A federal court in Texas vacated the regulation that defines micro-captive insurance companies as a listed transaction. [1] That case is currently being appealed.
On April 15, 2026 the US District Court for the Southern District of Texas, in the case Drake Plastics Ltd. Co. v. IRS,[2] vacated Treasury Regulation §1.6011-10, effectively declaring it a nullity from the date it had become effective. That regulation states that a micro-captive insurance company with certain characteristics will be treated as a listed transaction under the rules governing abusive tax shelters. As it now stands, pending reversal by the Fifth Circuit, no micro-captive with any characteristic will be treated as a listed transaction.
That is not to say that micro-captives are off the “potentially abusive tax shelter” radar screen. In a second ruling in the same case, the court found the fraternal twin regulation defining some micro-captives as a transaction of interest, Treasury Regulation §1.6011-11, to be valid, also pending appeal.
The basis for the District Court’s ruling on §1.6011-10 was that the IRS, in compiling the regulation and the administrative record on which it is based, failed to include the findings required by Congress under the Administrative Procedure Act that micro-captives are “presumptively tax avoidant.” Without such a finding there is no way for the Service to designate any micro-captive a listed transaction. On the other hand, the District Court found that the threshold to qualify a micro-captive as a transaction of interest was less robust and the Service met that quantum. The Service determined that a micro-captive with specified characteristics is “of a type” of transaction that has “a potential for tax avoidance or evasion,” and that finding was sufficient to validate §1.6011-11:
“. . . [T]he court concludes that, [in applying §706(2) of the Administrative Procedure Act], the agency (1) appropriately designated micro-captive transactions as transactions of interest under 26 C.F.R. § 1.6011-11 because they are of a type that has the potential for tax avoidance or evasion; but (2) exceeded its statutory authority in designating micro-captive transactions as listed transactions because there was no finding, supported by the administrative record, that the majority of the transactions covered by 26 C.F.R. § 1.6011-10 are to avoid or evade taxes.” Slip Opinion p. 27.
What does all this mean, assuming nothing changes on appeal?
- At the moment no micro-captive can be a listed transaction, and those previously designated a listed transaction are no longer so designated. With that they no longer have a disclosure obligation (the Form 8886) as a listed transaction.
- But, according to the case, micro-captives can still be transactions of interest. Thus, while not needing to file the Form 8886 to disclose the transaction under §1.6011-10 as a listed transaction, they still must file the Form 8886 under §1.6011-11 as a transaction of interest. Ironically, in both cases the captive and related parties are disclosing the very same information and potentially pay a penalty for failing to do so, albeit substantially less as a transaction of interest. To some this may appear to be a pyrrhic victory.
- And yet, in an unintended way, the vacatur of §1.6011-10 might necessitate the invalidation of §1.6011-11. An initial read of §1.6011-11 reveals that all definitions and some substantive provisions are simply cross-referenced from §1.6011-10. If the latter is now a nullity, as if it never existed, what does that do the former that cross-references to nothing? With the next printing of the Code of Federal Regulations, the presumably vacated regulations will be removed, leaving §1.6011-11 with nonsensical non-sequiturs until the Service completes the lengthy process of re-enacting that regulation.
- Since the regulation was vacated under the Administrative Procedure Act[3] it has effect nationwide and not just limited to the Southern District of Texas or to those plaintiffs.
- The Service may not be done with the captive listed-transaction regulation even if it loses on appeal. It need only beef up the administrative record with bona fide findings that micro-captives are so integrated in tax abuse that they are presumptively listed transactions. Will it? Can it?
The next phases are the cross-appeals and possibly the writ of certiorari. The captive and co-plaintiffs appealed the validation of the transaction-of-interest regulation to the Fifth Circuit Court of Appeals while the Service appealed the vacatur of the listed-transaction regulation. And so the wheel turns.
[1] Section 6707A establishes penalties for a taxpayer’s failure to disclose “reportable transactions” and “listed transactions.” A reportable transaction is a type of transaction the Secretary has determined has the potential for tax avoidance or evasion; a listed transaction is a reportable transaction which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction. The penalties under Section 6707A for failing to disclose a listed transaction are steep: $100,000 in the case of a natural person, and $200,000 otherwise. The penalties for failing to disclosure a reportable transaction are $10,000 in the case of a natural person, and $50,000 otherwise.
[2] No. 4:25-cv-02570 (S.D. Tex Apr. 15, 2026).
[3] Loper Bright Enters. v. Raimondo, 603 U.S. 369, 412 (2024); CIC Services, LLC v. Internal Revenue Service, 593 U.S. 209 (2021). See also, Ryan LLC v. Internal Revenue Service, No. 3:25-cv-0078-B, 2025 BL 396822 (N.D. Tex. Nov. 5, 2025).
