Wednesday, July 24, 2024

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IRS obsoletes Notice 2016-66, proposes new “micro-captive” regulations

The United States Treasury and Internal Revenue Service (IRS) have obsoleted Notice 2016-66 and confirmed they will not enforce the disclosure requirements or penalties that are dependent upon the procedural validity of the Notice.

In March 2022, the District Court of Eastern Tennessee struck down the IRS’ controversial Notice 2016-66. The Court also held that the IRS acted arbitrarily and capriciously based on the administrative record.

The Service has now issued proposed regulations identifying certain micro-captive transactions as “listed transactions” and certain other micro-captive transactions as “transactions of interest”.

The full proposed rules have been published on the Federal Register here.

“The IRS previously identified certain micro-captive transactions as transactions of interest in Notice 2016-66,” the Service stated on 10 April.

“Recent court decisions in the Sixth Circuit and the U.S. Tax Court ruled that the IRS lacks authority to identify listed transactions and transactions of interest by notices, such as Notice 2016-66, and must instead identify such transactions by following the notice and public comment procedures that apply to regulations.

“Treasury and the IRS disagree with these decisions that the IRS lacks authority to identify listed transactions by notice and continue to defend listing notices in litigation except in the Sixth Circuit.

“Treasury and the IRS will, however, no longer take the position that transactions of interest can be identified without complying with notice and public comment procedures. Treasury and the IRS issued the proposed regulations to ensure that these decisions do not disrupt the IRS’ ongoing efforts to combat abusive tax shelters throughout the nation.”

Micro-captives, as labelled by the IRS, are captive insurance companies that take the 831(b) tax election and have long been under scrutiny from the Service.

To qualify for the election, annual premium must now be below $2.65m. By taking the election the insurer is only taxed on investment income and not underwriting profit.

The Treasury Department and IRS intend to finalise the regulations, after reviewing public comments, this year and issue proposed regulations “identifying additional listed transactions in the near future”.

“The obsoletion of the notice, however, has no effect on the merits of the tax benefits claimed from the transactions themselves and related litigation, or income tax examinations and promoter investigations relating to micro-captive transactions,” the IRS states in its notice of proposed rulemaking.