Court Strikes Down Micro-Captive Reporting Requirement

On March 21, the U.S. District Court for the Eastern District of Tennessee vacated Notice 2016-66 in its entirety, finding that the Internal Revenue Service failed to engage in required notice-and-comment procedures and that issuance of the Notice was arbitrary and capricious¹. The Court declined the Service’s request to leave the Notice in place pending promulgation of a new or amended rule due to the Service’s poor history of complying with the applicable procedures.

Notice 2016-66 was promulgated to address concerns by the Service that so-called “micro-captive transactions” had the potential for tax avoidance or evasion. The Notice classified such transactions as “transactions of interest” for purposes of Treas. Reg. § 1.6011-4 and Code §§ 6011 and 6012 and directs that (1) persons engaging in such transactions must disclose the transaction on Form 8886 and (2) material advisors who make a tax statement with respect to the transaction have disclosure obligations.

A “micro-captive transaction” subject to the notice is structured as follows:

1. Taxpayer owns an interest in an entity conducting a trade or business (the “Insured”);


2. Taxpayer, Insured, or a related person owns another entity (“Captive”) that enters into an insurance contract with the Insured or reinsures a risk that an intermediary has previously insured;


3. Captive elects under Code § 831(b) to be taxed only on taxable investment income;


4. Taxpayer, Insured, or a related person own at least twenty percent of the voting power or value of the outstanding stock of Captive; and


5. Either (A) the total of insured losses and administrative expenses during a computation period are less than seventy percent of the excess of premiums received by Captive over dividends returned to the policyholder, or (B) Captive has made insurance premiums available to Taxpayer, Insured, or a related party during a computation period in a transaction that did not result in taxable income.

Although the Court vacated the Notice in its entirety, the ruling only affects taxpayers within the jurisdiction of the Sixth Circuit, where the Eastern District of Tennessee sits (this comprises the states of Tennessee, Kentucky, Ohio, and Michigan). Taxpayers in this jurisdiction should consult their tax advisors to see how this particular decision may affect their tax reporting requirements. Taxpayers who are residents of other circuits should expect the Service to continue enforcing the requirements of the Notice.

It should be noted that the Service is likely to appeal this decision. Taxpayers under the reporting requirements of the Notice should be cautious and keep an eye out for new developments.

If your business is engaged in micro-captive transactions or other reportable transactions, please reach out to an HBK Tax Advisor.

¹ CIC Services, LLC v. I.R.S., Case No. 3:17-cv-110 (E.D. Tenn. Mar. 21, 2022).