Texas Court Partially Strikes IRS Micro-Captive Rule

A federal court in Texas has issued a split ruling on the Internal Revenue Service's (IRS's) final micro-captive reporting regulations, upholding part of the rule while striking down another.

In Drake Plastics Ltd. Co. v. IRS, No. H-25-2570, 2026 U.S. Dist. LEXIS 82472 (S.D. Tex. Apr. 15, 2026), the US District Court for the Southern District of Texas ruled that the IRS can require disclosure of certain micro-captive arrangements as "transactions of interest," but went too far in labeling similar arrangements as "listed transactions."

The ruling contrasts with a recent decision from a Tennessee federal court that upheld the regulations in full, adding a new layer of uncertainty around the IRS's oversight of Section 831(b) captives.

The dispute centers on regulations finalized in January 2025 that require taxpayers and advisers to disclose certain micro-captive transactions the IRS believes may present tax-avoidance risk. The rules created two categories: "transactions of interest," which carry disclosure requirements, and "listed transactions," which are subject to stricter reporting and potential penalties.

The Texas court found that the IRS had enough support to justify the "transactions of interest" designation, pointing to tax court decisions and other evidence showing that some micro-captive arrangements may not function as insurance in the commonly accepted sense.

But the court reached a different conclusion on "listed transactions." It found the IRS had not adequately supported treating those arrangements as presumptively abusive and set aside that portion of the rule.

The ruling leaves the "transactions of interest" framework in place, meaning disclosure requirements still apply to many micro-captive arrangements. However, removing the "listed transaction" designation is significant because that classification carries heightened reporting obligations and steeper potential penalties. The decision may therefore affect how aggressively the IRS can enforce the rules against certain captive structures.

The court declined to issue a separate injunction, finding that striking down part of the rule was sufficient. It also delayed the effect of its decision until May 1, 2026, to avoid confusion for taxpayers during the current filing season. The ruling could be subject to further review on appeal.