The Internal Revenue Service (IRS) has published its regulations on micro-captive listed transactions and transactions of interest.
According to the IRS, in an abusive micro-captive insurance transaction, an insured entity that owns at least 20 per cent of the voting power or value of a captive deducts insurance premiums paid to the captive in an arrangement that does not constitute insurance for federal tax purposes.
Therefore, the captive insurance company excludes the premiums from taxable income under Code Sec. 831(b). Such arrangements often involve financing mechanisms that allow the captive to return tax-deferred amounts to the insured or related parties without triggering tax obligations.
Under the final rules, a micro-captive listed transaction must meet two tests: the ‘financing factor’ and the ‘loss ratio factor’.
The financing factor test examines whether the captive provides financing over the computation period, while the loss ratio factor test applies to captives with a loss ratio below 65 per cent.
Meanwhile, the definition of a micro-captive transaction of interest now focuses solely on transactions where the captive fails the loss ratio factor test over a 10-year computation period.
The final regulations lower the loss ratio factor percentage and extend the transaction of interest computation period from nine to ten years.
Effective from 14 January, 2025, the regulations apply to transactions that are the same as or substantially similar to those identified in the final rules.
Taxpayers and material advisers involved in such transactions are required to file disclosure statements under the finalised regulations. These regulations also cover captives who are seeking to revoke their 831(b) election, as well as taxpayers who have already disclosed transactions to the IRS.
