersede any law enacted by any State for the purpose of regulating
the business of insurance, or which imposes a fee or tax upon such
business, unless such Act specifically relates to the business of
insurance.'' 15 U.S.C. 1012(b). In other words, McCarran-Ferguson
prohibits application of Federal law not specifically relating to the
business of insurance if it would invalidate, impair, or supersede
State laws enacted for the purpose of regulating the business of
insurance. Humana Inc. v. Forsyth, 525 U.S. 299, 307 (1999). Courts
have uniformly upheld Tax Code provisions pertaining to the taxation of
insurance companies in the face of a McCarran-Ferguson challenge. See,
e.g., Modern Life & Acc. Ins. Co. v. Commissioner, 420 F.2d 36, 37 (7th
Cir. 1969) (holding that taxpayer did not show that Commissioner's
determination of taxpayer's status under the Internal Revenue Code
``will interfere with the choice made by [State].''); Indust. Life Ins.
Co. v. United States, 344 F. Supp. 870, 875 (D.S.C. 1972), aff'd, 481
F.2d 609 (4th Cir. 1973) (holding that Congress did not give up the
right to tax by passing McCarran-Ferguson); Hanover Ins. Co. v.
Commissioner, 65 T.C. 715, 722 (1976) (``Congress did not, under the
McCarran-Ferguson Act, surrender to the States the power of the Federal
Government to tax insurance companies and to issue regulations
implementing the taxing statute.'').
Moreover, McCarran-Ferguson was enacted to prevent inadvertent
Federal intrusion on the State's rights to regulate insurance. See
Barnett Bank of Marion Cty. v. Nelson, 517 U.S. 25, 39. McCarran-
Ferguson does not prevent the Federal Government from issuing insurance
regulations. Id. The Supreme Court has stated that McCarran-Ferguson
does not ``cede the field of insurance regulation to the States, saving
only instances in which Congress expressly orders otherwise.'' Humana,
525 U.S. at 308; see also SEC v. Nat'l Sec., Inc., 393 U.S. 453, 459-60
(1969) (``The [McCarran-Ferguson Act] did not purport to make the
States supreme in regulating all the activities of insurance
companies.''); Modern Life & Acc. Ins. Co., 420 F.2d at 37-38; Indust.
Life Ins. Co., 344 F. Supp. at 875; Hanover Ins. Co., 66 T.C. at 721-
22. The Supreme Court also stated that ``[t]he term `invalidate'
ordinarily means `to render ineffective, generally without providing a
replacement rule or law . . . [a]nd the term `supersede' ordinarily
means `to displace (and thus render ineffective) while providing a
substitute rule.'' Humana, 525 U.S. at 307 (citations omitted). The
Supreme Court relied on the dictionary definition of ``impair,'' which
is ``[t]o weaken, to make worse, to lessen in power, diminish, or
relax, or otherwise affect in an injurious manner.'' Humana, 525 U.S.
at 309-10 (citing Black's Law Dictionary 752 (6th ed. 1990)). Thus,
``[w]hen federal law does not directly conflict with state regulation,
and when the application of federal law would not frustrate any
declared state policy or interfere with a State's administrative
regime, the McCarran-Ferguson Act does not preclude its application.''
Humana, 525 U.S. at 310.
The proposed regulations do not render ineffective any State law,
nor do they displace or diminish any State regulator's ability to
regulate the insurers within their jurisdiction. Rather, the proposed
regulations run parallel to the State laws. Identification of a
transaction as a listed transaction or a transaction of interest,
solely for Federal tax purposes, does not in any way invalidate,
impair, supersede, or affect State insurance laws. As in United States
v. Redcorn, ``state insurance regulations remain fully in force.'' 528
F.3d 727, 736 (10th Cir. 2008) (holding that prosecution under 18
U.S.C. 669 (``Theft or embezzlement in connection with health care'')
did not conflict in any way with state insurance law for purposes of
McCarran-Ferguson); see also United States v. Del. Dep't of Ins., 66
F.4th 114, 132 (3d Cir. 2023) (holding that Delaware State law
prohibiting the Delaware Department of Insurance from disclosing
certain information about captive insurance companies to anyone,
including the Federal Government, did not, under McCarran-Ferguson,
override the IRS's statutory authority to issue summonses to the
Department and have them enforced).
Commenters cite to United States Dep't of Treasury v. Fabe, 508
U.S. 491 (1993), to support their argument that the proposed
regulations violate the McCarran-Ferguson Act, but the proposed
regulations can be readily distinguished from the Federal statute at
issue in Fabe. In Fabe, a State preference for distributions to
policyholders for claims and expenses incurred in the administration of
insolvency proceedings was found to be the ``business of insurance.''
The Supreme Court found that the Ohio statute at issue in Fabe was
``aimed at protecting or regulating, directly or indirectly, the
relationship between the

[[Page 3537]]

insurance company and its policyholders.'' Fabe, 508 U.S. at 491-92
(citing SEC v. Nat'l Sec., Inc., 393 U.S. at 460). Considering the
relationship between the insurer and the insured, the Supreme Court
held that, to the extent (1) the State law at issue in Fabe protected
policyholders and (2) the Federal priority statute under 31 U.S.C.
3713(a)(1)(A)(iii) would impair that relationship, Federal law did not
preempt State law. The Court in Fabe had to choose between Federal and
State statutes because they were in direct conflict. Conversely, the
proposed regulations are not in conflict with any State regulations;
the relationship between insurer and insured is in no way impacted.
Taxpayers remain free to enter into captive insurance transactions in
any State and to structure such transactions within the confines of
State regulations, and States remain free to regulate such
transactions. However, if such structure is described in Sec. 1.6011-
10 or Sec. 1.6011-11, participants must disclose information about the
arrangement to the IRS. In other words, the proposed regulations attach
specific tax obligations (in the form of disclosure) to specific acts
(in the form of participating in a transaction described in Sec.
1.6011-10 or Sec. 1.6011-11), but the proposed regulations do not
change how those acts are done.
Second, the act of disclosing a transaction to the tax authorities
is not the ``business of insurance.'' The threshold question under 15
U.S.C. 1012(a), in determining whether the anti-preemption mandate of
15 U.S.C. 1012(b) applies, is whether the challenged conduct broadly
constitutes the ``business of insurance'' in the first place. If the
contested activities are wholly unrelated to the insurance business,
then McCarran-Ferguson has no place in analyzing Federal regulation
because only when ``[insurance companies] are engaged in the `business
of insurance' does the act apply.'' Sabo v. Metropolitan Life Ins. Co.,
137 F.3d 185, 190 (3d Cir. 1998) (citing SEC v. Nat'l Sec., Inc., 393
U.S. at 459-60); see also United States v. Del. Dep't of Ins., 66 F.4th
at 125 (reaffirming the threshold inquiry precedent set in Sabo). The
``core of `the business of insurance'' is ``[t]he relationship between
insurer and insured, the type of policy which could be issued, its
reliability, interpretation and enforcement.'' United States v. Del.
Dep't of Ins., 66 F.4th at 130 (citing SEC v. Nat'l Sec., Inc., 393
U.S. at 460). The ``business of insurance'' is also understood to be
``[an]other activity of insurance companies [that] relate[s] so closely
to [their] status as reliable insurers that [it] must be placed in the
same class.'' Id. The conduct at issue in the proposed regulations is
the filing of disclosure statements upon identification as participants
in or material advisors of a transaction that, for Federal tax
purposes, either is a listed transaction or a transaction of interest.
Like the information gathering conduct via the summonses at issue in
the United States v. Del. Dep't of Ins., the disclosure requirements in
the proposed regulations are not ``the business of insurance.'' The
final regulations do not adopt any changes based on these comments.
B. Federalism Implications
Commenters also argued that the proposed regulations have
federalism implications and fail to satisfy Executive Order 13132
(Federalism). Executive Order 13132 generally provides that an agency
is prohibited from publishing any rule that has federalism implications
if the rule imposes substantial, direct compliance costs on State and
local governments, and is not required by statute, or if the rule
preempts State law, unless the agency satisfies, among other things,
the consultation and federalism summary impact statement requirements
of section 6 of the Executive order.
The proposed regulations do not have federalism implications, and
the requirements in section 6 of Executive Order 13132 to consult with
State and local officials and issue a federalism impact statement do
not apply. As described in this preamble, the proposed regulations do
not preempt State law, nor do they impose substantial, direct
compliance costs on State and local governments, as there is no
obligation created by the regulations with which any State or local
agency may need to comply. The final regulations do not adopt any
changes based on these comments.
C. Constitutionality, Fairness, and Retroactivity
Commenters contended that the proposed regulations are
unconstitutional for a number of reasons. First, commenters argued that
requiring participants to disclose transactions they participated in,
even if such taxpayers were examined for one or more years for which
reporting would be required and for which the IRS did not make any
adjustments to the taxpayers' returns, is unconstitutional and
retroactive in nature. Second, commenters argued that the proposed
regulations are intended to shut down the captive insurance industry
and may constitute a ``taking'' under the Fifth Amendment of the U.S.
Constitution, by restricting the rights of taxpayers to engage in
captive insurance transactions.
With respect to the first argument, commenters did not specify what
provision of the Constitution is allegedly violated by the potential
need to disclose participation in a transaction after an examination
resulted in no change to the examined returns, and we are not aware of
any Constitutional provision that would be violated. In addition, any
such disclosure requirement in these regulations is not retroactive in
nature; the final regulations will be effective January 14, 2025. To
the extent the final regulations result in a disclosure obligation with
respect to transactions occurring in prior taxable years for which the
statute of limitations on assessment has not expired, such obligation
is a current reporting obligation that arises after January 14, 2025.
With respect to the comment about reporting requirements for
taxpayers whose returns have been examined, the reporting rules are
outside the scope of these final regulations, which merely identify a
listed transaction and a transaction of interest, respectively. The
reporting rules for listed transactions and transactions of interest
are found in Sec. 1.6011-4, which was issued pursuant to notice and
comment and finalized most recently on August 3, 2007, in TD 9350 (72
FR 43146), and which is not amended by these regulations. However,
there are tax administration reasons to maintain these reporting
requirements. Most importantly, initial disclosures of reportable
transactions are filed with the Office of Tax Shelter Analysis (OTSA)
to ensure that all information is collected in one place. The OTSA's
mission is, among other things, to ensure that the IRS has the
information necessary to detect abusive tax shelters and identify
issues of significant compliance risk to tax administration. The OTSA
collects and analyzes information about abusive tax shelters and
reportable transactions to identify trends and disseminates the results
to those in a position to take appropriate action. In order to identify
participants and promoters of tax avoidance transactions, the OTSA
needs to receive and review Forms 8886 in a timely and efficient
manner. Limiting disclosure to a subset of transaction participants
(such as taxpayers whose examinations have been closed) would provide
an incomplete picture of the transaction and hinder the OTSA's efforts.
Accordingly, the final regulations do not

[[Page 3538]]

adopt any changes based on these comments.
The commenters' second Constitutional argument, under the Fifth
Amendment, is also without merit. As relevant here, the Fifth Amendment
provides, in addition to the other limitations on government power,
that ``private property [shall not] be taken for public use, without
just compensation.'' The proposed regulations identify a transaction as
a listed transaction or a transaction of interest for Federal tax
purposes and require the filing of disclosures with the IRS and the
OTSA. Requiring disclosure of participation in these transactions does
not implicate the Fifth Amendment; no property interest is taken for
public use by the government under the proposed regulations
necessitating compensation.
Taxpayers remain free to engage in any captive insurance
transaction, regardless of whether such transaction is identified in
Sec. 1.6011-10 or Sec. 1.6011-11, respectively; however, there may be
Federal tax consequences if the transaction is not a valid captive
insurance transaction. As there is no limitation on participation in
any transaction by operation of the proposed regulations, there is no
``taking'' for Fifth Amendment purposes.
D. The Administrative Procedure Act
Commenters argued that the proposed regulations lack legal
foundation and assert that the regulations will be challenged and set
aside just as Notice 2016-66 was set aside in CIC Services, LLC v. IRS,
592 F.Supp.3d 677 (E.D. Tenn. 2022). In CIC Services, the district
court followed the analysis in Mann Construction, Inc. v. United
States, 27 F.4th 1138 (6th Cir. 2022), rev'g 539 F.Supp.3d 745 (E.D.
Mich. 2021), which held that the identification of a listed transaction
must follow the notice-and-comment procedures of the Administrative
Procedure Act (``APA''). The district court in CIC Services held that
Notice 2016-66 should be vacated because the IRS did not follow the
APA's notice-and-comment procedures. The district court held in the
alternative that the IRS acted arbitrarily and capriciously based on
the administrative record. CIC Services, 592 F.Supp.3d at 687.
In light of the decision by the district court in CIC Services and
other judicial decisions, the Treasury Department and the IRS published
the proposed regulations and obsoleted Notice 2016-66. The NPRM
provided for a comment period from April 11, 2023, through June 12,
2023, and more than 100 comment letters were received. The Treasury
Department and the IRS conducted a public hearing on July 19, 2023,
providing further opportunity for taxpayers to comment on the proposed
regulations. The APA notice-and-comment procedures have been followed.
Some commenters suggested that the IRS's purpose for publishing the
proposed regulations is to harass otherwise valid businesses, but the
purpose is simply to require disclosures with respect to transactions
described in Sec. Sec. 1.6011-10 and 1.6011-11, in the interest of tax
administration. Examinations of taxpayers and promoters have helped to
clarify the Treasury Department's and the IRS's understanding of micro-
captive transactions, including the scope of participation. The factors
used to identify the Micro-captive Listed Transaction and the Micro-
captive Transaction of Interest are neither arbitrary nor capricious.
They reflect the IRS's long-standing positions with respect to abusive
micro-captives as made public in annual Dirty Dozen tax schemes
publications and case law. The factors 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 objectivity and reasonableness of each
factor is discussed more fully throughout this Summary of Comments and
Explanation of Revisions, notably in part II. (Loss Ratio Factor); part
III. (Financing Factor); and part VI.B. (20 Percent Relationship Test).
The existing case law with respect to micro-captives demonstrates the
commonalities in the fact patterns in these transactions, which is
relevant to the development of the transaction fact patterns identified
in these regulations. The Tax Court has consistently determined in its
section 831(b) decisions issued to date that taxpayers in the relevant
micro-captive transactions remitted amounts treated as premiums for
something other than insurance. See Avrahami, 149 T.C. at 197-98;
Syzygy v. Commissioner, T.C. Memo. 2019-34, at *45; Caylor Land & Dev.,
Inc. v. Commissioner, T.C. Memo. 2021-30, at *48-49; Keating v.
Commissioner, T.C. Memo. 2024-2, at *64; Swift v. Commissioner, T.C.
Memo. 2024-13, at *44-45; Patel v. Commissioner, T.C. Memo. 2024-34, at
*51-52, and Royalty Mgmt. Ins. Co., Ltd. v. Commissioner, T.C. Memo.
2024-87, at *49-50. Current examinations and litigation also are
relevant, as they demonstrate consistency with the transaction fact
patterns identified in these regulations.
Section 6707A(c) delegates to the IRS the authority to promulgate
regulations pursuant to section 6011 identifying reportable
transactions. Specifically, section 6707A(c)(1) states that ``[t]he
term `reportable transaction' means any transaction with respect to
which information is required to be included with a return or statement
because, as determined under regulations prescribed under section 6011,
such transaction is of a type which the Secretary determines as having
a potential for tax avoidance or evasion.'' Section 6707A(c)(2) defines
the term ``listed transaction'' as ``a reportable transaction which is
the same as, or substantially similar to, a transaction specifically
identified by the Secretary as a tax avoidance transaction for purposes
of section 6011.'' Section 6707A(a) provides that ``[a]ny person who
fails to include on any return or statement any information with
respect to a reportable transaction which is required under section
6011 to be included with such return or statement shall pay a penalty
in the amount determined under subsection (b)'' (emphasis added). Under
section 6011(a), returns and statements, including disclosures, should
be filed ``according to the forms and regulations prescribed by the
Secretary.'' The proposed regulations do not create any law that is
contrary to any statute; rather, the proposed regulations identify
transactions that must be disclosed per the existing rules under the
Code with respect to reportable transactions, as sections 6707A(c) and
6011 prescribe.
In addition, the Secretary has general regulatory authority under
section 7805(a) to ``prescribe all needful rules and regulations for
the enforcement of'' the Code. The Treasury Department and the IRS have
clear authority to issue the proposed regulations and have followed the
procedural requirements of the APA. As explained more fully throughout
this Summary of Comments and Explanation of Revisions, these final
regulations are based on consideration of comments in response to the
proposed regulations, case law, and the IRS's years of experience with
abusive micro-captives.
E. Definition of Insurance for Federal Tax Purposes
Commenters also argued that by identifying a micro-captive
transaction as a listed transaction or a transaction of interest on the
basis of a Loss Ratio Factor, a Financing Factor, or both, the proposed
regulations define insurance for Federal tax purposes in a manner
inconsistent with case law. Commenters cited a number of cases,
including Reserve Mech. Corp. v. Commissioner,

[[Page 3539]]

34 F.4th 881 (10th Cir. 2022), aff'g, T.C. Memo. 2018-86; United Parcel
Service of America, Inc. v. Commissioner, 254 F.3d 1014 (11th Cir.
2001); Harper Grp. v. Commissioner, 979 F.2d 1341 (9th Cir. 1992),
aff'g, 96 T.C. 45 (1991); Sears Roebuck & Co. v. Commissioner, 972 F.2d
858 (7th Cir. 1992); AMERCO v. Commissioner, 96 T.C. 18 (1991); Humana,
Inc. v. Commissioner, 881 F.2d 247 (6th Cir. 1989); Caylor, T.C. Memo.
2021-30; Syzygy, T.C. Memo. 2019-34; Avrahami, 149 T.C. 144 (2017);
R.V.I. Guar. Co. v. Commissioner, 145 T.C. 209 (2015); Rent-A-Center,
142 T.C. 1 (2014); and Securitas Holdings, Inc. v. Commissioner, T.C.
Memo. 2014-225. Additionally, several commenters pointed to the IRS's
concession in Puglisi v. Commissioner, 2021 WL 7162530 (T.C. Oct. 29,
2021), as proof that the IRS has accepted facts similar to those
described in the proposed regulations as insurance for Federal tax
purposes, and therefore, the apparent attempt by the proposed
regulations to redefine insurance for Federal tax purposes is contrary
to established precedent.
The proposed regulations do not redefine insurance for Federal tax
purposes by identifying the specific fact patterns set forth in
Sec. Sec. 1.6011-10 and 1.6011-11 as listed transactions or
transactions of interest, respectively. The proposed regulations
identify fact patterns that are consistently present in the micro-
captive cases tried on their merits and the examined cases with respect
to which the IRS has determined that the transaction at issue lacked
the necessary characteristics, based on the specific facts in each
case, to qualify as insurance for Federal tax purposes under existing
caselaw. (Although section 6103 prohibits the IRS from disclosing
specific taxpayer information, it does not preclude the IRS from
identifying consistent fact patterns based on specific taxpayer
information.)
For specific cases with respect to which the IRS received comments,
section 6103 of the Code prohibits the IRS from discussing taxpayer
return information. However, section 6103(b)(2) clarifies that the IRS
is not prohibited from disclosing information to the extent it is ``in
a form which cannot be associated with, or otherwise identify, directly
or indirectly, a particular taxpayer,'' such as, for example, fact
patterns based on specific taxpayer return information. In general,
there are a variety of reasons why certain examined cases may have
conceded an otherwise valid challenge to the taxpayer's position,
either by the IRS Independent Office of Appeals (Appeals) or in
litigation.
Several commenters incorrectly assumed that the proposed
regulations declare all entities electing the alternative tax under
section 831(b) as tax avoidant or potentially tax avoidant, contrary to
Congressional intent to encourage the use of small captives by enacting
section 831(b) and subsequent amendments thereof, including section 333
of the PATH Act. This assumption is incorrect for several reasons.
First, the proposed regulations identify a specific fact pattern
involving related parties, including a Captive, at least 20 percent of
the voting power or the value of the outstanding stock or equity
interest of which is owned, directly or indirectly, by an Insured, an
Owner, or persons Related to Insured or an Owner (as such terms are
defined in Sec. 1.6011-10(b)). The definition of Captive includes the
section 831(b) election, but there are several other factors that must
be met before the transaction is described as a Micro-captive Listed
Transaction or a Micro-captive Transaction of Interest. The closely
held nature of the arrangement coupled with the section 831(b) election
and the use of premiums for personal investments or for related-party
financing and not to pay losses are what renders these transactions
appropriate subjects of disclosure as tax avoidance transactions or
transactions of interest.
Second, Congress enacted section 831(b) in the interest of
simplifying the Code, not to encourage the use of small captive
insurance companies. H.R. Rep. No. 99-426, at 678 (1985) (``The present
law applicable to small and certain ordinary mutual companies is
inordinately complex and should be simplified.''). Congress amended
section 831(b) to provide that the election may be revoked only with
the consent of the Secretary, with the clear intent ``that the election
not be used as a means of eliminating tax liability (e.g., by making
the election only for years when the taxpayer does not have net
operating losses), but rather as a simplification for small
companies.'' H.R. Rep. No. 100-795, at 121 (1988); S. Rep. 100-445, at
127 (1988). Nothing in the statutory language or the legislative
history of section 831(b) suggests that Congress intended to provide
the benefits of section 831(b) to companies that do not qualify as
insurance companies for Federal tax purposes.
Third, the Code does not permit a current deduction for amounts set
aside for self-funding of future losses. See, e.g., Harper Grp, 96 T.C.
at 46 n.2 (1991) (``Losses incurred by the self-insured taxpayer are
deductible (if at all) only in the year paid out from the reserve
fund.''), aff'd, 979 F.2d 1341 (9th Cir. 1992); Stearns-Roger Corp. v.
United States, 774 F.2d 414, 415 (10th Cir. 1985) (``Payments [for
self-insurance] are not deductible as insurance premiums''). The
transactions described in Sec. 1.6011-11 have many of the
characteristics of self-insurance, and as such, taxpayers who deduct
amounts paid to captives in such transactions may be engaged, as a
matter of substance, in self-insurance, but more information is needed
to determine if that is the case.
F. Small and Mid-Sized Businesses and the Captive Industry
A number of commenters suggested that the proposed regulations
discriminate against small and mid-sized businesses by designating
certain micro-captive transactions as listed transactions, and certain
other micro-captive transactions as transactions of interest.
Commenters also stated that the proposed regulations will impermissibly
chill the captive insurance industry. Although it may be the case that
many small and mid-sized businesses utilize captive insurance entities
that make an election under section 831(b), the proposed regulations do
not discriminate against such businesses on the basis of their size by
identifying their captive as a Micro-captive Listed Transaction or a
Micro-captive Transaction of Interest. Regarding Insureds, there is no
specific size of company at issue; large and small businesses alike may
engage in a captive insurance transaction, but if such transaction
meets the description of a Micro-captive Listed Transaction or a Micro-
captive Transaction of Interest, the participants in and material
advisors thereof must file disclosure statements. The Treasury
Department and the IRS do not intend to discourage the use of section
831(b) by entities that qualify for the election, nor should these
regulations be construed as intending to discourage the use of section
831(b) by such entities. These regulations do not hinder the formation
of valid captive insurance companies, as discussed more fully at parts
VI.C. and H. of the Summary of Comments and Explanation of Revisions.

II. Comments and Changes Relating to the Loss Ratio Factors as
Described in Proposed Sec. Sec. 1.6011-10(c)(2) and 1.6011-11(c)

A. Overview of Comments Relating to the Loss Ratio Factors
Commenters expressed a number of concerns about the Loss Ratio
Factors

[[Page 3540]]

and Computation Periods. In response to these concerns, the final
regulations significantly narrow the scope of the Micro-captive Listed
Transaction description by providing that transactions are identified
as listed transactions under the final regulations only if both the
Financing Factor and the Loss Ratio Factor tests are met. The final
regulations also lower the Loss Ratio Factors for both Micro-captive
Listed Transactions and Micro-captive Transactions of Interest in
response to comments. With respect to the proposed Loss Ratio
Computation Period set forth at proposed Sec. 1.6011-10(b)(2)(ii) and
the proposed Transaction of Interest Computation Period set forth at
proposed Sec. 1.6011-11(b)(2) (collectively, the ``Computation
Periods''), as further discussed in this part II. of the Summary of
Comments and Explanation of Revisions, the final regulations make no
substantive changes to the Loss Ratio Computation Period but do extend
the Transaction of Interest Computation Period to a period of up to ten
years.
Many of the comments related to the Loss Ratio Factors in the
proposed regulations raised multiple concerns that were not clearly
delineated from other comments or recommendations. For clarity,
comments received with respect to the Loss Ratio Factors are addressed
categorically in the remaining subparts of this part II. of the Summary
of Comments and Explanation of Revisions.
B. Tax Avoidance or Potential for Tax Avoidance Identified by Loss
Ratio Factors
Several commenters suggested that the Loss Ratio Factors as set
forth at proposed Sec. Sec. 1.6011-10(c)(2) and 1.6011-11(c) are
inappropriate metrics for the captive insurance industry and should not
be determinative of whether a transaction is a Micro-captive Listed
Transaction or a Micro-captive Transaction of Interest. Some cited
Puglisi, 2021 WL 7162530, for support, suggesting that the IRS conceded
the case because the captive at issue, which had a loss ratio below 65
percent, was not participating in a tax avoidance transaction.
Commenters also argued that the IRS is treating similarly situated
taxpayers differently, by predicating whether a micro-captive
transaction involving an entity electing the alternative tax under
section 831(b) is a reportable transaction using the Loss Ratio Factors
but not doing the same for entities that do not make the section 831(b)
election. Other commenters asserted that the Loss Ratio Factors were
inappropriate because captives may recover funds through reinsurance,
which would have the effect of lowering loss ratios.
In the context of closely held section 831(b) entities, the Loss
Ratio Factors generally identify transactions involving circumstances
inconsistent with insurance for Federal tax purposes, including
excessive pricing of premiums and artificially low or nonexistent
claims activity. The Loss Ratio Factor measures whether the amount of
liabilities incurred for insured losses and claims administration
expenses is significantly less than the amount of premiums earned,
adjusted for policyholder dividends. The primary purpose of premium
pricing is to ensure funds are available should a claim arise. The
pricing of premiums should naturally reflect the economic reality of
insurance operations, to ensure that policies are ``price[d] in such a
way that the premiums brought in cover losses and the insurer's
business expenses with enough profit left over to keep investors
happy.'' Avrahami, 149 T.C. at 152. Typically, actuaries establish a
policy rating scheme and classify risks ```to allow credible
statistical inferences regarding expected outcomes.''' Id. (quoting
Actuarial Standard of Practice No. 12: Risk Classification (for All
Practice Areas), sec. 3.3 (Actuarial Standards Bd. 2005). The work
should be reproducible and permit ``another actuary qualified in the
same practice area [to] make an objective appraisal of the
reasonableness of the actuary's work.'' Actuarial Standard of Practice
No. 41: Actuarial Communications, sec. 3.2 (Actuarial Standards Bd.
2010), https://www.actuarialstandardsboard.org/standards-of-practice/
(last visited Jan. 6, 2025). Pricing premiums far in excess of what is
reasonably needed to fund insurance operations results in a lower loss
ratio and remains a strong indicator of tax avoidance. Further, while
amounts paid for insurance may be deductible business expenses, amounts
set aside in a loss reserve as a form of self-insurance are not. See,
e.g., Harper Grp., 96 T.C. at 46 n.2; Stearns-Roger Corp., 774 F.2d at
415.
With respect to comments suggesting that the outcome of specific
examined cases (such as Puglisi, 2021 WL 7162530) demonstrates the
impropriety of using Loss Ratio Factors generally, or that
determinations in such cases demonstrate that the Service is treating
similarly situated taxpayers differently, section 6103 prohibits the
IRS from disclosing specific taxpayer information. However, as
discussed in part I.E. of this Summary of Comments and Explanation of
Revisions, section 6103 does not preclude the IRS from identifying
consistent fact patterns based on specific taxpayer information. The
IRS's decision to concede or settle a given case in no way alters these
findings and conclusions, nor are these findings and conclusions
altered by the examination of entities that do not fit the identified
fact pattern.
Further, commenters suggested that the inclusion of a section
831(b) election as an identifying factor in the proposed regulations
but not doing the same for entities that do not make a section 831(b)
election means similarly situated taxpayers are being treated
differently. However, an entity that does not make a section 831(b)
election is not similarly situated. An insurance company taxed under
section 831(a) has a corresponding income recognition for amounts paid
as insurance premiums, lessening the potential of ongoing tax deferral
present in the transactions identified by these regulations.
In response to the commenters who asserted that reinsurance would
have the effect of lowering loss ratios, the Treasury Department and
the IRS respectfully disagree. Any reinsurance obtained by the Captive
for risks attributable to direct written coverage would tend to reduce
the premiums earned by the Captive (as most if not all amounts
attributable to the reinsurance would typically be ceded to the
reinsurer and deducted from premiums earned), thereby increasing the
Captive's Loss Ratio Factor percentage and making it less likely that
such transaction would be described in the regulations. The final
regulations do not eliminate the Loss Ratio Factors based on these and
similar comments.
C. Potential To Capture Transactions That Are Not Tax Avoidance
Transactions as Listed Transactions
Commenters asserted that micro-captive transactions that are not
tax avoidance transactions may have loss ratios that fall below the
threshold established by the Loss Ratio Factors. Commenters opined that
a loss ratio factor of 65 percent leaves determination of whether a
transaction is a listed transaction up to ``random chance,'' because
future loss experience cannot be known when premiums are set, which
makes the Loss Ratio Factors inappropriate for identifying tax
avoidance transactions or transactions of interest. Commenters stated
that premiums are intentionally set at high rates for long periods of
time to ensure that there are adequate reserves to pay claims in case
of catastrophic loss. Some suggested that transactions meeting the
proposed 65 percent Loss Ratio Factor

[[Page 3541]]

using a ten-year Loss Ratio Computation Period be identified as Micro-
captive Transactions of Interest instead of Micro-captive Listed
Transactions. Commenters expressed concern that transactions that are
not tax avoidance transactions would be captured if the Loss Ratio
Factors are retained, arguing that limited loss history does not mean
that risks are not present, or that premiums are overpriced. Commenters
pointed to a governmental program that provides reimbursement coverage
for certain losses attributable to acts of terrorism set forth in the
Terrorism Risk Insurance Act of 2002 (``TRIA'') as an example for why a
loss ratio well below the proposed 65 percent is not inherently
indicative of tax avoidance. Several commenters pointed to the Tax
Court's holdings in R.V.I. Guar. Co., Ltd. & Subs. v. Commissioner, 145
T.C. 209 (2015), as support for why the proposed 65 percent for a loss
ratio is too high.
With respect to concerns that transactions that are not tax
avoidance transactions could be identified as Micro-captive Listed
Transactions based on a ten-year Loss Ratio Computation Period and
proposed 65 percent Loss Ratio Factor, the IRS recognizes that low loss
ratios may be the result of coverage of low-frequency, high-severity
risks. Inherent in insurance underwriting is the concept that by
assuming numerous independent risks that will occur randomly, losses
will become more predictable over time, and pricing should reflect
those anticipated losses. See, e.g., Clougherty Packing Co., Inc. v.
Commissioner, 811 F.2d 1297, 1306 (9th Cir. 1987) (``The likelihood
that a loss will occur is of uncertain but predictable magnitude; the
size of the loss is similarly uncertain but predictable.''). This
concept is notably absent from the micro-captive cases tried to date,
as premiums were consistently priced to meet the target threshold under
section 831(b) without regard to reasonable estimates for loss
experience. See Avrahami, 149 T.C. at 194-198; Syzygy, T.C. Memo. 2019-
34, at *33-34; Caylor, T.C. Memo. 2021-30, at *45-47; Keating, T.C.
Memo. 2024-2, at *59-61; Swift, T.C. Memo. 2024-13, at *40-42; Patel,
T.C Memo. 2024-34, at *48-50; and Royalty Mgmt., T.C. Memo. 2024-87, at
*23, 46-48; see also Reserve Mech., 34 F.4th at 891-94. The Loss Ratio
Factor percentage is not intended to act as a proxy for the actuarial
basis of premium pricing, as such a basis would be too fact specific to
establish an administrable test that would adequately put all relevant
taxpayers on notice of their obligations under the Code in accordance
with every taxpayer's right to be informed. See Taxpayer Bill of
Rights, https://www.irs.gov/taxpayer-bill-of-rights (last visited Jan.
6, 2025).
Commenters identifying loss ratios at issue in specific Tax Court
cases did not specify what the loss ratios would be in those cases if
computed as set forth in the proposed regulations over the proposed
ten-year Loss Ratio Computation Period, nor did they specify an
administrable metric that would enable better identification of tax
avoidance transactions. The inclusion of a ten-year Loss Ratio
Computation Period is intended to allow a Captive significant time to
develop a reasonable loss history that supports the use of a micro-
captive for legitimate insurance purposes. The final regulations retain
the ten-year Loss Ratio Computation Period in the proposed listed
transaction regulations, but in response to concerns that the proposed
Loss Ratio Factors are nevertheless set too high and will capture
transactions that are not tax avoidance transactions, the final
regulations lower the Loss Ratio Factor for purposes of designating a
listed transaction under Sec. 1.6011-10 to 30 percent.
The percentage was selected in response to comments indicating that
the Tax Court's holding in R.V.I. supports a lower loss ratio. R.V.I.
is the one case cited by commenters that analyzed loss ratios for time
periods corresponding to the Loss Ratio Computation Period for the
Micro-captive Listed Transaction. In R.V.I., the Tax Court listed the
captive's loss ratios from 2000 through 2013. R.V.I., 145 T.C. at 216.
The listed loss ratios ranged from a low of 0.2 percent (2012) to a
high of 97.9 percent (2008). Id. As the Tax Court found, when
considered in their totality, these ratios reflect ``significant claims
and . . . . significant insurance losses.'' Id. at 215. The average
loss ratio in R.V.I. for the five ten-year periods analyzed by the Tax
Court (2000 through 2009; 2001 through 2010; 2002 through 2011; 2003
through 2012; and 2004 through 2013) themselves ranged from a low of 28
percent (2000 through 2009) to a high of 35 percent (2004 through
2013). Taking the average of those five ten-year periods, the average
ten-year loss ratio in the R.V.I. case was 32 percent. This amount is
rounded down to 30 percent in the final regulations.
Further, to better target those transactions that are properly
identified as listed transactions rather than as transactions of
interest, the final regulations require that the transaction meet both
the Loss Ratio Factor and the Financing Factor (a conjunctive test) to
be designated as a listed transaction, as explained more fully in part
III. of this Summary of Comments and Explanation of Revisions. This
change to a conjunctive test, coupled with the lower Loss Ratio Factor
percentage for Micro-captive Listed Transactions, significantly narrows
the scope of the Micro-captive Listed Transaction in the final
regulations and should provide adequate relief for taxpayers who
suggested comparisons to specific business line loss ratios, as well as
for taxpayers who expressed concerns about the breadth of the Micro-
captive Listed Transaction under the proposed regulations or who
requested that transactions that would have met the proposed 65 percent
Loss Ratio Factor be identified as transactions of interest instead.
Although the example of the TRIA's loss experience is not strictly
relevant (that is, because the TRIA is a governmental relief program,
not an insurance company) the significantly narrowed scope of the
Micro-captive Listed Transaction is intended to respond to concerns
that lower losses do not necessarily mean risks were not present or
that premiums were overpriced.
For clarity, the proposed Loss Ratio Computation Period is retitled
as the ``Listed Transaction Loss Ratio Computation Period'' and the
proposed Transaction of Interest Computation Period is retitled as the
``Transaction of Interest Loss Ratio Computation Period''. The final
regulations generally retain the substance of the proposed Computation
Periods except the Transaction of Interest Loss Ratio Computation
Period is increased in the final regulations from a Captive's nine most
recent taxable years to its ten most recent taxable years (or all
taxable years of the Captive's existence if it has been in existence
for less than ten taxable years) as discussed more fully in part II.D.
of this Summary of Comments and Explanation of Revisions. If an
established transaction that is otherwise described in the final
regulations has not had adequate time to develop a ten-year loss
history, the transaction may only be designated as a transaction of
interest rather than a listed transaction. In addition, the Loss Ratio
Factor for identification as a transaction of interest is also lowered
from 65 percent to 60 percent in the final regulations, as described in
part II.D. of this Summary of Comments and Explanation of Revisions.
D. Comparison to National Averages
The proposed Loss Ratio Factors were generally formulated by using
the medical loss ratio in section 833 of the

[[Page 3542]]

Code, to inform the original loss ratio factor in Notice 2016-66, and
by using national data for commercial property and casualty insurers,
to inform the proposed regulations. A number of commenters contended
that these metrics are inappropriate because section 831(b) captive
insurers are materially different from commercial insurers due to the
different types of coverage offered by commercial and captive insurers.
For example, several commenters asserted that the inclusion in national
averages of certain lines of coverage (identified by one commenter as
private passenger auto liability, commercial auto liability, and
accident and health coverage lines) that captives do not typically
write, or may not be permitted to write, may tend to skew industry-wide
loss ratios higher. Another commenter relatedly suggested that the Loss
Ratio Factor's reliance on data from the National Association of
Insurance Commissioners (NAIC) as a benchmark was inappropriate because
the data does not include the experience of the vast majority of
captive insurance companies, including those which have elected to be
taxed under section 831(b). One commenter asserted that the national
industry average relied upon in the proposed regulations lacks an
actuarial basis, and another commenter stated that aggregated data of
the U.S. property-casualty insurance industry would reflect more risk
diversification and geographic diversity than would be present in a
typical micro-captive arrangement.
As noted in the preamble to the proposed regulations, the Loss
Ratio Factors are modified loss ratios spread out over the course of
many years, unlike the single-year NAIC averages, and are also lower
than the NAIC industry averages. The NAIC industry averages ranged
between 67.2 and 76.2 percent per year from 2012 to 2021. See Insurance
Industry Snapshots and Analysis Reports, https://naic.soutronglobal.net/Portal/Public/en-US/RecordView/Index/26555 (last
visited Jan. 6, 2025). In the latest published NAIC industry report,
national averages ranged between 69.0 and 76.4 percent per year from
2014 to 2023. See 2023 Annual Property & Casualty Insurance and Title
Insurance Industries Analysis Report, https://naic.soutronglobal.net/Portal/Public/en-US/RecordView/Index/26555 (last visited Jan. 6, 2025).
Accordingly, even a Captive electing the alternative tax under section
831(b) that has a loss ratio below the industry-wide average for
property and casualty companies in a given year will not necessarily
have a loss ratio that causes it to be a participant to a transaction
identified by the regulations.
With respect to concerns that the use of NAIC data as a benchmark
for the Loss Ratio Factor is inappropriate because the NAIC does not
capture micro-captive data, the commenter did not identify any
alternative published data set that would capture the experience of
``the vast majority of captive insurance companies, including micro-
captive insurance companies,'' nor is the IRS aware of one. The
commenter included a table illustrating the distribution of AM Best
Company's average loss and loss administration expenses ratios for
small insurance companies, described as insurers grouped by capital and
surplus up to $10 million, but this data set is inappropriate. As the
commenter noted, the AM Best Company's data set includes ``vastly
different claims characteristics than micro-captives'' covering risks
that micro-captives are not generally permitted to cover, such as
personal automobile liability and homeowner's liability. The NAIC data,
conversely, represents industry averages generally applicable to all
nonlife insurers, and, accordingly, was relied upon in the proposed
regulations as a starting point, which was modified by the inclusion of
policyholder dividends in the computation and by the application of an
extended Computation Period. Further, as previously discussed in part
II.C. of this Summary of Comments and Explanation of Revisions, the
threshold for the Loss Ratio Factor for identification of a Micro-
captive Listed Transaction has been lowered significantly in the final
regulations.
The comments regarding the lines of coverage included in the NAIC
averages provide support for a reduction to the proposed Loss Ratio
Factor for identification as a transaction of interest. The specific
business lines identified by the commenters would, based on the NAIC
Profitability Study provided by one of the commenters, result in an
average nine-year loss ratio of approximately 59 percent. However,
there are other high frequency, low severity coverages and other
business lines that captives are unlikely to cover in the data provided
by the commenter that the commenter failed to mention: private
passenger auto physical damage, homeowners' multiple peril, and
mortgage guaranty lines. Removing these lines from the data set
provided by the commenter would reduce the average nine-year loss ratio
percentage from 65 percent identified in the proposed regulations to
slightly over 60 percent.
However, this relies on the national average computation of loss
ratios, which as commenters pointed out, is not the modified
computation set forth in the proposed regulations. The modified
computation ratio in the final regulations would potentially be lower,
in part because policyholder dividend payments reduce the ratio. To
determine what the average loss ratio would be using the modified loss
ratio computation set forth in the proposed regulations, the IRS
considered the annual NAIC Report on Profitability by Line by State for
each year from 2013 through 2022 to understand a typical property and
casualty company loss ratio. See, e.g., 2013 Report on Profitability by
Line by State, Center for Insurance Policy & Research, https://naic.soutronglobal.net/Portal/Public/en-US/RecordView/Index/7008 (last
visited Jan. 6, 2025). By removing the high frequency, low severity
coverages that captives are unlikely to cover for each year from 2013
through 2022 from the annual data and computing the comparison of
liabilities incurred for insured losses and claim administration
expenses to premiums earned less policyholder dividends as set forth in
the regulations, the average nine-year modified loss ratio is
approximately 66 percent, which is slightly higher than the proposed 65
percent established in the proposed regulations. The average ten-year
modified loss ratio is also slightly higher, at approximately 67
percent.
In light of commenters' concerns that the proposed 65 percent
modified loss ratio is still too high, the Loss Ratio Factor percentage
for identification of a transaction of interest in these regulations is
lowered to 60 percent. This amount represents a discount from the
lowest loss ratio supported by available data. The Loss Ratio Factor
percentage for identification as a listed transaction has been reduced
much more substantially to 30 percent, for other reasons, as described
in part II.C. of this Summary of Comments and Explanation of Revisions.
In the interest of ensuring all taxpayers can easily determine their
status under the regulations, the Loss Ratio Factor remains based on
the aggregated NAIC average as modified in the final regulations;
although commenters were critical of the aggregated data provided by
the NAIC, commenters did not point to, and the IRS is not aware of, an
alternative publicly-available data set that would be more appropriate.
Further, the Treasury Department and the IRS considered alternative

[[Page 3543]]

Computation Periods and determined that a difference of one year in the
Computation Periods between the Micro-captive Listed Transaction and
the Micro-captive Transaction of Interest when the loss ratio
thresholds are different adds unnecessary complexity and burden to
affected taxpayers. The Transaction of Interest Loss Ratio Computation
Period is accordingly increased to a period of up to ten years, or if
the Captive has not been existence for ten full years, all years of the
Captive's existence. This change will afford affected taxpayers more
time to develop a loss history and will enable the computation of one
ratio when affected taxpayers are considering if they need to report
under Sec. 1.6011-10 or Sec. 1.6011-11.
E. Proposed Alternatives to the Loss Ratio Factors
Commenters suggested alternatives to the Loss Ratio Factors
including: (1) evaluating the methodology used to price premiums to
ensure the premiums either are priced commensurate with commercial
insurance market premiums, or are priced at arm's length, given that
several Code sections (such as section 482) and the regulations
thereunder place strict limitations on what may be considered arm's
length in a given industry; (2) applying the definition of a qualified
insurance company (QIC) set forth in the passive foreign investment
company rules; (3) comparing micro-captives to commercial carriers and
special markets, such as commercial excess and surplus lines (``E&S'')
carriers; (4) comparing micro-captives to county mutual insurance
companies, which commenters said have loss ratios of 40 percent and
frequently make section 831(b) elections; or (5) establishing
variations of the Loss Ratio Factors for specific regions or States.
These recommendations are addressed in turn in this part II.E. of the
Summary of Comments and Explanation of Revisions.
1. Premium Pricing Methodology
Many commenters stated that they believe a better standard for
assessing whether a micro-captive transaction should be identified as a
listed transaction is to evaluate whether an independent, licensed
actuary annually determines the premiums. Some commenters suggested
that the IRS's real concern is whether premiums are priced fairly, and
that if taxpayers can demonstrate that the premiums were priced by a
credentialed actuary, employing actuarial techniques to establish
premium rates that appropriately reflect the risk of loss and
applicable costs, the transaction should be of no concern to the IRS.
The determination of whether a transaction is insurance for Federal
tax purposes is based on the totality of the circumstances, but these
regulations are not defining insurance for either Federal or State law
purposes. Rather, these regulations identify a set of recurring and
consistent fact patterns indicating the lack of a non-tax business
purpose in related-party transactions that purport to offer insurance
for Federal tax purposes. In related party transactions, the lack of
arm's length dealing is often a source of abuse. In the micro-captive
cases tried to date, the participation of an actuary or other
professional in the computation of the premiums (and the taxpayer's
insistence that pricing was at arm's length) was not sufficient to make
the premiums reasonable, as is necessary for a valid insurance
transaction for Federal tax purposes. See, e.g., Avrahami, 149 T.C. at
196; Syzygy, T.C. Memo. 2019-34, at *34-36; Caylor, T.C. Memo. 2021-30,
at *45-47; Keating, T.C. Memo. 2024-2, at *61-62; Swift, T.C. Memo.
2024-13, at *41-44; Patel, T.C. Memo. 2024-34, at *49-50; and Royalty
Mgmt., T.C. Memo. 2024-87, at *46-47; see also Reserve Mech., T.C.
Memo. 2018-86, at *55-56, 61; cf. Harper Grp., 96 T.C. at 59 (premiums
were stipulated to be priced at arm's length); Securitas, T.C. Memo.
2014-225, at *12 n.4 (``Respondent does not challenge the
reasonableness of premiums.'').
For example, in Avrahami, the premiums were priced by a
credentialed actuary. The Tax Court was unpersuaded that the actuary's
involvement resulted in reasonable premiums and found that the
actuary's ``calculations [were] aimed not at actuarially sound
decision-making but at justifying total premiums as close as possible
to $1.2 million--the target--without going over.'' 149 T.C. at 196. The
Tax Court expressed similar skepticism in subsequent micro-captive
cases. See, e.g., Syzygy, T.C. Memo. 2019-34, at *17-18, 34-36 (finding
that premiums were not actuarially determined after concluding that
there was no evidence demonstrating that actuarial methods were
followed; that a feasibility study completed by an actuarial consulting
firm and an actuarial review completed by the State of Delaware
Department of Insurance were focused on solvency, not the
reasonableness of premiums; and that the advice of a credentialed
actuary was ignored regarding the allocation of premiums between layers
in a layered reinsurance arrangement); Caylor, T.C. Memo. 2021-30, at
*45-47 (finding that a captive manager's pricing methodology was not
actuarially sound); Keating, T.C. Memo. 2024-2, at *30 n.30 (actuary's
opinion that pricing methodology was reasonable did not address
specific policies). Further, while section 482 and the regulations
thereunder provide standards for when a transaction between related
parties is considered arm's length, such determination is wholly fact
specific to each arrangement and thus inappropriate as a metric for
identifying reportable transactions.
Accordingly, the final regulations do not adopt the commenters'
recommendation to replace the Loss Ratio Factors with a metric
evaluating pricing methodology. While commenters were critical of the
Loss Ratio Factors and suggested that the IRS evaluate pricing
methodology, they provided no specific pricing methodology or reliable
commercial market source that would enable the IRS to better
distinguish between transactions that are or may be tax avoidance
transactions and those that are not. The final regulations do not adopt
any changes based on this recommendation.
2. Qualified Insurance Company Rules
Section 1297 of the Code sets forth the rules for determining
whether a foreign corporation is a passive foreign investment company
(PFIC), which can result in adverse Federal tax consequences to a U.S.
shareholder of that corporation. Generally, pursuant to section
1297(a), a foreign corporation is a PFIC if: (1) 75 percent or more of
its gross income for the taxable year is passive income or (2) the
average percentage of assets held by such corporation during the
taxable year which produce passive income or which are held for the
production of passive income is at least 50 percent. However, section
1297(b)(2)(B) provides that passive income does not include income
derived in the active conduct of an insurance business by a QIC.
Generally, to be a QIC, the foreign insurer must: (1) be a corporation
that would be subject to tax under Subpart L if it were a domestic
corporation and (2) have ``applicable insurance liabilities'' (AILs)
that exceed 25 percent of its total assets, as provided in section
1297(f)(1), which is referred to as the ``AIL test'' in this preamble.
The commenter stated that QIC status creates a rebuttable
presumption that the purported insurer is a bona fide insurance company
and that applying the same QIC test to domestic insurers that have
elected to be taxed under

[[Page 3544]]

section 831(b) should create a similar rebuttable presumption in these
regulations.
The Treasury Department and the IRS have determined that QIC status
is not appropriate for determining whether a micro-captive transaction
is a tax avoidance transaction or has the potential to be a tax
avoidance transaction. Foremost, QIC status does not create a
rebuttable presumption that the foreign company is a bona fide
insurance company. Rather, QIC status depends on the foreign company
being a bona fide insurance company, as that is a prerequisite to
satisfying the first prong of the QIC test, that it would be subject to
tax under subchapter L (that is, would be taxable as an insurance
company for Federal tax purposes) if it were a domestic corporation.
The commenter's proposed test is unworkable because it is circular.
Further, the entities identified as Captives by the proposed and final
regulations claim eligibility to be taxed under section 831(b) of
subchapter L and therefore would presumably take the position that they
are subject to tax under subchapter L. However, as discussed more fully
in parts I.E. and VI.C. of this Summary of Comments and Explanation of
Revisions, litigation and audit experience demonstrate that many micro-
captive transactions do not meet the requirements for taxation as
insurance under the Code.
Nor is the second prong of the QIC test, the AIL test, suitable for
determining whether a company is a bona fide insurance company or for
identifying micro-captive listed transactions or transactions of
interest. The AIL test is based on the ratio of a foreign corporation's
applicable insurance liabilities to its total assets as reported on the
foreign insurance company's applicable financial statement for a
taxable year, as those terms are defined in Sec. 1.1297-4.
The AIL test is appropriate in the PFIC context because the
objective of the PFIC provisions generally, that is, independent of
insurance considerations, is identifying foreign companies with U.S.
shareholders that are predominately passive investment vehicles focused
on holding investment assets and earning investment income. The AIL
test achieves this objective by identifying foreign insurance companies
that, though they are engaged in the active conduct of an insurance
business, are nevertheless predominantly passive investment vehicles
because they have a very large amount of total assets compared to their
insurance liabilities. By failing the AIL test, such foreign insurance
companies do not constitute QICs and therefore do not qualify for the
PFIC insurance exception under section 1297(b)(2)(B).
The AIL test is not part of the determination of whether a foreign
corporation would be an insurance company taxable under subchapter L if
it were a domestic company. Further, a foreign insurance company that
fails the AIL test would still be a PFIC even if it is a bona fide
insurance company and is engaged in the active conduct of an insurance
business. It is thus inappropriate to use the AIL test in determining
if a company is a bona fide insurance company or to identify micro-
captive listed transactions or transactions of interest. Instead, the
Loss Ratio Factors are appropriate for this purpose, in part because
one indicium of tax avoidance in a micro-captive transaction is
excessive premium payments (which taxpayers claim are deductible to the
Insured and not taxable to the Captive pursuant to the section 831(b)
election) when compared to liabilities incurred for insured losses and
claim administration expenses.
3. Commercial and Special Markets Comparison
Commenters compared micro-captives to commercial carriers and
special markets, such as commercial E&S (excess and surplus lines)
carriers. Commenters pointed out that many commercial insurance
business lines and geographical locations consistently have loss ratios
of less than 65 percent, and some recommended the loss ratio percentage
be based on each line of coverage written by the Captive or similar
coverages written by commercial carriers. One commenter identified
specific commercial lines of coverage, including Boiler & Machinery,
Burglary & Theft, Earthquake, Fidelity, Surety, and Other Liability-
Claims Made, as examples of lines of coverage that many micro-captives
offer and stated that micro-captives therefore have similar loss and
loss ratio distributions to these commercial lines.
Generally, commercial E&S carriers cover risks that are too
uncommon, too large, or too unquantifiable to be insured by admitted
carriers. In a commercial E&S market, multiple financial backers,
grouped in syndicates, come together to pool and spread diversified
risks that are placed with the syndicates through authorized brokers.
Certain Captives may share some similarities with a commercial E&S
carrier, but as a general matter, a typical micro-captive does not
comport itself consistently with insurers operating in the commercial
E&S market. For example, the risks covered by a micro-captive are often
those of relatively few insureds who are concentrated in a small
geographic region. See, e.g., Caylor, T.C. Memo. 2021-30, at *38 (risks
were concentrated in a group operating in a specific geographic
location); Swift, T.C. Memo. 2024-13, at *31 (risks were concentrated
in a specific industry in a small geographical area). Commenters did
not explain what aspect of a commercial E&S carrier's loss ratio is
substantially comparable to the average loss ratio for a typical micro-
captive or how a more reliable metric to identify tax avoidant micro-
captives can be derived from a commercial E&S carrier's loss ratio.
Thus, loss ratio comparisons between micro-captives and commercial E&S
carriers would not constitute an improvement over the current Loss
Ratio Factors.
With respect to comments suggesting alternatives based on
comparable commercial lines, the Treasury Department and the IRS have
determined sufficient relief is afforded by the reductions to the Loss
Ratio Factors for both Micro-captive Listed Transactions and Micro-
captive Transactions of Interest, as discussed further in parts II.C.
and II.D. of this Summary of Comments and Explanation of Revisions.
With respect to comments suggesting comparison to certain business
lines, the Treasury Department and the IRS are not persuaded that the
few specific lines identified by the commenters better represent the
variety of lines offered by micro-captives than the case law and
national averages for property and casualty companies (excluding
certain consumer and business lines), as discussed further in parts
II.C. and II.D. of this Summary of Comments and Explanation of
Revisions. The final regulations do not adopt any changes based on
these recommendations.
4. County Mutual Insurance Company Comparisons
A commenter suggested comparing micro-captives to county mutual
insurance companies, which the commenter said have loss ratios of 40
percent and frequently make section 831(b) elections. Like commercial
E&S and special markets, county mutual insurance companies are
similarly inappropriate for comparison. Although they may also cover
risks concentrated in a small geographical area, county mutual
insurance companies are subject to different incentives and constraints
compared to micro-captive insurance companies because they are wholly
owned by their many unrelated policyholders in a manner that does not

[[Page 3545]]

resemble the closely held nature of micro-captive insurance companies.
For example, if premiums collected by a county mutual insurance company
are not used to pay claims, the unrelated policyholders would expect
that the county mutual insurance company will reduce future premiums or
return some portion of the excess funds to the owners as a dividend or
return premiums. Micro-captive insurance companies, on the other hand,
face no such expectation. The final regulations do not adopt any
changes based on this recommendation. However, for the reasons
described in part II.C. of this Summary of Comments and Explanation of
Revisions, and consistent with the request by commenters regarding the
loss ratios of county mutual insurance companies, the final regulations
lower the Loss Ratio Factor for purposes of identification as a listed
transaction under Sec. 1.6011-10 to 30 percent.
5. Variations for Regions or States
Some commenters recommended establishing variations of the Loss
Ratio Factors for specific regions or States. Accounting for
disparities in loss experience from region to region would not be
administrable, and, within a given region, different coverages would be
subject to different disparities, which would further complicate the
analysis. The final regulations do not adopt any changes based on this
recommendation because the Treasury Department and the IRS have
determined that sufficient relief is afforded by the changes to the
Loss Ratio Factors described in parts II.C. and II.D. of this Summary
of Comments and Explanation of Revisions.
F. Inclusion of Policyholder Dividends in Loss Ratio Factor Computation
Commenters expressed concerns about the inclusion of policyholder
dividends in the computation, indicating that issuance of policyholder
dividends may require regulatory approval and is not a common practice
of micro-captives, thereby situating a micro-captive to fail the test
for insurance in the commonly accepted sense. The Loss Ratio Factors
are modified loss ratios, determined for Federal tax purposes, and the
inclusion of policyholder dividends in the computation is intended to
afford taxpayers a means of correcting inappropriately accumulated
premiums, thereby avoiding characterization of their micro-captive
arrangements as ``transactions of interest'' or ``listed
transactions.'' The Loss Ratio Factors have no other purpose or
relevance and do not in any way affect or impede the functioning of a
Captive. Further, removing policyholder dividends from the computation
would unfairly disadvantage Captives that choose to use policyholder
dividends to correct overpriced policies. The Treasury Department and
the IRS are not persuaded that the issuance of policyholder dividends
by itself would cause a transaction to fail the commonly accepted sense
prong of the four-prong test for insurance for Federal tax purposes
described in part I. of the Background of this Preamble. Courts
consider many factors to determine whether an arrangement constitutes
insurance in the commonly accepted sense, including whether policies
are valid and binding, whether premiums were reasonable and the result
of arm's length transactions, and whether claims were paid, and no one
factor within the commonly accepted sense prong is dispositive. See,
e.g., Avrahami, 149 T.C. at 191-97; Caylor, T.C. Memo. 2021-30, at *41-
48; and Keating, T.C. Memo. 2024-2, at *53-64. The final regulations do
not modify the Loss Ratio Factors in response to these comments.
G. Solvency Concerns
Some commenters protested that establishing a minimum loss
threshold by application of the Loss Ratio Factors would negatively
impact solvency for captives, by requiring artificially low premiums or
imprudent issuance of policyholder dividends. This concern is
misplaced. Captive insurers would avoid insolvency in the same way they
always have; that is, by insuring risks that are selected and duly
reserved for in accordance with sound business judgement and the
regulatory requirements of their domicile. Nothing in these regulations
requires, encourages, or allows micro-captives to make contractual
promises that exceed risk-bearing capabilities. The final regulations
do not modify the Loss Ratio Factors in response to these comments.
H. Clarifications Regarding Computation of Loss Ratio Factors
Commenters argued that it may not be possible to calculate a loss
ratio applicable to a given taxable year because losses under a policy
may not be resolved for years (for example, long-tail coverage), and
sought some clarification in the computation of the Loss Ratio Factors.
For example, commenters asked whether the ``liabilities incurred for
insured losses'' amount used in the Loss Ratio Factors computations
includes losses incurred through participation in pooling arrangements,
reinsurance agreements, and retrocession agreements, how micro-captives
should compute the applicable loss ratio for long-tail coverage, and
whether the current taxable year is included in the number of years
being counted for the Computation Periods.
The Computation Periods of ten years for Micro-captive Listed
Transactions and up to ten years for Micro-captive Transactions of
Interest, respectively, are intended to accommodate the existence of
potential long-tail coverage. These commenters appear to contemplate
situations in which a Captive incurs losses but for which claims have
not been reported (incurred but not reported, or IBNR) or are
undergoing further development (incurred but not enough reported, or
IBNER). To clarify, the Loss Ratio Factor is computed using the amount
of liabilities incurred for insured losses as such term is applied
under the relevant accounting method used by the participant taxpayer,
as of the end of the relevant taxable year(s). See, e.g., Sec. 1.446-
1(c)(1)(ii) (defining when a liability is considered incurred for
accrual method taxpayers). The final regulations do not adopt any
changes based on these comments.
With respect to whether the Loss Ratio Factors include losses
incurred through pooling arrangements, reinsurance agreements, and
retrocession agreements, the final regulations place no limitation on
the source of losses incurred by the Captive. The Computation Periods
as set forth in Sec. Sec. 1.6011-10(b)(2)(i) and (ii) and 1.6011-
11(b)(2)(i) and (ii) include the most recent concluded taxable year in
accordance with Sec. 1.6011-4(e)(2), Rev. Proc. 2005-26, 2005-17
I.R.B. 965, and the Instructions to Form 8886.

III. Comments and Changes Relating to the Financing Factor as Described
in Proposed Sec. 1.6011-10(c)(1)

A few commenters argued that the Financing Factor should be removed
as a factor for identifying listed transactions and transactions of
interest. As proposed, such commenters assert that the Financing Factor
fails to consider the circumstances for the financing, suggesting that
a better measure of a transaction's potential for tax avoidance is
whether the financing reflects an overconcentration in illiquid assets.
One commenter stated that nothing in the Code or existing precedent
treats related-party financing that is arm's length as abusive.
Commenters noted that State regulators generally must approve financing
in related-party transactions, and if approved by the State, financing
should not be of concern to the IRS.

[[Page 3546]]

One of the key abuses seen in micro-captive transactions is the
indefinite deferral of tax. Such abuses may be compounded by the use of
tax-deferred income for the personal benefit of the related persons
involved. See, e.g., Avrahami, T.C. 149 at 169-71 (portions of premiums
paid made available as loans to related real estate holding company);
Swift, T.C. Memo. 2024-13, at *18-19 (portions of premiums paid made
available to invest in real estate and limited liability companies for
the direct or indirect benefit of petitioners); and Patel, T.C. Memo.
2024-34, at *11 (portions of premiums paid made available to invest in
life insurance for the direct or indirect benefit of petitioners). In
an abusive micro-captive transaction, an Insured entity deducts amounts
paid directly or indirectly to the Captive that the parties treat as
insurance premiums in an arrangement that does not constitute insurance
for Federal tax purposes. Captives then exclude those amounts from
taxable income under section 831(b). When a financing arrangement is
involved, such Captives return some portion of those tax-deferred
amounts directly or indirectly to the Insured or related parties via a
loan, capital contributions to a special purpose vehicle, or other
financing arrangement for which a current tax does not apply. Thus, in
a financing arrangement involving an abusive micro-captive transaction,
amounts paid as premiums have not only avoided ordinary taxation but
have continued to avoid tax while back in the hands of the related
parties who caused the premiums to be paid and deducted. This
deliberate, continuing avoidance of income tax using benefits to which
the participants are not entitled is abusive and identifying
transactions with similar fact patterns as listed transactions is
consistent with the IRS's pronouncements with respect to micro-captives
since before the publication of Notice 2016-66. See, e.g., ``Captive
Insurance,'' IR-2015-19 (Feb. 3, 2015), https://www.irs.gov/newsroom/abusive-tax-shelters-again-on-the-irs-dirty-dozen-list-of-tax-scams-for-the-2015-filing-season (last visited Jan. 6, 2025.)
Several commenters noted that related-party financing such as the
arrangements described by the Financing Factor can be subject to
substantial scrutiny, to the extent that State insurance regulators
will permit such financing only after an extensive approval process.
See, e.g., Avrahami, 149 T.C. at 170 (``Insurance regulators often
raise bureaucratic eyebrows at related-party dealings.''). Even so, the
IRS has seen multiple transactions for which approval was required but
not sought, or for which approval may have been granted but,
nevertheless, the parties' treatment of the financing arrangement did
not comport with industry standards. Based on its experience, the IRS
maintains that, in transactions structured as described in the proposed
regulations, financing arrangements that create a tax-deferred circular
flow of funds are indicative of tax avoidance.
One commenter argued that inclusion of specific factors, such as
the Loss Ratio Factor and the Financing Factor, improperly assumes
insurance company status can be determined by reference to a single
factor. However, the proposed regulations neither define insurance for
Federal tax purposes nor identify transactions by a single factor. As
discussed more fully in part I.E. of this Summary of Comments and
Explanation of Revisions, these regulations do not presume to define
insurance for Federal tax purposes; rather, the regulations identify
fact patterns that are consistently associated with transactions that
are or may be tax avoidance transactions. Regarding commenters'
suggestions that the liquidity of a captive is a better measure than
the Financing Factor, the commenters did not specify what potential
measure of liquidity (such as the character of assets, amount of
assets, or comparison of assets to Captive's liabilities) would better
identify micro-captive transactions that are or may be tax avoidance
transactions. Further, regardless of the specific measure of liquidity
used, determinations thereof would be too fact-specific (and dependent
upon individual policy terms and jurisdictional requirements) to be
administrable. The use of amounts paid as premiums in a tax-preferred
manner, and the return of such amounts directly or indirectly to the
related parties who benefitted from the original tax deduction, is the
tax avoidance addressed by the Financing Factor. While some
participants may have obtained regulatory approval to issue the
related-party financing, from a Federal tax perspective, the approval
of a regulatory body does not answer the question of whether the
transaction as a whole should be respected for Federal tax purposes.
The final regulations therefore retain the Financing Factor.
However, the Treasury Department and the IRS agree that the
presence of related-party financing in a micro-captive transaction by
itself may not rise to the level of tax avoidance, as it may be that
such financing was determined at arm's length or otherwise treated as a
bona fide financing arrangement between the related parties. See
Avrahami, 149 T.C. at 199-204 (finding that the economic reality of the
related-party financing at issue, while a close question, could be
treated as a bona fide debt obligation, notwithstanding the court's
determination that the Avrahami's captive transaction was not insurance
for Federal tax purposes). The concern with respect to financing
arrangements is the continuing deferral of tax. Such deferral should
not be considered tax avoidance unless coupled with the continued
accumulation of tax-deferred amounts in a transaction involving
circumstances inconsistent with insurance for Federal tax purposes,
including the excessive pricing of premiums and artificially low or
nonexistent claims activity. Accordingly, the final regulations have
revised the factors identifying a listed transaction to reflect a
conjunctive test: taxpayers who are engaged in a transaction described
by the regulations that meets the Financing Factor as described in
Sec. 1.6011-10(c)(1), in conjunction with the Loss Ratio Factor as
described in Sec. 1.6011-10(c)(2), are identified as listed
transactions in the final regulations. This change, to require both the
Financing Factor and the Loss Ratio Factor in the identification of
Micro-captive Listed Transactions, should provide substantial relief to
taxpayers participating in transactions with loss ratios below 30
percent but for which the Financing Factor is not met.
Because the potential for tax avoidance still exists when there is
related-party financing, the final regulations include the Financing
Factor in the identification of a Micro-captive Transaction of
Interest. Taxpayers who are engaged in a transaction described by the
regulations that meets the Financing Factor as described in Sec.
1.6011-11(c)(1), the Loss Ratio Factor as described in Sec. 1.6011-
11(c)(2), or both, are identified as participating in a transaction of
interest in the final regulations. The Financing Computation Period for
Micro-captive Transactions of Interest is the same as the Financing
Computation Period for Micro-captive Listed Transactions.

IV. Comments and Changes Relating to the Consumer Coverage Exception as
Described in Sec. 1.6011-10(d)(2)

A ``Consumer Coverage Arrangement'' as described in the proposed
regulations includes certain arrangements in which a service provider,
automobile dealer, lender, or retailer (``Seller'') sells contracts
that the parties treat as insurance contracts (``Contracts'' as defined
in proposed Sec. 1.6011-10(b)(3)) either issued or reinsured by a
Captive

[[Page 3547]]

related to the Seller (``Seller's Captive'') to its Unrelated Customers
(as defined in proposed Sec. 1.6011-10(b)(11)) in connection with the
products or services being sold. As noted in the preamble to the
proposed regulations, as a general matter, participation in this type
of reinsurance arrangement is neither a Micro-captive Listed
Transaction nor a Micro-captive Transaction of Interest under the
proposed regulations because the insured is not sufficiently related to
the Seller's Captive. Generally, in a Consumer Coverage Arrangement,
the Insureds under the Contracts that are issued or reinsured by the
Seller's Captive are Unrelated Customers of Seller, and these Unrelated
Customers, their owners, and persons related to the Unrelated Customers
or their owners do not directly or indirectly own at least 20 percent
of the voting power or value of the outstanding stock of any entity
issuing or reinsuring the Contract.
Nonetheless, the proposed regulations would provide relief from
identification as either a Micro-captive Listed Transaction or as a
Micro-captive Transaction of Interest under Sec. Sec. 1.6011-10(d)(2)
and 1.6011-11(d)(2) (``Consumer Coverage Exception'') for certain
Consumer Coverage Arrangements that would otherwise be Micro-captive
Listed Transactions or Micro-captive Transactions of Interest. The
proposed exception would apply to arrangements in which the following
criteria are met: (1) the arrangement involves a Seller's Captive
(meaning a Captive related to Seller as defined in proposed Sec.
1.6011-10(b)(10)); (2) Seller's Captive insures or reinsures some or
all of the Contracts sold by Seller; (3) 100 percent of the business of
the Seller's Captive is insuring or reinsuring Contracts in connection
with products or services being sold by the Seller or persons related
to Seller; and (4) commissions or remunerations paid for the sale of
such Contracts, as a percentage of the premiums paid by the Seller's
customers, is at least the greater of: (a) 50 percent; or (b) the
unrelated commission percentage (meaning the highest commission for the
sale of Contracts connected to Seller's products that are not issued or
reinsured by Seller's Captive). Proposed Sec. 1.6011-10(d)(2)(iv)(B)
is referred to as the ``Unrelated Commissions Test''; proposed Sec.
1.6011-10(d)(2)(iv)(A) and (B) are collectively referred to as the
``Commissions Test.''
As further discussed in this part IV. of the Summary of Comments
and Explanation of Revisions, commenters expressed appreciation for the
inclusion of the Consumer Coverage Exception but requested
clarification of the Consumer Coverage Exception provisions and
recommended changes to the exception, particularly with respect to the
Commissions Test.
A. The Commissions Test
Several commenters recommended that the Commissions Test be
eliminated from the Consumer Coverage Exception. One commenter
recommended that if the Commissions Test is not eliminated from the
Consumer Coverage Exception altogether, it should at least be
eliminated for commercial insurers acting as Intermediaries (as such
term is defined in proposed Sec. 1.6011-10(b)(5)). Several commenters
specifically requested the elimination of the Unrelated Commissions
Test set forth at proposed Sec. 1.6011-10(d)(2)(iv)(B), expressing
concern about the ability of taxpayers to comply with the provision as
written.
To explain why the Commissions Test should be eliminated, one
commenter argued that commissions seemingly have no applicability to
the validity of the insurance arrangement. Two commenters remarked on
the lack of a basis for the 50 percent threshold in the Commissions
Test, as set forth in proposed Sec. 1.6011-10(d)(2)(iv)(A). The
commenters suggested that use of this percentage to determine
``abusiveness'' of the transactions does not necessarily have any
substantive connection to the economic realities of the transaction,
which is negotiated at arm's length between customers and Sellers.
Commenters noted that customers negotiate the purchase price of
consumer coverage with Sellers without regard to the tax implications
of Sellers' participation in the underwriting profit of the consumer
coverage, and Sellers sometimes agree to lower prices and lower
commissions, not for any tax-motivated reason, but because otherwise
the customer will not buy the product. One of these commenters said
that, as a result, the Commissions Test sets an ``arbitrary'' standard.
The other commenter suggested that the proposed regulations would
injure consumers by essentially requiring Sellers to caution their
salespeople not to offer discounts, for fear of losing the Consumer
Coverage Exception and triggering ``transaction of interest'' status. A
third commenter noted that, for standard types of coverage written by
commercial insurers, such as automobile service contracts, the market
is strongly competitive, and the effect of the proposed regulations
would be to reduce that competition by requiring consumers to pay a
commission mark-up on consumer coverage of at least 100 percent of the
net premium charged by the insurer.
One of the commenters remarked that the 50 percent threshold in the
Commissions Test would only make sense if the IRS had reason to believe
that the sale of products at a lower rate is an indication of a non-
market driven effort to artificially transfer otherwise taxable revenue
to the micro-captive. The commenter asserted that, in over 30 years,
the commenter had never seen this issue raised in examination, read
cases of this happening, or heard that the IRS has actual evidence that
it in fact occurs. The commenter further asserted that Consumer
Coverage Arrangements ``have already been examined, and deemed not to
justify listed transaction treatment,'' as evidenced by the listing of
certain consumer coverage transactions in Notice 2002-70, 2002-2 C.B.
765, and subsequent ``de-listing'' of those transactions in Notice
2004-65, 2004-2 C.B. 599. The commenter distinguished Consumer Coverage
Arrangements from the micro-captive transactions determined by the Tax
Court in recent cases not to be insurance for Federal tax purposes. To
the extent the IRS has had successful Tax Court outcomes in the micro-
captive area, the commenter asserted, those cases all concerned
enterprise risk; none were concerned with unrelated third-party
consumer risk arrangements.
Another commenter called the Commissions Test ``vague, unworkable,
anti-consumer and anti-competitive,'' asserting that the IRS should not
be requiring, or even encouraging, payment of high commission rates as
a condition of the exception. The commenter observed that the
Commissions Test seems to be based upon section 482 of the Code
transfer-pricing concerns rather than failure of risk transfer and risk
distribution and lack of arm's-length dealing and sound business
practices, the issues identified by the preamble to the proposed
regulations as the focus of the proposed regulations. The commenter
asserted that the real concern of the regulations should be to ensure
that the net premiums paid to the Captive are not excessive. The
commenter observed that commercial insurers writing consumer coverage
for sale through dealers typically specify a schedule listing various
products and the applicable net premium for each (that is, after the
dealer's withheld commission) payable to the insurer for each, and that
these net premiums are set by the commercial insurer based upon
actuarial analysis of the risks to be covered. The commenter further

[[Page 3548]]

observed that the gross amount paid by the customer (including the
amount above the specified net premium that the dealer retains as a
commission) is subject to negotiation by each customer, and the
commercial insurer may not be informed of the commission or who earns
it.
To address this commercial insurer scenario, the commenter proposed
a safe harbor from material advisor and participant status for
commercial insurers acting as Intermediaries (as defined in proposed
Sec. 1.6011-10(b)(5)) in transactions that do not involve the payment
of excessive premiums to the captive. However, because the proposed
safe harbor would be for any commercial insurer acting as an
Intermediary in a micro-captive transaction, unless the commercial
insurer (or related company) retrocedes risks with respect to consumer
products and pays a reinsurance premium in excess of an arm's length
amount, the effect of this safe harbor would not be limited to Consumer
Coverage Arrangements. Because the proposed safe harbor has
implications beyond Consumer Coverage Arrangements, it is discussed in
part V.B. of this Summary of Comments and Explanation of Revisions.
Commenters also remarked that elimination of the Commissions Test
would make application of the Consumer Coverage Exception more
streamlined and efficient and less burdensome. One of the commenters
expressed concern that not all Sellers capture information about sales
and commissions in a way that will facilitate calculation of ``the fee,
commission, or other remuneration earned by any person or persons, in
the aggregate, for the sale of the Contracts, described as a percentage
of the premiums paid by the Seller's customers.'' The commenter
asserted that this additional cost and effort is not justified ``to
guard against a theoretical abuse in an industry where the Service has
already found that insufficient evidence of abuse exists to justify
listed transaction treatment.''
After careful consideration of the comments received generally
requesting the elimination of the Commissions Test and specifically
requesting the elimination of the Unrelated Commissions Test, the
Treasury Department and the IRS are persuaded that elimination of the
Commissions Test in the Consumer Coverage Exception is appropriate. The
tax avoidance or potential for tax avoidance that the Commissions Test
intended to identify is distinguishable from the closely held
arrangements associated with the fact patterns identified in Sec. Sec.
1.6011-10(a) and 1.6011-11(a); for example, the ultimate policyholders
are commonly Unrelated Customers in Consumer Coverage Arrangements.
Accordingly, the Commissions Test is eliminated from the Consumer
Coverage Exception in the final regulations.
One commenter also sought clarification of certain aspects of the
Commissions Test. However, because the Commissions Test is eliminated
from the Consumer Coverage Exception in the final regulations, no
further explanation is necessary.
B. Restricting Consumer Coverage Arrangements Identified as Reportable
Transactions Through Clarification of Defined Terms
The definition of ``Insured'' set forth in proposed Sec. 1.6011-
10(b)(4) and incorporated in proposed Sec. 1.6011-11(b)(4) is ``any
person that conducts a trade or business, enters into a Contract with a
Captive or enters into a Contract with an Intermediary that is directly
or indirectly reinsured by a Captive, and treats amounts paid under the
Contract as insurance premiums for Federal income tax purposes.'' One
commenter on the Consumer Coverage Exception recommended that the final
regulations clarify that this definition is not intended to include
someone who is only covered by the policy for a momentary period of
time during which the underlying sales transaction is being finalized.
The commenter noted that the preamble appears to indicate that
guaranteed asset protection (GAP) products are an example of a ``dealer
obligor'' arrangement in which a Seller could be considered the Insured
for a short transitory time period occurring between the time the
covered product is delivered to the Unrelated Customer of Seller and
the financing to purchase the product is finalized for the Unrelated
Customer. The commenter asserted that such situations should not
trigger a reporting obligation since this is a temporary condition
arising solely from an administrative need to allow third parties to
process paperwork.
Another commenter asked that the final regulations clarify that a
Seller that only directly or indirectly reinsures Contracts that
ultimately benefit Unrelated Customers, such as GAP contracts, is not
an Insured, even if the Seller is technically a transitory or residual
obligor under the contract. The commenter suggested that if this
recommendation is not adopted, the definition of ``Captive'' set forth
in proposed Sec. 1.6011-10(b)(1) and incorporated in proposed Sec.
1.6011-11(b)(1), should be modified to exclude any entity that only
issues Contracts to Insureds, where the ultimate beneficiaries of such
contracts are Unrelated Customers, to the extent that the total
percentage of issued and reinsured GAP and similar Contracts provided
to Insureds of such entity do not exceed 25 percent of the total issued
and reinsured Contracts for such entity. The commenter noted that this
definition would remove burdensome compliance data collection from what
is essentially a minority of the entity's contracts and would permit
the IRS to focus on situations where there is greater potential for tax
avoidance.
The final regulations make no change to the definitions of Insured
and Captive in response to these comments. A Seller is an Insured only
if it ``enters into a Contract with a Captive or enters into a Contract
with an Intermediary that is directly or indirectly reinsured by a
Captive.'' A Seller is not an Insured if it facilitates an Unrelated
Customer entering into a Contract with Seller's Captive or an
Intermediary but is not itself a party to the Contract. A Seller is an
Insured only if it treats amounts paid under the Contract as insurance
premiums for Federal tax purposes. To the extent a Seller receives and
makes payments under a Contract as an agent of a party or parties to
the Contract, the Seller would not treat amounts paid under a Contract
as insurance premiums for Federal tax purposes. As a general matter,
therefore, a Seller that only facilitates the direct or indirect
insurance or reinsurance of Contracts that ultimately benefit Unrelated
Customers, such as GAP contracts, and does not reflect the tax benefits
of participating in a purported insurance transaction in its filed
returns, will not be an Insured that is a participant under these
regulations. A Seller that satisfies all the requirements of the
definition of Insured is appropriately considered an Insured. However,
in recognition of concerns expressed by commenters that such situations
could potentially arise, the final regulations retain the Consumer
Coverage Exception, which may prevent a Consumer Coverage Arrangement
in which a Seller (or related person) is an Insured from being
identified as a Micro-captive Listed Transaction or Micro-Captive
Transaction of Interest.
C. Revising Definition of Seller To Permit De Minimis Sales to Related
Persons
The definition of ``Seller'' set forth in proposed Sec. 1.6011-
10(b)(9) and incorporated in proposed Sec. 1.6011-11(b)(8) is ``a
service provider, automobile dealer, lender, or retailer that sells
products or services to

[[Page 3549]]

Unrelated Customers who purchase insurance contracts in connection with
those products or services.'' A commenter recommended modification of
this definition to prevent an occasional sale of an automobile and
insurance contract to a related party from disqualifying a Seller's
Captive from the Consumer Coverage Exception. The commenter also stated
it is important to clarify that it is not a requirement for all
purchasers of insurance contracts to be Unrelated Customers for the
dealer to be a Seller. The commenter asserted that there is a low risk
of tax avoidance if a majority of the Contracts being insured or
reinsured by a Seller's Captive are either directly sold to an
Unrelated Customer or are for the ultimate benefit of an Unrelated
Customer. The commenter suggested a de minimis exception for related
party sales by establishing a five percent threshold for such
transactions.
In response to these comments, Sec. 1.6011-10(b)(9) of the final
regulations clarify that a Seller is a service provider, dealer
(including an automobile dealer), lender, wholesaler, or retailer that
sells products or services to customers who purchase insurance
contracts in connection with those products or services provided no
more than five percent of all its sales of products or services to
persons who purchase insurance contracts in connection with those
products or services are to customers other than Unrelated Customers.
Additionally, the Consumer Coverage Exception in Sec. Sec. 1.6011-
10(d)(2) and 1.6011-11(d)(2) of the final regulations is modified to
require that no more than five percent of the Seller's Captive's
business is issuing or reinsuring Contracts purchased by persons other
than Unrelated Customers in connection with products or services sold
by the Seller or persons Related (as defined in Sec. 1.6011-10(b)(8)
of the final regulations) to the Seller.
D. Other Requests for Clarification
A commenter asked for clarification of whether the Consumer
Coverage Exception applies when the Seller's Captive neither assumes
reinsurance from an unrelated fronting company, nor cedes reinsurance
to an unrelated insurer. The Consumer Coverage Exception set forth in
proposed Sec. 1.6011-10(d)(2) and incorporated in proposed Sec.
1.6011-11(d)(2) requires that ``Seller's Captive issue or reinsure some
or all of the Contracts sold to Unrelated Customers in connection with
the products or services being sold by the Seller,'' that ``100 percent
of the business of the Seller's Captive is insuring or reinsuring
Contracts in connection with products or services being sold by the
Seller or persons Related to the Seller,'' and that the Commissions
Test set forth in proposed Sec. 1.6011-10(d)(2)(iv) is met with
respect to ``the Contracts issued or reinsured by the Seller's
Captive.'' The involvement of an unrelated fronting company or other
unrelated insurer is not required.
The commenter also asked if the Consumer Coverage Exception is
intended to apply if Seller's Captive directly insures an entity
related to or affiliated with Seller for certain contracts described in
the proposed regulations but without fronting or reinsurance attached.
The Consumer Coverage Exception set forth in the proposed regulations
would not apply in these circumstances because the Seller's Captive is
insuring an entity related to or affiliated with Seller (rather than
Unrelated Customers of Seller). This would be the case whether or not a
fronting company or reinsurer were involved. However, as discussed in
part IV.C. of this Summary of Comments and Explanation of Revisions,
under Sec. Sec. 1.6011-10(d)(2)(iv) and 1.6011-11(d)(2) of the final
regulations, the Consumer Coverage Exception may apply when a Seller's
Captive issues or reinsures Contracts purchased by persons other than
Unrelated Customers in connection with products or services sold by the
Seller or persons related to Seller, provided that no more than five
percent of the Seller's Captive's business is issuing or reinsuring
such Contracts. Accordingly, the Consumer Coverage Exception set forth
in the final regulations would potentially apply in the circumstances
described by the commenter.
A commenter suggested that ``coverage for incurring diminished
value'' should be considered a type of consumer coverage. The preamble
to the proposed regulations explains that a ``Consumer Coverage
contract generally provides coverage for repair or replacement costs if
the product breaks down or is lost, stolen, or damaged; coverage for
the customer's payment obligations if the customer dies or becomes
disabled or unemployed; coverage for the difference between all or a
portion of the value of the product and the amount owed on the
product's financing, including a lease, if the product suffers a
covered peril; or a combination of one or more of the foregoing types
of coverage.'' However, this is a non-exclusive list. The Consumer
Coverage Exception may apply when a Seller's Captive issues or
reinsures Contracts in connection with the products or services being
sold by the Seller. Such Contracts could include those providing
coverage for incurring diminished value.
Another commenter noted that warranty products are also widely sold
and reinsured outside the automotive space and often in the business-
to-business environment, suggesting that this should be taken into
account when drafting terminology in the final regulations related to
consumer products and seller captive concepts. The description of the
Consumer Coverage Exception and related definitions use generic terms
intended to encompass a broad range of products and services, not
limited to automotive products and services. Nonetheless, in response
to this commenter's apparent concern that the Consumer Coverage
Exception as proposed may exclude arrangements ``in the business to
business environment,'' the final regulations clarify that the term
Seller includes a wholesaler that sells products or services to
customers who purchase insurance contracts in connection with those
products or services.
Finally, one commenter asked that the final regulations apply
prospectively to Seller's Captives, meaning reporting would be required
with respect to Seller's Captives only for taxable years subsequent to
the effective date of the final regulations, because otherwise a number
of legitimate captives would be subjected to very burdensome
information gathering, testing, and reporting for a very small amount
of premium income per captive. The commenter suggested that changes
such as a 50 percent commission threshold should be applied on a
prospective basis only to provide notice to taxpayers. As discussed in
the preamble to the proposed regulations, as a general matter,
participation in Consumer Coverage Arrangements is neither a Micro-
captive Listed Transaction nor a Micro-captive Transaction of Interest
because the insured is not sufficiently related to the insurer or any
reinsurer. The proposed regulations were not intended to change this,
but nonetheless provide a potential exception for taxpayers considered
to be participating in a reportable Consumer Coverage Arrangement. The
clarifications and changes to the proposed regulations described in
this part of the Summary of Comments and Explanation of Revisions are
only intended to provide further reassurance that Consumer Coverage
Arrangements generally do not give rise to a Micro-captive Listed
Transaction or a Micro-captive Transaction of Interest. Further, if the
Consumer Coverage Exception for Seller's Captives applied only to
taxable

[[Page 3550]]

years after the regulations are effective as suggested by the
commenter, then the exception would not apply to otherwise open taxable
years for which reporting would be required. This would disadvantage
taxpayers who otherwise may have qualified for the Consumer Coverage
Exception in open taxable years. Consequently, the final regulations do
not adopt any changes in response to this comment.

V. Comments and Changes Relating to Identification as Reportable
Transactions and Reporting Requirements

A. Comments Relating to Safe Harbors From Identification as Reportable
Transactions
1. Proposed Safe Harbors for Amended Returns
A commenter requested a change to the proposed regulations that
would allow taxpayers who file amended returns that remove tax benefits
previously recognized from participation in the micro-captive
transaction to not be designated as participating in a Micro-captive
Listed Transaction or a Micro-captive Transaction of Interest.
Taxpayers who file amended returns after the due date, including
extensions, are considered participants in the transaction if their
transaction otherwise meets the description of a Micro-captive Listed
Transaction or a Micro-captive Transaction of Interest because their
original return reflects the tax benefits of participation. In order
for the IRS to obtain a complete picture of participation in these
transactions, such taxpayers must file disclosures. However, a taxpayer
whose timely-filed amended return is treated as the original return for
the taxable year (that is, a superseding return) is not considered to
have filed a return reflecting the tax benefits of participation in the
transaction and would not be required to file disclosures under the
final regulations. Further, whether amended returns determine
participation is outside the scope of these regulations and the final
regulations do not adopt any changes based on this request.
Several commenters expressed concern that the proposed regulations
would require taxpayers to amend returns for approximately three to
four taxable years prior to the promulgation of these regulations as
final regulations. The regulations do not require taxpayers to file an
amended return or an Administrative Adjustment Request (AAR) for
certain partnerships. The proposed regulations would require taxpayers
whose transactions are described in either Sec. 1.6011-10(c) or Sec.
1.6011-11(c) to file a disclosure statement in the form and manner
prescribed by Sec. 1.6011-4. The preamble to the proposed regulations
acknowledged that because the IRS will take or may take a position that
taxpayers are not entitled to the purported tax benefits, taxpayers who
have filed tax returns taking such positions should consider filing an
amended return or AAR. The preamble to the proposed regulations
provided a method for filing such amended returns or AARs, if so
desired. The final regulations do not adopt any changes pursuant to
these comments.
2. Proposed Safe Harbors for Captives With Certain Features
Commenters requested that the IRS clarify whether taxpayers who
issue premium refunds or policyholder dividends to meet the Loss Ratio
Factor will be designated as participating in a Micro-captive Listed
Transaction or a Micro-captive Transaction of Interest. As described
more fully in part II. of this Summary of Comments and Explanation of
Revisions, the Loss Ratio Factors compare the amount of liabilities
incurred for insured losses and claim administration expenses to the
premiums earned less policyholder dividends paid by the Captive, over
the course of the defined Computation Periods. Thus, if a taxpayer
issues premium refunds or policyholder dividends, either of which would
reduce the amount to which liabilities for insured losses and claim
administration expenses over the relevant Computation Period are
compared, the relevant loss ratio for purposes of identification as a
Micro-captive Listed Transaction or Micro-captive Transaction of
Interest will be higher. Further, as described more fully in parts
II.B. and III. of this Summary of Comments and Explanation of Revisions
and as clarified in the bright-line rules of Sec. 1.6011-10(e) of the
final regulations, only taxpayers participating in a transaction that
(1) involves a Captive that elects under section 831(b) to include in
taxable income only taxable investment income (defined in section 834)
in lieu of the tax imposed under section 831(a) (that is, to exclude
premiums from taxable income) and (2) meets both the Financing Factor
and the Loss Ratio Factor, will be designated as participating in a
Micro-captive Listed Transaction under the final regulations. That is,
if Captive's loss ratio is 30 percent or more for the Listed
Transaction Loss Ratio Computation Period, or if the Captive does not
meet the Financing Factor, the transaction is not identified as a
Micro-captive Listed Transaction. With respect to Micro-captive
Transactions of Interest, if the taxpayer does not meet the Financing
Factor, and has effectively lowered the percentage of premiums earned
as compared to liabilities incurred for claims and administration by
issuing policyholder dividends, the transaction is not identified as a
Micro-captive Transaction of Interest under the final regulations. That
is, if Captive's loss ratio is 60 percent or more for the Transaction
of Interest Loss Ratio Computation Period as set forth in Sec. 1.6011-
11(b)(2) and Captive has not made Captive's capital available in a way
that furthers the deferral of tax, the taxpayer is already not a
participant in a Micro-captive Transaction of Interest. This is
clarified in the final regulations setting forth the bright-line rules
at Sec. 1.6011-11(e).
One commenter recommended that a transaction should not be
designated as a Micro-captive Listed Transaction or Micro-captive
Transaction of Interest if the Captive has paid claims in any amount,
there is an annual rate and reserve study conducted by a qualified
actuary, and there is commercial coverage available for the risks
covered by the Captive. The commenter indicated that all of these
factors together should be sufficient to demonstrate that a micro-
captive transaction was not entered into for tax avoidance purposes.
Several other commenters asserted that taxpayers who can demonstrate
that the premiums charged in their transaction were actuarially
determined by a credentialed actuary should not be designated as
participating in a Micro-captive Listed Transaction or a Micro-captive
Transaction of Interest. Additional commenters suggested that the
existence of a feasibility study prepared by a credentialed actuary, or
a third-party transfer pricing memorandum certifying the transaction,
would provide better metrics for identification as a listed transaction
or transaction of interest, and transactions for which such feasibility
studies or third-party transfer pricing memoranda have been prepared
should not be designated as participating in a Micro-captive Listed
Transaction or a Micro-captive Transaction of Interest.
With respect to proposed safe harbors involving claims, the
Treasury Department and the IRS are aware of promoters encouraging the
filing of claims under contracts that the parties treat as insurance
contracts to establish the appearance of a legitimate insurance
arrangement, regardless of business need. Because these transactions

[[Page 3551]]

involve closely held related entities, there is little to no barrier to
the manufacture of claims in these arrangements. Further, in many of
the micro-captive cases tried to date, the handling of claims was
atypical of valid insurance arrangements, with claims paid despite
lacking in substantiation and under the direction of the Insured or its
Owners without regard to the validity of the claim. See, e.g., Caylor,
T.C. Memo. 2021-30, at *42-43; Keating, T.C. Memo. 2024-2, at *63-64.
The existence of paid claims in any amount is therefore not a viable
metric for distinguishing between transactions that are or may be tax
avoidance transactions and those that are not.
With respect to the involvement of an actuary or other professional
in the transaction, as observed in Avrahami and discussed more fully at
part II.E.1. of this Summary of Comments and Explanation of Revisions,
such involvement does not establish that the arrangement is not, and
does not have the potential to be, a tax avoidance transaction, and
further is not dispositive of a valid transaction for Federal tax
purposes.
Similarly, with respect to Captives covering risks for which
commercial coverage is available, the presence of such risks is not
dispositive of the validity of a transaction. Many abusive micro-
captive transactions involve purported risks that would be a typical
insurance risk for another company but would be inappropriate for the
Insured to purchase given the nature of the Insured's business, such as
construction coverage for an entity that ``wasn't constructing
anything.'' Avrahami, 149 T.C. at *196.
In all micro-captive cases tried to date, courts have found the
arrangement at issue not to be insurance for Federal tax purposes even
though the factors identified by the commenters as appropriate for safe
harbors were present--claims were paid; an actuary or other
professional prepared pricing reports, feasibility studies, or the like
in the transaction; and the captive covered some typical insurance-type
risks. See Avrahami, 149 T.C. at *149-52, 167, 186-87, 195-97; Syzygy,
T.C. Memo. 2019-34, at *15-17, 35, 44; Caylor, T.C. Memo. 2021-30, at
*14, 19-23, 25-26, 48-49; Keating, T.C. Memo. 2024-2, at *14, 20-25,
30, 33, 35, 63-64; Swift, T.C. Memo. 2024-13, at *12, 15-17, 44; Patel,
T.C. Memo. 2024-34, at *9, 14-22, 29-30, 50-51; Royalty Mgmt., T.C.
Memo. 2024-87, at *16-17, 21, 47; see also Reserve Mech., T.C. Memo.
2018-86, at *9, 11-20, 47-48, 61. Accordingly, the final regulations
provide no exclusion from identification as a Micro-captive Listed
Transaction or a Micro-captive Transaction of Interest in response to
these comments.
One commenter argued that if the following facts are present, the
transaction should be excepted from identification as either a Micro-
captive Listed Transaction or a Micro-captive Transaction of Interest:
(a) 90 percent of the coverage written is coverage that is commercially
available, (b) Insureds purchase or have purchased such coverage from
commercial carriers in a similar amount to what is now purchased from
the Captive, (c) the commercial carrier has credible loss experience
for the types of coverage in the Insured's location, and (d) commercial
rates are used to extrapolate the Captive's premiums, taking into
account the Captive's expenses and layers written.
As discussed in this part V.A.2. of the Summary of Comments and
Explanation of Revisions, the coverage of risks for which commercial
coverage is available does not guarantee the validity of the
transaction. The Tax Court has held multiple arrangements did not
qualify as insurance arrangements for Federal tax purposes despite
purporting to cover such risks. See, e.g., Avrahami, 149 T.C. at 150,
153-56, 159, 197 (administrative actions and employee fidelity);
Keating, T.C. Memo. 2024-2, at *20-27, 64 (workers' compensation);
Swift, T.C. Memo. 2024-13, at *7-8, 12, 14-15, 44 (medical malpractice
and terrorism); Patel, T.C. Memo. 2024-34, at *15-20, 51 (business
interruption and regulatory). Further, Insureds' purchase of such
coverage from commercial carriers in a similar amount to what is now
purchased from the Captive does not guarantee the validity of the
transaction. The availability of commercial coverage may indicate a
lack of a business need for captive coverage. See, e.g., Keating, T.C.
Memo. 2024-2, at *59-60 (petitioners provided no credible evidence of a
business need for captive coverage in light of comprehensive commercial
coverage). Additionally, the commenter did not clarify whether the
purchase of coverage from commercial carriers in a similar amount to
what is now purchased from the Captive would include duplicative
coverage, coverage of different layers of risk, or both. The commenter
did not specify what commercial markets or rates are relevant nor what
constitutes a ``similar amount'' or a ``credible loss experience''
sufficient to exempt the participant's identification under these
regulations. Nor did the commenter explain how the experience of a
commercial insurer would be known to the participants in the micro-
captive transaction. The suggested factors are too subjective and
complex to be administrable, and sufficient relief is afforded by the
changes to the Loss Ratio Factors described in parts II.B. and II.C. of
this Summary of Comments and Explanation of Revisions.
One commenter recommended that transactions with Captives that have
been rated highly by an independent third-party credit or rating agency
specializing in insurance should not be designated as a Micro-captive
Listed Transaction or Micro-captive Transaction of Interest. In
general, such agencies rate the financial strength of Captives, that
is, the ability to pay claims should they arise. Thus, their ratings
are not informative regarding the nature of an entity or a transaction
for Federal tax purposes. This recommendation is not adopted in the
final regulations.
A commenter suggested that transactions with Captives that are
licensed or domiciled in a jurisdiction that regulates many Captives
should not be designated as a Micro-captive Listed Transaction or
Micro-captive Transaction of Interest. The commenter also suggested
that taxpayers whose Captive uses template insurance policies accepted
by the State regulator, or whose Captive offers coverage that has been
accepted as adequate proof of insurance by other State or Federal
agencies, should not be designated as a Micro-captive Listed
Transaction or Micro-captive Transaction of Interest. Another commenter
recommended a broader exception for all State-licensed domestic
captives.
However, whether a captive is regulated in a given domicile does
not determine whether a transaction is abusive or has the potential for
abuse for Federal tax purposes. See, e.g., Avrahami, 149 T.C. at 192
(captive regulated in St. Kitts); Syzygy, T.C. Memo. 2019-34, at *38
(captive regulated in Delaware); Caylor, T.C. Memo. 2021-30, at *41
(captive regulated in Anguilla); Keating, T.C. Memo. 2024-2, at *53
(captive regulated in Anguilla); Swift, T.C. Memo. 2024-13, at *37
(captive regulated in St. Kitts); Patel, T.C. Memo. 2024-34, at *46
(captives regulated in St. Kitts and Tennessee, respectively); cf.
Royalty Mgmt., T.C. Memo. 2024-87, at *43-44 (no regulatory oversight
in Tribal domicile). As each micro-captive case describes, whether a
company is organized and regulated as an insurance company is not the
end of the inquiry, as courts ``must look beyond the formalities and
consider the realities of the purported insurance transaction.''
Hospital Corp. of Am. v. Commissioner,

[[Page 3552]]

T.C. Memo. 1997-482, 1997 WL 663283, at *24 (citing Malone & Hyde, Inc.
v. Commissioner, 62 F.3d 835, 842-43 (6th Cir. 1995)). In the micro-
captive transactions identified as transactions that are or may be tax
avoidance transactions, the realities of the purported insurance
transaction, including the closely held nature of the arrangement, the
section 831(b) election, and the use of premiums primarily for
investment or related-party financing (rather than to pay losses)
indicate tax avoidance or the potential for tax avoidance. Further, a
safe harbor identifying a specific domicile or specific domiciles would
require the IRS to evaluate the manner in which the respective domicile
regulates insurance, which would be administratively burdensome and
inject uncertainty. Accordingly, the final regulations do not adopt
these suggestions.
A commenter indicated that taxpayers whose Captive covers risks
with a specified number of Insureds or risk units, or pools risk with a
specified distribution of the risk of loss, should not be designated as
participating in a Micro-captive Listed Transaction or Micro-captive
Transaction of Interest. However, these aforementioned factors only
relate to the degree to which a transaction distributes risk. Risk
distribution is just one of the four prongs used by the courts in
determining whether an arrangement qualifies as insurance for Federal
tax purposes and does not alone establish that a transaction has no
potential for tax avoidance. See part I. of the Background section of
this Preamble for further explanation of the four-prong test. The final
regulations do not adopt these suggestions.
3. Captives Providing Certain Types of Coverage or Serving Certain
Industries
Other commenters suggested that taxpayers who can demonstrate that
the Captive directly or indirectly reinsures contracts issued by a
commercial carrier should not be designated as participants in a Micro-
captive Listed Transaction or Micro-captive Transaction of Interest.
The final regulations do not adopt this suggestion. First, as discussed
in part V.A.2. of this Summary of Comments and Explanation of
Revisions, the involvement of commercially covered risks in the
transaction does not guarantee the validity of the transaction. The
commenter did not specify what commercial carriers are relevant nor
what portion of reinsurance would be sufficiently significant to exempt
the participants from identification under these regulations. Second,
if the entirety of a captive's business is the reinsurance of a
commercially rated program, it is less likely that the transaction
would be described by these regulations, as the individuals or entities
insured would not be sufficiently related to the captive to meet the 20
Percent Relationship Test. Accordingly, a safe harbor based on a
Captive's direct or indirect reinsurance of contracts issued by a
commercial carrier is not appropriate.
A commenter recommended that taxpayers who operate as risk
retention groups pursuant to the Federal Liability Risk Retention Act
(FLRRA), 15 U.S.C. 3901, et. seq., should not be designated as
participating in a Micro-captive Listed Transaction or Micro-captive
Transaction of Interest because the FLRRA establishes that a risk
retention group licensed in one State can transact business as an
insurance company in every State, and the IRS does not have the
authority to repeal the FLRRA. A risk retention group is ``a group-
owned insurer organized for the purpose of assuming and spreading the
liability risks to its members.'' NAIC Glossary of Insurance Terms,
https://content.naic.org/glossary-insurance-terms (last visited Jan. 6,
2025). Risk retention groups formed pursuant to the FLRRA are unlikely
to be described by the proposed regulations as they would have too many
member-owners to satisfy the 20 Percent Relationship Test. Further, the
proposed regulations do not repeal the FLRRA. By identifying certain
micro-captive transactions as reportable transactions, the proposed
regulations impose disclosure requirements and provide notice that the
tax treatment of the transactions will or may be challenged by the IRS.
They do not in any way prevent any taxpayer from transacting business
as an insurance company. The final regulations do not adopt this
recommendation.
Commenters expressed concern that community banks in particular
will be negatively impacted by the proposed regulations to the
detriment of their communities. Commenters recommended that community
banks as a whole be exempted from identification as a Micro-captive
Listed Transaction. Regardless of the industry, taxpayers engaged in
transactions identified as listed transactions or transactions of
interest in the final regulations must disclose such participation.
There is no one industry whose constituents should be categorically
exempted from identification as a Micro-captive Listed Transaction or
as a Micro-captive Transaction of Interest. Adverse impacts to
individual taxpayers or specific industries consequent to
implementation of these regulations are limited to disclosure and
recordkeeping requirements and are outweighed by the public interest in
sound tax administration. Accordingly, the final regulations do not
adopt any changes in response to this concern.
A commenter argued for an exception for any micro-captive that
``writes `deductible reimbursement' policies for the deductible or
self-insured retention (`SIR') layer(s) underlying policies issued by
Licensed Insurers and uses comparable rates taking into account the
layer written and [the] micro-captive's expenses.'' The commenter did
not provide any additional explanation, including why such an exception
was appropriate. To the extent a transaction involving a Captive
writing such policies otherwise falls within the description of Micro-
Captive Listed Transaction or Micro-Captive Transaction of Interest,
the transaction remains one that is or may be a tax avoidance
transaction. The final regulations do not adopt any changes based on
this comment.

B. Comments Relating to Reporting Required Under Proposed Sec. Sec.
1.6011-10(g) and 1.6011-11(g), Pursuant to Sec. 1.6011-4(d) and (e)

With respect to Micro-captive Listed Transactions, proposed Sec.
1.6011-10(g) would provide that participants must disclose their
participation in the transaction pursuant to Sec. 1.6011-4(d) and (e).
Similarly, with respect to Micro-captive Transactions of Interest,
proposed Sec. 1.6011-11(g) would provide that participants must
disclose their participation in the transaction pursuant to Sec.
1.6011-4(d) and (e).
Section 1.6011-4(d) and (e) provides that the disclosure
statement--Form 8886 (or successor form)--must be attached to the
taxpayer's tax return for each taxable year for which a taxpayer
participates in a reportable transaction. A copy of the disclosure
statement must be sent to the OTSA at the same time that any disclosure
statement is first filed by the taxpayer pertaining to a particular
reportable transaction. Section 1.6011-4(e)(2)(i) provides that if a
transaction becomes a listed transaction or a transaction of interest
after the filing of a taxpayer's tax return reflecting the taxpayer's
participation in the transaction and before the end of the period of
limitations for assessment for any taxable year in which the taxpayer
participated in the transaction, then a disclosure statement must be
filed with the OTSA within 90 calendar days after the date on which the
transaction becomes a listed transaction or transaction of interest.
This requirement extends to an amended return and exists

[[Page 3553]]

regardless of whether the taxpayer participated in the transaction in
the year the transaction became a listed transaction or transaction of
interest.
Proposed Sec. Sec. 1.6011-10(g)(2) and 1.6011-11(g)(2) would
provide relief from disclosure for participants in Micro-captive Listed
Transactions and Micro-captive Transactions of Interest, respectively,
who have finalized settlement agreements with the IRS with respect to
the transaction. Such taxpayers do not need to disclose their
participation in the transaction for years covered by the settlement
agreement. Proposed Sec. 1.6011-11(g)(2) provides similar relief for
participants in a Micro-captive Transaction of Interest who disclosed
their participation in the transaction under Notice 2016-66 and file no
more returns reflecting participation in the transaction after the
final regulations are finalized.
One commenter expressed concern that settlements in litigation are
not covered by the disclosure relief for taxpayers who have finalized
settlement agreements that would be provided in proposed Sec. Sec.
1.6011-10(g)(2) and 1.6011-11(g)(2). This provision in the proposed
regulations is intended to cover settlement agreements with respect to
the transaction reached in litigation or during the course of
examination. The final regulations clarify this provision by explicitly
referencing litigation. See Sec. Sec. 1.6011-10(h)(2) and 1.6011-
11(h)(2) of the final regulations.
Another commenter argued that excusing taxpayers from filing
disclosure statements if they have finalized a settlement agreement
with the IRS is an illusory reporting exemption because the IRS
effectively requires Captives to wind up and liquidate as part of
certain private settlement agreements. However, if this provision was
removed from the regulations, taxpayers who had conclusively settled
taxable years under audit that would otherwise be subject to the
reporting requirements in the regulations would be forced to disclose
for those years. It may not be clear that such disclosure would be
unnecessary and, accordingly, the final regulations retain the
exception.
One commenter stated that reporting more than once is unjust to
taxpayers and suggested that Form 8886 should only have to be filed
with the IRS once with respect to each Micro-captive Listed Transaction
or Micro-captive Transaction of Interest. Consistent with Sec. 1.6011-
4, participation in a listed transaction that involves a purported
insurance arrangement means that the taxpayer is claiming tax benefits
each year to which the taxpayer is not entitled. Similarly,
participation in a transaction of interest that involves a purported
insurance arrangement means that the taxpayer may be claiming tax
benefits each year to which the taxpayer may not be entitled (that is,
the IRS needs more information to determine whether the transaction is
a tax avoidance transaction). As discussed in part I.C. of this Summary
of Comments and Explanation of Revisions, the reporting rules for
listed transactions and transactions of interest under Sec. 1.6011-4
are outside the scope of these final regulations. The final regulations
do not adopt any changes based on this comment; taxpayers must disclose
their participation for each year in which such tax benefits are
claimed unless otherwise relieved of the obligation in the regulations.
A commenter requested an expansion of the proposed safe harbors set
forth at Sec. Sec. 1.6011-10(e)(2) and 1.6011-11(e)(2) (``Disclosure
Safe Harbor for Owners''), which provide that an Owner of an Insured is
not required under Sec. 1.6011-4 to file a disclosure statement with
respect to a Micro-captive Listed Transaction or Micro-captive
Transaction of Interest provided that person receives written or
electronic acknowledgment that Insured has or will comply with its
separate disclosure obligation under Sec. 1.6011-4(a) with respect to
the transaction. The preamble to the proposed regulations explained
that the receipt of an acknowledgment that Insured has or will comply
with its disclosure obligation does not relieve the Owners of Insured
of their disclosure obligations if Insured fails to disclose the
transaction in a timely manner. The commenter requested that an Owner
that relies on an acknowledgement pursuant to this safe harbor should
be allowed to rely solely on the acknowledgement and should not also
need to confirm that the Insured actually timely disclosed the
transaction. However, such a position could result in non-filing by
both an Owner and the Insured. To ensure that Insureds file, or Owners
file if the Insured fails to do so, the final regulations do not adopt
this recommendation.
Commenters also requested that the final regulations expand the
Disclosure Safe Harbor for Owners to all Insured entities for
transactions in which the Captive entity reported, or to all Captive
entities for transactions in which the Insured reported. The final
regulations do not adopt this request because unlike Owners, who must
only disclose the information required by Sec. 1.6011-10(g)(1),
Captives and Insureds must also provide the information required by
Sec. 1.6011-10(g)(2) and (3), respectively. See Sec. Sec. 1.6011-
10(g) and 1.6011-11(g) of the final regulations.
Commenters suggested that transactions for which disclosure
statements were filed under Notice 2016-66 should not be required to
report under the proposed regulations. Proposed Sec. Sec. 1.6011-
10(g)(2) and 1.6011-11(g)(2) already limit the disclosure requirements
to taxpayers who have filed a tax return (including an amended return)
reflecting their participation in a Micro-captive Listed Transaction or
Micro-Captive Transaction of Interest prior to January 14, 2025, and
who have not finalized a settlement agreement with the IRS with respect
to the transaction. Additionally, proposed Sec. 1.6011-11(g)(2)
already provides that taxpayers who have filed a disclosure statement
regarding their participation in a transaction identified by the
proposed regulations as a Micro-captive Transaction of Interest with
the OTSA pursuant to Notice 2016-66, will be treated as having made the
disclosure pursuant to the final regulations for the taxable years for
which the taxpayer filed returns before the January 14, 2025. Similar
relief should not be extended with respect to any transaction
identified by the proposed regulations as a Micro-captive Listed
Transaction because disclosure statements filed under Notice 2016-66 do
not identify participation in a listed transaction. The final
regulations do not adopt any changes based on this comment.
One commenter stated that the requirement that taxpayers
participating in transactions that become listed transactions under the
proposed regulations must file again under the final regulations, even
if they already filed Forms 8886 pursuant to Notice 2016-66, is
duplicative and a waste of taxpayers' time because the IRS already has
most of the necessary information about these transactions, and there
is little marginal value to the IRS in obtaining another round of
filings. The commenter suggested that there is no justification for
this other than a transparent effort by the Treasury Department and the
IRS to extend the applicable statute of limitations period under
section 6501(c)(10) unilaterally for years where the limitations period
has expired or is about to (such as 2021, for instance) and that
requiring material advisors to file Forms 8918 with the OTSA, again
irrespective of whether they previously filed under Notice 2016-66, is
similarly unnecessary. The commenter asserts that both these duplicate
filing requirements run contrary to the Paperwork Reduction

[[Page 3554]]

Act (44 U.S.C. 3507(c)) and are themselves abusive.
This additional disclosure for listed transactions is needed
because Notice 2016-66 only identified transactions of interest, so
disclosure pursuant to Notice 2016-66 does not disclose that a
transaction meets the threshold for listed transactions under the
proposed regulations. Further, for Micro-captive Transactions of
Interest, there are differences between the proposed regulations and
Notice 2016-66 in both the scope of transactions identified and the
information required to be disclosed. The final regulations also
significantly narrow the scope of transactions identified as Micro-
captive Listed Transactions compared to the proposed regulations, as
further discussed in part II. of this Summary of Comments and
Explanation of Revisions. Accordingly, disclosure under the final
regulations will provide the IRS with new information, including
identifying transactions that are now listed, and will not create
unnecessary duplicative reporting requirements. The final regulations
do not adopt any changes based on this comment.
Commenters asserted that the requirement in Sec. 1.6011-4(e)(2)(i)
(to report to the OTSA) is unfair because it will require some
taxpayers who were already subject to audits that closed without
adjustment (to Captive) to report under this provision. Similarly,
other commenters suggested that taxpayers who are under examination
should not have to disclose because the IRS will have access to
detailed taxpayer records through the examination process and should
not need Form 8886 disclosures to identify participation in the
transaction. The Form 8886 disclosure statements to the OTSA and the
IRS are necessary, even if a taxpayer is in examination for the
reporting year or was examined in an earlier year. While the IRS
endeavors to resolve all tax issues in a given examination, examination
may be specific to a given issue or return that does not clearly
address the tax benefits of participating in a Micro-captive Listed
Transaction or a Micro-captive Transaction of interest. The final
regulations do not adopt these suggested changes.
A commenter requested that taxpayers who are commercial insurers
acting as Intermediaries (as defined in proposed Sec. 1.6011-10(b)(5))
and material advisors to such commercial insurers be excepted from
reporting because commercial insurers ceding risks to a reinsurer need
to be certain that the reinsurer will satisfy its financial obligations
to the ceding company, a need that is generally met by requiring that
the reinsurer provide security. With security in place, the commenter
states that there is no business reason for the ceding company to
investigate the reinsurer's ownership, tax status, overall loss ratio
(including any other business the reinsurer may write), or financing
practices. The final regulations do not adopt this suggestion.
Commercial insurers acting as Intermediaries should know as part of
their due diligence the nature of the entity with which they have
contracted. The material advisors to such commercial insurers,
similarly, should know as part of their due diligence the nature of the
transaction about which they are providing advice. Also, as a general
matter, the most likely type of micro-captive transaction involving a
commercial insurer is a Consumer Coverage Arrangement. The final
regulations have significantly broadened the reporting exception set
forth in the proposed regulations for Consumer Coverage Arrangements to
eliminate their possible identification as a Micro-captive Listed
Transaction, as discussed more fully at part IV. of this Summary of
Comments and Explanation of Revisions, which should afford sufficient
relief to commercial insurers acting as Intermediaries.

VI. Other Comments and Requested Changes to the Proposed Regulations

In addition to comments on the authority of the Treasury Department
and the IRS to issue the proposed regulations, specific comments on the
Loss Ratio Factor and the Financing Factor, comments on the Consumer
Coverage Exception, and comments seeking safe harbors from
identification as or disclosure of a Micro-captive Listed Transaction
or a Micro-captive Transaction of Interest, commenters expressed
additional concerns, sought clarification, and recommended additional
changes to the proposed regulations.
A. Request for Clarification Regarding Effect on Cannabis Businesses
One commenter stated that because the sale of cannabis constitutes
``trafficking in controlled substances'' under section 280E, cannabis
businesses may not claim deductions for amounts paid or incurred during
the taxable year, including amounts paid for insurance premiums. The
commenter asked for guidance on how the proposed regulations will
impact the cannabis industry. A cannabis business that enters into a
Contract with a Captive would be an Insured under the proposed
regulations if it treats amounts paid under the Contract as insurance
premiums for Federal income tax purposes, even if it cannot deduct such
amounts. Accordingly, a transaction between a cannabis business and
Captive may meet the definition of a Micro-captive Listed Transaction
or a Micro-captive Transaction of Interest under the proposed
regulations. Any taxpayer engaged in such a transaction would be
subject to the disclosure requirements set forth in the proposed
regulations, except as otherwise provided therein, if their returns
reflect the tax consequences of participation in the transaction. The
tax return of an Insured that cannot deduct an amount paid or incurred
for purported insurance payments by operation of section 280E is not
likely to reflect the tax consequences of participation in a Micro-
captive Listed Transaction or Micro-captive Transaction of Interest,
and therefore, the Insured will likely not be a ``participant'' in the
transaction under these regulations. However, others involved in the
transaction, such as Captive, which generally will exclude amounts
received as premiums from income based on the position that it is an
insurance company, would therefore reflect the tax consequences of
participation in their returns, and may nonetheless be considered
``participants'' subject to the disclosure requirements set forth in
these regulations.
B. Comments Regarding the 20 Percent Relationship Test
Some commenters suggested that the 20 Percent Relationship Test set
forth in proposed Sec. 1.6011-10(b)(1)(iii) and incorporated in
proposed Sec. 1.6011-11(b)(1) is inconsistent with the diversification
requirements of section 831(b)(2)(B) as enacted pursuant to the PATH
Act. One part of the PATH Act diversification requirements is based on
the percentage of premiums from related insureds, requiring that no
more than 20 percent of net written premiums (or if greater, direct
written premiums) for a taxable year is attributable to any one
policyholder. The other part is based on the relative concentration of
ownership in an insurance company and its policyholders. An insurance
company must meet one of the PATH Act diversification requirements to
make a section 831(b) election. However, the PATH Act diversification
requirements are not sufficient to eliminate the possibility that a
transaction is or may be a tax avoidance transaction. The final
regulations describe fact patterns that strongly indicate tax avoidance
or the potential for tax avoidance by entities that make a section
831(b) election and share a concentration in ownership with

[[Page 3555]]

any policyholder that exceeds the 20 Percent Relationship Test. The
final regulations do not adopt any changes based on these comments.
Another commenter requested clarification regarding what kinds of
derivatives will cause a taxpayer to meet the 20 Percent Relationship
Test. The commenter expressed concern that as risk management vehicles,
derivatives are not comparable to ownership of an entity through stock.
To be clear, any derivative that is derived from a direct or indirect
interest in the assets held by the Captive or the Captive's stock is
included in the definition of Owner for the Captive. Any derivative
that is derived from a direct or indirect interest in the assets held
by the Insured or the Insured's stock is included in the definition of
Owner for the Insured. While the commenter asserted that derivatives
are generally used for risk management, the Treasury Department and the
IRS are aware of promoters of abusive micro-captive transactions using
derivatives to replicate ownership interests, specifically in response
to Notice 2016-66. For example, a taxpayer may enter into a derivative
contract such as a tracking stock warrant with respect to a Captive's
stock. Such a contract would lack the voting rights or equity interest
considered ownership under Notice 2016-66, but the taxpayer is provided
with the same or similar economic benefits as owning the Captive
directly through its eligibility to exercise the warrant to obtain one
or more shares in the Captive. The final regulations do not adopt any
changes based on this comment.
One commenter argued that the 20 Percent Relationship Test is
contrary to the micro-captive concept, asserting that micro-captives
are typically structured with a single owner, who has a single
business, that is also the sole policyholder of the micro-captive. The
commenter appeared to suggest that section 831(b) was intended
specifically for the benefit of such micro-captives, but this is not
consistent with the history of section 831(b). Section 831(b) arose out
of tax laws specific to certain small and mutual insurers, which are
traditionally held by their members in a given geographical location
``solely for the protection of their own property and not for profit.''
Revenue Act of 1914, Public Law 63-217, 38 Stat. 745, 762. These small
insurers, including groups of farmers and fire associations, were
exempt from ordinary income tax laws and were understood to collect
funds only up to what was needed for losses and expenses. See H.R. Rep.
No. 69-1, at 9 (1925). Under the current Code, these and other types of
small insurers use section 831(b) to exclude premiums from taxable
income. Accordingly, while the Code does contemplate small insurers,
such contemplation is not specific to a single captive covering a sole
policyholder. The inclusion of the 20 Percent Relationship Test in the
proposed regulations was intended to exclude entities such as the
mutual insurers, which are more likely to have diversified ownership
and thus have significantly reduced potential for tax avoidance. The
final regulations do not adopt any changes based on this comment.
C. Recommendations To Eliminate or Delay Some or All of the Proposed
Regulations
Commenters recommended that the proposed regulations identifying
Micro-Captive Listed Transactions should not be finalized. Commenters
noted that captive transactions can differ significantly from one
transaction to the next and because the test for whether a transaction
is insurance for Federal tax purposes is a totality of the
circumstances inquiry, it is unreasonable to designate any category of
transactions as transactions known to be abusive. The final regulations
do not adopt this recommendation. However, the final regulations
significantly narrow the scope of Sec. 1.6011-10 to decrease the
likelihood that transactions that are not tax avoidance transactions
are identified as listed transactions. As commenters noted, the IRS has
received information on micro-captive transactions, whether in response
to Notice 2016-66 or as part of examinations or litigation, for many
years. The IRS is confident from its review of examinations and case
law that the fact pattern described in the final regulations is a fact
pattern that consistently gives rise to tax avoidance.
Commenters recommended that finalization of these regulations be
postponed until a decision is reached in Loper Bright Enterprises v.
Raimondo, Sup. Ct. Dkt. No. 22-451 (certiorari granted on the question
of ``[w]hether the Court should overrule Chevron or at least clarify
that statutory silence concerning controversial powers expressly but
narrowly granted elsewhere in the statute does not constitute an
ambiguity requiring deference to the agency''). The Supreme Court
issued its decision in this case on June 28, 2024, and as such, this
recommendation is moot. Loper Bright Enterprises v. Raimondo, 144 S.Ct.
2244 (2024). Further, as described more fully in the Authority section
of this preamble, sections 6011 and 7805(a) provide express delegations
of authority to the Secretary to identify the form and manner of
taxpayer filing requirements and make rules, respectively. Section
6707A provides an express delegation of authority to identify
reportable transactions. The final regulations do not adopt any changes
based on these comments.
Commenters recommended modification of Form 1120-PC, U.S. Property
and Casualty Insurance Company Tax Return, to capture the information
required to be reported by Captives in the proposed regulations, in
lieu of finalizing the proposed regulations. This recommendation was
not adopted for the reasons explained in the preamble to the proposed
regulations. Changes to the Form 1120-PC would at a minimum impact all
nonlife insurance companies that make section 831(b) elections, not
only participants in the micro-captive transactions described in these
regulations. Some of the requested information is not readily available
from filed Forms 1120-PC, such as the descriptions of the types of
coverages provided by a Captive and the name and contact information of
any actuary or underwriter who assisted Captive in the determination of
amounts treated as premiums. Additionally, limiting the collection of
information to only those entities filing the Form 1120-PC would be
insufficient to gather relevant information, including information
regarding Insureds and promoters of the transactions. Reporting for the
specific transactions identified in these regulations is best captured
in the manner of all reportable transactions, by requiring disclosure
on Form 8886, for consistency in enforcement of the reportable
transaction regime.
Commenters expressed concern that the IRS should have sufficient
information on micro-captives in the responses filed to Notice 2016-66
and thus the regulations are not needed. Commenters stated the IRS
should not require any further reporting. As commenters also noted, the
IRS has received information on micro-captive transactions for several
years. The IRS is confident from its review of examinations and case
law that the fact pattern described in the regulations is a fact
pattern that consistently gives rise to tax avoidance or otherwise
potentially gives rise to tax avoidance. However, promoters continue to
promote participation in these transactions, and the IRS is aware of
new entrants to these transactions. Thus, despite information collected
to date, the IRS needs to continue collecting information to identify
who the participants are and the nature of

[[Page 3556]]

their transactions. The final regulations do not adopt any changes
based on these comments.
Commenters recommended that the proposed regulations be withdrawn
in their entirety and that guidance be issued instead on what would
make a micro-captive arrangement an insurance arrangement for Federal
tax purposes in the IRS's estimation. As the Tax Court explained in
Syzygy, ``[a]n inherent requirement for a company to make a valid
section 831(b) election is that it must transact in insurance.'' T.C.
Memo. 2019-34, at *28; see also Reserve Mech., 34 F.4th at 904. Like
any insurance transaction, a valid micro-captive arrangement for
Federal tax purposes is one that meets the four-prong test of insurance
as detailed by the courts in a significant body of case law. See Le
Gierse, 312 U.S. at 539; see also Avrahami, 149 T.C. at 181 (citing
Rent-A-Center, 142 T.C. at 13-14) (additional citations omitted);
Syzygy, T.C. Memo. 2019-34, at *29; Caylor, T.C. Memo. 2021-30, at *31-
32; Keating, T.C. Memo. 2024-2, at *51-52; Swift, T.C. Memo. 2024-13,
at *27; Patel, T.C. Memo. 2024-34, at *37-38; Royalty Mgmt., T.C. Memo.
2024-87, at *35. The IRS has issued guidance regarding what makes a
captive insurance arrangement an insurance arrangement for Federal tax
purposes that is applicable to all insurance companies, including those
making section 831(b) elections. See, e.g., Rev. Rul. 2002-89, 2002-2
C.B. 984; Rev. Rul. 2002-90, 2002-2 C.B. 985; Rev. Rul. 2002-91, 2002-2
C.B. 991; Rev. Rul. 2005-40, 2005-2 C.B. 4; Rev. Rul. 2007-47, 2007-2
C.B. 127; Rev. Rul. 2008-8, 2008-1 C.B. 340; and Rev. Rul. 2009-26,
2009-38 I.R.B. 366. Nonetheless, in many micro-captive transactions,
the manner in which the contracts are interpreted, administered, and
applied is inconsistent with arm's length transactions, actuarial
standards, and sound business practices. The captive typically does not
behave as an insurance company commonly would, indicating that the
captive is not issuing insurance contracts and the transaction does not
constitute insurance for Federal tax purposes. The final regulations
therefore do not adopt any changes based on these comments.
D. Requests for Clarification Regarding Revoked or Inapplicable Section
831(b) Elections
Commenters requested clarification whether reporting is still
required for years in which a Captive's section 831(b) election has
been revoked or is otherwise inapplicable for a given taxable year.
Under section 831(b)(2)(A), a section 831(b) election, once made, may
be revoked only with the consent of the Secretary. Once an election is
made, the alternative tax under section 831(b) applies only if the net
written premiums (or, if greater, the direct written premiums) for the
taxable year do not exceed the threshold set forth in section
831(b)(2)(A)(i) (as adjusted for inflation) and if the electing entity
meets the diversification requirements set forth in section
831(b)(2)(B), for that taxable year.
Under proposed Sec. Sec. 1.6011-10(b)(1)(i) and 1.6011-11(b)(1),
an entity would be a Captive only if it elects under section 831(b) to
exclude premiums from taxable income. Under proposed Sec. Sec. 1.6011-
10(a) and 1.6011-11(a), a transaction would be a Micro-Captive Listed
Transaction or Micro-captive Transaction of Interest only if it
involves a Captive. Separately, pursuant to Sec. 1.6011-4(a), the
disclosure requirements for reportable transactions apply to a taxpayer
that is a participant in a reportable transaction for taxable years in
which the taxpayer's filed return reflects the tax consequences of
participation in the transaction, as set forth in Sec. 1.6011-
4(c)(3)(i)(A).
An entity that revokes its section 831(b) election would not be a
Captive under the proposed regulations beginning in the year of
revocation. Similarly, for taxable years after a Captive has filed its
final return, it has effectively revoked its section 831(b) election.
See Sec. 1.6011-10(b)(1)(i); but see Sec. Sec. 1.6011-10(b)(2)(iv)
and 1.6011-11(b)(2)(iii) (regarding successor corporations).
Accordingly, for taxable years in which a Captive's section 831(b)
election has been revoked or the Captive has previously filed its final
return, the arrangement generally is not a Micro-Captive Listed
Transaction or Micro-Captive Transaction of Interest under the proposed
regulations in that taxable year.
However, if the alternative tax under section 831(b) is
inapplicable (either because premiums exceed the threshold or the
entity fails the diversification requirements set forth in section
831(b)(2)(B) for that year), because the section 831(b) election
remains in effect, the entity may still be a Captive under the proposed
regulations. Thus, in taxable years in which a Captive's section 831(b)
election is inapplicable but has not been revoked, and the arrangement
is otherwise described in the regulations, the arrangement would still
be a Micro-Captive Listed Transaction or Micro-Captive Transaction of
Interest under the proposed regulations. The potential of using of the
section 831(b) election for tax avoidance is not eliminated until the
election is revoked. Taxpayers must disclose the transaction in such
years if their returns reflect the tax consequences of participation.
The effect of revocation or inapplicability of the section 831(b)
election, as described with respect to the proposed regulations, is
retained in the final regulations. However, in the interest of limiting
the reporting required by these regulations, the final regulations
provide transition relief for section 831(b) revocations. Specifically,
if the Captive in a transaction identified as a Micro-captive Listed
Transaction or Micro-captive Transaction of Interest in Sec. Sec.
1.6011-10(a) and 1.6011-11(a) of the final regulations requests the
Secretary's consent to revoke its section 831(b) election on or before
the date by which the participants' disclosures must be filed with the
OTSA, the transaction will not be identified as a Micro-captive Listed
Transaction or Micro-captive Transaction of Interest for taxable years
ending before January 1, 2026, pursuant to Sec. Sec. 1.6011-10(h)(1)
and 1.6011-11(h)(1).
Additionally, the final regulations provide certainty regarding the
disclosure obligations of taxpayers who have participated in a Micro-
captive Listed Transaction or Micro-captive Transaction of Interest
involving a Captive that has subsequently revoked its section 831(b)
election and therefore ceased to be a Captive. With respect to taxable
years in which the section 831(b) revocation is effective, Sec. Sec.
1.6011-10(f)(3) and 1.6011-11(f)(3) of the final regulations provide
taxpayers involved in the transaction with a safe harbor from
identification as participants in that transaction.
Commenters also requested a streamlined method by which taxpayers
could obtain the Secretary's consent to revoke section 831(b)
elections. Currently, consent is obtained through the private letter
ruling procedures, published annually. See, e.g., Rev. Proc. 2024-1,
2024-1 I.R.B. 1. The IRS intends to issue a Revenue Procedure that
describes a simplified process for revocation of section 831(b)
elections.
E. Request for Clarification Regarding the Definition of Intermediary
A commenter requested clarification on whether the defined term
``Intermediary,'' as described in proposed Sec. Sec. 1.6011-10(b)(5)
and 1.6011-11(b)(5), includes fronting companies. Generally,
``fronting'' is ``an arrangement in which a primary insurer acts as the
insurer of record by issuing a policy, but then passes the entire risk
to a reinsurer in exchange for a commission. Often, the fronting
insurer

[[Page 3557]]

is licensed to do business in a state or country where the risk is
located, but the reinsurer is not.'' NAIC Glossary of Insurance Terms,
https://content.naic.org/glossary-insurance-terms (last visited Jan. 6,
2025). The term ``Intermediary'' as defined in the proposed regulations
means an entity that issues Contracts to an Insured, which are then
reinsured, directly or indirectly, by a Captive. A ``fronting'' company
would fall within the definition of ``Intermediary'' if it issues
Contracts to an Insured, which are then reinsured, directly or
indirectly, by a Captive.
F. Recommendation To Limit the Effective Period of Section 831(b)
Elections for Companies That Do Not Meet Loss Ratio Threshold
A commenter recommended that no loss ratio factor apply for the
first five years of a section 831(b) election, after which any entity
that elected the alternative tax under section 831(b) would
automatically revert to an entity taxable under section 831(a) unless
it meets a loss ratio threshold. The commenter did not specify what an
appropriate loss ratio threshold would be, but implied that the loss
ratio threshold should be lower than the Loss Ratio Factor percentages
set forth in the proposed regulations.
An automatic conversion to a taxable insurance company under
section 831(a) would be inconsistent with the statutory language of
section 831(b). Valid insurers who rely on the section 831(b) election
would be impermissibly harmed by this recommendation. To the extent the
commenter intended to recommend a five-year grace period from formation
of a Captive to identification as either a Micro-captive Listed
Transaction or a Micro-captive Transaction of Interest, this could
enable participants in micro-captive arrangements that are or may be
tax avoidance transactions to permanently avoid reporting that would
otherwise be required by, for instance, setting up a new Captive every
five years. The final regulations do not adopt any changes based on
this comment.
G. Comments Regarding Constitutionality of Potential Adjustments if
Transaction Examined
Commenters expressed concern that the potential adjustments
applicable to abusive transactions, as described in the preamble to the
proposed regulations, are unconstitutional as double tax. Specifically,
the preamble to the proposed regulations noted that examinations may
result in adjustments including full disallowance of claimed micro-
captive insurance premium deductions and the inclusion in income of
amounts received by the Captive. These adjustments are consistent with
the adjustments sustained against taxpayers in the relevant micro-
captive court cases. See Avrahami, 149 T.C. at 199 (disallowed premium
deductions), Syzygy, T.C. Memo. 2019-34, at *45-46 (disallowed premium
deductions and required income inclusion by the Captive), Caylor, T.C.
Memo. 2021-30, at *48-53 (disallowed premium deductions and penalties);
Keating, T.C. Memo. 2024-2, at *65-66, 77 (disallowed premium
deductions and penalties); Swift, T.C. Memo. 2024-13, at *44-50
(disallowed premium deductions and penalties); Patel, T.C. Memo. 2024-
34, at *52 (disallowed premium deductions), and Royalty Mgmt., T.C.
Memo. 2024-87, at *49-50, 52-53 (disallowed premium deductions and
required income inclusion by the Captive); see also Reserve Mech., T.C.
Memo. 2018-86, at *62-64 (income to a tax-exempt entity under section
501(c)(15)). Further, while the IRS may challenge the tax benefits
claimed in these transactions, adjustments will be asserted only to the
extent warranted by the facts, following examination by the IRS. The
final regulations do not adopt any changes based on these comments.
H. Comments Regarding Impact on the Captive Insurance Industry
Commenters expressed concern that the proposed regulations will
negatively impact the captive insurance industry and would eliminate
many benefits to its participants. Commenters stated that the benefits
of captives include the following: providing coverage that is either
unavailable or prohibitively expensive commercially, providing entry to
reinsurance markets that are otherwise unavailable to participants,
allowing for competition with commercial insurers, and serving to
manage catastrophic risks for many businesses, such as the risks
arising under the Coronavirus Disease 2019 (COVID-19) pandemic. These
benefits are available to all section 831(a) captives and to those
section 831(b) captives that are not engaged in transactions that are
tax avoidance transactions. These regulations do not hinder the
formation of valid captives. Accordingly, the final regulations do not
adopt any changes based on these comments.
I. Comments Regarding Compliance Concerns
Some commenters argued that the proposed regulations are
retroactive in nature, that there would be no way for an existing
micro-captive to ``come into compliance with the proposed regulation,''
and that there would be no way for a taxpayer to know whether they are
entering into a reportable transaction. As previously stated in part
I.C. of this Summary of Comments and Explanation of Revisions, the
proposed regulations are not retroactive in nature; the final
regulations will be effective as of January 14, 2025. Section 1.6011-
4(e)(2)(i) is clear that reporting is required for transactions entered
into and reflected on a tax return for a year prior to the publication
of guidance identifying a transaction as a listed transaction or a
transaction of interest, if the statute of limitations is still open on
the effective date of the listing. While the disclosures mandated by
Sec. 1.6011-4 may be with respect to prior periods, if the period of
limitations on assessment for such periods has not expired, the
disclosure obligation is itself not retroactive--it is a current
reporting obligation. The comments regarding an impermissible
retroactive burden are without merit and outside the scope of these
final regulations.
Moreover, existing participants in transactions identified under
the final regulations as a Micro-Captive Listed Transaction or a Micro-
Captive Transaction of Interest may successfully comply by fulfilling
their reporting obligations as set forth in the final regulations at
Sec. Sec. 1.6011-10(g) and 1.6011-11(g). Lastly, taxpayers are
encouraged to make informed decisions and seek independent tax advice
before entering into any transaction. Taxpayers have been placed on
notice of the IRS's concern with abuse of the section 831(b) election
since at least 2015 when the IRS first identified micro-captive
transactions on its annual Dirty Dozen list. The final regulations do
not adopt any changes based on these comments.
J. Comment Expressing Concerns About Access to Administrative Appeals
Finally, a commenter expressed concern that taxpayers whose micro-
captive transactions are examined do not have access to good faith
administrative appeals. Appeals is an independent office of the IRS.
Section 7803(e)(3) of the Code provides that it is the function of
Appeals to resolve Federal tax controversies without litigation on a
basis which is fair and impartial to both the Government and the
taxpayer, and promotes a consistent application and interpretation of,
and voluntary compliance with, the Federal tax laws. The Appeals
resolution process is generally available to all taxpayers. Appeals
endeavors to be consistent in its approach with the goal

[[Page 3558]]

of making a fair and reasoned determination on each case presented to
it, considering the facts of the case and existing case law. Taxpayers
concerned about their specific case and the handling thereof should
raise the matter to the appropriate authorities within Appeals.

Special Analyses

I. Regulatory Planning and Review

Pursuant to the Memorandum of Agreement, Review of Treasury
Regulations under Executive Order 12866 (June 9, 2023), tax regulatory
actions issued by the IRS are not subject to the requirements of
section 6 of Executive Order 12866, as amended. Therefore, a regulatory
impact assessment is not required.

II. Paperwork Reduction Act

The collection of information contained in the final regulations is
reflected in the collection of information for Forms 8886 and 8918 that
have been reviewed and approved by OMB in accordance with the Paperwork
Reduction Act (44 U.S.C. 3507(c)) under control numbers 1545-1800 and
1545-0865. To the extent there is a change in burden as a result of
these regulations, the change in burden will be reflected in the
updated burden estimates for the Forms 8886 and 8918. The requirement
to maintain records to substantiate information on Forms 8886 and 8918
is already contained in the burden associated with the control numbers
for the forms and is unchanged.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number assigned by OMB.

III. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA) (5 U.S.C. part I, chapter 6)
requires agencies to ``prepare and make available for public comment an
initial regulatory flexibility analysis,'' which will ``describe the
impact of the rule on small entities.'' 5 U.S.C. 603(a). Section 605(b)
of the RFA allows an agency to certify a rule if the rulemaking is not
expected to have a significant economic impact on a substantial number
of small entities.
The Secretary of the Treasury hereby certifies that the final
regulations will not have a significant economic impact on a
substantial number of small entities pursuant to the RFA. The basis for
these final regulations is Notice 2016-66, 2016-47 I.R.B. 745 (as
modified by Notice 2017-08, 2017-3 I.R.B. 423). The following chart
sets forth the gross receipts of respondents to Notice 2016-66, based
on data for taxable year 2022:

Notice 2016-66--Respondents by Size
------------------------------------------------------------------------
Filings
Receipts Firms (%) (%)
------------------------------------------------------------------------
Under 5M.......................................... 74.45 70.87
5M to 10M......................................... 7.17 7.56
10M to 15M........................................ 4.36 4.76
15M to 20M........................................ 2.49 2.80
20M to 25M........................................ 1.87 2.24
Over 25M.......................................... 9.66 11.76
---------------------
Total......................................... 100 100
------------------------------------------------------------------------

This chart shows that the majority of respondents to Notice 2016-66
reported gross receipts under $5 million. Even assuming that these
respondents constitute a substantial number of small entities, the
final regulations will not have a significant economic impact on these
entities because the final regulations implement sections 6111 and 6112
and Sec. 1.6011-4 by specifying the manner in which and time at which
an identified Micro-captive Listed Transaction or Micro-captive
Transaction of Interest must be reported. Accordingly, because the
regulations are limited in scope to time and manner of information
reporting and definitional information, the economic impact of the
final regulations is expected to be minimal.
Further, the Treasury Department and the IRS expect the reporting
burden to be low; the information sought is necessary for regular
annual return preparation and ordinary recordkeeping. The estimated
burden for any entity required to file Form 8886 (as revised Oct. 2022)
is approximately 10 hours, 16 minutes for recordkeeping; 4 hours, 50
minutes for learning about the law or the form; and 6 hours, 25 minutes
for preparing, copying, assembling, and sending the form to the IRS.
The IRS's Research, Applied Analytics, and Statistics division
estimates that the appropriate wage rate for this set of taxpayers is
$73.48 (2022 dollars) per hour. Thus, it is estimated that a respondent
will incur costs of approximately $1,581.05 per filing. Disclosures
received to date by the Treasury Department and the IRS in response to
the reporting requirements of Notice 2016-66 indicate that this small
amount will not pose any significant economic impact for those
taxpayers now required to disclose under the final regulations. The
Treasury Department and the IRS have concluded that the cost of filing
the disclosure statements required by these regulations will not pose
any significant economic impact.
Some commenters expressed concern that the cost of filing
disclosure statements is too onerous for taxpayers. Specifically,
commenters stated that they incurred significant costs in responding to
Notice 2016-66 and will again face those costs if new disclosures are
required. In response to comments on Notice 2016-66 and the proposed
regulations, the final regulations narrow the scope of transactions
described in Sec. Sec. 1.6011-10(h) and 1.6011-11(h). New disclosures
are needed to identify participants in these transactions, but the
final regulations provide in Sec. 1.6011-11(h)(2) that taxpayers who
have filed a disclosure statement regarding their participation in a
transaction that is the same as, or substantially similar to, the
transaction described in Sec. 1.6011-11(a) with the OTSA pursuant to
Notice 2016-66, will be treated as having made the disclosure pursuant
to the final regulations for the taxable years for which the taxpayer
filed returns before January 14, 2025.
One commenter asserted that the reporting obligations would be
particularly onerous for arrangements using a pooled reinsurance
structure with numerous participants and likened the cost of filling
out a Form 8886 to effectively imposing a tax on the entire community
of captive insurers electing the alternative tax under section 831(b).
Taxpayer compliance burden is not equivalent to a tax, and the
Instructions to Forms 8886 and 8918 make clear that the time needed to
complete and file such forms will vary depending on individual
circumstances.
Two commenters indicated that the $77.50 (2020 dollars) wage rate
per hour used to approximate the total cost of preparing and filing a
Form 8886, as referenced in the proposed regulations, is too low. One
of these commenters implied that the applicable average wage rate per
hour is closer to $268.50. Given the availability of more recent data,
the hourly rate estimate is revised in the final regulations to $73.48
(2022 dollars). This updated figure does not address the substantial
difference from the commenter's estimate. The difference is likely
attributable to the different methodologies used. The commenter likely
used the hourly rate that an independent professional would charge a
retail customer to prepare a Form 8886.
These commenters also expressed disagreement with the estimated
average amounts of time required to complete Forms 8886 and 8918, as
indicated in the instructions to each of those forms. One commenter
described the estimate

[[Page 3559]]

of 21.5 hours to comply as ``significantly underestimated.'' However,
the commenter did not elaborate on the amount of time actually required
for the commenter. Additionally, the Instructions to Forms 8886 and
8918 make clear that the time needed to complete and file such forms
will vary depending on individual circumstances. One of the commenters
stated that based on a survey of 2,397 respondents, the average amount
of time spent by each respondent ``for compliance'' under Notice 2016-
66 (using it as a proxy for these final regulations) was 50.97 hours,
which the commenter noted is above the estimated average amounts of
time for completion indicated in the instructions to each of those
forms. However, based on the information provided by this commenter
regarding the same survey, the total number of hours spent on
``compliance'' by all respondents was 121,755 hours, and the total
number of Forms 8886 and 8918 completed by respondents for this
``compliance'' was 15,021. Consequently, the average amount of time
spent per form by these respondents appears to be approximately 8.11
hours (that is, approximately 8 hours, 6 minutes). This amount falls
below the estimated average time of 21 hours, 31 minutes for Form 8886
(as revised Oct. 2022) and 14 hours, 31 minutes for Form 8918 (as
revised Nov. 2021) as provided in the instructions to those forms,
respectively.
For the reasons stated, a regulatory flexibility analysis under the
RFA is not required. Pursuant to section 7805(f)(1), the notice of
proposed rulemaking preceding the final regulations was submitted to
the Chief Counsel for the Office of Advocacy of the Small Business
Administration for comment on its impact on small business, and no
comments were received.

IV. Unfunded Mandates Reform Act

Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA)
requires that agencies assess anticipated costs and benefits and take
certain other actions before issuing a final rule that includes any
Federal mandate that may result in expenditures in any one year by a
State, local, or Tribal government, in the aggregate, or by the private
sector, of $100 million in 1995 dollars, updated annually for
inflation. This final rule does not include any Federal mandate that
may result in expenditures by State, local, or Tribal governments, or
by the private sector in excess of that threshold.

V. Executive Order 13132: Federalism

Executive Order 13132 (Federalism) prohibits an agency from
publishing any rule that has federalism implications if the rule either
imposes substantial, direct compliance costs on State and local
governments, and is not required by statute, or preempts State law,
unless the agency meets the consultation and funding requirements of
section 6 of the Executive order. This final rule does not have
federalism implications and does not impose substantial direct
compliance costs on State and local governments or preempt State law
within the meaning of the Executive order. See also part I.B. of the
Summary of Comments and Explanation of Revisions.

VI. Congressional Review Act

Pursuant to the Congressional Review Act (5 U.S.C. 801 et seq.),
the Office of Information and Regulatory Affairs has designated this
rule as not a ``major rule,'' as defined by 5 U.S.C. 804(2).

Drafting Information

The principal author of these regulations is Allan H. Sakaue,
Office of Associate Chief Counsel (Financial Institutions and
Products), IRS. However, other personnel from the Treasury Department
and the IRS participated in their development.

Availability of IRS Documents

The notices cited in this preamble are published in the Internal
Revenue Bulletin and are available from the Superintendent of
Documents, U.S. Government Publishing Office, Washington, DC 20402, or
by visiting the IRS website at https://www.irs.gov.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

Accordingly, the Treasury Department and the IRS amend 26 CFR part
1 as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding
entries for Sec. Sec. 1.6011-10 and 1.6011-11 in numerical order to
read in part as follows:

Authority: 26 U.S.C. 7805 * * *
* * * * *
Section 1.6011-10 also issued under 26 U.S.C. 6001 and 6011.
Section 1.6011-11 also issued under 26 U.S.C. 6001 and 6011.
* * * * *

0
Par. 2. Section 1.6011-10 is added to read as follows:

Sec. 1.6011-10 Micro-captive listed transaction.

(a) Identification as listed transaction. Transactions that are the
same as, or Substantially Similar to, transactions described in
paragraph (c) of this section are identified as listed transactions for
purposes of Sec. 1.6011-4(b)(2), except as provided in paragraph (d)
of this section.
(b) Definitions. The definitions in this paragraph (b) apply for
purposes of this section:
(1) Captive. The term Captive means any entity that is described in
each of the paragraphs (b)(1)(i), (ii), and (iii) of this section.
(i) The entity elects under section 831(b) of the Internal Revenue
Code (Code) to include in taxable income only taxable investment income
(defined in section 834 of the Code) in lieu of the tax imposed under
section 831(a).
(ii) The entity issues a Contract to an Insured, reinsures a
Contract of an Insured issued by an Intermediary, or both.
(iii) At least 20 percent of the entity's assets or the voting
power or value of its outstanding stock or equity interests is directly
or indirectly owned, individually or collectively, by an Insured, an
Owner, or persons Related to an Insured or an Owner. For purposes of
this paragraph (b)(1)(iii), the rules of paragraph (b)(1)(iii)(A) or
(B) of this section apply to the extent application of a rule (or
rules) would increase such direct or indirect ownership.
(A) A person that holds a derivative is treated as indirectly
owning the assets referenced by the derivative.
(B) The interest of each beneficiary of a trust or estate in the
assets of such trust or estate must be determined by assuming the
maximum exercise of discretion by the fiduciary in favor of such
beneficiary and the maximum use of the trust's or estate's interest in
the company to satisfy the interests of such beneficiary.
(2) Computation periods--(i) Financing Computation Period. The term
Financing Computation Period means the most recent five taxable years
(including the most recent concluded taxable year) of a Captive (or all
taxable years of a Captive if the Captive has been in existence for
less than five taxable years).
(ii) Listed Transaction Loss Ratio Computation Period. The term
Listed Transaction Loss Ratio Computation Period is the most recent ten
taxable years (including the most recent concluded taxable year) of
Captive. A Captive that does not have at least ten taxable years cannot
have a Listed

[[Page 3560]]

Transaction Loss Ratio Computation Period, and therefore is not
described in paragraph (c)(2) of this section.
(iii) Taxable years. For purposes of paragraphs (b)(2)(i) and (ii)
of this section:
(A) Each short taxable year is a separate taxable year.
(B) If the Captive is a successor to one or more other Captives,
taxable years of each such other Captive are treated as taxable years
of the Captive.
(iv) Successors. The term successor means any entity described in
paragraph (b)(2)(iv)(A), (B), or (C) of this section.
(A) A successor corporation as defined in Sec. 1.382-2(a)(5).
(B) An entity that, directly or indirectly, acquires (or is deemed
to acquire) the assets of another entity and succeeds to and takes into
account the other entity's earnings and profits or deficit in earnings
and profits.
(C) An entity that receives (or is deemed to receive) any assets
from another entity if such entity's basis in such assets is
determined, directly or indirectly, in whole or in part, by reference
to the other entity's basis in such assets.
(3) Contract. The term Contract means any contract that is treated
by a party to the contract as an insurance contract or reinsurance
contract for Federal income tax purposes.
(4) Insured. The term Insured means any person that conducts a
trade or business, enters into a Contract with a Captive or enters into
a Contract with an Intermediary that is directly or indirectly
reinsured by a Captive, and treats amounts paid under the Contract as
insurance premiums for Federal income tax purposes.
(5) Intermediary. The term Intermediary means any entity that
issues a Contract to an Insured or reinsures a Contract that is issued
to an Insured, and such Contract is reinsured, directly or indirectly,
by a Captive. A transaction may have more than one Intermediary.
(6) Owner. The term Owner means any person who, directly or
indirectly, holds an ownership interest in an Insured or its assets.
For purposes of this paragraph (b)(6), the rules of paragraph (b)(6)(i)
or (ii) of this section apply to the extent application of a rule (or
rules) would increase such direct or indirect ownership.
(i) The interest of a person that holds a derivative must be
determined as provided in paragraph (b)(1)(iii)(A) of this section.
(ii) The interest of each beneficiary of a trust or estate in the
assets of such trust or estate must be determined as provided in
paragraph (b)(1)(iii)(B) of this section.
(7) Recipient. The term Recipient means any Owner, Insured, or
person Related to an Owner or an Insured engaged in a transaction
described in paragraph (c)(1) of this section.
(8) Related. The term Related means having a relationship described
in one or more of sections 267(b), 707(b), 2701(b)(2)(C), and
2704(c)(2) of the Code.
(9) Seller. The term Seller means a service provider, dealer
(including an automobile dealer), lender, wholesaler, or retailer that
sells products or services to customers who purchase insurance
contracts in connection with those products or services and at least 95
percent of sales of products or services by Seller for the taxable year
to persons who purchase such insurance contracts are sales to Unrelated
Customers.
(10) Seller's Captive. The term Seller's Captive means a Captive
Related to Seller, an owner of Seller, or individuals or entities
Related to Seller or owners of Seller.
(11) Substantially Similar. The term Substantially Similar is
defined in Sec. 1.6011-4(c)(4).
(12) Unrelated Customers. The term Unrelated Customers means
persons who do not own an interest in, and are not wholly or partially
owned by, Seller, an owner of Seller, or individuals or entities
Related to Seller or owners of Seller.
(c) Transaction description. A transaction is described in this
paragraph (c) if the transaction is described in both paragraphs (c)(1)
and (2) of this section.
(1) The transaction involves a Captive that, at any time during the
Captive's Financing Computation Period, directly or indirectly, engages
in a transaction described in paragraph (c)(1)(i) of this section,
taking into account paragraph (c)(1)(ii) of this section.
(i) The Captive made available as financing or otherwise conveyed
or agreed to make available or convey to a Recipient, in a transaction
that did not result in taxable income or gain to the Recipient, in
whole or in part, any portion of the amounts received under a Contract,
such as through a guarantee, a loan, or other transfer of Captive's
capital, or made such financings or conveyances prior to the Financing
Computation Period that remain outstanding or in effect at any point in
the taxable year for which disclosure is required.
(ii) Any amounts that a Captive made available as financing or
otherwise conveyed or agreed to make available or convey to a Recipient
are presumed to be portions of the amounts received under a Contract to
the extent that such amounts, when made available or conveyed, are in
excess of Captive's cumulative after-tax net investment earnings minus
any outstanding financings or conveyances.
(2) The transaction involves a Captive for which the amount
described in paragraph (c)(2)(i) of this section is less than 30
percent of the amount described in paragraph (c)(2)(ii) of this
section.
(i) The amount of liabilities incurred for insured losses and claim
administration expenses during the Listed Transaction Loss Ratio
Computation Period.
(ii) The amount equal to premiums earned by the Captive during the
Listed Transaction Loss Ratio Computation Period, less policyholder
dividends paid by the Captive during the Listed Transaction Loss Ratio
Computation Period.
(d) Exceptions. A transaction described in paragraph (c) of this
section is not identified as a listed transaction for purposes of this
section and Sec. 1.6011-4(b)(2) if the transaction:
(1) Provides insurance for employee compensation or benefits and is
one for which the Employee Benefits Security Administration of the U.S.
Department of Labor has issued a Prohibited Transaction Exemption under
the procedures provided at 29 CFR 2570.30 through 2570.52; or
(2) Is an arrangement in which a Captive meets all of the
requirements described in this paragraph (d)(2).
(i) The Captive is a Seller's Captive.
(ii) The Seller's Captive issues or reinsures some or all of the
Contracts purchased by Unrelated Customers in connection with the
products or services being sold by the Seller.
(iii) 100 percent of the business of the Seller's Captive is
issuing or reinsuring Contracts in connection with products or services
being sold by the Seller or persons Related to the Seller.
(iv) At least 95 percent of the Seller's Captive's business for the
taxable year is issuing or reinsuring Contracts purchased by Unrelated
Customers in connection with products or services sold by Seller or
persons Related to Seller.
(e) Bright-line rules. A transaction is not considered
Substantially Similar (as defined in paragraph (b)(11) of this section)
to the listed transaction identified in this section if the
transaction:
(1) Does not involve an entity that has elected under section
831(b) to include in taxable income only taxable investment income
(defined in section

[[Page 3561]]

834) in lieu of the tax imposed under section 831(a); or
(2) Involves a Captive for which the amount described in paragraph
(c)(2)(i) of this section is 30 percent or more of the amount described
in paragraph (c)(2)(ii) of this section.
(f) Special participation rules--(1) In general. Whether a taxpayer
has participated in the listed transaction identified in paragraph (a)
of this section, including Substantially Similar transactions, will be
determined under Sec. 1.6011-4(c)(3)(i)(A). Participants include, but
are not limited to, any Owner, Insured, Captive, or Intermediary with
respect to the transaction whose tax return reflects tax consequences
or a tax strategy identified in paragraph (a), except as otherwise
provided in paragraphs (f)(2) and (3) of this section.
(2) Disclosure safe harbor for Owners. An Owner who, solely by
reason of the Owner's direct or indirect ownership interest in an
Insured, has participated in the listed transaction described in this
section will not be required to disclose participation in the
transaction under section 6011(a) of the Code, notwithstanding Sec.
1.6011-4(c)(3), if the Owner receives acknowledgement, in writing or
electronically, from the Insured that the Insured has or will comply
with the Insured's separate disclosure obligation under Sec. 1.6011-4
with respect to the transaction and the Insured discloses the
transaction in a timely manner. The acknowledgment can be a copy of the
Form 8886, Reportable Transaction Disclosure Statement (or successor
form), filed (or to be filed) by the Insured and must be received by
the Owner prior to the time set forth in Sec. 1.6011-4(e) in which the
Owner would otherwise be required to provide disclosure. Owners who
meet the requirements of the safe harbor in this paragraph (f)(2) will
not be treated as having participated in an undisclosed listed
transaction for purposes of Sec. 1.6664-2(c)(3)(ii) or as having
failed to include information on any return or statement with respect
to a listed transaction for purposes of section 6501(c)(10) of the
Code.
(3) Disclosure safe harbor for taxpayers in transactions with
revoked section 831(b) elections. If the Captive has revoked its
section 831(b) election, taxpayers who participated in the listed
transaction with respect to that Captive, including any Insureds,
Owners, and Intermediaries, will not be considered participants in the
transaction under section 6011(a), notwithstanding Sec. 1.6011-
4(c)(3), for any taxable year in which the section 831(b) revocation is
effective, provided that a successor Captive has not been established
as described in paragraph (b)(2)(iv) of this section. In addition, if
the Captive has revoked its section 831(b) election, taxpayers who meet
the requirements of this safe harbor, for any taxable year in which the
section 831(b) revocation is effective, will not be treated as having
participated in an undisclosed listed transaction for purposes of Sec.
1.6664-2(c)(3)(ii) or as having failed to include information on any
return or statement with respect to a listed transaction for purposes
of section 6501(c)(10).
(g) Disclosure requirements--(1) Information required of all
participants. Participants must provide the information required under
Sec. 1.6011-4(d) and the Instructions to Form 8886 (or successor
form). For all participants, describing the transaction in sufficient
detail includes, but is not limited to, describing on Form 8886 (or
successor form) when, how, and from whom the participant became aware
of the transaction, and how the participant participated in the
transaction (for example, as an Insured, a Captive, or other
participant). Paragraphs (g)(2) and (3) of this section describe
additional information required of a Captive and an Insured,
respectively.
(2) Additional information required of a Captive. For a Captive,
describing the transaction in sufficient detail includes, but is not
limited to, describing on Form 8886 (or successor form) the items
described in each of the paragraphs (g)(2)(i) through (v) of this
section.
(i) All the type(s) of policies issued or reinsured by the Captive
during the year of participation or each year of participation (if
disclosure pertains to multiple years).
(ii) The amounts treated by the Captive as premiums written for
coverage provided by Captive during the year of participation or each
year of participation (if disclosure pertains to multiple years).
(iii) The name and contact information of each and every actuary or
underwriter who assisted in the determination of the amounts treated as
premiums for coverage provided by the Captive during the year or each
year of participation (if disclosure pertains to multiple years).
(iv) The total amounts of claims paid by the Captive during the
year of participation or each year of participation (if disclosure
pertains to multiple years).
(v) The name and percentage of interest directly or indirectly held
by each person whose interest in the Captive meets the 20 percent
threshold or is taken into account in meeting the 20 percent threshold
under paragraph (b)(1)(iii) of this section.
(3) Additional information required of Insured. For Insured,
describing the transaction in sufficient detail includes, but is not
limited to, describing on Form 8886 (or successor form) the amounts
treated by Insured as premiums paid for coverage provided to Insured,
directly or indirectly, by the Captive or by each Captive (if
disclosure pertains to multiple Captives) during the year or each year
of participation (if disclosure pertains to multiple years), as well as
the identity of all persons identified as Owners to whom the Insured
provided an acknowledgment described in paragraph (f)(2) of this
section.
(h) Applicability date--(1) In general. This section identifies
transactions that are the same as, or Substantially Similar to, the
transactions identified in paragraph (a) of this section as listed
transactions for purposes of Sec. 1.6011-4(b)(2), effective January
14, 2025, except as otherwise provided in this paragraph (h)(1). If, on
or before the date prescribed for filing disclosure statements with the
Office of Tax Shelter Analysis under Sec. 1.6011-4(e), the Captive
involved in the transaction has requested the consent of the Secretary
to revoke its section 831(b) election, the transaction is not
identified as a listed transaction for purposes of this section and
Sec. 1.6011-4(b)(2) for taxable years ending before January 1, 2026.
(2) Obligations of participants with respect to prior periods.
Pursuant to Sec. 1.6011-4(d) and (e), taxpayers who have filed a tax
return (including an amended return) reflecting their participation in
transactions described in paragraph (a) of this section prior to
January 14, 2025, must disclose the transactions as required by Sec.
1.6011-4(d) and (e) provided that the period of limitations for
assessment of tax (as determined under section 6501, including section
6501(c)) for any taxable year in which the taxpayer participated has
not ended on or before January 14, 2025, except as otherwise provided
in this paragraph (h)(2). Taxpayers who have finalized a settlement
agreement with the Internal Revenue Service with respect to the
transaction, in examination or litigation, will be treated as having
made the disclosure for years subject to that agreement.
(3) Obligations of material advisors with respect to prior periods.
Material advisors defined in Sec. 301.6111-3(b) of this chapter who
have previously made a tax statement with respect to a transaction
described in paragraph (a) of this section have disclosure and list

[[Page 3562]]

maintenance obligations as described in Sec. Sec. 301.6111-3 and
301.6112-1 of this chapter, respectively. Notwithstanding Sec.
301.6111-3(b)(4)(i) and (iii) of this chapter, material advisors are
required to disclose only if they have made a tax statement on or after
the date that is six years before January 14, 2025. Material advisors
that are uncertain whether the transaction they are required to
disclose should be reported under this section or Sec. 1.6011-11
should disclose under this section and will not be required to disclose
a second time if it is later determined that the transaction should
have been disclosed under Sec. 1.6011-11.

0
Par. 3. Section 1.6011-11 is added to read as follows:

Sec. 1.6011-11 Micro-captive transaction of interest.

(a) Identification as transaction of interest. Transactions that
are the same as, or Substantially Similar to, transactions described in
paragraph (c) of this section are identified as transactions of
interest for purposes of Sec. 1.6011-4(b)(6), except as provided in
paragraph (d) of this section.
(b) Definitions. The definitions in this paragraph (b) apply for
purposes of this section.
(1) Captive. Captive has the same meaning as provided in Sec.
1.6011-10(b)(1).
(2) Computation periods--(i) Financing Computation Period.
Financing Computation Period has the same meaning as provided in Sec.
1.6011-10(b)(2)(i).
(ii) Transaction of Interest Loss Ratio Computation Period. The
term Transaction of Interest Loss Ratio Computation Period means--
(A) The most recent ten taxable years of a Captive; or
(B) In the case of a Captive that has been in existence for less
than ten taxable years, all taxable year(s) of the Captive.
(iii) Rules for computation periods. The rules provided in Sec.
1.6011-10(b)(2)(iii) and (iv) for computation periods apply for
purposes of this paragraph (b)(2).
(3) Contract. Contract has the same meaning as provided in Sec.
1.6011-10(b)(3).
(4) Insured. Insured has the same meaning as provided in Sec.
1.6011-10(b)(4).
(5) Intermediary. Intermediary has the same meaning as provided in
Sec. 1.6011-10(b)(5).
(6) Owner. Owner has the same meaning as provided in Sec. 1.6011-
10(b)(6).
(7) Recipient. Recipient has the same meaning as provided in Sec.
1.6011-10(b)(7).
(8) Related. Related has the same meaning as provided in Sec.
1.6011-10(b)(8).
(9) Seller. Seller has the same meaning as provided in Sec.
1.6011-10(b)(9).
(10) Seller's Captive. Seller's Captive has the same meaning as
provided in Sec. 1.6011-10(b)(10).
(11) Substantially Similar. Substantially Similar has the same
meaning as provided in Sec. 1.6011-10(b)(11).
(12) Unrelated Customers. Unrelated Customers has the same meaning
as provided in Sec. 1.6011-10(b)(12).
(c) Transaction description. A transaction is described in this
paragraph (c) if the transaction is described in paragraph (c)(1) of
this section, paragraph (c)(2) of this section, or both.
(1) The transaction involves a Captive that, at any time during the
Captive's Financing Computation Period, directly or indirectly, engages
in a transaction described in paragraph (c)(1)(i) of this section,
taking into account paragraph (c)(1)(ii) of this section.
(i) The Captive made available as financing or otherwise conveyed
or agreed to make available or convey to a Recipient, in a transaction
that did not result in taxable income or gain to the Recipient, in
whole or in part, any portion of the amounts received under a Contract,
such as through a guarantee, a loan, or other transfer of Captive's
capital, or made such financings or conveyances prior to the Financing
Computation Period that remain outstanding or in effect at any point in
the taxable year for which disclosure is required.
(ii) Any amounts that a Captive made available as financing or
otherwise conveyed or agreed to make available or convey to a Recipient
are presumed to be portions of the amounts received under a Contract to
the extent such amounts, when made available or conveyed are in excess
of a Captive's cumulative after-tax net investment earnings minus any
outstanding financings or conveyances.
(2) The transaction involves a Captive for which the amount
described in paragraph (c)(2)(i) of this section is less than 60
percent of the amount described in paragraph (c)(2)(ii) of this
section.
(i) The amount of liabilities incurred for insured losses and claim
administration expenses during the Transaction of Interest Loss Ratio
Computation Period.
(ii) The amount equal to premiums earned by the Captive during the
Transaction of Interest Loss Ratio Computation Period, less
policyholder dividends paid by the Captive during the Transaction of
Interest Loss Ratio Computation Period.
(d) Exceptions. A transaction described in paragraph (c) of this
section is not identified as a transaction of interest for purposes of
this section and Sec. 1.6011-4(b)(6) if the transaction:
(1) Is described in Sec. 1.6011-10(d)(1);
(2) Is described in Sec. 1.6011-10(d)(2); or
(3) Is identified as a listed transaction in Sec. 1.6011-10(a), in
which case the transaction must be reported as a listed transaction
under Sec. 1.6011-10.
(e) Bright-line rules. A transaction is not considered
Substantially Similar (as defined in paragraph (b)(11) of this section)
to the transaction of interest identified in this section if the
transaction:
(1) Does not involve an entity that has elected under section
831(b) of the Internal Revenue Code (Code) to include in taxable income
only taxable investment income (defined in section 834 of the Code) in
lieu of the tax imposed under section 831(a); or
(2) Involves a Captive for which the amount described in paragraph
(c)(2)(i) of this section is 60 percent or more of the amount described
in paragraph (c)(2)(ii) of this section.
(f) Special participation rules--(1) In general. Whether a taxpayer
has participated in the transaction of interest identified in paragraph
(a) of this section, including Substantially Similar transactions, will
be determined under Sec. 1.6011-4(c)(3)(i)(E). Participants include,
but are not limited to, any Owner, Insured, Captive, or Intermediary
with respect to the transaction whose tax return reflects tax
consequences or a tax strategy identified in paragraph (a), except as
otherwise provided in paragraphs (f)(2) and (3) of this section.
(2) Disclosure safe harbor for Owners. An Owner who, solely by
reason of the Owner's direct or indirect ownership interest in an
Insured, has participated in the transaction of interest described in
this section will not be required to disclose participation in the
transaction under section 6011(a), notwithstanding Sec. 1.6011-
4(c)(3), if the Owner receives acknowledgment, in writing or
electronically, from the Insured that the Insured has or will comply
with Insured's separate disclosure obligation under Sec. 1.6011-4 with
respect to the transaction and the Insured discloses the transaction in
a timely manner. The acknowledgment can be a copy of the Form 8886,
Reportable Transaction Disclosure Statement (or successor

[[Page 3563]]

form), filed (or to be filed) by the Insured and must be received by
the Owner prior to the time set forth in Sec. 1.6011-4(e) in which the
Owner would otherwise be required to provide disclosure.
(3) Disclosure safe harbor for taxpayers in transactions with
revoked section 831(b) elections. If the Captive has revoked its
section 831(b) election, taxpayers who participated in the transaction
of interest with respect to that Captive, including any Insureds,
Owners, and Intermediaries, will not be considered participants in the
transaction under section 6011(a), notwithstanding Sec. 1.6011-
4(c)(3), for any taxable year in which the section 831(b) revocation is
effective, provided that a successor Captive has not been established
as described in paragraph (b)(2)(iii) of this section (referencing
Sec. 1.6011-10(b)(2)(iii) and (iv)).
(g) Disclosure requirements. Participants must provide the
information required under Sec. 1.6011-4(d) and the Instructions to
Form 8886 (or successor form). For all participants, describing the
transaction in sufficient detail includes, but is not limited to,
describing on Form 8886 (or successor form) when, how, and from whom
the participant became aware of the transaction, and how the
participant participated in the transaction (for example, as an
Insured, a Captive, or other participant). A Captive and an Insured
must also provide the information required in Sec. 1.6011-10(g)(2) and
(3), respectively.
(h) Applicability date--(1) In general. This section identifies
transactions that are the same as, or Substantially Similar to, the
transaction identified in paragraph (a) of this section as transactions
of interest for purposes of Sec. 1.6011-4(b)(6) effective January 14,
2025, except as otherwise provided in this paragraph (h)(1). If, on or
before the date prescribed for filing disclosure statements with the
Office of Tax Shelter Analysis under Sec. 1.6011-4(e), the Captive
involved in the transaction has requested the consent of the Secretary
to revoke its section 831(b) election, the transaction is not
identified as a transaction of interest for purposes of this section
and Sec. 1.6011-4(b)(6) for participants with respect to that Captive
for taxable years ending before January 1, 2026.
(2) Obligations of participants with respect to prior periods.
Pursuant to Sec. 1.6011-4(d) and (e), taxpayers who have filed a tax
return (including an amended return) reflecting their participation in
transactions described in paragraph (a) of this section prior to
January 14, 2025, must disclose the transactions as required by Sec.
1.6011-4(d) and (e) provided that the period of limitations for
assessment of tax (as determined under section 6501 of the Code,
including section 6501(c)) for any taxable year in which the taxpayer
participated has not ended on or before January 14, 2025, except as
otherwise provided in this paragraph (h)(2). Taxpayers who have
finalized a settlement agreement with the Internal Revenue Service with
respect to the transaction, in examination or litigation, will be
treated as having made the disclosure for years subject to that
agreement. Taxpayers who have filed a disclosure statement regarding
their participation in the transaction with the Office of Tax Shelter
Analysis pursuant to Notice 2016-66, 2016-47 I.R.B. 745, will be
treated as having made the disclosure pursuant to the final regulations
for the taxable years for which the taxpayer filed returns before
January 14, 2025. If a taxpayer described in the preceding sentence
participates in the Micro-captive Transaction of Interest in a taxable
year for which the taxpayer files a return on or after January 14,
2025, the taxpayer must file a disclosure statement with the Office of
Tax Shelter Analysis at the same time the taxpayer files their return
for the first such taxable year.
(3) Obligations of material advisors with respect to prior periods.
Material advisors defined in Sec. 301.6111-3(b) of this chapter who
have previously made a tax statement with respect to a transaction
described in paragraph (a) of this section have disclosure and list
maintenance obligations as described in Sec. Sec. 301.6111-3 and
301.6112-1 of this chapter, respectively. Notwithstanding Sec.
301.6111-3(b)(4)(i) and (iii) of this chapter, material advisors are
required to disclose only if they have made a tax statement on or after
the date that is six years before January 14, 2025. Material advisors
that are uncertain whether the transaction they are required to
disclose should be reported under this section or Sec. 1.6011-10
should disclose under Sec. 1.6011-10 and will not be required to
disclose a second time if it is later determined that the transaction
should have been disclosed under this section.

Douglas W. O'Donnell,
Deputy Commissioner.
Approved: January 3, 2025.
Aviva R. Aron-Dine,
Deputy Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2025-00393 Filed 1-10-25; 4:15 pm]
BILLING CODE 4830-01-P

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