Form 8886: Looming Changes for Micro-Captive Reporting

When Notice 2016-66 was put into effect in 2016, the Internal Revenue Service established onerous reporting requirements for taxpayers involved in small captive insurance transactions. Lacking clarification for the automotive dealership industry, many dealers protectively filed Form 8886, Reportable Transaction Disclosure Statement, to ensure they met the compliance requirements.

After being challenged, the Notice was set aside by the Federal courts in 2022. The reason?

The issuance of the Notice failed to follow the notice and comment procedures of the Administrative Procedures Act (APA), since the Notice was a “legislative rule.”

In response, the IRS issued proposed regulations in April 2023. This notice of proposed rulemaking is the first step in developing legislative rules that follow the APA process. Second, public commentary was solicited until June 12, 2023. Further, a public hearing on any commentary was held on July 19, 2023. After considering the comments received, the Service will likely issue final regulations.

They must, however, conclude that the proposed solution will help accomplish the goals or solve the problems identified, in conjunction with a cost-benefit analysis. Given the high profile of the micro-captive issue, however, additional commenting periods, changes to the proposed rules, or publishing of supplemental proposed rules could be seen before final regulations are issued.

Fortunately, dealers in the United States had an advocate in the commenting process. On behalf of the National Auto Dealers Association (NADA), Crowe LLP submitted comments to the IRS in response to the proposed regulations. Key summaries of the recommendations to Treasury included:

• Clarification that dealerships are not an insured (and subject to the reporting requirements) when the ultimate beneficiaries of GAP and other products are unrelated customers.
• Adoption of a 25% threshold if dealers cannot be specifically excluded as an insured. Effectively, this amends the definition of a Captive to exclude entities where the total amount of GAP and similar contracts issued and reinsured does not exceed 25% of the total contracts issued or reinsured.
• Modified definition of seller to prevent occasional sale of an automobile and contract to a related party from causing the dealer to be subject to the reporting requirements. A 5% limit has been suggested for related party sales.
• Revision of the Captive definition, suggesting the fee earned in the sale of a contract must be 50% or more of the amount premium paid by the customer.
• Recommendation the final regulations be applied on a prospective basis.
• Allow a one-time revocation of the insurance company election where captives are only taxed on investment earnings—IRC §831(b)—without the need for a Private Letter Ruling.
• Expansion of definition of consumer contracts to include diminished value contracts.

As advisors to dealerships, we are carefully watching the development of these new rules and regulations related to micro-captives. As feedback becomes available from the recent public hearing, we will be certain to share it. Keep an eye out for more information.

In the meantime, please reach out to us if you have any questions.