Court Invalidates IRS Loss-Ratio Rule for Micro-Captive Transactions

Federal Court Invalidates IRS Loss-Ratio Standard for Micro-Captive Reportable Transactions

November 18, 2025

A recent federal district court decision has delivered a significant blow to the IRS’s regulatory approach toward micro-captive insurance companies. In Ryan LLC v. Internal Revenue Service, the court held that the IRS’s use of the 30% and 60% loss-ratio thresholds—used to classify micro-captive arrangements as either listed transactions or transactions of interest—was arbitrary and capricious, violating the Administrative Procedure Act (APA).

This ruling could have far-reaching effects, calling into question the final micro-captive regulations (T.D. 10029) issued in January 2025 and their overall applicability and enforceability.

Background: The IRS’s 30% / 60% Loss-Ratio Framework

The final micro-captive regulations issued in January 2025 set forth the criteria for when a micro-captive transaction is considered a transaction of interest and when it is classified as a listed transaction. Both classifications are primarily based on the loss ratio, with additional requirements needed to meet listed transaction status:

• Transaction of Interest: The micro-captive has a loss ratio below 60%.

• Listed Transaction: The micro-captive has a loss ratio below 30%, has been in existence for at least 10 years, and has issued financing to a related party.

Court Ruling on Loss Ratios: Arbitrary and Capricious

In Ryan, LLC v. Internal Revenue Service, Ryan, LLC claims that the IRS’s loss ratio thresholds are arbitrary and capricious because Treasury provided no explanation for why the loss ratios chosen would effectively distinguish abusive transactions from permissible ones.

The 60% Threshold for Transactions of Interest

The 60% threshold is based on property and casualty loss ratios for commercial insurers as reported in the Annual NAIC Report on Profitability by Line by State for each year from 2013 through 2022. After excluding certain business lines that micro-captive insurance companies typically do not or cannot cover, Treasury ended up with an “average modified loss ratio factor of 67%.”

Based on this data, the original proposed regulations in 2024 set the loss ratio threshold at 65%. The IRS later lowered it to 60% after commenters argued the ratio remained too high. The key issues raised by commenters were:

• Micro-captive insurance companies typically pay out only for major, infrequent events, resulting in lower loss ratios compared to commercial insurers.

• The data set to determine the 60% ratio primarily consisted of commercial insurers, which have different loss profiles than micro-captive insurance companies, making the comparison unreliable.

Despite acknowledging these issues, Treasury failed to explain why the final 60% loss ratio would be an appropriate measure for identifying abusive micro-captive arrangements. Treasury simply noted that commenters had not “identified any alternative published data set” and that it was not “aware of one” that could provide a more accurate ratio. Effectively, the Treasury relied on an apples-to-oranges comparison because no better data existed.

As a result, Ryan, LLC argued that Treasury did not provide a “satisfactory explanation for its actions,” rendering the 60% loss ratio arbitrary and capricious.

The 30% Threshold for Listed Transactions

Treasury settled on a 30% loss ratio after considering the Tax Court case R.V.I. Guar. Co., Ltd. & Subs. v. C.I.R., 145 T.C. 209 (2015), 90 Fed. Reg. at 3541. In that case, the insurance company’s loss ratio fluctuated dramatically, from a low of 0.2% to a high of 97.9%, with a ten-year average of 32%. Based on this data, Treasury concluded that a 30% loss ratio was a reasonable ratio.

Ryan, LLC challenged this approach, arguing that relying on a single case to justify the 30% loss ratio was insufficient, as one insurance company does not provide a large enough data set from which to draw reliable conclusions. Ryan, LLC further noted that the Tax Court found that the insurance company was not engaged in a tax avoidance scheme, yet its loss ratio history showed the following:

• In nine of the fourteen years in question, the loss ratio was below 30%.
• If not for one year when the loss ratio spiked to 97%, the company’s average loss ratio would have been well below 30%.
• In four of the fourteen years, the loss ratio was at or below 1%.

Ryan, LLC contended that this data demonstrates that even a legitimate insurance company can have a loss ratio below Treasury’s 30% threshold in most years. Therefore, Ryan, LLC alleged that Treasury failed to draw a “rational connection between the facts found and the choice made” in selecting the 30% loss ratio, rendering it arbitrary and capricious.

Conclusion

The Tax Court’s decision does not automatically invalidate the micro-captive regulations, but it does open the door for additional challenges to the loss-ratio metric as a valid measure for identifying abusive micro-captive transactions. If other courts reach similar conclusions, the IRS could be compelled to withdraw or substantially revise the regulations, potentially replacing the loss-ratio test with more appropriate metrics. The landscape of micro-captive regulation is evolving, and we will continue to monitor developments and provide timely insights.

For additional guidance, learn more from our micro-captive series.  These articles go through the essential information contained in the Final Regulations issued on January 10, 2025, by the Department of the Treasury and the Internal Revenue Service  (Regs. Secs. 1.6011-10 and 1.6011-11) related to micro-captive insurance companies. 

Larson and Company has developed a suite of services specifically to serve the needs of captive insurance companies.  Contact our Larson captive team to find out how this will affect your micro-captive.