Micro-captives: real insurance tool, favorite audit target

Primary sources: IRC §831(b); IRS micro-captive listed-transaction regulations; Avrahami v. Commissioner and successors

The honest short answer

A captive is an insurance company you own that insures your business's real risks; a §831(b) micro-captive can elect to be taxed only on investment income, making premiums deductible to your business and largely untaxed to the captive. Genuinely used — real risks, actuarial pricing, actual claims — it's a legitimate risk-management tool for substantial businesses. The abusive version sells the deduction: premiums reverse-engineered to hit the annual cap, policies for implausible risks that never see a claim, money looping back to the owner. That version has lost repeatedly in Tax Court, carries listed/reportable-transaction status, and sits on the IRS's most-scrutinized list year after year.

What's legitimately true in the pitch

Captives are a century-old, court-recognized structure used by serious companies for gaps commercial insurers won't cover well.
The 831(b) election is in the statute — small captives were deliberately given favorable treatment.
Self-insuring real risk can beat commercial premiums for businesses with genuine exposure and good loss history.

Where the pitches mislead

Premiums priced to the deduction, not the risk. When every client's premium lands just under the statutory cap regardless of their business, that's not underwriting.
Policies designed never to pay. Exotic coverages, no claims history across the promoter's whole book, and claims processes nobody uses.
Circularity. Premiums out, "loans" or investments back to the owner — the pattern courts cite when unwinding these.
The fee load is enormous — formation, management, actuarial-lite paperwork — for a structure that may just be buying you a listed-transaction disclosure.

Questions to ask before forming one

What real, quantifiable risks am I insuring that commercial markets price badly?
Who sets premiums, with what independent actuarial support?
Has this manager's book ever paid meaningful claims?
Would I form this captive if premiums weren't deductible?

Our position: a business with seven-figure genuine risk exposure and a claims-paying captive run like an insurer — defensible, sometimes smart. A dentist deducting six figures of premiums for "reputational harm" coverage that has never paid a claim — that's the case the IRS wins, with your name on it.

Being pitched a captive — or already in one?

We'll assess the risk substance, the pricing support, and the disclosure posture honestly. If it's defensible we'll say so; if it's a deduction in a costume, we'll say that too.

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This review discusses a category of investment and tax marketing generally, not any specific company or offering, and is not investment, legal, or tax advice for any particular situation.