Blog · 16 October 2026

Microcaptive Insurance Premium Deduction: What Capstone and Ocean Drilling Teach US CPA Firms

By Keshav Bansal, CA

A microcaptive insurance premium deduction survives only if the arrangement is insurance for federal tax purposes, and the test a court applies can depend on where the case is heard. On September 25, 2026, the U.S. Court of Federal Claims denied summary judgment to Capstone Associated Services, Ltd. in its microcaptive case (Capstone Associated Services, Ltd. v. United States, 2026 WL 2919108), Thomson Reuters Checkpoint News reported on October 13, 2026. The court applied the Federal Circuit’s three-part Ocean Drilling test, not the Tax Court’s four-part test, and found factual disputes under each prong. For US CPA firms, it is a useful walk-through of the insurance tests themselves.

What happened in Capstone

Per Checkpoint, Capstone deducted $239,773 in premiums paid in 2016 to two captive insurers, FinServ Casualty Corporation and PoolRe Insurance Corporation. The IRS disallowed the deductions as not insurance premiums and urged the Tax Court’s four-part test; the Claims Court held that binding precedent required the three-part test from Ocean Drilling & Exploration Co. v. United States: based on the totality of the circumstances, the captive must not be a sham, the arrangement must transfer risk, and the insurer must distribute risk.

Denying summary judgment is not a merits loss; the facts must be tried. The disputes the court listed read like an exam checklist:

• Premium payments. The government questioned whether Capstone actually paid the premiums and challenged post-litigation allocation documents.
• Claims handling. Capstone staff handled FinServ’s claims; evidence suggested practice deviated from formal policy, with too little verification before payment.
• Investments. FinServ’s investments were loans to its owners and other affiliated businesses, which the court said could be evidence of self-dealing.
• Circular pooling. Premiums PoolRe received were nearly identical to the premiums it ceded to a risk pool, and coverage options appeared designed to hit a target ceded percentage rather than market rates.
• Limited real risk and independence. PoolRe’s liability was limited to funds collected from pool participants; it was called a “wholly owned subsidiary of Capstone” in a conflict-of-interest policy although formally third-party owned; and its owner had pledged all his stock as collateral for a loan from FinServ.
• Clustered risks. Many insureds shared an office building and employees, so one event could hit several at once.

Where the insurance tests come from

Section 162(a) allows ordinary and necessary business expenses, and Treas. Reg. §1.162-1(a) lists “insurance premiums against fire, storm, theft, accident, or other similar losses in the case of a business.” The Code does not define insurance, so courts start with Helvering v. Le Gierse, 312 U.S. 531 (decided March 3, 1941), where the Supreme Court said: “Historically and commonly insurance involves risk-shifting and risk-distributing.”

• Risk shifting: the insured moves its risk of loss to the insurer. If losses simply come back to the same owners, the risk never left.
• Risk distribution: the insurer spreads its potential liability across many independent exposures. In Ocean Drilling (Fed. Cir. March 9, 1993), unrelated business of about 44% and 66% of the captive’s business in the two years at issue was enough for both shifting and distribution, and the premiums were deductible.

Checkpoint notes the Ocean Drilling test rests on Le Gierse and Moline Properties (1943), which respects a corporation as separate from its owners unless it is a sham; see our Risan alter-ego and COGS article.

The Tax Court’s four criteria

In Avrahami v. Commissioner, 149 T.C. No. 7 (August 21, 2017), the first §831(b) captive case to reach trial, the Tax Court used four criteria: the arrangement must involve risk shifting, involve risk distribution, involve insurance risk, and meet commonly accepted notions of insurance. Per EY, the captive, Feedback, failed risk distribution and was not insurance in the commonly accepted sense, with no claims until after the IRS audit began, unreasonable premiums, and investment mainly in illiquid loans to related parties. The premium deductions were disallowed and Feedback’s §831(b) and §953(d) elections were held invalid.

The two tests overlap heavily. A Tax Court case starts before payment, after a notice of deficiency; the Claims Court and district courts hear refund suits after the tax is paid, so forum choice can change which precedent and framing apply. For refund forums, see our Letter 105C and refund-suit guide.

What §831(b) does, and what it doesn’t

Under 26 U.S.C. §831(b), a non-life insurance company that elects can be taxed only on taxable investment income, at §11(b) rates, instead of on all its taxable income under §831(a). The statute’s $2,200,000 premium ceiling is inflation-indexed; Rev. Proc. 2025-32 sets it at $2,900,000 of net written premiums (or direct written premiums, if greater) for taxable years beginning in 2026. The company must also meet diversification rules: generally no more than 20% of premiums from any one policyholder (related policyholders count as one), or an ownership test that stops descendants and certain spouses from holding more than 2 percentage points more of the captive than of the insured assets.

The election does not make anything insurance; it only changes how a real insurer is taxed. If the arrangement fails Le Gierse, the operating company loses the deduction regardless.

Disclosure: the 2025 microcaptive regulations

Final regulations (T.D. 10029, effective January 14, 2025) treat a §831(b) captive that is at least 20% owned by insureds, their owners or related persons as a reportable transaction in two tiers:

• Listed transaction (Treas. Reg. §1.6011-10): the captive made premium funds available, tax-free, as financing (such as loans or guarantees) to owners, insureds or related persons within its most recent five taxable years and its loss ratio over its most recent ten taxable years is under 30%. A captive with fewer than ten taxable years cannot be listed.
• Transaction of interest (Treas. Reg. §1.6011-11): the financing factor or a loss ratio under 60%.

Participants, including the insured, the captive and owners, disclose on Form 8886; a safe harbor relieves an owner who gets written acknowledgment that the insured has disclosed or will disclose. Under §6707A, failing to disclose costs 75% of the tax decrease from the transaction, capped at $200,000 for a listed transaction ($100,000 for a natural person) and $50,000 ($10,000) for other reportable transactions, with a $10,000 ($5,000) minimum. FinServ’s loans to owners in Capstone are the kind of fact the regulations call financing. Our CRAT listed-transactions article covers Form 8886 mechanics, and our Clear Sky §6662 penalty article covers what happens after a captive fails.

A file checklist for captive clients

• Get the captive’s premium, claims and loss-ratio history for up to ten years, and any loans or guarantees to related parties.
• Test risk distribution: how many independent insureds and exposures, and whether they share an office, staff or a single event.
• Trace pooling and reinsurance cash for circular flows.
• Confirm Form 8886 filings by the insured, the captive and each owner, or the owner safe-harbor acknowledgment.

Where Tax Brew fits

Captive files turn on premium ledgers, intercompany loan schedules and loss-ratio workpapers. Tax Brew provides bookkeeping, cleanup and tax prep support for US CPA firms, including those schedules; your firm keeps the judgment and signature. The first 20 hours are free for qualifying engagements. See our services, or email info@taxbrewglobal.com.

Sources: Checkpoint News Staff, Thomson Reuters, “Claims Court denies Capstone’s summary judgment in microcaptive case” (Oct. 13, 2026), reporting Capstone Associated Services, Ltd. v. United States, 2026 WL 2919108 (Fed. Cl. Sept. 25, 2026); Helvering v. Le Gierse, 312 U.S. 531 (1941) (Cornell LII); Ocean Drilling & Exploration Co. v. United States, 988 F.2d 1135 (Fed. Cir. 1993); EY Tax News 2017-1382 on Avrahami v. Commissioner, 149 T.C. No. 7 (2017); 26 U.S.C. §§831 and 6707A (Cornell LII); Rev. Proc. 2025-32 §4.36; Treas. Reg. §§1.162-1(a), 1.6011-10, 1.6011-11 (eCFR); T.D. 10029, 90 FR 3534 (Jan. 14, 2025). General information, not tax or legal advice. As of 16 October 2026.