W hat is going on with captives? A nearly 40-year

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1 Tax Management Weekly State Tax Report Reproduced with permission from Tax Management Weekly State Tax Report, Volume: 2012 Issue: 37, 09/07/2012. Copyright 2012 by The Bureau of National Affairs, Inc. ( ) Revenue Captive insurance companies, which enjoy certain tax advantages under state law, lately have made their appearance in corporate structures as a means of preserving tax benefits that would not normally be allowed to related parties, most notably in the area of holding and managing intangible assets. In this article, Mark Sommer, of Bingham Greenebaum Doll LLP, and his colleagues discuss some of the important judicial and legislative developments facing captive insurance companies in state taxation. Are Taxing Authorities Holding Your SALT Planning Captive? A Look at Captive Insurance Trends in State and Local Tax BY MARK F. SOMMER, ROSS D. COHEN, AND JENNIFER Y. BARBER W hat is going on with captives? A nearly 40-year battle with the IRS and targeted state legislation limiting tax planning opportunities, and now, captives in the context of SALT are showing up in advance sheets of court decisions across the country. Recent Salt Developments Two states have recently had occasion to address captive insurance companies in the context of a SALT situation: Wendy s International Inc. v. Virginia Dept. Mark Sommer and Ross Cohen are Partners and tax attorneys resident in the Louisville office of the law firm of Bingham Greenebaum Doll LLP, where Mr. Sommer serves as Chair of the Tax and Bankruptcy Practice Group and specializes in state and local taxation. Mr. Cohen s practice is in federal tax, focusing on transactional and planning issues. Ms. Jennifer Barber, who is an associate of the firm, practices in the area of state and local taxation. of Taxn. 1 and Scioto Insurance Co. v. Oklahoma Tax Comn. 2 The courts, in addressing generally the same business structure, rendered two opinions different in analysis. In Wendy s International Inc. v. Virginia Dept. of Taxn., a captive insurance company was used to hold the trademarks and trade names of its parent through a disregarded entity. Wendy s International Inc. ( Wendy s ) formed Scioto 3 Insurance Company, a captive insurance company, which then formed Oldemark LLC ( Oldemark ). Oldemark s sole purpose was to hold Wendy s trademarks and trade names, and was classified as a disregarded entity for Virginia tax purposes. In calculating its Virginia corporation income tax, Wendy s added back the 3 percent royalties which it paid to Oldemark to sublicense the trademarks and trade names to related and unrelated restaurants. 4 In an income tax refund case, decided on March 29, 2012, a Virginia Circuit Court held that, despite the lack 1 Va. Cir. Ct. No. CL , Mar. 29, Okla. No , May 1, Scioto, pronounced sy-oh-toh, takes its name presumably from the Scioto River, which has its headwaters in Columbus, Ohio, the home of Wendy s International headquarters. 4 See id. Copyright 2012 TAX MANAGEMENT INC., a subsidiary of The Bureau of National Affairs, Inc. ISSN

2 2 of direct connection between Oldemark and the unrelated third-party restaurants, Wendy s qualified for the related-party addback exception, since Oldemark received at least one-third of its revenue from the unrelated restaurants (which is what the Virginia add back statute required), even though the royalties were received through Wendy s. 5 The addback exception did not require a direct connection between related member Oldemark and the unrelated sublicensees in order for Wendy s to preserve its deductions for intangible expenses and costs. In other words, Wendy s did not lose any of the tax benefits of its licensing payments. Although the use of a captive insurance company was not directly at issue in this case, its juxtaposition in the overall Wendy s corporate structure which was so heavily scrutinized by the Court, once again demonstrates that captive insurance companies for state tax planning purposes are the subject of enhanced, perhaps targeted, scrutiny by state tax officials these days. In Scioto Insurance Co. v. Oklahoma Tax Comn., 6 the Oklahoma Tax Commissioner assessed corporate income taxes against Scioto Insurance Company ( Scioto ), a Vermont corporation which insured various risks of Wendy s international and affiliates, based on payments Scioto received from the use of its trademarks by Wendy s restaurants in Oklahoma. In establishing Scioto, Wendy s International transferred the trademarks to Scioto to meet the capitalization requirements that the State of Vermont imposed upon insurance entities. Scioto protested the assessments on the ground that it did not contract with the Wendy s restaurants in Oklahoma for the use of the trademarks in question and did not conduct any business in Oklahoma. While Scioto derived income from licensing the trademarks, it argued that its only licensing agreement was with Wendy s International not individual Wendy s restaurants, which sub-licensed with Wendy s International to use the trademarks. On appeal, on May 1, 2012, the Supreme Court of Oklahoma vacated the Court of Civil Appeals adverse opinion, and held that Oklahoma simply has no connection to or power to regulate the licensing agreement between Scioto and Wendy s International, any more than it has a say in whether the State of Vermont should license or allow the intellectual property to be one of Scioto s capital assets. 7 Here, the use of a captive insurance company was directly at issue, and the juxtaposition of same in Wendy s corporate structure created additional distance to avoid corporate income taxation in Oklahoma. Captives Overview Back in the day, a captive insurance company was nothing more than an insurance company organized by one or more individuals or entities for the primary purpose of insuring the risks of related or affiliated businesses. Over time, captive insurance companies have evolved and adapted, now insuring risks of unrelated entities. Although current law offers some federal and state tax benefits for establishing and operating captives, the common view is that a captive arrangement 5 See id. 6 Okla. No , May 1, See id. should only be pursued for valid non-tax business purposes and only in the appropriate factual settings. There are varying, albeit common, types of captives. One of the most common is a single-parent captive insurance company, which consists of a captive established as a wholly-owned subsidiary of its parent company. The owner(s) of a single-parent itself can be one or more individuals or entities that also own (directly or through an affiliate) both the insured operating companies and the captive. A second type of captive, known as a group captive, is owned by several unrelated companies, which are usually also the insureds. One example would be competitors in the same industry (or an association of those competitors), that together form a group captive to insure a risk common to each of them. Yet another type of captive is a cell company, which is a corporation that is divided into many cells (each cell is a division of the corporation whose assets and liabilities are segregated from every other cell, and also from the core). Often the owner of the cell company core is an entity with customers, such as an insurance agent or captive manager, where each customer owns an individual cell. Sometimes, a series limited liability company is used in lieu of a cell company. There are multiple permutations of the foregoing. Use of a series LLC structure instead of a cell company structure is available only in those states which have enacted series LLC statutes and whose insurance regulators have approved their use. Conceptually, however, the two structures are similar. Rather than each customer owning an individual cell, it would own a particular series of the series LLC. In proposed regulations issued in 2010, the IRS advised that for Federal tax purposes, cell companies and series LLCs should be analyzed under the same framework, each being classified as a series organization. 8 As an example, a series LLC could be established with three members and three separate series. Under the terms of a limited liability company agreement, each member would be considered the owner of one of the series. Captive insurance arrangements are established for a number of business and economic reasons, including some or all of the following: risk management, risk retention, inability to obtain needed coverage, cost savings from lower premiums, ability to dampen the fluctuation of premiums, ability to contract directly for claims handling, direct access to wholesale reinsurance markets, desire to capture the commercial insurance industry s profits, need for increased coverage and capacity, and to bring formality to the risk management and financial aspects of retained risk. The Virginia and Oklahoma Wendy s cases, discussed infra, suggest an additional business use: intangible personal property asset holding and management. I. IRS Attacks Captives have been under attack by the IRS for years, and now it seems state and local authorities are taking aim at them as well. In 1977, the IRS announced that captive insurance arrangements for insuring related parties would not be respected for federal income tax purposes, no matter how they were structured. 9 The 8 See Prop. Reg (a)(5). 9 Rev. Rul , C.B Copyright 2012 TAX MANAGEMENT INC., a subsidiary of The Bureau of National Affairs, Inc. TM-WSTR ISSN

3 3 IRS won several early court cases because the captive at issue was poorly capitalized, or because the parent or insureds guaranteed the performance or solvency of the captive. 10 Over time the tide changed, and taxpayers with well-capitalized captives won several court cases, generally on one of two theories: the captive insured enough affiliates that owned no stock in the captive ( brother-sister ) 11 or the captive insured a sufficient amount of unrelated business ( third-party business ). 12 In 2001, the IRS formally reversed its 24-year policy on captives and announced that it would generally respect captive insurance arrangements for federal income tax purposes. However, the IRS ruled that it would continue to challenge certain captive arrangements based on their particular facts and circumstances. 13 Since 2001, in a series of rulings the IRS has further refined its views on when captive insurance arrangements should not be respected. 14 II. Federal Tax Benefits Section 162(a) of the Internal Revenue Code of 1986, as amended ( Code ), provides the general rule permitting deductions for all ordinary and necessary expenses incurred in connection with the operation of a trade or business. Treas. Reg (a) expressly provides that insurance premiums are deductible as ordinary and necessary business expenses. While the term insurance is not specifically defined in the Code or the Treasury Regulations, the United States Supreme Court in 1941 in Helvering v. Le Gierse 15 stated that historically and commonly insurance involves risk-shifting and risk-distributing. Although this case did not involve a captive insurance context, its requirements of risk-shifting and risk distribution have been adopted by courts in cases involving captive insurance companies. Subsequent cases have introduced additional requirements for a valid insurance arrangement. III. Elements of Insurance and Its Deductibility A valid insurance arrangement requires: (1) an insurance risk; (2) risk shifting; (3) risk distribution; and (4) commonly accepted notions of insurance See Beech Aircraft Corp. v. U.S., 797 F.2d 920 (10th Cir. 1986); Stearns-Roger Corp. v. U.S., 774 F.2d 414 (10th Cir. 1985); Carnation Co. v. Commissioner, 640 F.2d 1010 (9th Cir. 1981). See also Malone & Hyde Inc. v. Commissioner, 62 F.3d 835 (6th Cir. 1995). 11 See Humana v. Commissioner, 881 F.2d 247 (6th Cir. 1989). 12 See, e.g., Ocean Drilling & Exploration Co. v. U.S., 988 F.2d 1135 (Fed.Cir. 1993); Amerco v. Commissioner, 979 F.2d 162 (9th Cir. 1992); Sears, Roebuck and Co. v. Commissioner, 972 F.2d 858 (7th Cir. 1992); Harper Group v. Commissioner, 979 F.2d 1341 (9th Cir. 1992). 13 Rev. Rul , C.B See, e.g., Rev. Rul , C.B. 984; Rev. Rul , C.B. 985; Rev. Rul , C.B U.S. 531 (1941). 16 See, e.g., Sears, Roebuck and Co. v. Commissioner, 96 T.C. 61, (1991), aff d in part, rev d and remanded in part, 972 F.2d 858 (7th Cir. 1992); Harper Group v. Commissioner, 96 T.C. 45, 58 (1991), aff d, 979 F.2d 1341 (9th Cir. 1992); Amerco v. Commissioner, 96 T.C. 18, 38 (1991), aff d, Insurance Risk. The risk involved must be an insurance risk. Risks such as fire, windstorm, accident, etc. are obvious insurance risks. Risks that can produce a gain, rather than only a loss or neutral result, are investment risks rather than insurance risks. The IRS has ruled that retroactive insurance was not insurance under the facts involved because the covered event had occurred prior to obtaining coverage and thus shifted only investment risk; 17 however, many tax advisors generally think that retroactive insurance can be insurance under the right circumstances. In the area of warranties, the IRS has privately ruled that an imbedded express limited warranty is not an insurance risk, but rather is a business risk. 18 In subsequent rulings, the IRS has privately ruled that a separately priced extended warranty that can be declined by the customer is an insurance risk. 19 Recently, the IRS issued a Technical Advice Memorandum which concluded that a residual value risk is not an insurance risk. 20 Risk-Shifting. Risk-shifting requires that the risk involved must be transferred from the insured to the captive. Taxpayers have lost their cases because the parent or insured guaranteed the obligations of the captive, agreed to capitalize the captive if losses occurred or otherwise undercut the purported transfer of the risk to the captive. 21 Where no such guarantees exist and the captive is fully capitalized, risk shifting is normally found. Risk Distribution. Risk distribution has generated the most controversy of late. To find risk distribution, enough premiums must be pooled from enough risks such that the law of large numbers (law of averages) will result in actual losses approximating the projected losses. The IRS believes that no matter how many exposure units there are, there must be many different insured entities. The IRS position is that there can never be insurance if there is only one insured (nor if there are two insureds where one insured has 90% of the risks); this is true even where the insured and insurer are completely unrelated. 22 Generally, if there are enough operating subsidiaries (of a parent), then the premiums paid to the captive subsidiary (of the same parent) by those brother-sister subsidiaries are insurance, but the parent s premiums are not deductible (unless there is sufficient unrelated business). For example, the IRS will treat the arrangement as insurance if there are at least 12 subsidiaries, each of which pay between 5% and 15% of the captive s premiums. 23 The IRS does not count a disregarded single-member limited liability company as an insured. 24 It has informally concluded that a multi-member limited liability company (taxed as a partnership) is an insured and that each general part- 979 F.2d 162 (9th Cir. 1992); Ocean Drilling & Exploration Company v. U.S., 24 Cl. Ct. 714, 730 (1991), aff d, 988 F.2d 1135 (Fed. Cir. 1993). 17 Rev. Rul , C.B I.R.S. CCA (Jul. 14, 2006). 19 See I.R.S. Priv. Ltr. Rul (Aug. 4, 2006); I.R.S. Priv. Ltr. Rul (Mar. 14, 2008). 20 I.R.S. Tech. Adv. Mem (Dec. 9, 2011). 21 See cases cited supra note Rev. Rul , C.B. 4, Situations 1&2. 23 Rev. Rul , C.B Rev. Rul , C.B. 4, Situation 3. TAX MANAGEMENT WEEKLY STATE TAX REPORT ISSN BNA TAX

4 4 ner of a limited partnership is an insured, but not the individual members of a multi-member limited liability company or the limited partners of a limited partnership. 25 If there is enough unrelated business, the parent s premiums are insurance. The IRS s official position is that insurance exists where there is more than 50% unrelated business, but not where there is 10% unrelated business. The most favorable case for the taxpayer found insurance to exist where there was 29% unrelated business. 26 Commonly Accepted as Insurance. Ultimately, the captive insurance arrangement should have the look and feel of insurance. Perhaps not as perfunctory as the proverbial looks like a duck, walks like a duck test, but close to it. For instance, there should be reasonable capitalization, reasonable premiums, standard policy forms, reasonable reserves, standard investments, corporate formalities maintained, independent operation, and reasonable regulation. If a captive arrangement meets the definition of providing insurance, the captive entity may deduct the discounted present value of reserves for property or casualty losses and may include estimated losses in such reserves, even though claims may not yet have been filed. 27 A self-insured operating company cannot deduct reserves for property or casualty losses (e.g., liability, workers compensation, etc.), 28 In a similar vein, an operating company that buys insurance from a commercial carrier may deduct the premiums, 29 but it cannot deduct an equivalent amount set aside inside the entity for self-insurance, even if the amount of the set-aside is placed in an escrow account restricted to only paying claims. Since a captive insurance company is generally taxable on its premium income, the net federal income tax benefit to the entire group is typically the discounted present value of the loss reserve deduction claimed by the captive insurance company. State Taxation At the state tax level, captive insurance companies may afford insured parent corporations and other affiliates, important income tax advantages, and cash savings, because premium payments to the captive are generally deductible. The captive is then generally required to recognize the payment as premium income but since premiums are usually taxed at a more favorable rate than most other state level taxes, including income taxes, an advantage exists. At the state level, nearly all states do not subject an insurance company to a corporate income tax otherwise in place. Thus, even if a state has consolidated or combined corporate filing requirements, an insurance company oftentimes is carved 25 See I.R.S. Tech. Adv. Mem (Apr. 18, 2008); see also I.R.S. Priv. Ltr. Rul (Dec. 24, 2009). 26 Harper Group v. Commissioner, 979 F.2d 1341 (9th Cir. 1992). 27 I.R.C. 832(b)(5). 28 See, e.g., Treas. Reg (g)(2). 29 Treas. Reg (a). out of the taxable group. 30 In such an instance, as the income tax deduction for premiums paid may ultimately not be reduced or denied (or added-back), that tax benefit, coupled with the earnings of the captive upon its assets and reserves likely escaping state corporate income tax, makes the prospect of permanent, and material, tax benefits come front and center. While exceptions to all of the above may exist in various corners of the country, in theory the general rules prevail. And any premium tax which applies, if any, is generally that of the state where the covered risk is located. All of this enables a parent to shift risk to a captive insurance company, take a deduction for its premiums, and usually pay only a smaller premium tax through its captive insurance company and zero tax on non-premium earnings and gains. In light of these benefits, the use of captive insurance companies has increased dramatically in recent years. 31 Originally, captives were domiciled offshore, in socalled favorable tax countries like Bermuda where still nearly twenty-five percent (25%) of the world s captive insurance companies are registered and the Cayman Islands (roughly twenty percent (20%)). 32 But as of today, roughly thirty (30) states have adopted captive insurance statutes and structures, and many are in the process of altering their current laws in an effort to attract new captives and claim a piece of a more than $10 billion industry. 33 So, SALT impact as to the use of captives has surfaced, and is on many a taxing agency s radar screen. I. Mechanics of State Level Taxation As briefly touched upon, potential state tax benefits can come in several forms: (1) a tax deduction for the payor for insurance premiums paid to the captive; (2) possibly no income tax-related give-back, haircut, or addback of the premium paid (deducted) by the payor to the captive; (3) the earnings (including premium income) may avoid state corporation income taxation everywhere thus non-premium earnings, capital gain and the like of the captive might not be taxed for state corporation income tax purposes; (4) premium taxes paid by the captive are generally based on the location of the risk covered, which may allow a tax savings as a result; and (5) some jurisdictions may offer extrafavorable premium tax provisions (i.e., lower rates) as an inducement to having a captive insurance company locate there. Most states with captive insurance laws use a sliding scale to tax premiums, with the percentage of premi- 30 See AT&T Corp. and Subsidiaries v. Kentucky Finance and Admin. Cabinet, Jefferson Cir. Ct. No. 08-CI Sept. 9, 2008, on appeal, Ky. Ct. App. No CA See Cassandra R. Cole & Kathleen A. McCullough, Captive Domiciles: Trends and Recent Changes, 26-4 JOURNAL OF IN- SURANCE REGULATION 61 (2008). 32 See International Association of Insurance Supervisors, Issues Paper on the Regulation and Supervision of Captive Insurance Companies, p. 50 (Oct. 2006); William Elliot, A Guide to Captive Insurance (Part 1), JOURNAL OF INTERNATIONAL TAXATION (2008). 33 See Mary Williams Walsh & Louise Story, Seeking Business, States Loosen Insurance Rules, N.Y. TIMES (May 8, 2011); Cyril Touhy, How to docile a jostle for domiciles? Seeking a niche onshore captive domiciles jockey for position behind Vermont. Competing for second place is tougher than it used to be, 17 RISK &INSURANCE 26 (2006) Copyright 2012 TAX MANAGEMENT INC., a subsidiary of The Bureau of National Affairs, Inc. TM-WSTR ISSN

5 5 ums taxed decreasing as premium volume increases. At the core, this encourages the captive to locate in state. There is, of course, variation in the taxes levied within and among each state but a majority of states provide a minimum and maximum premium tax as well. For example, Alabama, New York, and Oklahoma require captive insurance companies to pay taxes on direct premiums and reinsurance premiums at different rates per each $20 million increment, but also provide a minimum premiums tax of $5,000 in the event that the company s total tax on direct premiums and reinsurance premiums falls below that figure. 34 Vermont provides for a $7,500 minimum premiums tax and a $200,000 annual maximum aggregate tax, 35 while South Carolina provides for a maximum premium tax payment of $100, The rates are all over the board. II. Economic Competition Among the States 34 See generally Ala. Code 27-31B; N.Y. Tax Law 1502; Okla. Stat. tit. 36, See generally Vt. Stat. Ann. tit. 8, See generally S.C. Code Ann See Cyril Tuohy, A further deepening of advocacy: after 40 years, the time has come for CICA to take a stand and spend more time advocating on behalf of its members. Will it lose its original reason for being? 23 RISK & INSURANCE 32 (2012); Lynnley Browning, Vermont Becomes Offshore Insurance Haven, N.Y. TIMES (Apr. 4, 2007). 38 See Tuohy, supra note See Walsh, supra note See id. Published reports suggest that with 590 active captive insurance companies licensed in Vermont, it is easily the leader among the states trying to attract captive insurers to domesticate therein. 37 And Vermont s list of captive insurance companies continues to grow. In 2011 alone, Vermont added 41 new captive insurance companies to those already operating in state. 38 Perhaps another jobs war is at hand among the states in the insurance arena? Vermont has had captive insurance laws on its books since the early 1980s, and generally has the most developed regulations and administrative enforcement, making it the ideal domicile for domestic captives. Attracting captive insurance companies promotes prestige, business travel and jobs from which states receive direct tax revenue; not to mention revenue from premium taxes, and payroll taxes, etc. Vermont aggressively sought out the captive insurance industry in 2001, when Governor Howard Dean announced the state would take on Bermuda. 39 Before long, the taxes levied by Vermont on the insurance premiums collected by its domiciled captive insurance companies were approximately 2 percent of the state s spending, and the captives industry accounted for 1,400 full and part-time jobs, with a resulting roughly $1 billion deposited with in-state banks and financial institutions. 40 With all of the above comes additional state and local tax revenue in various pieces and tranches, and let us not forget the economic multiplier impact on the locales and businesses therein for all of this cash. Now a handful of other states including Arizona, Hawaii, Utah, and Delaware are aggressively remaking their laws to become more competitive with Vermont. 41 For example, Hawaii lowered taxes on the premiums received by captive insurance companies to a rate lower than that of Vermont, causing Vermont to reconsider its rates. 42 III. State Efforts to Combat Captives With aggressive pro-captive industry action on the formation and regulatory side well underway, one might wonder why the increased scrutiny of the captives for SALT purposes? The answer may very well be the same for each: Show me the money. While the number of captive insurance companies have increased significantly in recent years, so, too, have some states enforcement against what they allege are potentially abusive effects of, and fallout from, captive insurance companies translation: increased tax revenue. There are at least three rather basic ways for a state to combat the potentially abusive tax effects of captive insurance companies. First, the state could attack the captive directly by arguing that the captive is not an insurance company as a matter of law and, therefore, cannot benefit from the favorable premium tax rate, and the concomitant exemption from corporate income tax or its reduced rates. With pro-industry action on the formation and regulation of captives, why the increased scrutiny of captives for SALT purposes? Second, the state could adopt tightened combined reporting for corporate income tax purposes, specifically addressing and including captive insurance companies. Under combined reporting, the parent and most subsidiaries, including any captives, are treated as a single entity for state income tax purposes, possibly resulting in a tax to the captive approximately equal to its share of the entity s combined tax liability. This could also be addressed directly or indirectly through the haircut or addback mechanisms that are designed to eliminate tax benefits from related parties. One example of an attack is found in Illinois Dept. of Rev. v. Gatsby Industries Inc., 43 where an Illinois administrative law judge held that a Vermont captive insurance company that did not qualify as an insurance company for federal income tax purposes was not an insurance company for Illinois state income tax purposes. There, the captive insurance company made loans to the parent, which accounted for roughly 98 percent of the captive s assets and 68 percent of the captive s income. The captive did not issue any insurance policies to third parties. The Illinois administrative judge held that the captive had to be included in the parent corporation s unitary group income tax return. Many states do not define what constitutes an insurance company 41 See Browning, supra note 28; Cole, supra note 37, at Table 1 (for full list of states that have captive insurance laws ranked by number of captives located in each state). 42 See Walsh, supra note Illinois Administrative Hearing IT 00-10, No. 98-IT-0000, May 16, TAX MANAGEMENT WEEKLY STATE TAX REPORT ISSN BNA TAX

6 6 for corporation income tax purposes. 44 Accordingly, some freedom may exist on the ground now, which a state could close through tighter legislation on the controlling definitions. Not surprisingly, still other states have adopted specific legislative measures to combat captive arrangements. For example, Illinois imposes a privilege tax on a domestic captive insurance company doing business in the state and an income tax on a captive insurance company if the captive s income is derived solely from within the state. 45 New York, viewed by many as one of the most progressive states when it comes to state tax laws, excludes overcapitalized captive insurance companies from the definition of an insurance corporation and requires such overcapitalized captives to be included in a combined return with the closest controlling stockholder. 46 In New York, captive insurance companies must pay a tax on all gross direct premiums and all reinsurance premiums located or resident in New York. South Carolina s approach is different it imposes a tax on captive insurance companies based on direct premiums and reinsurance premiums collected on policies of insurance contracts written by the captive insurance company. South Carolina also excludes the use of captive insurance companies from workers compensation insurance. 47 IV. Dodd-Frank Act And to state the obvious, the more things change, the more they stay the same, even in the world of captives. Included as part of the 2,319 page federal Wall Street Reform and Consumer Protection Bill, commonly known as the Dodd-Frank Act, was a relatively obscure provision aimed at simplifying state taxation and regulation of surplus lines insurance. The Non-Admitted and Reinsurance Reform Act of 2010 ( NRRA ), effective July 21, 2011, provides that no state, except the home state of the insured, may impose a premium tax on non-admitted insurers. 48 For companies with a captive insurance company in their structure, the issues are: (1) will their home state impose a premium tax on 100 percent of the premiums paid to the captive, regardless of where the risk is located; (2) at what rate; (3) is the home state a member of the multistate compact; and (4) if so, what does the multistate compact require? 44 See, e.g., Ky. Rev. Stat. Ann See 35 ILCS 5/ See N.Y. Tax Law See S.C. Code Ann See Section 521 of the Dodd-Frank Act. Non-admitted insurance means any property and casualty insurance permitted to be placed directly or through a surplus lines broker with a non-admitted insurer eligible to accept such insurance. 49 Home state means the state in which an insured maintain its principal place of business or, in the case of an individual, the individual s primary residence. 50 If 100% of the insured risk is located out of the state, then the home state is the state to which the greatest percentage of the insured s taxable premium for that insurance contract is allocated. 51 The NRRA is yet another piece of legislative and regulatory action fundamentally altering the tax liability of many companies employing a captive insurance entity within its corporate family. While the NRRA was aimed primarily at simplifying the taxation and regulation of surplus lines insurance, the collateral effect on captive insurance companies is significant. Companies that did not pay a premium tax on insurance purchased from its captive insurance company likely have significantly increased its liability if its home state imposes its tax on all risks wherever located. So far, reports are that more than half of states have incorporated the elements of NRRA in state tax codes. Conclusion In some cases, corporate taxpayers already have captive insurance companies within their pre-existing corporate group for good and valid business purposes, and are well positioned to simply capitalize on inherent SALT opportunities, which are ample, and for some, quite material. In other instances, corporate taxpayers can create those alternative entities for varying business reasons, including, among others, holding assets, streamlining corporate structure, and reducing state and local taxes. While state tax authorities may be predisposed to attack structures involving entities created primarily for the purpose of avoiding state and local taxes, this is often far from a clear determination. So where are we now, given all of the above? At this point, prudence suggests that companies like Wendy s, which use captive insurance companies in their corporate structure for one reason or another, should become aware of the increased efforts by some state and local taxing authorities to combat captive arrangements, and monitor all appropriately. 49 See Section 527(9) of the Dodd-Frank Act. 50 See Section 527(6) of the Dodd-Frank Act. 51 See id Copyright 2012 TAX MANAGEMENT INC., a subsidiary of The Bureau of National Affairs, Inc. TM-WSTR ISSN