IRS Notice 2017-73: Micro-Captive Disclosure Rules
Understand the IRS criteria that designate a micro-captive as a Transaction of Interest and the resulting mandatory reporting duties for taxpayers and advisors.
The Internal Revenue Service (IRS) requires taxpayers and their advisors to disclose certain arrangements that it believes have the potential for tax avoidance. Following court decisions that invalidated prior guidance, the IRS and Treasury Department issued final regulations on January 14, 2025. These regulations are the primary authority defining which micro-captive insurance arrangements are reportable transactions.
The regulations establish two categories: “Listed Transactions” and “Transactions of Interest.” This classification does not automatically mean a transaction is illegal, but it imposes mandatory disclosure obligations to allow the IRS to scrutinize these structures.
Reportable Micro-Captive Arrangements
An arrangement is subject to disclosure if it involves a specific type of insurance company and meets financial tests defined in the 2025 final regulations. The arrangement begins with a business making payments to a captive insurance company for coverage. This captive insurer, at least 20% owned by the insured business’s owner, makes an election under Internal Revenue Code (IRC) Section 831(b) to be taxed only on its investment income. For 2025, this election is available to small insurance companies with annual net written premiums not exceeding $2,850,000.
The 2025 regulations created two distinct classifications based on a financing factor and a loss ratio test. A transaction is designated as a Listed Transaction if it meets two conditions. First, the captive insurance company makes its funds available to the insured business or its owners through non-taxable means, such as loans. Second, the captive’s paid losses and loss adjustment expenses are less than 65% of its earned premiums over a specific computation period.
If the arrangement does not meet the financing condition but its paid losses are still less than 65% of its earned premiums, it is classified as a Transaction of Interest. This loss ratio is a metric the IRS uses to question whether the entity is operating like a genuine insurance company, which is expected to pay out a reasonable portion of its premiums to cover claims.
Disclosure Requirements for Participants
Any taxpayer who has engaged in a Listed Transaction or a Transaction of Interest is a “participant” with a specific disclosure duty. This primarily includes the business entity that paid premiums to the micro-captive insurer for coverage. The obligation for these participants is to file Form 8886, Reportable Transaction Disclosure Statement.
Preparing Form 8886 requires describing the transaction in sufficient detail for the IRS to understand its structure and expected tax consequences. This includes identifying the captive insurer, the amount of premiums paid, and the nature of the insurance coverage provided. The form also requires the participant to state which tests the transaction met that define it as a reportable transaction.
Obligations for Material Advisors
Professionals who provide guidance on these arrangements also have reporting duties. An individual or firm is a “material advisor” if they provide material aid, assistance, or advice with respect to organizing, managing, promoting, selling, or implementing any reportable transaction. This often includes accountants, attorneys, and financial planners who receive a minimum amount of fees for their services.
A material advisor’s obligation is to file Form 8918, Material Advisor Disclosure Statement. This form requires the advisor to disclose information about the reportable transaction itself, including a description of the arrangement and its potential tax benefits. They are also required to maintain a list of all participants for whom they acted as a material advisor for that specific transaction.
Filing Procedures and Deadlines
The submission process for disclosing a reportable micro-captive transaction involves a dual-filing requirement. Participants must attach a completed Form 8886 to their federal income tax return for each year they participate. Both participants and material advisors must also send a separate copy of their respective forms to the IRS Office of Tax Shelter Analysis (OTSA).
The general deadline for these filings is tied to the due date of the relevant tax return, including extensions. The final regulations issued in January 2025 included a special retroactive requirement. Participants and material advisors were required to file disclosures for all prior, open tax years within 90 days of the regulations’ publication, with a limited penalty waiver available for filings by July 31, 2025.
Penalties for Non-Compliance
Failure to comply with the disclosure rules carries significant financial penalties, with enforcement based on the 2025 final regulations. For participants, the failure to properly disclose a reportable transaction on Form 8886 can result in a penalty under IRC Section 6707A. The penalty is 75% of the decrease in tax shown on the return as a result of the transaction.
For a Transaction of Interest, the penalty is capped at $10,000 for individuals and $50,000 for other entities. For a Listed Transaction, the maximum penalty is significantly higher, at $100,000 for individuals and $200,000 for other entities.
Material advisors face separate penalties under IRC Section 6707 for failing to file an accurate Form 8918 or for not maintaining the required investor list. The penalty for failure to furnish the disclosure form is generally $50,000, and if the failure was intentional, the penalty can be substantially higher.