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Tax consulting firm permitted to challenge final micro-captive reporting regulations

by | Dec 2, 2025 | , ,

Ryan, LLC v. Internal Revenue Service[1] is the latest example of success in overcoming procedural hurdles to challenge the validity of a US Department of the Treasury (Treasury) regulation. In a recent opinion, the US District Court for the Northern District of Texas held that:

  • Ryan has standing to challenge the validity of the Treasury’s final regulations[2] that require disclosure of certain transactions engaged in by businesses and their “micro-captive insurance companies” (MCICs).
  • Ryan sufficiently pleaded its claim that the final regulations under challenge were “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law” and must be set aside under the Administrative Procedure Act (APA).[3]
  • The court’s opinion confirms that nontaxpayer actors may have standing to challenge Treasury regulations. The case is also another example of a plaintiff reaching the merits stage of a challenge to a Treasury regulation in the aftermath of Loper Bright v. Raimondo.[4]

Background

Ryan is an advisor to businesses seeking to establish and maintain MCICs. “Captive” insurance companies are specialized insurance companies that exist to insure the entities that own them. When the owning entities make premium payments to the captive, the premiums do not need to include commissions or other fees associated with traditional insurers, making captives an attractive option especially when coverage is unavailable or costly through traditional insurers. Certain small captive insurance companies, commonly called MCICs, qualify for favorable tax treatment. Under section 831(b), MCICs are not taxed on the first $2.2 million in premiums paid by their owner-insured. The Internal Revenue Service (IRS) has increased its scrutiny of the captive insurance industry because of concerns that these arrangements may be exploited for fraud and abuse.

The Treasury’s new regulations

Section 6707A requires the disclosure of certain “reportable transactions,” defined as transactions that, in the IRS’s determination, have a “potential for tax avoidance or evasion.” A “listed transaction” is a type of reportable transaction in which the taxpayer is presumed to have engaged in the transaction for the purpose of tax avoidance or evasion.[5] A “transaction of interest” is a reportable transaction designated by the IRS as having a potential for abuse but is not presumed abusive.[6] These designations create heavy reporting requirements by taxpayers and their advisors (e.g., Ryan).

Under the Treasury’s new regulations, a micro-captive insurance transaction is defined based on a loss ratio factor and a financing factor. The loss ratio factor is the ratio of the captive insurance company’s cumulative insured losses to the cumulative premiums earned over a specified period, typically the most recent 10 taxable years (or all years if less than 10). The financing factor refers to whether the captive insurance company participated in certain related-party financing arrangements within the most recent five taxable years, such as making loans or other transfers of funds to insureds, owners, or related parties. A transaction is classified as a “listed transaction” if the MCIC’s loss ratio is [...]

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Tax Court confirms codified economic substance doctrine requires threshold relevancy determination, upholds 40% strict-liability penalty

by and | Nov 24, 2025 | , ,

Patel v. Commissioner, 165 T.C. No. 10 (Nov. 12, 2025), gave the US Tax Court its “first opportunity to examine when the codified economic substance doctrine applies.” Patel at *16. The Tax Court made two key holdings:

  • Section 7701(o) requires a relevancy determination that “is not coextensive with the two-part test set forth in section 7701(o)(1)(A) and (B).” Patel at *17.
  • Adequate disclosure to reduce the 40% economic substance penalty imposed by sections 6662(b)(6) and (i) must be made at the time the return is filed and not at a later time. Patel at *30.

Relevancy determination

Section 7701(o) provides:

Sec. 7701(o). Clarification of economic substance doctrine.—

 

(1) Application of doctrine.—In the case of any transaction to which the economic substance doctrine is relevant, such transaction shall be treated as having economic substance only if—

 

(A) the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position, and

 

(B) the taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into such transaction.

While the Internal Revenue Service (IRS) endorses a seemingly limitless application of the codified economic substance doctrine, taxpayers contend that it does not apply to every transaction. Rather, the plain language of section 7701(o)(1) requires a threshold relevancy determination. If the economic substance doctrine is not relevant, the inquiry ends.

There are very few cases that have considered whether section 7701(o) requires a threshold relevancy determination. And those that have found that section 7701(o) does not impose a separate relevancy requirement. See Liberty Global, Inc. v. United States, No. 20-cv-63501, 2023 WL 8062792 (D. Colo. Oct. 31, 2023); Chemoil Corp. v. United States, No. 19-cv-6314, 2023 WL 6257928 (S.D.N.Y. Sept. 26, 2023). While Liberty Global was appealed to the US Court of Appeals for the Tenth Circuit – and many speculate the Tenth Circuit may clarify that there is a relevancy requirement – the Tax Court beat the appellate court to the punch.

The Tax Court’s holding had solid statutory support. The plain language of section 7701(o)(1) states: “In the case of any transaction to which the economic substance doctrine is relevant…” After quoting these words, the Tax Court stated, “we easily conclude that the statute requires a relevancy determination. To put it plainly—the statute says so, right there, on its face.” Patel at *17.

Adequate disclosure of transactions

The second key holding in Patel is that the taxpayers in the case are liable for a 40% penalty for engaging in a transaction that lacks economic substance that was not adequately disclosed. Section 6662(b)(6) imposes a 20% penalty on transactions that lack economic substance. This penalty is increased to 40% under section 6662(i) if the transaction is not adequately disclosed.[1]

In the current wave of economic substance challenges, it is unclear what constitutes adequate disclosure under section 6662(i) such that the 20% (instead of the 40%) penalty applies. Based on current audit activity, [...]

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The Employee Retention Credit: A court challenge to IRS guidance

by , and | Jul 8, 2025 | , ,

Case: Stenson Tamaddon LLC v. IRS, No. CV-24-01123-PHX-SPL, 2025 WL 1725942 (D. Ariz. June 20, 2025)

On June 20, 2025, the US District Court for the District of Arizona denied a motion for summary judgment that was filed by Stenson Tamaddon LLC (StenTam). The tax advisory firm argued that IRS Notice 2021-20, which provided informal guidance on claiming the Employee Retention Credit (ERC), was invalid because it was a “legislative rule” that was not promulgated through notice and comment rulemaking as required by the Administrative Procedure Act (APA). The court ruled that while StenTam had standing to challenge the validity of the notice, the notice was an “interpretive rule” and its issuance as such did not violate the APA. The court also addressed StenTam’s arguments that the Internal Revenue Service (IRS) exceeded its statutory authority in issuing the notice and that it acted in an arbitrary or capricious manner.

Background on the Employee Retention Credit

The ERC was enacted in 2020 as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act to provide financial relief to businesses affected by the COVID-19 pandemic. Congress’s goal was to incentivize businesses experiencing significant disruptions because of COVID-19-related government orders or a substantial decline in gross receipts to retain employees on payroll and rehire displaced workers. The ERC is calculated as a percentage of qualified wages paid to employees during periods in 2020 and 2021.

Millions of employers have filed refund claims seeking ERC. Since the enactment of the CARES Act, the IRS has issued roughly $269 billion in ERC. However, more than 200,000 claims have been disallowed, reversed, or recaptured, and another 592,000 remain pending as of late April 2025. To the frustration of many, taxpayers whose claims have been processed in 2025 waited an average of more than 18 months before the IRS took action. According to a recent report from the Taxpayer Advocate Service, the IRS will need until at least the end of 2025 to process all remaining ERC claims. However, the IRS may still seek to recapture refunds relating to ERC claims well into the future.

IRS Notice 2021-20

A 102-page document presented in “question-and-answer” format, the IRS published Notice 2021-20 in March 2021 with the intention to “provide[ ] guidance on the [ERC] . . . .” In its suit, StenTam alleged that the notice “defined various terms in Section 3134 [providing for the ERC], identified factors or elements necessary to claim the credit, set minimum thresholds for recovery of ERC, and imposed new, related record-keeping requirements—all of which resulted in the ERC being restricted to a lesser number of businesses than originally contemplated by Congress.” The parties disputed whether the notice created substantive duties and restrictions that carry the force of law. Under the APA, agencies are generally required to follow notice and comment rulemaking procedures before issuing guidance that creates such duties or restrictions.

StenTam’s challenge to Notice 2021-20

StenTam is a tax services firm that advises clients claiming ERC. The firm contended that its business [...]

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Potential Refund Opportunity for Interest and Penalty Amounts Accrued During COVID-19 Federally Declared Disaster

by and | Jun 12, 2025 | , , , ,

Taxpayers who made payments to the Internal Revenue Service (IRS) that included underpayment interest and/or failure-to-file/pay penalties that accrued during all or part of the period between January 20, 2020, through July 10, 2023, should consider filing a refund claim with the IRS to potentially recover accrued interest and penalty amounts.

Internal Revenue Code (IRC) § 7508A (as in effect during the COVID-19 pandemic), legislative history, regulations, and the US Tax Court’s opinion in Abdo v. Commissioner, 168 T.C. 148 (2024), provide the basis for potential refund claims. IRC § 7508A(d) provides for a mandatory postponement period of certain tax-related obligations, including the suspension of the accrual of underpayment interest for the duration of the COVID-19 incident period plus 60 days (January 20, 2020 – July 10, 2023). IRC § 7508A also appears to have paused the increase of failure-to-file/pay penalties, which are based on the time during which the taxpayer is not in compliance.

Taxpayers considering this refund opportunity should be aware that the statute of limitations to file a refund claim expires three years from the filing deadline of the original tax return or two years from the date on which payment was made – whichever is later (unless the statute of limitations period was otherwise extended). This refund opportunity may apply to underpayment interest and/or penalties paid with respect to federal income, estate, gift, employment, or excise taxes.



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IRS Roundup May 15 – June 2, 2025

by , , , and | Jun 5, 2025 | , ,

Check out our summary of significant Internal Revenue Service (IRS) guidance and relevant tax matters for May 15, 2025 – June 2, 2025.

IRS GUIDANCE

May 15, 2025: The IRS issued Notice 2025-29, providing guidance on the corporate bond monthly yield curve, corresponding spot segment rates under Internal Revenue Code (Code) § 417(e)(3), and the 24-month average segment rates under Code § 430(h)(2). The notice also provides guidance on the interest rate for 30-year Treasury securities under Code § 417(e)(3)(A)(ii)(II) (for plan years in effect before 2008) and the 30-year Treasury weighted average rate under Code § 431(c)(6)(E)(ii)(I).

May 15, 2025: The IRS issued Revenue Ruling 2025-12, providing prescribed rates for federal income tax purposes for June 2025, including, but not limited to:

  1. Short-, mid-, and long-term applicable federal rates for June 2025 for purposes of Code § 1274(d)
  2. Short-, mid-, and long-term adjusted applicable federal rates for June 2025 for purposes of Code § 1288(b)
  3. The adjusted federal long-term rate and the long-term tax-exempt rate, as described in Code § 382(f)
  4. The federal rate for determining the present value of an annuity, an interest for life, or for a term of years, or a remainder or a reversionary interest for purposes of Code § 7520.

May 19, 2025: The IRS released Internal Revenue Bulletin 2025-21. It includes Revenue Procedure 2025-19, which provides the 2026 inflation adjusted amounts for Health Savings Accounts (HSAs) as determined under Code § 223, as well as the maximum amount that may be made newly available for excepted benefit health reimbursement arrangements under Code § 54.9831-1(c)(3)(viii). Revenue Procedure 2025-19 is effective for HSAs for the 2026 calendar year and for excepted benefit health reimbursement arrangements beginning in 2026.

May 22, 2025: The IRS issued a notice to US taxpayers living or working abroad, encouraging them to file their 2024 federal income tax returns by June 16, 2025.

June 2, 2025: The IRS issued Notice 2025-27, providing interim guidance on the application of the corporate alternative minimum tax (CAMT), as well as relief from certain additions to tax for a corporation’s underpayment of estimated tax under Code § 6655. Among other things, this notice also provides an optional simplified method for determining applicable corporation status and waives certain additions to tax under Code § 6655 concerning a corporation’s CAMT liability under Code § 55. The US Department of the Treasury (Treasury) and the IRS also plan on issuing a notice of proposed rulemaking, revising the CAMT proposed regulations in § 2.02(2) of this notice to include a method for determining applicable corporation status.

The IRS also released its weekly list of written determinations (e.g., Private Letter Rulings, Technical Advice Memorandums, and Chief Counsel Advice).

TAX CONTROVERSY DEVELOPMENTS

On May 22, 2025, the US Tax Court issued its opinion in Facebook Inc. v. Commissioner.

THE “BIG, BEAUTIFUL BILL”

The “
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The Employee Retention Credit: IRS’s “Risking” Model Faces Legal Challenge

by , and | Apr 24, 2025 | , ,

Case: ERC Today LLC et al. v. John McInelly et al., No. 2:24-cv-03178 (D. Ariz.)

In an April 2025 order, the US District Court for the District of Arizona denied a motion for a preliminary injunction filed by two tax preparation firms. The firms sought to halt the Internal Revenue Service’s (IRS) use of an automated “risk assessment model” that the IRS used to evaluate and disallow claims for the Employee Retention Credit (ERC), seeking to restore individualized review of ERC claims.

BACKGROUND ON THE ERC

The ERC was enacted in 2020 as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act to provide financial relief to businesses affected by COVID-19 by incentivizing employers to retain employees and rehire displaced workers. The ERC allowed employers that experienced significant disruptions due to government orders or a substantial decline in gross receipts to claim a tax credit equal to a percentage of qualified wages paid to employees. Millions of employers have filed amended employment tax returns (Form 941-X) claiming the credit for periods in 2020 and 2021. Since the enactment of the CARES Act, the IRS has issued roughly $250 billion in ERC.

THE IRS’S MORATORIUM AND AUTOMATED RISK ASSESSMENT MODEL

In September 2023, the IRS instituted a moratorium on processing ERC claims to review its procedures, reduce the backlog of claims, and identify potential fraud. Before the moratorium, all ERC claims received individualized review. During the moratorium, the IRS developed an automated “risk assessment model” to facilitate the processing of claims. This model, which is alternatively known as “risking,” utilizes taxpayer-submitted data and publicly available information to predict the likelihood that a taxpayer’s claim is valid or invalid. Claims deemed to be “high risk” by the system are excluded from review by an IRS employee and instead are designated for immediate disallowance. In August 2024, the IRS lifted its ERC processing moratorium and began issuing thousands of disallowance notices to taxpayers. Notwithstanding these actions, the number of pending ERC claims remained above one million as of November 2024.

THE COURT CHALLENGE TO THE IRS’S “RISKING” MODEL

In their motion for a preliminary injunction, filed January 7, 2025, the plaintiffs (the tax preparation firms) sought a court order compelling the IRS to, among other things, stop the use of “risking” and restore individualized employee review of ERC claims. The plaintiffs claimed to be injured by the “risking” model because they were unable to collect contingency fees from clients when claims were disallowed.

In support of their motion, the plaintiffs pointed to having received on behalf of their clients many boilerplate rejections immediately following the end of the moratorium. The plaintiffs alleged that these summary disallowances were arbitrary and capricious, thus violating the Administrative Procedure Act (APA), because the “risking” model precluded the IRS from acquiring information necessary to properly evaluate the claims.[1] The plaintiffs also contended that the disallowances reflected a shift in IRS policy to disfavor ERC, with the result being that several legitimate claims were being [...]

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Supreme Court Rules Against Taxpayers in IRC Section 965 Case

by , and | Jun 21, 2024 | ,

On June 20, 2024, the Supreme Court of the United States issued a 7-2 opinion in Moore v. United States, 602 U.S. __ (2024), ruling in favor of the Internal Revenue Service (IRS).

Moore concerned whether US Congress and the IRS could tax US shareholders of controlled foreign corporations (CFCs) on those corporations’ earnings even though the earnings were not distributed to the shareholders. The case specifically focused on the so-called “mandatory repatriation tax” under Internal Revenue Code (IRC) Section 965, a one-time tax on certain undistributed income of a CFC that is payable not by the CFC but by its US shareholders. Some viewed the case as hinging upon whether Congress has the power to tax economic gains that have not been “realized.” (i.e., In the case of a house whose value has appreciated from $500,000 to $600,000, the increased value is “realized” only when the house is sold and the additional $100,000 reaches the taxpayer’s coffers.)

However, Justice Brett Kavanaugh, joined by Chief Justice John Roberts and Justices Sonia Sotomayor, Elena Kagan and Ketanji Brown Jackson, rejected that position on the ground that the mandatory repatriation tax “does tax realized income,” albeit income realized by a CFC. On this basis, they reasoned that the question at issue was whether Congress has the power to attribute realized income of a CFC to (and tax) US shareholders on their respective shares of the undistributed income. This group of justices ultimately decided Congress does have the power.

The majority went out of its way to avoid expressing any opinion as to whether Congress can tax unrealized appreciation, with Justice Amy Coney Barrett’s concurrence and Justice Clarence Thomas’s dissent asserting that it cannot. Perhaps the Court was signaling a distaste for the Billionaire Minimum Income Tax proposed by US President Joe Biden, which would impose a minimum 20% tax on the total income of the wealthiest American households, including both realized and unrealized amounts, among other Democratic proposals.

Practice Point: We previously noted that certain taxpayers should consider filing protective refund claims contingent on the possibility that Moore would be decided in favor of the taxpayers. In light of the case’s outcome, however, those protective claims are now moot.



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United States v. Eaton: IRS Summons Power Overrides EU Privacy Laws

by and | May 31, 2024 | , ,

A US federal district court judge recently endorsed the broad investigative powers of the Internal Revenue Service (IRS) in United States v. Eaton Corp., No. 1:23-mc-00037, May 16, 2024 (N.D. Ohio). During its audit of Eaton’s transfer pricing of a royalty arrangement with Eaton’s Irish affiliate, the IRS sought performance evaluations of certain employees of the affiliate. Eaton declined to provide the evaluations citing relevancy and legal objections based on EU privacy laws. The IRS subsequently served Eaton with an administrative summons seeking the evaluations.

In the ensuing summons enforcement action, Eaton initially prevailed before a magistrate judge on both grounds. However, the IRS persuaded the district court judge to reject the magistrate’s recommendation and enforce the summons.

The district court judge rejected Eaton’s position that a heightened relevancy standard applies when the IRS seeks personal information, such as employee valuations. The judge distinguished between civil discovery disputes where such a standard might apply and summons enforcement disputes, which engage the broad authority of the IRS to seek information that may be relevant to its audit. While the IRS’s case for relevancy could have been stronger, the judge nonetheless found that the IRS had sufficiently supported the connection between potential information in the evaluations and its audit of the royalty arrangement.

The district court judge also ruled that the European Union’s General Data Protection Regulation (GDPR) did not bar the IRS’s legitimate exercise of its audit powers. The judge acknowledged that the GDPR generally prohibits the transfer of personal information, such as employee valuations, outside of the EU. However, the judge also found that exceptions to that prohibition applied where the IRS properly requested the information as part of its audit function and the EU Member State (in this case Ireland) had entered into a treaty with the United States that addressed corporate cross-border relationships and sought generally to combat tax evasion by resident entities. Comity concerns did not prevent enforcement of the summons according to the judge.

Practice Point: Given the effort the IRS expended in this case to obtain marginally relevant information, we clearly see the effects of increased audit resources at work and of the IRS’s mandate to target large corporate taxpayers. While there are certainly instances in every audit where a taxpayer should not expend resources just to fight a battle, the difficulty in cases like this is that absent this decision, Eaton likely felt bound to adhere to the GDPR for the sake of the employees working for its Irish affiliate.



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Understanding the IRC’s Excessive Refund Claim Penalty

by , and | May 8, 2024 | , , ,

Recently, the Internal Revenue Service (IRS) has been asserting the Internal Revenue Code Section 6676 penalty much more frequently in examinations and in court. For example, in 2023, a government counterclaim in the US District Court for the Middle District of Georgia sought to recover Section 6676 penalties in Townley v. United States. And, internal IRS guidance requires examiners to consider whether to assert the penalty in every case in which a refund is disallowed.

In light of these factors, and major questions being raised in high-profile tax cases like Moore v. United States, which is currently pending before the Supreme Court of the United States, taxpayers are wondering whether the penalty can be asserted as a protective refund claim.

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IRS (Belatedly) Strikes Back Against FedEx in Ongoing Foreign Tax Credit Case

by | Mar 14, 2024 | ,

FedEx Corporation, previously the victor in a closely watched dispute regarding the government’s regulatory attempt to prevent taxpayers from claiming foreign tax credits on offset earnings (131 AFTR 2d 2023-1284 (W.D. Tenn. 2023)), recently filed a motion for judgment in the US District Court for the Western District of Tennessee to confirm its resulting refund amount. FedEx says it filed the motion because the government ended negotiations for a joint proposal of judgment, told FedEx to file a motion and said it would oppose the motion based on a new argument that would reduce FedEx’s refund amount. The government did not provide a written description of its new argument, so FedEx forged ahead with what it could gather based on conversations with the government and filed its motion on March 8, 2024.

According to FedEx, the government’s new argument appears to rest on a different regulation (Treasury Regulation Section 1.965-5(c)(1)(i)), which limits foreign tax credits by withholding taxes paid to a foreign jurisdiction. This is known as the “Haircut Rule.” FedEx provides several reasons why the government’s argument based on the Haircut Rule should be rejected, including that the rule cannot apply where a taxpayer did not claim foreign tax credits based on withholding taxes, that the rule itself is procedurally deficient under the Administrative Procedure Act and that the government is simply too late in presenting the argument.

Practice Point: Given the late stage of the litigation, the government will likely face headwinds to get the court to consider its argument of whether the Haircut Rule applies. It is unclear from the motion how transparent the government was with the court while the parties attempted to reach a mutually agreeable refund computation. However, it appears fairly clear that the government could have argued the Haircut Rule as an alternative to its main position throughout the course of the 2023 briefing before the court. As with any argument newly conceived in the heat of litigation, parties should carefully consider the consequences of waiting to bring the argument to the court’s attention (with one of those consequences being that such new argument is rejected for dilatoriness).



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