Federal Court Upholds IRS Micro-Captive Transactions of Interest Rule

A federal district court in Texas has upheld the Internal Revenue Service (IRS) 2025 regulations requiring disclosure of certain micro-captive insurance arrangements as transactions of interest (TOIs), while declining to revisit a separate listed transaction rule that had already been vacated by another federal court. The decision came in Ryan, LLC v. IRS, in which Ryan LLC challenged the IRS's final regulations governing disclosure requirements for certain micro-captive insurance transactions. According to the court, the government's motion for summary judgment was granted in part, while Ryan's motion was denied.

The dispute centered on Treasury regulations issued in January 2025 that replaced IRS Notice 2016–66, which had previously required disclosure of certain micro-captive arrangements. The earlier notice was set aside in 2022 after a federal court concluded that the IRS had failed to follow required notice-and-comment procedures and had not adequately supported its conclusions regarding the potential for tax avoidance. According to the opinion, the 2025 Final Rule was developed through the formal rulemaking process and introduced separate reporting standards for listed transactions and transactions of interest.

The court explained that captive insurance companies are specialized insurers owned by the businesses they insure and can provide coverage for risks that may be difficult or expensive to obtain in the commercial insurance market. The opinion also discussed Section 831(b) of the Internal Revenue Code, which allows qualifying small non-life insurance companies, including certain captives, to elect favorable tax treatment. According to the court, while these provisions can serve legitimate insurance purposes, they have also created opportunities for abusive tax avoidance in some circumstances.

The Final Rule establishes two separate disclosure regimes. Under the listed transaction rule, certain closely held micro-captives meeting specified loss ratio and related-party financing criteria must be reported as listed transactions. The transactions of interest rule separately requires disclosure for certain closely held micro-captives that either fall below a specified loss-ratio threshold or engage in certain related-party financing arrangements. According to the opinion, Treasury modified several aspects of the proposal before issuing the final regulations, including lowering the loss-ratio thresholds and revising the criteria applicable to listed transactions and transactions of interest.

Before addressing Ryan's remaining claims, the court noted that the Southern District of Texas had already vacated the listed transaction regulation in Drake Plastics Ltd. v. IRS. As a result, the Northern District of Texas held that the parties' requests regarding the listed transaction provision were moot. The court therefore limited its review to the transactions of interest regulation contained in Treasury Regulation Section 1.6011–11. According to the opinion, that provision remained subject to judicial review because it had not been invalidated in the Drake Plastics decision.

Ryan argued that Treasury's determination that certain micro-captive transactions have the potential for tax avoidance lacked sufficient factual support and that the criteria used to identify reportable transactions were arbitrary and capricious. The company also challenged the specific use of loss ratios, related-party financing, and the rule's focus on closely held micro-captives as indicators of potential tax avoidance. According to the opinion, Ryan maintained that these factors could capture legitimate captive insurance arrangements rather than abusive transactions.

The court rejected those arguments, concluding that Treasury had developed a substantially stronger administrative record than existed when IRS Notice 2016–66 was invalidated. According to the opinion, Treasury relied on multiple United States Tax Court decisions involving abusive micro-captive arrangements, taxpayer examination findings, current litigation, industry data, and information gathered during the notice-and-comment process. Although the court expressed concern that some undisclosed taxpayer examination data could not be independently evaluated, it found that the publicly available evidence alone adequately supported Treasury's conclusion that at least some micro-captive arrangements present a potential for tax avoidance.

The court also concluded that Treasury reasonably selected the criteria used in the transactions of interest rule. According to the opinion, Treasury explained that unusually low loss ratios may indicate premiums that exceed amounts reasonably necessary to support insurance operations or reflect limited claims activity, while related-party financing may signal transactions warranting additional scrutiny. The court emphasized that the applicable statutory framework gives Treasury broad authority to identify categories of transactions that have the potential for tax avoidance, even if not every transaction meeting those criteria ultimately proves abusive.

Based on those findings, the court held that Treasury's transactions of interest regulation was not arbitrary or capricious under the Administrative Procedure Act. The decision leaves the transactions of interest reporting requirements in place, while the court treated challenges to the listed transaction provision as moot because that provision had already been vacated in Drake Plastics.