F A R M F O C U S

Looking Back, Planning Ahead

The Small Company Tax Issue

By David A. Winston, J.D.
Senior Vice President, NAMIC Federal Affairs

Last year, Congress devoted more attention to small property/casualty company taxation than in all of the previous years combined since 1986.

Two major developments occurred during 2004.

Congress preserved the small property/casualty company tax exemption while shutting down the abuses associated with Section 501(c)(15). Congress repealed the $350,000 premium test established in 1986 and reverted back to the pre-1986 gross receipts standard to determine tax-exempt status, however increasing the gross receipts threshold to $600,000, 50 percent of which must come from premium income.
Both the House and Senate passed legislation to increase the Section 831(b) small property/casualty company election to be taxed solely on investment income from the $1.2 million established in 1986 to $1.89 million with an annual cost-of-living increase. Unfortunately, due to some relatively minor differences in the two versions, the House-Senate conference committee on the FSC/ETI “Jobs” bill did not include this provision in the final conference report because of revenue considerations.

What’s on the Horizon

NAMIC is working with the IRS/Treasury to obtain clarification of the definition of “gross receipts” that is not as broad as in the instructions to IRS Form 990. NAMIC also will make the expansion of Section 831(b) one of its highest legislative priorities in the 109th Congress. This issue will be emphasized during the 2005 Congressional Contact Program. Some 35 states are expected to come to Washington, D.C. to lobby their Congressional delegations.

Background

NAMIC represents more than 90 percent of small insurance companies, and has worked to preserve and improve the small company tax exemption for many years. Until the Pension Equity Funding Act amended the Section 501(c)(15) tax exemption in early 2004, the tax exemption was last modified in the 1986 Tax Reform Act. In 1999-2000, NAMIC made expansion of the tax exemption a priority. Our policy-making committees and the NAMIC Board agreed with the need for this reform that had been advocated by state associations representing farm mutual insurance companies. Since then, working with member companies and state trade associations, NAMIC has been the only organization in Washington seeking to preserve and increase the tax exemption.

In the just-concluded 108th Congress, NAMIC successfully lobbied to have legislation introduced in both the House and Senate to increase the Section 501(c)(15) premium test from $350,000 to $575,000 to account for inflation since 1986. In March 2003, Senators Kit Bond (R-Mo.) and Tim Johnson (D-S.D.) introduced a Senate bill, which was referred to the Senate Finance Committee. On April 1, 2003, a House bill, introduced by Rep. Jim Nussle (R-Iowa), was referred to the House Ways and Means Committee.

Neither bill moved because of the notoriety surrounding alleged abuses of Section 501(c)(15) by wealthy individuals and corporations forming small property/casualty insurance companies for the sole purpose of sheltering large amounts of investment income. Major coverage of this perceived tax abuse appeared in the New York Times, in Forbes, and as recently as February 2004 in Barrons. This manipulation of Section 501 (c)(15) became so pervasive that the IRS considered it among the worst tax abuse situations. The Service was determined to shut down the practice – perhaps by repealing Section 501(c)(15) completely and thereby eliminating the small property/casualty insurance company tax exemption. The NAMIC-backed legislation would have increased the premium test for its intended legitimate use by small property/casualty insurance companies. However well intentioned its motives, the legislation did not resolve the perceived tax abuse situation and ultimately was not considered by either the House Ways and Means Committee or the Senate Finance Committee.

It should be underscored that NAMIC much preferred the expansion of the premium test. However, the perceived tax abuse of Section 501(c)(15) made this approach politically untenable. Instead, Congress reverted to a gross receipts test model, in effect before 1986, to replace the premium test preferred by NAMIC. In July 2003, the FSC/ETI or American Jobs Creation (JOBS) Act of 2003 was introduced in the House. It included the new gross receipts test by limiting the Section 501(c)(15) exemption to companies with gross receipts less than $600,000, one-half (50 percent) of which must come from premiums. In October 2003, the Senate version of the JOBS bill was marked up. It included a small company tax provision as well. A property/casualty insurance company is eligible to be exempt from federal income tax if: a) its gross receipts for the taxable year do not exceed $600,000, and b) the premiums received for the taxable year are greater than 50 percent of its gross receipts.

NAMIC recognized the danger posed to the survival of the small property/casualty company tax exemption as a result of a well-established tax abuse situation, the need to close loopholes in the face of record national budget deficits, and the inability to increase taxes in an election year.

On February 2, 2004, the Bush Administration released the President’s fiscal year 2005 budget. Included in it was language addressing the widely reported abuse of the tax exemption in 501(c)(15). The Administration proposed a drastic reduction in the tax exemption when it proposed that 501(c)(15) apply only to mutual property/casualty insurance companies with no more than $350,000 in annual gross income.

On April 10, 2004, President Bush signed into law H.R. 3108, the Pension Equity Funding Act. In order to reach its revenue goal, the Conference Committee incorporated the gross receipts test that was part of the JOBS bill, replacing the premium test. This provision was scored by the Joint Committee on Taxation to raise $1.184 billion over 10 years.

The modified section 501(c)(15) allows a small property/casualty insurance company to be eligible for tax-exempt status if its gross receipts do not exceed $600,000 and the premiums received for the taxable year are greater than 50 percent of its annual gross receipts. An additional provision was added that stipulates that a small mutual property/casualty company is eligible to be exempt from federal income tax under Section 501(c)(15) if its gross receipts for the taxable year do not exceed $150,000, and the premiums received for the taxable year are greater than 35 percent of gross receipts, provided certain requirements are met. Those requirements are that no employee of the company or member of the employee’s family is an employee of another company that is tax exempt under Section 501(c)(15). The limitation to mutual companies and the limitation on employees were intended to address the concerns about the inappropriate use of tax-exempt companies to shelter investment income from federal taxes.

The Pension bill also modified Section 831(b) providing that a property/casualty insurance company may elect to be taxed only on taxable investment income if its net written premiums or direct written premiums (whichever is greater) do not exceed $1.2 million (without regard to whether such premiums exceed $350,000). For purposes of determining the amount of a company’s new written premiums or direct written premiums under this rule, premiums received by all members of a controlled group of corporations (as defined in Section 831 (b)) of which the company is a part are taken into account.

Gross Receipts

Regarding the definition of gross receipts in the new Section 501(c)(15), there is nothing in the pension bill that directs that the definition in Form 990 be used. There are other definitions of gross receipts available in the Internal Revenue Code. It is normal in the legislative process to let regulatory agencies provide guidance as to how to implement a statute.

In every stage of the legislative process, NAMIC consulted closely with many farm mutuals and state associations throughout the country as this legislation was being developed.

There is evidence that the new gross receipts standard, even using the Form 990 definition, will, on balance, be favorable as reported to NAMIC by one CPA who stated that three companies he represents that were previously taxable will now be tax exempt (out of 45 companies for which he does accounting work). In the one instance in which a company he represents will now be taxable, he notes this company has a very strong balance sheet. Further, he says companies affected by maturing bonds can structure their bond ladders so they will not have too much maturing in any given year. He concludes by stating, “in a quick review of the new law it appears to really benefit the small companies that it was intended to help.” However, because there are companies that will become taxable because of this overly broad standard, NAMIC is pursuing a private letter ruling from the IRS on this issue through a member NAMIC company.

The new law is effective for tax years beginning after Dec. 31, 2003, and therefore applies to the 2004 tax year. However, if a company obtains appropriate extension from the IRS, the return for 2004 does not have to be filed until September 15, 2005. It is entirely possible that by September the IRS might provide clarification of the term gross receipts for purposes of section 501(c)(15), Accordingly, those companies who believe that they are adversely affected may wish to file for an extension.

David A. Winston joined NAMIC in 2003 as vice president - federal affairs. He leads the association’s federal lobbying efforts from its Washington, D.C. office. David has more than two decades of federal government and insurance industry experience and has worked on a wide variety of legislative and regulatory issues affecting the insurance industry.

Posted: Friday, April 01, 2005 12:00:00 AM. Modified: Wednesday, September 07, 2005 2:54:23 PM.

(317) 875-5250 - Indianapolis | (202) 628-1558 - Washington, D.C.

Contact NAMIC | Press | Advertise | Sponsor

We are 1,400 property/casualty insurance companies serving more than 135 million auto, home and business policyholders, with more than $196 billion in premiums accounting for 50 percent of the automobile/homeowners market and 31 percent of the business insurance market. We are the largest and most diverse property/casualty trade association in the country, with regional and local mutual insurance companies on main streets across America joining many of the country’s largest national insurers who also call NAMIC their home. More than 200,000 people are employed by NAMIC members.