Adapting to “The New World” of Micro-Captive Insurance Regulations

For business owners utilizing or exploring a micro-captive insurance company, the landscape has shifted considerably. The IRS’s final regulations on micro-captives, issued earlier this year, provide new criteria for reportable transactions as they relate to micro-captives. These developments reinforce a key principle: micro-captives can remain a valuable part of a sound risk-management strategy, but they must be structured and operated with clear economic substance and legitimate insurance purpose.

Micro-captives—small insurance companies that elect under Section 831(b) to exclude up to $2.85 million for 2025 ($2.9 million for 2026) of annual premiums from taxable income—have long appealed to privately held businesses seeking to have greater control over risk management. When properly managed, they can help stabilize premiums, improve cash flow, and retain underwriting profits. Yet the same tax advantages that make them appealing have also drawn greater scrutiny, underscoring the need for strong documentation, credible underwriting, and professional oversight.

Clarifying What Qualifies

Under the final regulations, the IRS defines specific thresholds to distinguish legitimate captives from those requiring additional reporting. The IRS’s final regulations draw sharper distinctions between two categories of concern: listed transactions and transactions of interest. Both relate to how premiums, losses, and funds flow between the captive and its insureds.

An arrangement is considered a listed transaction when both of the following conditions are met:

• During the previous 5 years, the insured or owner receives cash or other funds from the captive that were derived from premiums and were never taxed as income or gain—commonly referred to as loanbacks or similar financial transfers. This could be in the form of a loan, guarantee or other transfer of capital.
• Over a 10-year computation period, insured losses and claim-administration expenses are less than 30% of the premiums received, after subtracting any policyholder dividends.

If both factors exist, the captive is treated as a listed transaction, triggering heightened scrutiny and mandatory reporting on Form 8886. Captives that have not yet existed for 10 years, but have these characteristics, would be considered transactions of interest.

By comparison, a transaction of interest involves either of the same two factors but at a less restrictive threshold. Specifically, the IRS defines these arrangements as those in which untaxed funds flow back to the insured or owner, or in which the loss ratio is under 60% for the most recent 10 tax years, or the entire life of the captive if younger than a decade. In both cases, successor and predecessor captives are treated as a single entity when determining these periods.

The regulations also note limited exceptions, such as specific consumer-coverage arrangements (for example, warranty-type insurance) that meet particular conditions. Importantly, the IRS reduced the proposed loss ratio threshold for listed transactions—from 65% to 30%—after receiving public comments, signaling a more targeted but still strict approach.

Recent Developments and Continuing Risks

Alongside these final rules, new administrative guidance and court actions continue to shape the captive insurance environment. Revenue Procedure 2025-13 simplified the process for certain captives to revoke their Section 831(b) election, offering businesses reassessing whether a micro-captive structure still fits their needs greater flexibility. At the same time, litigation filed in the Northern District of Texas challenges aspects of the new regulations under the Administrative Procedure Act, arguing that some of the thresholds are arbitrary and fail to reflect the realities of insurance operations.

While that case is ongoing, the IRS remains steadfast in its enforcement priorities. The agency continues to pursue arrangements that lack true insurance intent, economic substance, or adequate risk distribution. Structures that recycle untaxed funds, show persistently low loss ratios, or lack credible underwriting are likely to draw additional scrutiny.

Evaluating and Strengthening Your Captive

For businesses with existing micro-captives, the time to review and document compliance is now. Owners should evaluate whether their premiums are actuarially sound, whether their policies cover genuine risks, and whether claims history supports the economic reality of insurance. Reviewing the 10-year loss-ratio calculation is particularly critical, as falling below the 30% or 60% thresholds can expose the arrangement to additional reporting requirements or examination.

Equally important is tracing any flow of funds back to the insureds or owners. Dividends, loans, or guarantees that are not properly taxed as income or gain raise significant red flags. Captive governance—through consistent board minutes, underwriting documentation, and clear policy language—should reinforce that the arrangement operates as a true insurance company, not as a tax shelter.

The new revenue procedure also provides an orderly path for businesses that choose to revoke their Section 831(b) election, allowing them to unwind or restructure while maintaining compliance.

Next Steps for Business Owners

Captive insurance can serve as an effective component of a company’s long-term risk-management and financial strategy, provided it’s structured, documented, and operated with clear intent. Working with experienced advisors can help ensure your arrangement meets IRS expectations, demonstrates true economic substance, and remains aligned with your organization’s overall goals.

If you currently operate or are considering forming a micro-captive, now is the time to evaluate your structure in light of the final regulations. Contact your CRI advisor to discuss potential considerations, identify areas that may warrant further review, and coordinate with your legal or tax counsel to confirm compliance and strengthen your overall risk-management strategy.