“Captive insurance” can be a legitimate risk-management tool. But IRS has placed micro-captives under a spotlight: in 2025, the Treasury finalized rules that formally classify specific micro-captive arrangements as “listed transactions” and others as “transactions of interest,” triggering mandatory participant disclosure on Form 8886 (and advisor disclosure on Form 8918) and steep non-disclosure penalties under §6707A. These final regulations (T.D. 10029) apply to transactions in effect on or after January 14, 2025. At the same time, IRS enforcement remains active—LB&I and IRS Criminal Investigation (CI) continue to investigate abusive micro-captive promoters and participants (with CI referring cases for criminal tax prosecution), and the IRS continues to warn taxpayers about these arrangements as part of its broader enforcement posture. At the Tax Law Offices of David W. Klasing, our dual-licensed Tax Attorneys and CPAs have tracked this crackdown for years—covering IRS campaign letters to thousands of participants, prior settlement initiatives, and continuing enforcement warnings—even as “Dirty Dozen” mentions have come and gone, the trend line has only steepened.
Courts are keeping pace. In Kadau v. Commissioner, T.C. Memo. 2025-81 (July 31, 2025), the Tax Court disallowed micro-captive premium deductions. It sustained accuracy-related penalties after finding no real risk distribution, non-arm’s-length pricing, thin capitalization, and a near circular flow of funds between related parties. The court criticized “actuarial” work that wasn’t grounded in company-specific data and policy terms that didn’t resemble commercial coverage. Importantly, although the IRS sought an increased deficiency premised on Subpart F for 2017, the court did not sustain that increase on the record presented, instead treating the transfers as nontaxable capital contributions. In CFM Insurance v. Commissioner, T.C. Memo. 2025-83, the court reached similar conclusions in a related captive context, again emphasizing substance over form. The message is consistent: where risk distribution is artificial, pricing is contrived, and cash circulates among associated parties, the “insurance” label will not carry the day.
Why Micro-Captives are Now “High-risk” by Default
Under Treasury’s 2025 final rules (T.D. 10029, effective January 14, 2025), certain micro-captives are treated as listed transactions and others as transactions of interest, which triggers strict disclosure and penalty regimes:
Who must disclose
- Participants file Form 8886;
- Material advisors may need to file Form 8918.
§6707A penalties for non-disclosure
- Calculated as 75% of the decrease in tax attributable to the transaction;
- Listed transactions: minimum $5,000 (individual) / $10,000 (entity); maximum $100,000 (individual) / $200,000 (entity);
- Other reportable/TOI transactions: maximum $10,000 (individual) / $50,000 (entity);
- These apply in addition to accuracy-related or civil-fraud penalties.
Statute of limitations—§6501(c)(10)
- If a required Form 8886 isn’t filed, the assessment period stays open until at least one year after proper disclosure (or after a material advisor furnishes a §6112 list);
- This extends the existing limitations period rather than creating a new one.
Short-term relief window (now closed)
- Notice 2025-24 allowed late micro-captive disclosures through July 31, 2025, for participants (Form 8886) and material advisors (Form 8918) to avoid §6707A/§6707 penalties.
Bottom line: if your arrangement falls within the 2025 definitions, get compliant disclosures on file now to stop §6501(c)(10) from keeping the year open and to minimize penalty exposure.
Red Flags the IRS and Tax Court Repeatedly Find Fatal
- No genuine risk distribution—too few independent insureds or “pools” that do not operate like bona fide reinsurance (losses never truly migrate to the excess layer).
- Non-arm’s-length premium setting—amounts far above commercial comparables, copied forward without new analysis, or reverse-engineered to hit a deduction target.
- Circular cash and thin capitalization—“premiums” boomerang through related entities; investments or loans bear no resemblance to a commercial insurer’s profile.
- Paperwork that doesn’t look or behave like insurance—policy terms, claims processes, and duty to defend that diverge from market practice, with perfunctory insider “adjusting.”
Disclosure, Exit, and Remediation—What to Do Right Now
At the Tax Law Offices of David W. Klasing, our dual-licensed Tax Attorneys & CPAs take control from the first call and keep every step under privilege. First, we run a privileged diagnosis. We wall off the file under attorney–client and work-product protections and bring accountants in under a Kovel agreement so sensitive fact-gathering remains confidential. We then pressure-test your structure against the 2025 listed/TOI definitions, the latest Form 8886 instructions, and the defects courts found fatal in Kadau/CFM—risk distribution, arm’s-length pricing, capitalization, cash circularity, and claims handling. The deliverable is a written, privilege-protected risk map that identifies disclosure duties, penalty exposure, statute posture, and criminal-risk indicators.
Next, we properly and in sequence fix your filings. Where disclosure is required, we prepare complete Form 8886 packages that stop §6501(c)(10) from keeping the year open, and—if you are or were a material advisor—we evaluate and, where appropriate, file Form 8918. In the same plan, we decide whether to amend or not amend particular returns, model §6707A and accuracy-related/civil-fraud penalties, and align our approach with existing settlement patterns the IRS has used in prior micro-captive campaigns, so you are negotiating from precedent, not hope.
If willfulness is a realistic concern, we steer you onto the safest on-ramp: the IRS-CI Voluntary Disclosure Practice. We handle pre-clearance (Form 14457, Part I) with IRS-CI, move to the complete submission (Form 14457, Part II) once cleared, and manage the civil phase to contain tax, interest, and penalties—often limiting civil fraud to a single year where facts allow. In complex files, we may recommend a “noisy disclosure”—a privilege-protected approach that engages CI before any amendments are filed—so your intent is crystal clear and piecemeal filings are not misconstrued.
Finally, we calendar the penalties and clocks—then use them. We compute the precise §6707A exposure, accuracy-related add-ons, and the §6501(c)(10) extension mechanics so your statute strategy is intentional, not accidental. Because listed/TOI transactions can keep assessment open until at least one year after proper disclosure, sequencing matters: we time disclosures, amendments, settlement overtures, and (if needed) VDP milestones to minimize open-year inventory and close exposure fast—federally and at the California state level.
How the Tax Law Offices of David W. Klasing Can Help
What differentiates our practice at the Tax Law Offices of David W. Klasing is execution depth and end-game design. Our dual-licensed Tax Attorneys and CPAs don’t just file forms—we engineer outcomes: reconstructing actuarial and claims files where salvageable, documenting commercial comparables to constrain “non-arm’s-length” premium arguments, and crafting reasonable-cause narratives that target penalty relief beyond §6707A. Where the IRS is already moving (IDRs, summonses, or assertions under §6501(c)(10)), we bring the Code, regs, and IRM to the table to negotiate from strength, including targeted closing agreements that unwind defective deductions without triggering unnecessary collateral adjustments. If the facts demand VDP, we manage the civil resolution to contain tax, interest, and penalties—often limiting any civil-fraud application to a single year where the record allows. Because micro-captive problems rarely stop at federal borders, we coordinate FTB/CDTFA (and other states) to prevent “me-too” assessments, and, where promoters touched the file, we navigate material-advisor rules to mitigate §6707 advisor penalties. Bottom line: one integrated, privilege-protected plan—from triage to finality—executed by professionals fluent in both litigation and the workpapers the IRS lives by.
If you’ve participated in a micro-captive or have received a disclosure or IDR letter, talk to the Tax Law Offices of David W. Klasing before you speak to IRS (LB&I or CI) or any state tax authority (FTB/CDTFA). Call 800-681-1295 or contact us online HERE to schedule a reduced-rate, privilege-protected initial consultation. We’ll deliver a precise risk map and a step-by-step plan to contain exposure and close the book—civilly and finally.
