In response to a two-year-old U.S. Supreme Court ruling, the IRS and the U.S. Treasury Department proposed regulations to identify micro-captive transactions as either "listed transactions" or "transactions of interest.”
“Listed transactions are abusive tax transactions that must be reported to the IRS,” the agency said in a statement. Such a transaction is defined by the IRS as “a transaction that is the same as, or substantially similar to, one that the IRS has determined to be a tax avoidance transaction and identified by IRS notice or other form of published guidance.”
The agency added that “parties who participate in listed transactions may be required to disclose the transaction as required by the regulations, register the transaction with the IRS, or maintain lists of investors in the transactions and provide the list to the IRS on request.”
Transactions of interest are “tax transactions that have the potential for tax avoidance or evasion that must also be reported to the IRS,” it stated.
Under the relevant section of the Tax Code, businesses are generally allowed to create "captive" insurance companies to protect against insurance risks. In abusive micro-captive structures, promoters, accountants or wealth planners persuade owners of closely held entities to participate in schemes that lack many of the attributes of genuine insurance, according to Accounting Today.
The IRS’s notice is in response to a 2021 U.S. Supreme Court case in which a company that specialized in helping small and midsized business owners to set up their own captive insurance companies to protect their assets sued the IRS over a notice that designated a micro-captive transaction as a “transaction of interest” that could potentially lead to tax avoidance or evasion. The notice put taxpayers and practitioners on notice that they needed to report such transactions or face potential penalties. The company ultimately prevailed in the high court in a unanimous decision.
More recent decisions, in the Sixth Circuit and in the U.S. Tax Court, ruled that the IRS lacked authority to identify listed transactions and transactions of interest by notices, and must instead identify such transactions by following the notice and public comment procedures that apply to regulations.
While the Treasury Department and the IRS disagreed with these decisions, they will no longer take the position that transactions of interest can be identified without complying with notice and public comment procedures. The proposed regulations aim to ensure that these decisions do not disrupt the agency’s ongoing efforts to combat abusive tax shelters throughout the nation, the IRS said.
The proposed regulations will be finalized after a public comment period that ends on June 12. The agency added that it intended to issue proposed regulations identifying additional listed transactions in the near future.