IRS Issues Final Micro-Captive Regulations for 2025

What Are Micro-Captives?

Micro-captives are small insurance companies, often owned by the businesses they insure, that can offer certain tax advantages if structured and operated legitimately. However, some have been used primarily for tax avoidance, prompting IRS scrutiny.

Who Is Impacted?

The IRS regulations aim to identify and regulate abusive micro-captive insurance arrangements. While many F&I participation structures, particularly those focused on ensuring consumer product risks, are likely to be exempt under the Consumer Coverage Exception, it’s crucial for businesses to carefully review their arrangements to ensure compliance and avoid potential penalties.

Impact of the Final Regulations

The regulations categorize certain micro-captive transactions as either “listed transactions” or “transactions of interest,” both of which trigger specific reporting requirements.

1. Listed Transactions: A micro-captive transaction is a listed transaction if it meets both of the following criteria:

• Loss Ratio Factor: Loss ratio < 30% over the past 10 years.
• Financing Factor: Engages in certain related-party financing arrangements during the past five taxable years.

2. Transactions of Interest: A transaction is a transaction of interest if it meets either of the following:

• Loss Ratio Factor: Loss ratio < 60% over the past 10 years.
• Financing Factor: Engages in certain related-party financing arrangements during the past five taxable years.

3. Consumer Coverage Exception: This is a crucial provision, especially for the automotive industry. It exempts “Seller’s Captives” — those used by businesses like dealerships, service providers, or retailers to insure risks associated with products or services sold to unrelated customers — from being classified as listed transactions or transactions of interest. For example, a car dealership’s captive that insures extended warranties sold to car buyers would likely qualify for this exception. The regulations also provide a de minimis safe harbor, allowing up to 5% of a seller’s captive business to involve related parties without losing the exception. This addresses concerns about minor transactions with related entities.

The Details of Your Structures Are Important

F&I participation structures, often involving reinsurance entities to manage risks on products sold to consumers (e.g., vehicle service contracts, GAP insurance), are directly affected by these regulations.

Most F&I structures are expected to fall outside the scope of the regulations or qualify for the Consumer Coverage Exception. This means that if the captive is primarily ensuring risks related to products sold to unrelated customers, and it meets the other criteria of the exception, it won’t be subject to the stricter reporting requirements.

However, F&I structures that incorporate non-qualifying products or don’t meet the exception criteria could be subject to disclosure requirements. For example, if a captive is used to ensure risks unrelated to consumer products or if it engages in significant related-party financing outside the de minimis safe harbor, it might be classified as a listed transaction or a transaction of interest.

Brady Ware Can Help Your Dealership Navigate Regulatory Changes

The IRS’s new micro-captive regulations could impact your tax strategy. Review your structures now to ensure compliance and avoid penalties. Need expert guidance? Contact Brady Ware today to safeguard your business and navigate these changes with confidence.