Clear Sky Insurance Micro-Captive: Tax Court Sustains Penalties in T.C. Memo. 2026-99 (September 29, 2026)
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Quick Answer
On September 29, 2026, Judge Nega of the U.S. Tax Court held in T.C. Memo. 2026-99 that a micro-captive arrangement run through Clear Sky Insurance Co., Inc. lacked economic substance, and sustained accuracy-related penalties against all eight related petitioners. The insured company had paid the captive $813,256 in premiums in late December 2015; the court had already held on March 25, 2025 that this was not insurance for federal income tax purposes. For the 2015 transaction the court applied the 40% penalty (sections 6662(a), (b)(6) and (i)) to every petitioner except the captive, because the returns disclosed nothing about the arrangement, and a 20% penalty to the captive because the IRS conceded the 40% rate for it. A separate 2016 advance from the captive to a shareholder, held a constructive dividend, drew a 20% penalty. Decisions were entered for the IRS in six of eight dockets; two are left for Rule 155 computations. As of November 9, 2026, the reporting side is unsettled: a federal district court in Texas vacated the “listed transaction” rule for micro-captives (26 CFR 1.6011-10) on April 15, 2026 and upheld the companion “transaction of interest” rule (26 CFR 1.6011-11).
Key Takeaways
- This is the penalty round, not the first ruling. The March 25, 2025 opinion (T.C. Memo. 2025-25) decided that the captive program was not insurance; the July 21, 2025 supplement (T.C. Memo. 2025-78) held the captive could not exclude the premiums from income. The September 29, 2026 opinion decided only the penalties.
- The objective test of the economic substance statute failed on a circular flow of money: premiums went from the insured company to the captive, from the captive to the OMNI Insurance Co. reinsurance pool, and back from the pool to the captive. The court said the small amounts that leaked out at each stage did not change that.
- Price mattered. The court found the captive coverage was between 48 and 63 times as expensive as the commercial insurance the insured company bought from The Hartford, and the insured company submitted no claims across 16 different policy coverages.
- The 40% rate turned on the return, not on a Form 8886. The insured company deducted $1,007,688 as “insurance expenses” on its 2015 Form 1120S, and the court found no return disclosed facts that would alert the IRS to the arrangement.
- Reasonable cause does not rescue the economic substance penalty. In the March 26, 2026 opinion in the Royalty Management matter the court wrote that the professional-advice defense “is not available for penalties under section 6662(b)(6).”
- The reporting rule that would have flagged most such captives is in limbo. Section 1.6011-10 requires both a financing factor and a loss ratio under 30%; the Southern District of Texas vacated it on April 15, 2026, with the vacatur stayed to May 1, 2026. Section 1.6011-11, with a 60% loss ratio and financing as separate triggers, was upheld.
- Nothing here is a ruling on every micro-captive. The same district court wrote that “some micro-captives are legitimate insurers, some are not,” and each Tax Court opinion rests on its own record.
CSV · 55 rows
Micro-captive insurance in the Tax Court: Clear Sky, the 2026 opinions and the reporting rules
55 rows: holdings, penalty rates and dollar figures from the Clear Sky opinions, three other 2026 Tax Court micro-captive opinions, the reviewed opinion of November 12, 2025, the thresholds in sections 1.6011-10 and 1.6011-11, Notice 2016-66 and the April 15, 2026 Texas ruling.
What the court decided on September 29, 2026
The opinion is short. It says the two earlier opinions “resolved all issues in dispute” except the penalty, and then works through three layers. Docket numbers 17165-19, 17169-19, 17177-19, 17178-19, 17187-19, 17201-19, 17205-19 and 17206-19 were consolidated; one is the captive and the other seven are the insured company's shareholders. We do not name the shareholders, who are private individuals.
| Question | Holding in T.C. Memo. 2026-99 | Penalty |
|---|---|---|
| 2015 premiums: did the transaction lack economic substance (section 7701(o))? | Yes. Both the objective test (change in economic position) and the subjective test (substantial non-tax purpose) failed. | 20% under section 6662(b)(6) |
| 2015: was it adequately disclosed on the returns? | No. The insured company's Form 1120S listed “insurance expenses” of $1,007,688 and the shareholders' returns disclosed nothing about the arrangement. | Raised to 40% under section 6662(i) for every petitioner except the captive |
| 2015: the captive itself | Liable for the penalty, but the IRS conceded the section 6662(i) enhancement. | 20% |
| 2016: the captive's $400,000 advance to a shareholder, held a constructive dividend in March 2025 | A separate transaction. The IRS did not show the economic substance penalty applied, so the court treated that point as abandoned and used the alternative grounds. | 20% for negligence or disregard (section 6662(b)(1)), or for substantial understatement (section 6662(b)(2)) depending on Rule 155 |
| Outcome by docket | Decisions for the IRS in six dockets; Rule 155 computations in Docket Nos. 17169-19 (the captive) and 17187-19. | Amounts to be computed |
Source: T.C. Memo. 2026-99 (Docket Nos. 17165-19 et al., filed September 29, 2026), sections II, III and IV.
The opinion does not state the deficiency amounts, so we cannot give the tax and penalty in dollars. What it does state is the $1,007,688 insurance deduction on the 2015 Form 1120S, and, from the July 2025 supplement, that the captive had to include $781,977 it received in 2015 as income in that year.
Why it was not insurance: the facts from the March 25, 2025 opinion
The penalty opinion relies on the facts in T.C. Memo. 2025-25, so the numbers that matter are there. The captive was incorporated in Montana and owned by the insured company's executive officers. It elected section 831(b), under which a small insurer is taxed only on investment income, and the premium ceiling in the years at issue was $1.2 million (it rose to $2.2 million for tax years after 2016).
| Fact the court found | Figure | Why it mattered |
|---|---|---|
| Premium paid to the captive in late December 2015 | $813,256 | Set after coverage lines were removed to bring the total down; the court called the target “maximal, yet affordable.” |
| Reinsurance premium the captive paid to the OMNI pool four days later | $409,693 (50.38% of the premium) | The pool paid it back to the captive as a retrocession premium, less a $52,000 trust deposit and fees of $7,500 and $7,875 |
| Captives in the OMNI risk pool, 2015 and 2016 | 31 | The captive sought risk distribution by pooling with other captives |
| Reinsurance premiums the pool received, 2011 through 2016 | $63,345,830 | It paid one claim of $150,000, a loss ratio of roughly 0.2% (our arithmetic: 150,000 divided by 63,345,830 is 0.24%) |
| Pool loss ratio for policy years 2015 and 2016 against the reinsurance industry | 0.69%; industry about 99 times higher | The court said this suggested the reinsurance premiums were excessive |
| Captive premium against the commercial policy | 48 to 63 times as expensive | Rate-on-line: over 81 cents per dollar of per-occurrence limit against 1.3 cents |
| Claims the insured company made on the captive | None, across 16 coverages | No loss history justified the price |
| Unsecured advance from the captive to a shareholder, August 2016 | $400,000, 1.5% interest | Over 40% of the captive's investment portfolio; held a constructive dividend |
Source: T.C. Memo. 2025-25 (filed March 25, 2025), findings of fact and sections IV and VI; T.C. Memo. 2026-99 for the 48-to-63 times quotation.
The March 2025 opinion gave two independent reasons the program was not insurance: the captive did not achieve risk distribution, and the program did not resemble insurance “in the commonly accepted sense.” It also rejected the argument that the IRS's own Revenue Ruling 2002-89 safe harbor applied, because the petitioners “failed to establish that less than 50% of the risk borne by CSI stems from the liability coverage provided to STW,” where CSI is the captive and STW the insured company.
The September 2026 opinion adds a sentence that readers holding a captive should read twice: “Aside from a deduction, what STW purchased, if anything, from CSI remains unclear.” And on pricing: “we have serious reservations about the reasonableness of premiums developed to hit a preordained target.” The court found the final mix of coverages was suggested by the promoter's chief operating officer, not by the business owners.
The 40% penalty is about what the return says
Section 6662(b)(6) imposes a 20% penalty on an underpayment attributable to a transaction lacking economic substance. Section 6662(i) raises it to 40% if the transaction was not adequately disclosed on the return or an attached statement. The court quoted the standard from its reviewed opinion of November 12, 2025 (165 T.C. No. 10): disclosure must alert the IRS to the nature of the transaction so that the decision to audit “may be a reasonably informed one.”
The same pattern appears in the other 2026 opinions. In the March 26, 2026 Royalty Management opinion the insured pass-through entity deducted $1,110,206 as “insurance” without breaking out the $1,099,900 of premiums, and the court sustained 40%. In the May 4, 2026 opinion on Surface Engineering & Alloy Co., Inc., the court noted none of the returns “reflects the common connection” to the two captives and that no Form 8275 was attached.
| Matter and citation | Date, judge | Result | Penalty |
|---|---|---|---|
| Clear Sky Insurance Co., Inc. and the insured company's shareholders: T.C. Memo. 2026-99 | September 29, 2026, Judge Nega | Not insurance (March 2025); lacked economic substance; premiums of $813,256 | 40% (captive 20%); 20% on the 2016 dividend |
| Royalty Management Insurance Company, Ltd.: T.C. Memo. 2026-26 | March 26, 2026, Judge Lauber | Not an insurance company (T.C. Memo. 2024-87); $1,099,900 of premiums lacked economic substance | 40% |
| Surface Engineering & Alloy Co., Inc. with Risk & Asset Protection Services, Ltd. and RMC Property & Casualty, Ltd.: T.C. Memo. 2026-37 | May 4, 2026, Judge Weiler | Payments not deductible insurance premiums (T.C. Memo. 2025-81) | 40% for 2012 through 2015; 20% for 2016 and 2017 |
| Beveled Edge Insurance Company, Inc., Cavallo Nero Insurance, Inc. and Micro Cap KY Insurance Company, Inc.: T.C. Memo. 2026-57 | July 20, 2026, Judge Halpern | Procedural ruling on requests for admission in 14 consolidated cases; no decision on the merits | Not decided |
Source: T.C. Memo. 2026-99, 2026-26, 2026-37 and 2026-57 as published by the U.S. Tax Court. The table lists the captive-insurance opinions we found by searching the Tax Court's opinion database for “captive” and “831(b)” between January 1 and November 9, 2026; a different search could surface more.
The reporting rule: what it says and what a Texas court did to it
Separately from the penalties, Treasury Decision 10029 (published January 14, 2025) created two reporting categories for micro-captives, in 26 CFR 1.6011-10 and 1.6011-11. Both apply only to a captive that has elected section 831(b) and is at least 20% owned by an insured, an owner or related persons. The difference is how many tests a transaction must meet.
| Feature | 1.6011-10 (listed transaction) | 1.6011-11 (transaction of interest) |
|---|---|---|
| Financing factor | Captive made available or conveyed contract money to an owner, insured or related person without taxable income to them, any time in the most recent five taxable years | Same factor |
| Loss ratio factor | Losses and claim expenses under 30% of earned premiums less policyholder dividends over the most recent ten taxable years | Under 60% over the most recent ten taxable years, or all years if the captive is younger |
| How the factors combine | Both must be met (paragraph (c)) | Either one is enough (paragraph (c)) |
| Bright line out | Loss ratio of 30% or more | Loss ratio of 60% or more |
| Status on November 9, 2026 | Declared unlawful and vacated on April 15, 2026 (Drake Plastics Ltd. Co. v. IRS, S.D. Tex. No. 4:25-cv-02570, Judge Rosenthal); vacatur stayed until May 1, 2026 | Held appropriate by the same court |
Source: 26 CFR 1.6011-10(b), (c), (e) and 1.6011-11(c); Drake Plastics Ltd. Co. v. IRS, Memorandum and Opinion entered April 15, 2026.
The district court's reasoning on the listed rule was narrow: Congress, in section 6707A(c)(2), requires a listed transaction to be a tax avoidance transaction, and the court wrote that “there is no finding that the Final Rule is sufficiently narrow to satisfy § 6707A(c)(2)'s requirement of presumptive tax avoidance.” It severed section 1.6011-10 and left section 1.6011-11 in place, and said that eliminating the former “does not affect a taxpayer's obligation to report under § 1.6011-11.” The Treasury preamble had explained where 30% came from: the average ten-year loss ratio in a Tax Court case on which commenters relied was 32%, “rounded down to 30 percent.”
Press reports we read (Mealey's, June 25, 2026) say both sides appealed to the Fifth Circuit; we did not read the appellate docket. The electronic CFR copy we downloaded for November 1, 2026 still prints the text of section 1.6011-10, and we did not locate IRS guidance on how the vacatur affects Form 8886 filings. Treat who must file what as a question for a tax professional who can see your facts.
The earlier regime was Notice 2016-66, effective November 1, 2016, which flagged micro-captives as a transaction of interest where the loss ratio was under 70% of the benchmark or the captive had financed related parties. The final rule lowered that loss ratio to 60% for the transaction of interest category and, for the listed category, to 30% together with financing.
A worked example of the loss-ratio arithmetic (our arithmetic): a captive with ten years of earned premium of $8,000,000, no policyholder dividends and $2,000,000 of incurred losses and claim expenses has a ten-year ratio of 25%. That is under 30%, so the loss-ratio factor of the listed rule would be met, and under 60%, so it would also meet the transaction-of-interest loss-ratio factor. Because the listed rule also needs the financing factor, it would not be listed on that alone. Under 1.6011-11 it would be reportable on the loss ratio by itself.
What a reader can do with this
- Read three numbers off your own captive's file. The ten-year loss ratio (incurred losses and claim expenses over earned premium less dividends), the premium against what a commercial insurer quoted for the same coverage, and whether any money has left the captive for you, your company or relatives as a loan or guarantee. Those are the facts the court and the regulation both turned on.
- Look at what your return said. The 40% rate in these opinions followed returns that showed only an “insurance” line. Ask your preparer what, if anything, was disclosed on the return or an attached statement for each open year.
- Ask who set the premium and how. The court distrusted premiums “developed to hit a preordained target,” and noted the promoter, not the owners, chose the coverage mix.
- If you are being pitched one now, ask for the actuarial study, the claims history of the pool and every year in which the pool paid claims. Our guides to syndicated conservation easements as a listed transaction, to private placement life insurance and to reading a private placement memorandum cover the same kind of promoter paperwork, and our K-1 guide explains how pass-through entities report to you.
- Do not read the vacatur as a safe harbor. The Tax Court penalties in these opinions do not depend on the reporting rule; they depend on economic substance and disclosure.
This is analysis of public documents, not investment, legal or tax advice.
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Sources: U.S. Tax Court, T.C. Memo. 2026-99 (Docket Nos. 17165-19, 17169-19, 17177-19, 17178-19, 17187-19, 17201-19, 17205-19, 17206-19, filed September 29, 2026), T.C. Memo. 2025-25 (March 25, 2025), T.C. Memo. 2025-78 (July 21, 2025), T.C. Memo. 2026-26 (March 26, 2026), T.C. Memo. 2026-37 (May 4, 2026), T.C. Memo. 2026-57 (July 20, 2026) and 165 T.C. No. 10 (November 12, 2025); U.S. District Court, Southern District of Texas, Drake Plastics Ltd. Co. v. IRS, Civil Action No. H-25-2570, Memorandum and Opinion (April 15, 2026); Treasury Decision 10029, 90 Fed. Reg. 3534 (January 14, 2025); 26 CFR 1.6011-10 and 1.6011-11; IRS Notice 2016-66. Appeal status per Mealey's (June 25, 2026), not independently confirmed.
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