Yes. 831(b) micro captive insurance arrangements are legal under U.S. tax law, provided they are structured and operated correctly. However, they have also been subject to IRS scrutiny, and abusive or poorly structured plans have been struck down in court. Compliant structures remain valid and widely used. 

Why 831(b) Captives Are Legal 

Section 831(b) was created by Congress as part of the Tax Reform Act of 1986 specifically to support small insurance companies and allow them to retain underwriting income tax‑free. The provision continues to exist today and is used by many businesses, large and small, to self‑insure risks. 

Over time, major companies like UPS and Rent‑A‑Center leveraged captive insurance, demonstrating its mainstream acceptance in risk management.  

Why 831(b) Captives Face IRS Scrutiny 

Although the structure is legal, the IRS has long scrutinized microcaptives due to the potential for tax abuse. This history is reflected in multiple regulatory and legal developments: 

Key IRS Actions 

  • Revenue Rulings 2002‑89 and 2009‑26 clarified what qualifies as true insurance (risk transfer, risk distribution, etc.).  
  • IRS Notice 2016‑66 imposed heightened disclosure requirements because 831(b) microcaptives were deemed a “transaction of interest.”  

Cases Against Abusive Micro Captive 
Among abusive 831(b) micro captives, there were clear, common recurring patterns:

Premiums must be grounded in credible actuarial analysis. Courts consistently scrutinize whether pricing reflects genuine risk—not statutory limits. 

Risk distribution must be meaningful. Participating in a pool alone is not enough; the pool must transfer real, unrelated risk. 

    Policies and claims must mirror standard insurance practices. Late policies, informal claims handling, and undocumented settlements raise red flags. 

    Captives must operate as true insurance companies. This includes capitalization, documentation, governance, reporting, and investment practices. 

    Economic substance matters. Courts look closely at the business purpose and real‑world function of the captive. 

    What Makes an 831(b) micro captive “Safe”? 

    To be compliant and safe, an 831(b) micro captive must meet a stringent 4-Part Test, among other regulations. This is why choosing the right 831(b) Plan Administrator is so important. Here are some resources to ensure compliance.  

    • Latest 831(b) Micro Captive Cases 

    Why Many Businesses Use 831(b) Plans 

    Despite scrutiny, 831(b) captives remain a legitimate and valuable tool: 

    • They help businesses self‑insure gaps not covered by commercial markets. 
    • They provide stability during hard insurance markets (like the 2024 P&C market hardening). 
    • The COVID‑19 pandemic demonstrated their usefulness when traditional insurers denied many business‑interruption claims.  

    When structured properly, 831(b) micro captives are not only legal, they’re highly effective risk‑management vehicles. 

    Bottom Line 

    ✅ Legal? Yes. 831(b) microcaptives are explicitly authorized under federal tax law. 

    ⚠️ Safe? Yes… if properly structured and operated as genuine insurance. 
    They become risky only when: 

    • Created primarily for tax avoidance, 
    • Lacking real insurance risk, 
    • Or failing IRS compliance requirements. 

    Because of historical abuses, the IRS carefully examines these arrangements, but compliant micro captives continue to withstand scrutiny and provide real value.