NCOIL Calls on IRS To Reconsider Proposed Micro-Captive Regulations

"Internal Revenue Service" lettering on white stone

July 05, 2023 |

"Internal Revenue Service" lettering on white stone

The National Conference of Insurance Legislators (NCOIL) has urged the US Internal Revenue Service (IRS) to retract a proposed micro-captive rule NCOIL says poses a significant threat to the US framework of state-based insurance regulation.

In a comment letter to the IRS, NCOIL said the proposed regulations violate the federal McCarran-Ferguson Act.

Proposed regulations put forward by the US Department of Treasury and the IRS clarify the meaning of " transaction of interest" and define how a micro-captive will be considered a "listed transaction."

The proposed regulations, IR2023-74, come after the IRS previously attempted to take a similar step several years ago through its Notice 2016-66. But recent court decisions in the Sixth Circuit and the US Tax Court found that the IRS lacks authority to identify listed transactions and transactions of interest by notices such as Notice 2016-66 and must instead follow notice and public comment procedures applying to regulations in order to identify such transactions.

A public hearing on the regulations is set for July 19.

"The proposed rule undermines the well-established and continually reaffirmed framework of the state-based system of insurance regulation," Arkansas Representative Deborah Ferguson, DDS, NCOIL president, said in a statement. "This system has created the strongest, safest, and most successful insurance market in the world, and it is imperative that state insurance legislators and regulators work together to prevent federal encroachment that has no basis in law."

NCOIL said that if promulgated, the new regulations would abrogate states' authority in a number of ways related to captive insurance.

"Many businesses across America have established captive insurance companies to mitigate against a wide range of extremely relevant risks," the NCOIL statement said. "A significant subset of these are on the smaller to medium size of the range and are able to make a small insurance company election, known as an 831(b) tax election."

The IRS's concerns over some companies' use of section 831(b) are "something that NCOIL takes no position on other than to condemn fraud in all instances," the statement said. But, in this case, in seeking to address its concerns, the IRS has gone too far, NCOIL said, "and seeks to insert itself into captive insurance companies' loss ratios, an insurance business aspect which constitutes the very heart and core of 'the business of insurance' which, pursuant to the McCarran-Ferguson Act, shall be 'regulated by the States.'"

So-called micro-captives are small captive insurance companies that elect to be taxed under section 831(b) of the Internal Revenue Code, which allows small insurance companies to be taxed only on their investment income. They have been the target of IRS scrutiny in recent years.

In an April statement announcing the proposed regulations, the IRS said that listed transactions are abusive tax transactions that must be reported to the IRS, while transactions of interest are tax transactions that have the potential for tax avoidance or evasion that must also be reported to the IRS.

While Notice 2016-66 established one metric for declaring a micro-captive as a listed transaction as having an average loss ratio of less than 70 percent the previous 5 years, the new proposed regulations lower that threshold to 65 percent.

"We at NCOIL urge the IRS to retract the proposed rule and return to the drawing board to address its stated concerns in a way that is narrow, tailored, non-retroactive, and most importantly does not violate the McCarran-Ferguson Doctrine by infringing on the Congressionally-delegated rights of the states to regulate the business of insurance," NCOIL CEO Tom Considine said in the statement.

July 05, 2023