`[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]



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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

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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`