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November 27, 2018

Illinois Corporate Income Tax- Apportioning Insurance Company Income

Authored by Christopher Lutz

 in State & Local Tax (SALT)

In a previous post, we addressed the basics of Illinois corporate income tax apportionment. We also addressed how while most corporations are required to follow the standard statutory formula, the state imposes unique rules on a number of industries, including  financial organizations. In addition to financial organizations, insurance companies must also apportion their income to Illinois according to special rules. As with financial organizations, beginning with the tax year ending December 31, 2017, insurance companies must be included in the combined return with the entire unitary business group.[1]

Identifying Financial Organizations

Insurance companies are defined as "any taxpayer properly treated as an insurance company for purposes of federal income taxation under subchapter L of the Internal Revenue Code (IRC sections 801 through 848)… No other taxpayer may be treated as an insurance company for purposes of the" Illinois Income Tax Act.[2] In 2013, the Illinois Appellate Court addressed whether a captive insurance company that was formed to self-insure risks could qualify as an insurance company for Illinois Income Tax purposes.[3] The insurance company was licensed in Vermont and for federal purposes to transaction business as an insurance company. In order for the company to be qualified in Vermont, the state of its formation, as a "captive insurance company," it was required to be sufficiently capitalized to cover all of its insurance obligations. As a result, the captive insurance company acquired an affiliate of the unitary group that held the unitary business group's trademarks. The subsidiary then licensed the trademarks in exchange for royalties.

Based on Illinois law in place at the time, the Illinois combined group excluded the captive insurance company from its Illinois base income because insurance companies were required to file separate returns in Illinois. The Illinois Department of Revenue took the position that the captive insurance company was required to be included in the combined group because it was not a proper insurance company. The Department contended that the entity was not an insurance company because "(1) there was not actual risk shifting and risk distribution to constitute insurance for federal income tax purposes, (2) the majority of [its] income is derived from intercompany royalty income, and (3) it is not regulated in all of the states in which it writes premiums."[4] Siding with the taxpayer, the Appellate Court concluded that although the company's income from "insurance premiums was dwarfed by its royalty and interest income, it is not any percentage of income that determines whether a company is taxable as an insurance company but rather the character of the business actually done by the company."[5] The captive insurance company was licensed by Vermont as an insurance company, and its only business was to furnish insurance to the combined group. The insurance company itself, moreover, was not engaged in the business of licensing intellectual property; that activity was conducted by its subsidiary. Finally, the ownership of the trademark subsidiary was directly related to the insurance company's conduct as an insurance company because it enabled the company to satisfy the capitalization requirements under Vermont law.  As a result, despite the substantial benefit of excluding all royalty income from the Illinois combined group's base income, the entity was in fact an insurance company, and was required to be excluded from the Illinois combined group. Of course, beginning with the tax year ending December 31, 2017, the company would be included in the Illinois combined group as a result of IL Public Act 100-0022.

Apportionment of Insurance Company Income

Once a company is identified as an insurance company, the business income of the entity for a taxable year shall be apportioned to Illinois by multiplying its income by a fraction, the numerator of which is the direct premiums written for insurance upon property or risk in Illinois, and the denominator of which is the direct premiums written for insurance upon property or risk everywhere. The term "direct premiums written" means the total amount of direct premiums written, assessments and annuity considerations as reported for the taxable year on the annual statement filed by the company with the Illinois Director of Insurance in the form approved by the National Convention of Insurance Commissioners or such other forms as may be prescribed in lieu thereof.[6]

Only direct premiums written for insurance, assessments against mutual policy holders, and consideration for annuity contracts that include elements of insurance should be included in the apportionment factor.[7] Other types of income should be excluded from the factor. Examples of these excluded receipts include: (1) interest, dividends, and other income from investments, (2) gains or losses from the adjustment of reserves, salvage, or subrogation, (3) deposit-type funds, and (4) premiums on which state income taxes are prohibited by federal law.[8]

In calculating the combined group's apportionment factor, a separate subgroup schedule has been created for entities subject to different apportionment methods, including insurance companies[9].  The "Illinois sales" calculated on the subgroup schedule are then used on Step 4, Lines 2 and 3 of the Schedule UB to calculate the blended Illinois apportionment formula. It is also always important to keep in mind that Illinois follows the "Joyce" rule. Consequently, if a member of a combined group does not have nexus with Illinois, its income should be included in base income and the denominator of the apportionment factor, but receipts that would otherwise be apportioned to Illinois should be excluded from the numerator of the apportionment factor.[10]

Conclusion

Illinois uses a fairly straightforward definition for insurance companies; all entities so qualified for federal purposes with their business purpose being the provision of insurance will be considered insurance companies under Illinois law.  For tax years beginning on tax year ending December 31, 2017, these entities should be included in an Illinois combined return. However, insurance companies continue to use a different apportionment formula, and exclude certain receipts, like interest income, from the apportionment factor. The factor is then combined with the rest of the Illinois group to create a blended apportionment ratio on the Illinois Schedule UB.



[1] IL Public Act 100-0022; 35 ILCS 5/1501; 86 Ill. Admin. Code 100.9750(b).

[2] 86 Ill. Admin. Code 100.3420(b).

[3] Wendy's Int'l Inc. v. Hamer, 375 Ill. Dec. 194 (2013).

[4] Id.

[5] Id. (internal quotations removed).

[6] 35 ILCS 5/304(b). 

[7] 86 Ill. Admin. Code 100.3420(2).

[8] 86 Ill. Admin. Code 100.3420(3)(A)-(D).

[9] Schedule UB Instructions. 

[10] 86 Ill. Admin. Code 100.9720(f). 

 

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