Notice 2016-66 identifies transactions

in which the loss ratio factor is less than 70 percent based on a Notice Computation Period of Captive’s most recent five taxable years (or all years of Captive’s existence if it has been in existence for less than five taxable years) as transactions of interest. The proposed regulations, however, identify as listed transactions those transactions in which the loss ratio factor is less than 65 percent for a computation period extended to Captive’s most recent ten taxable years (referred to as the Loss Ratio Computation Period). See proposed §1.6011-10(c)(2). Further, the proposed regulations identify transactions in which the loss ratio factor is less than 65 percent based on a Transaction of Interest Computation Period consisting of Captive’s most recent nine taxable years (or all years of Captive’s existence if Captive has been in existence for less than nine taxable years) as transactions of interest. See proposed §1.6011-11(c).

Regarding the reduction of the loss ratio threshold from 70 percent to 65 percent, the Treasury Department and the IRS are not aware of any non-abusive transactions for which disclosure was required under Notice 2016-66 as a result of the 70-percent loss ratio factor set forth therein. Nevertheless, for purposes of the proposed regulations and to ensure that disclosure is not required for non-abusive transactions, the Treasury Department and the IRS are lowering the applicable loss ratio factor to 65 percent. See proposed §§1.6011-10(c)(2) and 1.6011-11(c). The loss ratio factor helps to identify transactions involving circumstances inconsistent with insurance in the commonly accepted

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sense, including excessive pricing of premiums and artificially low or nonexistent claims activity. The primary purpose of premium pricing is to ensure funds are available should a claim arise. The pricing of premiums should naturally reflect the economic reality of insurance operations. Pricing premiums far in excess of what is reasonably needed to fund insurance operations results in a lower loss ratio and is a strong indicator of abuse. Any Captives that would be required to disclose as a result of the loss ratio factor may consider paying policyholder dividends to increase the loss ratio and eliminate the need to disclose.

The Treasury Department and the IRS are considering whether a combined ratio may be a better indicator for distinguishing abusive transactions from other captive transactions. A combined ratio is “an indication of the profitability of an insurance company, calculated by adding the loss and expense ratios.” NAIC Glos- sary of Insurance Terms, https://content. naic.org/consumer_glossary#C (last visited April 3, 2023). The 2021 NAIC P&C Report provides that the combined ratios for property and casualty insurance companies ranged from 96 percent to 103.9 percent over the ten-year period from 2012 to 2021, for a ten-year average of approximately 99.5 percent. See U.S. Property & Casualty and Title Insurance Industries

– 2021 Full Year Results (2022), https:// content.naic.org/sites/default/files/inlinefiles/2021%20Annual%20Property%20 %26%20Casualty%20and%20Title%20 Insurance%20Industry%20Report.pdf (last visited April 3, 2023). The combined ratio would compare losses incurred, plus loss adjustment expenses incurred and other underwriting expenses incurred by Captive during the relevant computation period to Captive’s earned premiums, less policyholder dividends, for the relevant computation period. For this purpose, Captive’s other underwriting expenses incurred would equal Captive’s expenses incurred in carrying on an insurance business, other than loss adjustment expenses and investment-related expenses. Transactions in which Captive’s combined ratio is less than a certain percentage for a Loss Ratio Computation Period of the most recent ten taxable years of Captive would be identified as listed transactions. Trans

actions in which Captive’s combined ratio is less than a certain percentage for a Transaction of Interest Computation Period of the most recent nine taxable years (or all years of Captive’s existence if it has been in existence for less than nine taxable years) would be identified as transactions of interest. The Treasury Department and the IRS invite comments on whether a combined ratio would better distinguish abusive transactions than the proposed loss ratio factor, and if so, what combined ratio threshold would be most effective in distinguishing abusive transactions.

Regarding the computation periods for the loss ratio factor, the Treasury Department and the IRS understand that it is possible that a Captive with a loss history of fewer than ten taxable years could have a loss ratio that falls below 65 percent solely because Captive provides coverage for low frequency, high severity losses and Insureds purchasing policies from such Captive do not incur such losses in every year. In recognition of this fact, the proposed regulations categorize transactions as either transactions of interest or listed transactions based on the length of the computation period on which the loss ratio is based. The Notice Computation Period used by Notice 2016-66 to identify transactions of interest based on a loss ratio factor was five taxable years, and it has been more than five years since Notice 2016-66 was published. The Treasury Department and the IRS have determined that extending the computation period by five years to a Loss Ratio Computation Period of ten taxable years (doubling the Notice Computation Period) allows Captives significant time to develop a reasonable loss history that supports the use of Captive for legitimate insurance purposes, and a loss ratio that remains below 65 percent for a Loss Ratio Computation Period of ten taxable years indicates a tax avoidance transaction. Accordingly, the proposed regulations identify transactions in which the loss ratio is less than 65 percent based on an extended Loss Ratio Computation Period of Captive’s most recent ten taxable years as listed transactions. See proposed §1.6011-10(b)(2).

However, the Treasury Department and the IRS also have determined that related party transactions in which the

loss ratio is less than 65 percent over a shorter period of time have a potential for tax avoidance or evasion. The proposed regulations therefore identify transactions in which Captive has a loss ratio of less than 65 percent based on a Transaction of Interest Computation Period of Captive’s most recent nine taxable years (or all years of Captive’s existence if it has been in existence for less than nine taxable years) as transactions of interest, provided such transactions are not otherwise characterized as listed transactions (that is, due to the presence of the financing factor described in proposed §1.6011-10(c) (1) or due to having a loss ratio factor of less than 65 percent based on a Loss Ratio Computation Period of Captive’s most recent ten taxable years). See proposed §1.6011-11(c) and (d)(3). Identification of these transactions as transactions of interest will permit the Treasury Department and the IRS to gather more information to determine if these transactions are being used for tax avoidance or evasion.

4. Information Sought from Participants

The proposed regulations significantly reduce the information required to be reported by Captives under §1.6011-4(d) as compared to Notice 2016-66. See proposed §§1.6011-10(f) and 1.6011-11(f). Unlike Notice 2016-66, the proposed regulations do not require Captive participants to identify which factors of the proposed regulations apply, state under what authority Captive is chartered, describe how amounts treated as premiums for coverage provided by Captive were determined, provide the amounts of reserves reported by Captive on its annual statement, or describe the assets held by Captive. The proposed regulations do, however, require Captive to identify the types of policies issued or reinsured, the amounts treated as premiums written, the name and contact information of actuaries and underwriters involved, and the total amount of claims paid by Captive. Additionally, proposed §§1.6011-10(b)(1) and 1.6011-11(b)(1) include a 20-percent relationship test in the definition of Captive, and the proposed regulations require Captive participants to identify the name and percentage of interest held directly or indirectly by each person whose interest

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in Captive meets the 20 percent threshold or is taken into account in meeting the 20 percent threshold under proposed §1.6011-10(b)(1)(iii). Also, the proposed regulations require each Insured (as defined in proposed §§1.6011-10(b)(4) and 1.6011-11(b)(4)) subject to the disclosure requirements set forth in §1.6011-4(d) to provide the amounts treated by Insured as insurance premiums for coverage provided to Insured, directly or indirectly, by Captive.

5. Disclosure Requirement Safe Harbor for Owners

The Treasury Department and the IRS believe that it is now feasible to generally limit the persons from whom reporting would be required under the proposed regulations to Captive, Insured, and material advisors to the transaction. Accordingly, the proposed regulations provide that any person who, solely by reason of their direct or indirect ownership interest in Insured, is subject to the disclosure requirements set forth in §1.6011-4 as a participant in a Micro-captive Listed Transaction or a Micro-captive Transaction of Interest, is not required under §1.6011-4 to file a disclosure statement with respect to that transaction provided that person receives written or electronic acknowledgment that Insured has or will comply with its separate disclosure obligation under §1.6011-4(a) with respect to the transaction. See proposed §§1.6011-10(e)(2) and 1.6011-11(e)(2). The acknowledgment can be a copy of the Form 8886, Reportable Transaction Disclosure Statement (or successor form), filed (or to be filed) by Insured and must be received by Owner prior to the time set forth in §1.60114(e) in which Owner would otherwise be required to provide disclosure. See proposed §§1.6011-10(e)(2) and 1.6011-11(e) (2). However, the receipt of an acknowledgment that Insured has or will comply with its disclosure obligation does not relieve the Owners of Insured of their disclosure obligations if Insured fails to disclose the transaction in a timely manner.

6. Exception for Consumer Coverage Arrangements

The proposed regulations provide a limited exception from classification as

a Micro-captive Listed Transaction or Micro-captive Transaction of Interest for certain Consumer Coverage reinsurance arrangements. See proposed §§1.601110(d)(2) and 1.6011-11(d)(2). In Consumer Coverage arrangements, a “Seller” (that is, a service provider, automobile dealer, lender, or retailer) sells products or services to “Unrelated Customers” (that is, customers who do not own an interest in and are not wholly or partially owned by Seller, an owner of Seller, or individuals or entities related (within the meaning of one or more of sections 267(b), 707(b), 2701(b)(2)(C), or 2704(c)(2)) to Seller or owners of Seller). An Unrelated Customer may also purchase an insurance contract in connection with those products or services (Consumer Coverage contract). The Consumer Coverage contract generally provides coverage for repair or replacement costs if the product breaks down or is lost, stolen, or damaged; coverage for the customer’s payment obligations if the customer dies or becomes disabled or unemployed; coverage for the difference between all or a portion of the value of the product and the amount owed on the product’s financing, including a lease, if the product suffers a covered peril; or a combination of one or more of the foregoing types of coverage.

An entity related to or affiliated with Seller may issue or reinsure the Consumer Coverage contracts. In some arrangements, the Consumer Coverage contracts name an unrelated third party, which may be referred to as a “Fronting Company,” as the provider of the coverage, and an entity related to or affiliated with Seller reinsures the Consumer Coverage contracts. In other arrangements, the Consumer Coverage contracts may name an entity related to or affiliated with Seller as the provider of the coverage. In these arrangements, an unrelated third party may reinsure the contracts and may also then retrocede risk under the contracts to the entity related to or affiliated with Seller. The parties may treat the entity related to or affiliated with Seller as an insurance company that elects under section 831(b) (and section 953(d) if the corporation is foreign) to exclude premium payments from taxable income.

As a general matter, participation in this type of reinsurance arrangement is neither a Micro-captive Listed Transac

tion nor a Micro-captive Transaction of Interest because the insured is not sufficiently related to the insurer or any reinsurer. Generally, the Consumer Coverage contracts insure Unrelated Customers of Seller, and Unrelated Customers, their owners, and persons related to Unrelated Customers or their owners do not directly or indirectly own at least 20 percent of the voting power or value of the outstanding stock of any entity issuing or reinsuring the Consumer Coverage contract. However, the 20-percent relationship factor in proposed §§1.6011-10(b)(1) and 1.601111(b)(1) may be met in some of these reinsurance arrangements. For instance, in “dealer obligor” arrangements in which the Seller would be legally required to pay a claim under certain conditions, such as a total loss of the covered product within a certain time frame, the Seller could potentially be considered an Insured under a Contract issued or reinsured by a Captive, and thus be required to disclose.

The Treasury Department and the IRS have determined that a limited exception for taxpayers in Consumer Coverage arrangements is appropriate, provided commissions paid for Consumer Coverage contracts issued or reinsured by the Seller’s Captive are comparable to the commissions paid for Consumer Coverage contracts covering Seller’s products or services that are not issued or reinsured by the Seller’s Captive. See proposed §§1.6011-10(d)(2) and 1.6011-11(d)(2).

C. Effect of Transaction Becoming a Listed Transaction or a Transaction of Interest Under these Regulations

Participants required to disclose these transactions under §1.6011-4 who fail to do so are subject to penalties under section 6707A. Participants required to disclose the listed transactions under §1.6011-4 who fail to do so are also subject to an extended period of limitations under section 6501(c)(10). Material advisors required to disclose these transactions under section 6111 who fail to do so are subject to the penalty under section 6707. Material advisors required to maintain lists of investors under section 6112 who fail to do so (or who fail to provide such lists when requested by the IRS) are subject to the penalty under section 6708(a). In addi

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described in proposed §1.6011-10(c) as listed transactions effective as of the date of publication in the Federal Register of a Treasury decision adopting these regulations as final regulations. Similarly, proposed §1.6011-11(a) would identify certain micro-captive transactions described in proposed §1.6011-11(c) as transactions of interest as of the date of publication in the Federal Register of a Treasury decision adopting these regulations as final regulations.

Effect on Other Documents

This document obsoletes Notice 201666 (2016-47 I.R.B. 745), as modified by Notice 2017-08 (2017-3 I.R.B. 423), as of April 11, 2023.

Special Analyses

I. Regulatory Planning and Review

The proposed regulations are not subject to review under section 6(b) of Executive Order 12866 pursuant to the Memorandum of Agreement (April 11, 2018) between the Treasury Department and the Office of Management and Budget (OMB) regarding the review of tax regulations.

II. Paperwork Reduction Act

The collection of information contained in these proposed regulations is reflected in the collection of information for Forms 8886 and 8918 that have been reviewed and approved by OMB in accordance with the Paperwork Reduction Act (44 U.S.C. 3507(c)) under control numbers 1545-1800 and 1545-0865. Any disclosures with respect to the safe harbor for owners as provided in §§1.6011-10(e)(2) and 1.6011-11(e)(2) are in the nature of an acknowledgment per 5 CFR 1320.3(h)(1), and therefore do not constitute a collection of information under the Paperwork Reduction Act.

To the extent there is a change in burden as a result of these regulations, the change in burden will be reflected in the updated burden estimates for the Forms 8886 and 8918. The requirement to maintain records to substantiate information on Forms 8886 and 8918 is already

tion, the IRS may impose other penalties on persons involved in these transactions or substantially similar transactions, including accuracy-related penalties under section 6662 or section 6662A, the section 6694 penalty for understatements of a taxpayer’s liability by a tax return preparer, the section 6700 penalty for promoting abusive tax shelters, and the section 6701 penalty for aiding and abetting understatement of a tax liability.

Taxpayers who have filed a tax return (including an amended return (or Administrative Adjustment Request (AAR) for certain partnerships)) reflecting their participation in these transactions prior to the date the Treasury decision adopting these regulations as final regulations is published in the Federal Register and who have not otherwise finalized a settlement agreement with the Internal Revenue Service with respect to the transaction must disclose the transactions as provided in §1.6011-4(d) and (e) provided that the period of limitations for assessment of tax, including any applicable extensions, for any taxable year in which the taxpayer participated in the transaction has not ended on or before the date the Treasury decision adopting these regulations as final regulations is published in the Fed- eral Register .

In addition, material advisors have disclosure requirements with regard to transactions occurring in prior years. However, notwithstanding §301.61113(b)(4)(i) and (iii), material advisors are required to disclose only if they have made a tax statement on or after six years before the date of the Treasury decision adopting these regulations as final regulations is published in the Federal Register .

A participant in a transaction that is a Micro-captive Listed Transaction must file a disclosure statement with OTSA when required to do so under §1.60114(e), regardless of whether the participant has previously disclosed the transaction to OTSA pursuant to Notice 2016-66. A participant in a transaction that is a Micro-captive Transaction of Interest that has previously filed a disclosure statement with OTSA pursuant to Notice 2016-66 will be treated as having made the disclosure pursuant to the final regulations for taxable years for which the taxpayer filed returns before the final regulations

are published in the Federal Register. However, if a taxpayer described in the preceding sentence participates in the Micro-captive Transaction of Interest in a taxable year for which the taxpayer files a return on or after the date the final regulations are published in the Federal Register, the taxpayer must file a disclosure statement with OTSA at the same time the taxpayer files their return for the first such taxable year.

A material advisor with respect to a transaction that is a Micro-captive Listed Transaction or Micro-captive Transaction of Interest must file a disclosure statement with OTSA when required to do so under §301.6111-3(e), regardless of whether the material advisor has previously disclosed the transaction to OTSA pursuant to Notice 2016-66.

The Treasury Department and the IRS recognize that some taxpayers may have filed tax returns taking the position that they were entitled to the purported tax benefits of the types of transactions described in these proposed regulations. Because the IRS will take the position that taxpayers are not entitled to the purported tax benefits of the listed transactions described in the proposed regulations, and may take such a position with respect to the transactions of interest described in the proposed regulations, taxpayers should consider filing amended returns or AARs for certain partnerships and ensure that their transactions are disclosed properly. Taxpayers filing an amended individual return should write “Microcaptive” at the top of the first page of the amended return and mail the amended return to:

Internal Revenue Service 2970 Market Street Philadelphia, PA 19104 Taxpayers filing amended business returns on paper should write “Microcaptive” at the top of the first page of the amended return and mail to the address listed in the instructions for the amended return. Taxpayers filing amended business returns electronically should include “Microcaptive” when explaining the reason for the changes.

Proposed Applicability Dates

Proposed §1.6011-10(a) would identify certain micro-captive transactions

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contained in the burden associated with the control numbers for the forms and is unchanged.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number assigned by OMB.

III. Regulatory Flexibility Act

The Secretary of the Treasury hereby certifies that the proposed regulations will not have a significant economic impact on a substantial number of small entities pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6).

As previously explained, the basis for these proposed regulations is Notice 2016-66, 2016-47 I.R.B. 745 (as modified by Notice 2017-08, 2017-3 I.R.B. 423). The following chart sets forth the gross receipts of respondents to Notice 2016-66, based on data for tax year 2020:

Notice 2016-66 Respondents by Size

This chart shows that the majority of respondents reported gross receipts under $5 million. Even assuming that these respondents constitute a substantial number of small entities, the proposed regulations will not have a significant economic impact on these entities because the proposed regulations implement sections 6111 and 6112 and §1.6011-4 by specifying the manner in which and time at which an identified Micro-captive Listed Transaction or Micro-captive Transaction of Interest must be reported. Accordingly, because the regulations are limited in scope to time and manner of information reporting and definitional information, the economic impact of the proposal is expected to be minimal.

Further, the Treasury Department and the IRS expect that the reporting burden is low; the information sought is necessary for regular annual return preparation and ordinary recordkeeping. The estimated burden for any taxpayer required to file Form 8886 is approximately 10 hours, 16 minutes for recordkeeping, 4 hours, 50 minutes for learning about the law or the form, and 6 hours, 25 minutes for preparing, copying, assembling, and sending the form to the IRS. The IRS’s Research, Applied Analytics, and Statistics division estimates that the appropriate wage rate for this set of taxpayers is $77.50 (2020

dollars) per hour. Thus, it is estimated that a respondent will incur costs of approximately $1,667.27 per filing. Disclosures received to date by the Treasury Department and the IRS in response to the reporting requirements of Notice 2016-66 indicate that this small amount will not pose any significant economic impact for those taxpayers now required to disclose under the proposed regulations.

For the reasons stated, a regulatory flexibility analysis under the Regulatory Flexibility Act is not required. The Treasury Department and the IRS invite comments on the impact of the proposed regulations on small entities. Pursuant to section 7805(f) of the Code, this notice of proposed rulemaking has been submitted to the Chief Counsel for the Office of Advocacy of the Small Business Administration for comment on its impact on small business.

IV. Unfunded Mandates Reform Act

Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA) requires that agencies assess anticipated costs and benefits and take certain other actions before issuing a final rule that includes any Federal mandate that may result in expenditures in any one year by a State, local, or Tribal government, in the aggregate, or by

the private sector, of $100 million (updated annually for inflation). This proposed rule does not include any Federal mandate that may result in expenditures by State, local, or Tribal governments or by the private sector in excess of that threshold.

V. Executive Order 13132: Federalism

Executive Order 13132 (Federalism) prohibits an agency from publishing any rule that has federalism implications if the rule either imposes substantial, direct compliance costs on State and local governments, and is not required by statute, or preempts state law, unless the agency meets the consultation and funding requirements of section 6 of the Executive order. This proposed rule does not have federalism implications and does not impose substantial direct compliance costs on state and local governments or preempt state law within the meaning of the Executive order.

Comments and Public Hearing

Before these proposed amendments to the regulations are adopted as final regulations, consideration will be given to any comments that are submitted timely to the IRS as prescribed in the preamble under the ADDRESSES section. The Treasury

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Department and the IRS request comments on all aspects of the proposed regulations. The Treasury Department and the IRS specifically request comments on the following:

1. What are the specific and objective metrics, factors, or standards, if any, that, if reported, would allow for the IRS to better identify and distinguish abusive micro-captive transactions from other micro-captive transactions?

2. With respect to proposed §§1.601110(c)(2) and 1.6011-11(c), whether the loss ratio described therein, which compares “the amount of liabilities incurred by Captive for insured losses and claim administration expenses during the

[applicable] Computation Period” to the “premiums earned by Captive during the

[applicable] Computation Period less policyholder dividends paid by Captive during the [applicable] Computation Period”, should be replaced by a combined ratio, which compares “losses incurred, plus loss adjustment expenses incurred and other underwriting expenses incurred by Captive during the [applicable] Computation Period” to “Captive’s earned premiums, less policyholder dividends, for the [applicable] Computation Period”, and if so, what percentage would be an effective threshold for purposes of identifying abusive transactions. For this purpose, Captive’s “other underwriting expenses incurred” would equal Captive’s expenses incurred in carrying on an insurance business, other than loss adjustment expenses and investment-related expenses.

3. With respect to the percentage of premiums retained as commissions for contracts as described at proposed §§1.6011-10(d)(2) and 1.6011-11(d)(2), what, if any, are the specific metrics, factors, or standards that, if reported, would allow for the IRS to better identify and distinguish abusive micro-captive transactions of this type from other such micro-captive transactions?

Any comments submitted will be made available at https://www.regulations.gov or upon request.

A public hearing is scheduled to be held by teleconference on July 19, 2023, beginning at 10:00 a.m. ET unless no outlines are received by June 12, 2023.

The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish to comment by telephone at the hearing must

submit written or electronic comments and an outline of the topics to be discussed as well as the time to be devoted to each topic by June 12, 2023, as prescribed in the preamble under the ADDRESSES section.

A period of ten minutes will be allocated to each person for making comments. After the deadline for receiving outlines has passed, the IRS will prepare an agenda containing the schedule of speakers. Copies of the agenda will be made available at https://www.regulations.gov, search IRS and REG-109309-22. Copies of the agenda will also be available by emailing a request to publichearings@irs.gov . Please put “REG-109309-22 Agenda Request” in the subject line of the email.