Coalition Seeks Repeal of IRS Rule on Microcaptive Arrangements
A coalition representing captive insurance, banking, and related sectors is urging the repeal of an Internal Revenue Service (IRS) rule targeting microcaptive arrangements. The rule, finalized in January 2025, classifies certain microcaptive transactions as ‘transactions of interest.’
The IRS rule imposes specific conditions for microcaptive transactions, including situations where the insured holds at least 20% of the captive’s voting power or value. Additionally, it applies when the captive’s loss ratio falls below 60% or when no taxable income was generated for fund recipients over the prior five years. Although the rule took effect in January, the IRS announced in April that it would not impose penalties on microcaptives failing to meet the disclosure requirement if they file by July 31.
The original deadline was in April but was extended due to difficulties filers faced during tax season. In a letter to the IRS and the US Department of the Treasury, organizations including the 831(b) Institute requested the rule’s repeal ahead of the new filing deadline. While the final rule incorporated some industry feedback, the coalition argues that it still undermines the purpose of Section 831(b) of the tax code.
Section 831(b), enacted nearly four decades ago, helps small and mid-sized businesses manage risk through captives, particularly when commercial insurance is limited or unaffordable. Proponents argue that the IRS’s current approach conflicts with the original legislative intent and imposes compliance obligations that many smaller firms are ill-equipped to manage. The provision allows certain small and medium-sized businesses to exclude premiums from federal income taxes if specific criteria are met.
The rule’s implementation could remove a key risk management option for small businesses, according to Dustin Carlson, president of the 831(b) Institute. “Commercial insurance is often insufficient, unavailable, or unaffordable to many small businesses; by further restraining access to alternative plans with wide-sweeping and ill-informed regulations, the IRS threatens the continued existence of our nation’s small businesses,” Carlson said.
The IRS began a nationwide audit initiative targeting microcaptives in 2008, citing concerns about tax avoidance. As of June 16, more than 1,100 small captive audit cases were pending, with only 10 having gone to trial. Of those cases, more than 27% resulted in settlements of 10% or less of the amounts initially assessed by the IRS.
Critics argue that the IRS rule paints all microcaptives with the same brush, regardless of whether they meet legitimate risk management criteria. The coalition maintains that the rule reflects a misunderstanding of captive insurance and its role in supporting small business resilience.
