Tax Court Rulings Offer No Help for Honest Microcaptive Insurers

While many Americans are focused on personal tax returns this time of year, it’s important to recognize a tax situation impacting owners of small US businesses.

Just two months into 2024, the IRS has secured a pair of victories against a form of self-insurance for small businesses known as microcaptive insurance. The cases—Keating v. Commissioner and Swift v. Commissioner—used fact patterns to support a preconceived notion that most or all microcaptives are tax shelters or tax schemes.

The US Tax Court found in favor of the IRS in both cases. Unfortunately, neither decision clarifies how honest microcaptive owners should structure their captive arrangements to remain compliant.

These victories obscure the reality of the situation. Under the 2015 Protecting Americans from Tax Hikes Act, companies are eligible for the insurance under Section 831(b) of the tax code when the owner of an insured business holds an interest in the insurer no greater than their interest in the business.

Section 831(b) was designed to empower small to mid-sized insurance companies by excluding part of their income from taxation, allowing them to better compete with larger insurance providers. While this arose from the insurance industry dynamics of the 1980s, lower insurance rates and increased competition are still necessary today.

IRS Commissioner Danny Werfel in January disclosed that nearly 1,100 microcaptives are under IRS investigation. The discrepancy between the number of microcaptives being audited and the number of IRS court victories is the result of an audit program instituted by the agency to ensnare a huge number of microcaptives and the businesses that own them.

The taxpayers caught up in this dragnet are then sifted through, with the agency seeking only cases where it is virtually certain to prevail. Instead of providing a conclusive determination for other taxpayers, the IRS keeps them in a state of legal limbo—placing an immense mental, emotional, and financial toll on small and mid-sized business owners around the country.

It is clear by now that the IRS dislikes microcaptives and is working to eliminate them through enforcement and regulation. This is in direct contradiction of repeated congressional support for the existence of microcaptive insurance. In other words, the IRS is undermining the laws passed by our nation’s elected representatives.

Several members of the House Ways and Means Committee wrote to Werfel in December with their concerns about how the IRS is treating microcaptives. They called for the agency to work with the industry to develop a mutually agreeable path forward.

The decision in Keating may have gone too far, with the judge alluding to the regulation of insurance companies, or how they ought to be regulated.

The McCarron-Ferguson Act of 1945 is clear—the federal government can define insurance for federal tax purposes but is explicitly barred from the regulation of insurance, as that is left to each individual state.

For a court to rule in favor of the IRS while appearing to support arguments about the agency’s regulation of insurance seems to cross the line drawn by McCarron-Ferguson.

While future cases likely will be brought over this issue, it’s hard to know whether they will materialize. Without action from Congress, or the IRS unexpectedly backing down, the overreach and abuse from the agency toward microcaptive owners appears likely to continue.

The cases are Keating v. Commissioner, T.C. Memo 2024-2, 1/4/24 and Swift v. Commissioner , T.C., No. 13705-16, 2/1/24.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Van Carlson is founder and CEO of SRA 831(b) Admin, with more than 25 years of experience in the risk management industry.

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