Mass. Proposes Corporate Tax for Insurer-Owned Pass-Through Entities

By | February 6, 2014

As part of his administration’s plan for new tax revenues, Massachusetts Gov. Deval Patrick recently proposed applying a corporate tax rate to the state’s “pass-through entities” that are owned by insurance companies. The proposal was part of Gov. Patrick’s fiscal year 2015 budget recommendation, filed on Jan. 22.

Currently, income earned by pass-through entities — such as partnerships — that are owned by licensed life or property/casualty insurers is excluded from Massachusetts income tax because the owners are subject to a premiums tax, and not the income or franchise tax based on the net income of the entity, according to law firm Sutherland Asbill & Brennan LLP. The governor’s proposal would treat pass-through entities that are at least 50 percent owned by insurance companies as corporate entities for Massachusetts tax purposes, the law firm notes.

Supporters of the governor’s proposal believe that insurers conducting non-insurance business in these pass-through entities obtain an unintended tax advantage, according to Sutherland Asbill & Brennan. The governor’s office was not immediately available for comment.

Marc Simonetti, a New York-based partner at Sutherland Asbill & Brennan who specializes in state taxation, said a similar proposal has been previously discussed at the Multistate Tax Commission, an organization of state tax administrators, but that it was later discontinued. And Massachusetts now appears to be the only state proposing this type of pass-through tax provision, he said.

Simonetti observed that in addition to more traditional investments, insurance companies have also been putting money in different types of pass-throughs such as partnerships and limited liability companies.

“And what has transpired is that there has been some thought among some state tax administrators that the income that is being earned by a pass-through entity that ultimately flows up to an insurance company was escaping the income tax,” Simonetti said. The reason for that is because insurance companies are subject to a premiums tax, which is different from the corporate income tax.

“That’s really a fundamental unwritten rule between insurance companies and state tax administrators, that insurance companies should be and are subject to tax on premium receipts — on a gross receipts basis — and so they pay that tax in lieu of any type of income tax,” he said. “So, whether the insurance company makes money or loses money, it doesn’t matter; whatever their premium receipts are for the year is what they pay tax on.”

Historically, this arrangement has been respected from both sides, from the insurance companies’ side as well as from state legislatures and state tax administrators’ side, Simonetti said.

“This recent development we are seeing is a push by state tax administrators, originally through the Multistate Tax Commission,” the attorney said. The Multistate Tax Commission had previously put forward this type of tax regime for pass-through entities, but the business community was successful in demonstrating to the Multistate Tax Commission that such a tax would be inappropriate, he noted.

“And now, it has materialized in the Massachusetts budget legislation, which says that pass-through entities that are owned or even partially owned by insurance companies would be subject to an income tax even though the insurance entity itself is still subject to the premiums tax on a gross basis.”

The Massachusetts proposal would apply to all insurance companies that have an ownership in pass-through entities that operate in Massachusetts, the attorney said. The pass-through entity legislation, which is lumped in with other pieces of legislation, values the proposed tax as part of $40 million in new tax revenues that could also include a room occupancy tax proposal on the mark-up that room resellers like online travel websites receive.

But Simonetti estimates the figure presented is probably much lower than the actual revenue that could be collected, if the proposal were to be implemented.

The next step for the governor’s proposal is the state legislature. “It will still have to go through the legislature and they would have to actually put forth legislation to enact the governor’s budget proposal,” Simonetti said.

Regarding the chances of passage, “I would say it’s a little uncertain right now,” he added. “I think you will see that as people become more aware of it, you will see a substantial push by the business community to illustrate to the governor why this is a bad tax policy. It goes counter to the unwritten agreement between insurance companies and the states.”

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