With apologies to Benjamin Franklin, nothing is certain in the insurance business except premium taxes. While many companies view premium taxes as simply a given 2% state levy on gross revenues, others are taking a closer look them. In reality, that 2% is a rough average. Premium tax rates can differ from state to state by as much as 3% or more.
What makes this more than just a bit of trivia with which to bore your non-insurance friends is the fact that companies legally domiciled in states with relatively high premium tax rates (states with rates above the 2% national average) also pay higher rates in other states than do companies domiciled in states with below-average tax rates. This added tax burden is known as the retaliatory tax. Through the imposition of the retaliatory tax, companies domiciled in high-tax states effectively pay to make up the difference between the taxes charged by lower-rate states and those levied by their home state upon business written by companies domiciled in those other states. For companies domiciled in high-tax states, retaliatory tax dollars can be significant. Consider the following example:
Your company recently purchased a mid-sized carrier domiciled in State A. The premium tax rate in State A is 2.75%. This subsidiary’s top five premium states are State A, State B with a 1.5% premium tax rate, State C with a 2.0% rate, State D with a 1.75% rate, and State E with a 2.25% rate. Since the tax rate in State A is higher than the rates charged by the remaining four states, the subsidiary would pay the State A rate on writings in all of the other states. Assuming the combined premium writings in States B through E total $100 million, the subsidiary would pay a total of $2.75 million in premium taxes on those writings.
Now assume that the subsidiary is domiciled in State B, the state with a 1.5% premium tax rate, instead of State A. Writings in State A would still be taxed at the 2.75% rate but, since State B’s tax rate is lower than the tax rate in the remaining states, writings in States B through E would now be taxed at each state’s statutory rate without retaliation. Assuming, for purposes of illustration, that the total $100 million in premium writings in States B through E is evenly distributed, the total premium tax bill on the writings in those states would look like this:
State B ($25,000,000) at 1.5% = $375,000
State C ($25,000,000) at 2.0% = $500,000
State D ($25,000,000) at 1.75% = $437,500
State E ($25,000,000) at 2.25% = $562,500
Total = $1.875 million
Now compare that total with the $2.75 million tax bill in the first example. The bottom line: your company could save $875,000 annually in taxes on the subsidiary’s writings in States B through E by changing the subsidiary’s state of domicile from State A to State B.
Redomestication, the process of changing a corporation’s state of domicile, has become an increasingly popular means for companies to avoid or reduce the impact of retaliatory taxes. Several major insurers and insurer groups have successfully redomesticated in recent years. To understand what redomestication entails, it is important to understand what redomestication is not.
First, redomestication does not require the complete, physical relocation of a company’s operations to the new state. As discussed later in this series, however, the new state will likely require the company to maintain some physical presence within its borders.
Second, redomestication does not require that the company withdraw from doing business in its current state. After redomesticating to the new state, the company may continue to operate in its former state of domicile as a foreign-state insurer. All approvals and agent appointments remain in effect in the former home state, as well as in the other states in which the company does business.
Other Possible Benefits
While the reduction or avoidance of retaliatory taxes is usually the main driver behind redomestication, it is important to consider other possible benefits as well. As one example, the company may find that the regulatory environment of its current home state is generally not as favorable as it is in other states. Perhaps the current home state imposes overly restrictive or burdensome requirements on domiciliary companies such as unreasonably strict limits on investments or costly disaster-recovery requirements. Redomestication offers companies in such states the opportunity to choose a more pro-business home state.
Redomestication may also offer the opportunity for greater efficiencies and reduced costs. Companies may find that the new state offers the opportunity to gain access to a deeper, better-qualified and/or more affordable labor pool than it enjoys in its current home state. Again, while redomestication generally does not require a significant shift in operations, some presence in the new state, usually in the form of new jobs, will likely be necessary. This is usually coupled with further tax incentives that, in turn, offer the opportunity for lower employment costs.
Finally, redomestication to a state where another affiliate is located offers the opportunity for the companies to operate under a common regulatory framework, thereby reducing compliance costs to the group. The new state may also place both companies on a common examination schedule thereby allowing the group to avoid the cost of redundant exams.
The Lawson Firm, LLC provides comprehensive legal services to insurers of all sizes including advice and assistance with redomestication, state licensing, tax reduction strategies, and compliance. For companies considering redomestication, the firm provides assistance with planning and analysis, domicile selection analysis, document preparation, state filing and regulatory approval. Please feel free contact me to discuss your company’s needs in this area: Scott Lawson, E: email@example.com, P: +1 (440) 666-9735.♦ Profile – Scott Lawson
Attorney Advertising. The Lawson Firm, LLC (“TLF”) is a law firm providing legal counsel and value-added legal services to its business clients. Further information about TLF may be found at www.lawsonfirm.net. This article is intended to provide general information only and is not intended to provide solutions to specific issues. Readers are cautioned not to attempt to solve specific issues solely on the basis of the information contained in the article. TLF does not claim expertise in the laws of jurisdictions other than those in which our attorneys are licensed. Certification in any of the practice areas mentioned in this article is not available in Ohio.