Illinois – Captive Insurance Company Qualifies as Insurance Company for Income Tax Purposes
In a recent decision, the Illinois Appellate Court held that a captive insurance company qualifies as an insurance company for Illinois corporate income tax purposes. The Appellate Court found that the captive insurance company did qualify as an insurance company because it was recognized as such for federal income tax purposes and its main business purpose aligned with that of an insurance company.
The Illinois Department of Revenue asserted that the entity was not an insurance company because there was not actual risk shifting to constitute insurance for federal income tax purposes, the majority of income was from intercompany royalties, and it is not regulated in all states in which it writes premiums.
Under Illinois income tax law, insurance companies cannot be included in the income tax filing of a unitary business group with non-insurance companies. Insurance companies are also subject to specific rules relating to apportionment of income to the state, as are financial institutions and transportation companies. In 2006, Illinois issued Wendy’s International, Inc. (Wendy's) two notices of deficiency for tax years 2001 – 2006 in a total amount of $2,491,313. Illinois argued that Scioto Insurance Company (Scioto), a wholly owned subsidiary of Wendy’s, was required to be included in the unitary business group filing because it did not qualify as an insurance company.
Illinois law provides that an insurance company is defined for Illinois purposes as it is defined under federal law. Wendy’s proved that Scioto is in fact a bona fide insurance company by showing that it does provide a wide-range of risk distribution services to its affiliated entities and that it had been audited by the IRS and regarded as an insurance company as a result of the examination. Wendy’s supported this with the fact that its consolidated income tax returns have been audited by the IRS for the same years that are in contention, and the IRS confirmed that Scioto was able to take deductions specifically available to insurance companies.
Several questions arise from this recent ruling:
- Can Illinois or any other state disagree with federal conclusions although there is supposed conformity in law?
- When a business derives income of a certain kind, does that income taint the main business purpose or type of an entity for tax purposes?
- Does the affiliation of entities and intercompany transactions change the nature of a business for state income tax purposes?
The case demonstrates the states’ continued challenge of entity structures and operations. Illinois has been particularly aggressive recently with regard to organizations structured around its unique statutory framework. It is very likely this case will be appealed.