New York’s Attempt to Subject Surplus Lines Insurers to Insurance Franchise Tax

New York has increasingly asserted that unauthorized insurance companies — including surplus lines insurance companies — are subject to New York insurance franchise tax. However, there are several arguments against these broad impositions of tax.

Unlike traditional premium taxes, New York’s insurance franchise tax operates like a corporate franchise tax. Under the insurance franchise tax, New York imposes tax on the insurance company’s entire net income or capital, not just on gross premiums. There is also a premium tax component for certain companies.

When New York first enacted the insurance franchise tax in the 1970s, it applied similarly to all types of insurance companies: life and nonlife. In 2003, New York amended its insurance tax regime. The newly enacted law, New York Tax Law § 1502-a, imposed a traditional premium tax in lieu of the insurance franchise tax for authorized nonlife insurance companies. The new law did not address unauthorized nonlife insurance companies, triggering uncertainty on its application.

The New York State Department of Taxation and Finance’s (Department) resolution to this uncertainty was to subject unauthorized nonlife and unauthorized life insurance companies to the franchise tax. The insurance franchise tax law provided a “cap” on the total amount of tax due, which was based on authorized New York life insurance premiums.

The Department reversed its position in a 2012 technical memorandum (TSB-M), which noted the “cap” did not apply to unauthorized life insurance companies.

The tax base for insurance franchise tax is entire net income or capital apportioned to New York, based 90 percent on a ratio of the New York premiums over the everywhere premiums (the other 10 percent is a compensation ratio). The capital tax base often applies to insurance companies, which may have nominal taxable income but substantial capital.

New York Advisory Opinions

In two recent advisory opinions, the Department determined that unauthorized nonlife insurance corporations (surplus lines companies) are subject to the insurance franchise tax (under N.Y. Tax Law § 1502), and not the insurance premium tax (under N.Y. Tax Law § 1502-a). TSB-A-16(4)C; TSB-A-16(5)C (June 10, 2016). The Department also reiterated its view that these insurance companies’ franchise tax liability will not be capped by N.Y. Tax Law § 1505(a)(1), consistent with Service Lloyds Ins. Co., TSB-A-09-(2)C (Mar. 2, 2009).

Insurance companies asserted that the insurance franchise tax does not apply to surplus lines companies because the direct placement tax or surplus lines tax is in lieu of the insurance franchise tax. The Department rejected this argument, concluding there was no double taxation.

New York imposes a direct placement tax or a surplus lines tax on the insured or broker at a rate of 3.6 percent of premiums paid for unauthorized insurance. Thus, it is arguably improper and inequitable for New York to also impose insurance franchise tax based on those same premiums.

The Department’s recent guidance is consistent with, though potentially much broader than, recent New York State Division of Tax Appeals administrative law judge (ALJ) determinations currently on appeal with the New York State Tax Appeals Tribunal. The ALJ determinations subjected unauthorized nonlife insurance companies (non-surplus lines insurance companies) to insurance franchise tax only on their distributive share of income and capital from limited partnerships doing business in New York, because the limited partnerships were the only connection the companies had with New York. However, the advisory opinions do not provide this limitation for surplus lines companies, which receive New York premiums.

Limiting New York’s Position

There are several arguments limiting New York’s position. As a threshold matter, insurance companies need to analyze whether they have sufficient contacts with New York for New York to statutorily and constitutionally impose a tax filing obligation on them. Recent ALJ determinations and advisory opinions do not address the nexus threshold, although some previous advisory opinions do.

Although the recent advisory opinions note that the direct placement tax/surplus lines tax is not in lieu of the insurance franchise tax, there are arguments against the Department’s position. These opinions are not precedential.

The federal Nonadmitted and Reinsurance Reform Act (NRRA) likely preempts New York from imposing insurance franchise tax on an unauthorized insurance company to the extent that the premiums are derived from insureds whose home state is not New York. The NRRA provides that no state other than the home state of an insured may require any premium tax payment for nonadmitted insurance. The NRRA defines “premium tax” as: (1) any charge; (2) imposed by a government entity; (3) directly or indirectly; (4) based on any payment made as consideration for nonadmitted insurance. New York’s franchise tax is a charge by a governmental entity that is, at least indirectly, based on a payment made as consideration for nonadmitted insurance. Therefore, New York’s position may be limited by the federal NRRA. Neither ALJ determinations nor New York advisory opinions have addressed this federal preemption issue.

The state tax landscape for unauthorized insurance companies is shifting rapidly, particularly in New York. Unauthorized insurance companies should pay careful attention to these developments and determine the extent to which they may be affected.

Topics Carriers New York Excess Surplus