State Taxation of Captive Insurance Companies

Captive insurance companies are subject to state taxes in the state where they are formed. These taxes may include license fees, premium taxes, and franchise taxes, etc.

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A captive is not necessarily subject to state taxes in states where it is not formed or qualified to do business, but where it is underwriting risks. For purposes of this discussion, let us consider the case where a person owns an operating business in State A and then forms a captive in State B.

The captive in State B will be used to underwrite some of the insurance risks of the operating business in State A.

Question: Will the captive be subject to taxes in State A because it is underwriting insurance in State A?

Answer: No, so long as the captive avoids certain factors that could cause it to be subject to regulation in State A.

The U.S. Supreme Court has held that a state (State A in this example) may not tax an out-of-state insurance company (State B in this example) so long as certain factors are present. The factors include:

• All of the insurers are domiciled outside of State A.

• All of the insurance agreements made the basis of the tax were contracted for, signed, issued, delivered, paid for, and accepted out of State A.

• None of the insurers has a permit or license from State A to write insurance in the state and none of the insurers are subject to examination or subject to any control by State A.

• None of the insurers has an office or agent in State A.

• None of the insurers investigated or adjusted claims within State A.

• None of the insurers ever solicited the insurance business or policies within State A.

• None of the insurers communicated with the operating business within State A.

• All decisions relative to the purchase and renewal of insurance, extent and amount of coverage, the selection of insurers and confirmation of insurance contracts are made outside of State A.

• Under the policies, all losses are payable out-of-state and all premiums are paid out of State A.

In other words, while a captive formed in State B may underwrite risks in State A without being subject to State A's taxes, the State B captive must have no other contacts whatsoever with State A. In practice, this means that the owner of the operating business in State A must travel to State B to negotiate, arrange, execute and pay the insurance contracts from the State B captive.

This is is all discussed at considerable length in a recent case where Texas unsuccessfully attempted to tax Dow Chemical's purchase of insurance from out-of-state insurance companies, see Dow Chemical Inc. v. Rylander

The practical ramifications of all this are as follows:

1. Don't domicile or qualify your captive in the same state as any operating business that it will be underwriting, and strenuously avoid any contacts with that state

2. Subject to no. 1, since you can put your captive anywhere, you might as well choose a captive domicile that imposes low taxes on the captive