What Are the Requirements of IRS Notice 2017-47?

The Internal Revenue Service (IRS) issued Notice 2016-66 to address specific arrangements involving micro-captive insurance companies. These structures, while sometimes legitimate, were identified by the agency as having the potential for tax avoidance. The notice designates certain micro-captive transactions as “Transactions of Interest,” a classification that triggers specific reporting obligations for taxpayers and their advisors. This designation does not automatically mean the transaction is improper, but it does require a higher level of transparency with the IRS.

Identifying Affected Transactions

A transaction is identified as a “Transaction of Interest” if it possesses characteristics suggesting it is not a conventional insurance arrangement. The primary test involves arrangements where the captive insurance company’s liabilities for losses and its administrative expenses amount to less than 65% of the net premiums earned during a computation period. A low ratio of losses and expenses to premiums can suggest the arrangement is used primarily to generate tax deductions rather than to provide genuine risk coverage.

Another factor involves how the captive’s capital is used. The notice targets situations where the captive has made its funds available to its owner or a related party through methods other than insurance claim payments. This can include loans, guarantees, or other transfers of capital from the captive. Such financing activities raise concerns that the premium payments are not for insurance but are instead circular movements of cash designed to create a tax benefit.

Required Disclosures and Reporting

Once a transaction is identified as a Transaction of Interest, both the participants and their advisors have mandatory reporting duties. A “participant” is typically the taxpayer, such as a business owner, who claims a tax deduction for premiums paid to the micro-captive. A “material advisor” is any individual or firm that provides assistance or advice regarding the structure of the transaction and receives a minimum level of compensation for those services.

Participants must file Form 8886, “Reportable Transaction Disclosure Statement.” This form requires detailed information about the transaction, including its designated name and identifying number as provided in the IRS notice. The completed Form 8886 must be attached to the taxpayer’s federal income tax return for every year of participation in the transaction.

In addition to filing with the tax return, a separate copy of Form 8886 must be sent directly to the IRS Office of Tax Shelter Analysis (OTSA). Material advisors have their own distinct reporting requirement and must file Form 8918, “Material Advisor Disclosure Statement.” This form provides the IRS with information about the advisor’s role and the transactions they have advised on.

Penalties for Non-Compliance

Failure to comply with the disclosure requirements outlined in the notice carries financial penalties. The penalties are applied separately to participants and material advisors and are outlined in the Internal Revenue Code (IRC).

For participants who fail to file Form 8886, IRC Section 6707A imposes a penalty calculated as 75% of the decrease in tax shown on the return as a result of the transaction. There are statutory minimum and maximum amounts for this penalty. This means even transactions with a small tax benefit can result in a large penalty if not properly disclosed.

Material advisors who fail to file Form 8918 or provide incomplete information are subject to penalties under IRC Section 6707. These penalties can be substantial and are intended to discourage advisors from promoting or facilitating undisclosed reportable transactions.