An April federal court case in Texas delivered a clear message regarding IRS overreach in the micro-captive insurance industry, setting the stage for small businesses to dramatically alter the way they manage risk.
In their ruling of Drake Plastics Ltd. v. IRS, the courts provided a split decision on IRS rules related to the utilization of Section 831(b) of the Tax Code; upholding transparency while rejecting government overreach.
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In this case, the courts upheld the IRS’s ability to label micro-captive insurance arrangements as “transactions of interest,” but struck down the IRS classification of micro-captive insurance arrangements as “listed transactions” without the presence of extensive evidence corroborating the heightened scrutiny necessarily associated with a listed transaction.
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Essentially, this ruling reinforces what many in the captive insurance industry have been claiming for years — that the IRS has unlawfully tried to treat an entire category of small business operators as inherently abusive without the evidence necessary to substantiate those claims. In ruling in this manner, the courts found that the IRS lacked the necessary evidence to prove these arrangements are “presumably tax avoidant.”
After years of advocacy and education on the topic of IRS overreach, this is a major win for leaders in the micro-captive insurance space and a positive step for clarifying rules, policies, and regulations associated with Section 831(b). The ruling comes at a critical time as many small businesses have been grappling with the ongoing insurance crisis. It has become apparent to small business owners that traditional insurers have been unable to keep up with the rapidly increasing risk in the American business markets, leading to increased policy premiums, decreased coverage, and complete loss of insurance plan access due to carriers abandoning entire markets.
With limited alternatives over the past several years, small businesses have relied on micro-captive plans to help provide necessary risk management and self-insure their businesses’ risks. Section 831(b) has truly become the safety net for their operations, protecting them from the supply chain disruptions, business closures, political decisions, and rippling economic shocks that innumerable small business owners have felt over the past several years. Despite the relief these plans provide to small businesses, the IRS has continued to condemn and vilify micro-captive insurance plans while lacking credible evidence.
That is why the ruling in Drake Plastics Ltd. v. IRS is critical to the future of our economy.
However, we still have a long way to go until these plans are truly accessible and supported by the U.S. government. The language outlining Section 831(b) and the recent January 2025 831(b) regulations still lack the clarity needed to both properly implement micro-captives and successfully identify true bad actors in the space. This court ruling has set the stage, but the next step ultimately falls to Congress.
In 1986, Congress made its intention clear with respect to micro-captive insurance by passing The Tax Reform Act of 1986, allowing American businesses a needed and logical solution to respond to the liability crisis of the 80s. However, over the years, heightened requirements by the IRS and increased scrutiny — without the needed IRS guidance and clarity — limited small businesses’ ability to utilize this critical risk tool, going directly against the intent of Congress.
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Once again, it is up to Congress to intervene and reinvigorate Section 831(b) as the tool many of us already know it to be — a lifeline for small businesses amid volatile insurance markets and myriad emerging global economic risks. We will continue our advocacy on this topic, but we need congressional help if we want to enable the resiliency of the American small business.
The industry is not asking for less oversight; it is seeking smarter, clearer, and more intentional oversight. This ruling is the first step in achieving that.
Dustin Carlson is President of the 831(b) Institute.
