This session will cover state budget and fiscal matters and related-tax policy implications as well as an update on captive insurance companies, self procurement taxes and recent legislation.

1. 22nd Annual Health Sciences
Tax Conference
State and local tax and insurance tax update
December 5, 2012

2. Disclaimer
► Any US tax advice contained herein was not intended or
written to be used, and cannot be used, for the purpose of
avoiding penalties that may be imposed under the Internal
Revenue Code or applicable state or local tax law
provisions.
Page 2 State and local tax and insurance tax update

3. Disclaimer
Ernst & Young refers to the global organization of member firms of Ernst & Young
Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-
serving member firm of Ernst & Young Global Limited operating in the US. For more
information about our organization, please visit www.ey.com.
This presentation is © 2012 Ernst & Young LLP. All rights reserved. No part of this
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transmission or distribution of this form or any of the material herein is prohibited and
is in violation of US and international law. Ernst & Young LLP expressly disclaims any
liability in connection with use of this presentation or its contents by any third party.
Views expressed in this presentation are not necessarily those of Ernst & Young LLP.
Page 3 State and local tax and insurance tax update

4. Presenters
► Kelvin Ault ► Brad Withrow
Sr. Vice President of Tax Ernst & Young LLP
Vanguard Health Systems Nashville, TN
Nashville, TN +1 615 252 2050
brad.withrow@ey.com
► Troy Deason
Sr. Manager, State Income Tax
HCA Inc. ► Kevin Owens
Nashville, TN Ernst & Young LLP
Washington, DC
+1 202 327 8828
kevin.owens@ey.com
Page 4 State and local tax and insurance tax update

5. Post-election state and local tax implications

6. Election 2012 — federal races
► Why is federal outcome important for state taxes?
► Presidential, Senate and House Races
► Head of the ticket — effect on state races
► Federal tax reform and tax law changes affect state taxes
► Federal legislation to limit state taxes
► Remote seller sales tax; nonresident withholding
► Supreme Court appointments
► Constitutional issues on state tax cases
Page 6 State and local tax and insurance tax update

7. Election 2012 — state races
Ballot initiatives — tax
► Proposition 30 (Governor Brown)
► ¼¢ increase in sales tax rate
► Up to 2.5% increase in personal income tax rates
on those making US$250k or more
► California’s highest marginal rate is now
13.3% (NYC: 12.696%)
California ► Retroactive to January 1, 2012
► Business share of temporary CA sales tax
increase may be as high as US$650m per year for
four years
► CA personal income tax increase on
business income
 Yes 53.9%  No 46.1%
Precincts reporting: 98.5%
Page 7 State and local tax and insurance tax update

8. Election 2012 — state races
Ballot initiatives — tax
► Proposition 39 (co-chair Tom Steyer)
► Mandatory single-sales factor
► Incremental monies raised dedicated to funding
clean energy investments
► Estimated cost to business of mandatory single
sales factor apportionment = +US$1b/yr.
California ► Questions:
► Complications with respect to Gillette Co. and
Multistate Tax Compact election. (Can taxpayers still elect
three-factor?)
► Alternative sales sourcing?
► Can California reduce rates if revenues are greater
than anticipated?
 Yes 60.1%  No 39.9%
Precincts Reporting: 98.5%
Page 8 State and local tax and insurance tax update

9. Election 2012 — state races
Governors races
► Governors races
► Only 12 state governors races in 2012
► Most states have governors races in “off-Presidential” year to avoid influence at
top of the ticket (Wisconsin Governor Walker (R)
survived recall)
► North Carolina
► Only state with a party change
► Governor, Senate and House now in Republican control
► Key retirements in the Department of Revenue (DOR) in the past month or so
► Strong possibility for tax reform, including potentially:
► Broadened base, lower tax rate, simplified franchise tax/business license fee, push to
eliminate personal and corporate income taxes
► Looking ahead to 2013 elections
► New Jersey — Chris Christie (R) and Virginia — Bob McDonnell (R)
Page 9 State and local tax and insurance tax update

10. Pre-2012 election: who controls state
governments?
Republicans Democrats Split
WA
MT VT ME
ND
MN
OR ID
NH
SD WI NY
WY MI
IA PA CT MA
NE
NV OH
IN NJ RI
UT IL
CA CO WV DE MD
VA
KS MO
KY
NC
TN
AZ OK
NM AR
SC
AK AL GA
MS
TX
LA
HI
FL
Source: Multistate Associates.
Page 10 State and local tax and insurance tax update

11. Post-2012 election: who controls state
governments?
Republicans Democrats Split
Republicans gain Democrats gain
WA
MT VT ME
ND
MN
OR ID
NH
SD WI NY
WY MI
IA PA CT MA
NE
NV OH
IN NJ RI
UT IL
CA CO WV DE MD
VA
KS MO
KY
NC
TN
AZ OK
NM AR
SC
AK AL GA
MS
TX
LA
HI
FL
Only 12 legislative
houses changed
from 2012
Source: Multistate Associates.
Page 11 State and local tax and insurance tax update

12. 2010 composition of state legislatures
Republicans held both houses Democrats held both houses
Control is split
WA
MT ME
ND
MN
OR ID NY
SD WI
VT
WY MI
NH
IA PA CT
NV NE* OH MA
IN NJ
UT IL
RI
CA CO WV DE
VA
KS MO MD
KY
NC
TN
AZ OK
NM AR
SC
AK AL GA
MS
TX
LA
HI
FL
Source: National Conference of State Legislatures (NCSL). * Nebraska has a non-partisan state legislature.
Page 12 State and local tax and insurance tax update

13. 2012 post-election composition of state
legislatures
Republicans held both houses Democrats held both houses
Control is split
WA
MT ME
ND
MN
OR ID
SD WI NY VT
WY MI
NH
IA PA CT
NV NE* OH MA
IN NJ
UT IL
RI
CA CO WV DE
VA
KS MO MD
KY
NC
TN
AZ OK
NM AR
SC
AK AL GA
MS Dems. pick up four
TX states; GOP picks
LA
HI
up three states
FL
Source: NCSL. * Nebraska has a non-partisan state legislature.
Page 13 State and local tax and insurance tax update

14. 2012 post-election supermajorities
Republicans supermajority both houses Democrats supermajority both houses
Republicans supermajority one house Democrats supermajority one house
Supermajority —
more than 2/3rds
WA
vote of a
legislative house MT ME
ND
OR MN
ID NY
SD WI
VT
WY MI
NH
IA PA CT
NV NE* OH MA
IN NJ
UT IL
RI
CA CO WV DE
VA
KS MO MD
KY
NC
TN
AZ OK
NM AR
SC
AK AL GA
MS
TX LA
HI
FL
* Nebraska has a non-partisan state legislature.
Page 14 State and local tax and insurance tax update

15. States where one party has “supermajority”
legislative control
► 2/3 Republican control of both ► 2/3 Democratic control of both
chambers: chambers
► Indiana ► California
► Idaho ► Hawaii
► Kansas ► Massachusetts
► Missouri ► Rhode Island
► North Dakota ► 2/3 Democratic control of one
► Oklahoma
chamber
► South Dakota
► Illinois
► Tennessee
► New York
► Utah
► Vermont
► Wyoming
► West Virginia
► 2/3 Republican control of one
chamber: ► Why is a supermajority significant?
► Alabama
► Satisfy constitutional requirements for
► Michigan 2/3rds vote of tax bills
► Ohio
► Amend state constitutions
► Virginia
► Pass legislation without debate
► Supermajorities don’t last forever
Page 15 State and local tax and insurance tax update

16. Business tax issues being addressed
► Sales tax on business inputs
► Taxation of tangible personal property
► Growing importance of intangibles: property factor,
sourcing, property tax base
► Business tax competitiveness
► Effectiveness of incentives: transparency and targeting
► Effective tax rates for combined state-local business taxes,
including corporate income taxes
Page 16 State and local tax and insurance tax update

17. States considering tax reform
► Connecticut
► Business tax task force recommends phase-out of
corporate income tax (CIT) surcharge, minimum CIT
and business-entity tax
► North Carolina
► Lower the corporate tax rate and expand the sales/use
tax base to include various services
► New York
► Governor Cuomo (D) is set to announce members of
NY State Tax Reform and Fairness Commission
► Governor wants “revenue-neutral” tax reform that
increases economic growth
Page 17 State and local tax and insurance tax update

18. States considering tax reform
► Iowa
► Governor Branstad (D) proposing income and property tax cuts for
businesses and individuals — 2012 revenues exceeded forecasts by
US$260m
► Wants to use revenue to make Iowa “more competitive” and reduce
“job killing” property taxes
► Kentucky (Blue Ribbon Commission)
► Goal: shift taxes from business capital and labor income to
consumption
► Broaden sales tax base, but “tax B-to-B less and tax consumption
more”; option of local sales tax
► Major reform option: replace CIT with gross receipts tax
► Other: eliminate tangible personal property (TPP) tax, adopt single
sales factor (SSF) with destination sales
Page 18 State and local tax and insurance tax update

19. Blurring lines between tax-exempt and
taxable health care providers

20. Recent events
► Ascension Health forms joint venture with Oak Hill Capital
Partners to acquire hospitals in a taxable platform.
► Ascension Health partners with India-based Narayana
Hrudayalaya Hospitals to build US$2 billion health
campus in Grand Cayman.
► Mayo Clinic, NYU Hospitals and Dignity Health have
issued US$1.1 billion in taxable bonds.
► Caritas Christi converts to investor-owned status via
acquisition by Cerberus Capital.
► Detroit Medical Center is acquired by Vanguard.
Page 20 State and local tax and insurance tax update

21. Related articles
► “Illinois hospital tax break costs $10M, could help
MetroSouth,” Southland News, November 9, 2012
► “State may put non-profit hospitals on tax rolls, with
incentives,” ChicagoBusiness.com, November 29, 2011
► “Non-profits no better on charity care,”
ChicagoBusiness.com, October 19, 2009
► “Much is given by hospitals, more is asked,” Boston
Sunday Globe, May 31, 2009
► “Real Property Tax Exemptions at Risk,” Taxation of
Exempts (WG&L Journals), 2008
Page 21 State and local tax and insurance tax update

22. 2006 Congressional Budget Office study
Page 22 State and local tax and insurance tax update

23. Illinois charity care credit
► Income tax credit equal to the lesser of
► Property taxes on hospital parcel
Or
► Cost of charity care provided
► Effective for tax years ending on or after December 31, 2012
► Credit may be transferred or carried forward for five years
► Initially discussed as an offset to 2007 gross receipts tax proposal, then
ultimately enacted as part of grand compromise with hospitals on Medicaid
and non-profit hospital tax exemption in 2012 spring legislative session
► Some legislators were initially proposing to tax all hospitals
► Possible constitutional challenges to legislation in light of
Provena decision
► Charity care credit is also subject to a sunset clause as are all Illinois tax credits
Page 23 State and local tax and insurance tax update

24. State tax implications: electronic health
records

25. Medicare and Medicaid electronic health
record incentive programs
► Medicare incentive payments
► The American Recovery and Reinvestment Act of 2009 (ARRA), Pub. L. No.
111, sec. 4102(a) (Feb 17, 2009), amended Section 1886 of the Social
Security Act to establish incentive payments for certain eligible professionals
and hospitals participating in the Medicare Fee For Service (FFS) program
where they demonstrate “meaningful use” of certified electronic health records
(EHR) technology, beginning in 2011 and ending in 2016.
► Medicaid incentive payments
► Section 4201 of ARRA amended Section 1903 of the Social Security Act to
establish incentive payments for certain eligible professionals and hospitals
participating in the Medicaid program to “purchase, implement, operate
(including support services and training for staff) and meaningfully use”
certified EHR technology, beginning in 2011 and ending in 2021.
► Eligible hospitals may receive both incentives as long as they meet
requirements of each program.
Page 25 State and local tax and insurance tax update

26. State tax issues: EHR incentives receipts
► State income tax implications of the incentives receipts
► Federal income tax treatment conformity
► Separate entity-level treatment/allocation
► Tax base and apportionment impact
► Receipts factor inclusion
► Receipts factor sourcing
► Receipts from federal government
► State and local receipts-based taxes and related
implications of the incentives receipts
► Definition of taxable receipt
► Sourcing
► Offsets, exemptions, receipts from federal government
Page 26 State and local tax and insurance tax update

27. State tax issues: EHR expenditures
► Sales tax issues related to multistate hardware and
software costs
► Credit and incentive opportunities related to EHR
expenditures
► Headquarter state opportunities
► Multistate opportunities related to expenditures at the facilities
► Consider any potential negative implications to credit and incentive
programs limited by government funding
► Property tax valuation issues
► Franchise tax implications
Page 27 State and local tax and insurance tax update

28. State tax nuances
► Texas margins tax
► Health care providers (100% exemption for government revenue)
► Health care institutions (50% exemption for government revenue)
► Administrative guidance
► Comptroller’s Ruling 200810212L (10/27/2008)
► Comptroller’s Ruling 201001990L (01/27/2010)
► Consider how your compliance group accumulates the data
► Others?
Page 28 State and local tax and insurance tax update

29. Nonresident withholding

30. Introduction
► More and more states are focusing on nonresident withholding
► States are looking for money and many already have laws on
their books
► Nonresident withholding is becoming more highly scrutinized
► Exemptions/waivers
► Corporation signs waiver, indicating they will file/pay at corporate level
► Corporate owners often meet the exceptions to the requirements, but if
they fail to certify in writing, the states may go after the partnership for
failure to withhold
► ASC 740
► The pass-through entity is not subject to income tax but the entity is liable
for the nonresident withholding
► Consider characterization of income as an income tax at the partnership
level
Page 30 State and local tax and insurance tax update

31. Nonresident withholding: Georgia
► Georgia audit example
► Notification of audit
► Assessments at the partnership level
► Potential policy change (regarding penalty abatement)
► In this example, Georgia Department of Revenue appears
to be focusing more on this issue from a policy
perspective and may be less willing to waive penalties
Page 31 State and local tax and insurance tax update

32. Working in the clouds: state tax
considerations of cloud computing

33. Background
► Cloud computing is the delivery of shared resources, software and
information over a network or the internet which can be accessed by
computer or other devices.
► Users are typically not aware of the underlying technologies used to
provide the services (e.g., servers), only that the resources they wish
to purchase are available over the internet (the backbone of the
cloud).
► Cloud revenue growth is forecast to experience a 26% compound
annual growth rate between 2011 and 2014 — five times faster than
the IT industry as a whole.
► Cloud computing is borderless by nature but tax regulations and
compliance are not.
► Cloud computing gives rise to complex and potentially material tax
issues.
Page 33 State and local tax and insurance tax update

34. Cloud computing defined
The three primary service models of cloud computing are:
► Software as a Service (SaaS): applications both general, such as
word processing, email and spreadsheet, and specialized, such as
customer relationship management (CRM) and enterprise resource
planning (ERP). SaaS is sometimes referred to as hosted or
managed software, and the original offerings were from application
service providers (ASPs)
► Platform as a Service (PaaS): databases, development tools and
other components required to support the delivery of custom
applications
► Infrastructure as a Service (IaaS): raw computing power, storage
and network bandwidth
Page 34 State and local tax and insurance tax update

35. What’s happening now in the states?
► States try to expand existing law
► Legislative, judicial and regulatory developments occurred
at an increasing rate
► Most notably with respect to nexus and tax base
► Primary focus has been on sales and use taxes
► Convenient source of revenue
► Perception that it is less complicated and politically charged than going
after income-based taxes
Page 35 State and local tax and insurance tax update

36. Why have the issues become so prevalent
from a sales-tax perspective?
► Hosted software, “cloud” computing and ASP
► SaaS vs PaaS vs IaaS
► States still coming to grips with IaaS and PaaS
► IaaS as a rental of tangible personal property
► Historical treatment of SaaS
► Electronic delivery?
► Information service or database access?
► Another enumerated taxable/non-taxable service?
Page 36 State and local tax and insurance tax update

37. Sales tax on software
► Who is the “taxable person”?
► Is the vendor or the hosting company physically present in the
taxing state?
► Where are the data centers located?
► Where is the software housed?
► How are transactions sourced?
► Generally based on destination — where the customer
uses/accesses the software/service
► Customer multistate use exemption
► Difficult for vendor or hosting company to determine where
use occurs
► Streamlined sales tax (SST) sourcing rules
Page 37 State and local tax and insurance tax update

38. Sales tax on software: classification
determines taxability
► First consideration
► Canned
► “Off-the-shelf”
► Designed for multiple users
► Custom
► Designed for specific single user
► Modifications to canned software can be a gray area
► Second consideration: method of delivery
► Tangible format
► Electronic delivery
► ASP — also called SaaS or “in-demand software” or
“cloud computing”
► Load and leave/load and return
Page 38 State and local tax and insurance tax update

39. Sales tax on software: cloud computing
(ASP model)
► Is the transaction taxable?
► Look to state treatment of ASP/SaaS/cloud computing
► What does the customer receive?
► Access to software or access to infrastructure?
► State positions taken (note this is based on various levels of authority
and specific facts)
► Not taxable: AL, AR, CO, IL, KS, LA, ME, MS, NE, NV, NJ, OK, PA, RI,
TN, VA, WI
► Taxable: AZ, CT, HI, ID, IN, KY, MA, MI, NM, NY, SC, SD, TX, UT, VT,
WA, WV
► Other states that lack specific guidance may determine taxability by
treating transaction as:
► Sale/license of electronically delivered software
► Provision of “computer” services (e.g., data processing, information
services)
Page 39 State and local tax and insurance tax update

40. Sales tax on digital goods and services
► How are digital goods/services taxed?
► SST states
► Specified digital products
► Other products “transferred electronically”
► Non-SST states will tax based on classification
► Look to definition of “tangible personal property”
► Consider state sales and use tax treatment of service transactions
► Growing trend toward providing specific guidance and toward taxing
“digital equivalents”
► Is the digital good a software or a service? For example:
► New York — online games are taxable as “pre-written software”
► Texas — online games are taxable: “data processing,” “pre-written
software” or “amusement services”
Page 40 State and local tax and insurance tax update

41. Sales tax on digital goods and services
► What are digital goods/services?
► SST: “specified digital products” means electronically transferred:
► “Digital audio-visual works”
► “Digital audio works”
► “Digital books”
► Non-SST states will often look to agreement to determine
characterization of sales as:
► Tangible personal property
► Services
► Mixed transaction
► Something else
Page 41 State and local tax and insurance tax update

42. Sales tax on digital goods and services
► Federal
► The proposed law (The Digital Goods and Services Tax Fairness
Act of 2011, H.R. 1860/S. 971) would establish a national
framework for taxation of digital goods and services and prevent
retail sales of such products from being taxed by multiple states.
► The bill stops short of prescribing a specific system for how states
can tax sales of digital goods.
► It prohibits state and local governments from applying taxes to
those products that do not apply to similar tangible goods.
Page 42 State and local tax and insurance tax update

43. Sales tax sourcing issues
► Should transaction be sourced (i.e., taxing location) based
on:
► Location of the seller?
► Where SaaS is used?
► Some other location?
► Once the situs has been determined, a sales tax
determination can be made.
Page 43 State and local tax and insurance tax update

44. Multistate Tax Compact (the Compact)
election

45. California
► S.B. 1015 (enacted June 27, 2012) — repeals all
provisions related to the Compact, effective immediately
► California no longer “sovereignty member” of Compact
► Not approved by 2/3rds vote of either house — Prop 26 problem?
► Doctrine of election — Legislative Counsel’s Digest — Legislature
“intended” that any election must be made on an originally
filed return
► Gillette (Cal. App. Ct.) — The 1993 law change mandating
that the double-weighted sales factor be used did not
repeal the Compact election and, therefore, taxpayers
were entitled to make the Compact election.
► The Compact is a valid compact that California as a signatory
state is bound by until the state withdraws from the Compact.
Page 45 State and local tax and insurance tax update

46. Other states
► Michigan
► H.B. 4479 (enacted May 25, 2011) — beginning January 1, 2011,
taxpayers cannot apportion/allocate income in accordance with the
Compact, but rather must use the method provided by the
Michigan Business Tax (MBT) and CIT.
► Litigation (IBM) is currently before the Court of Appeals on whether
the election is allowed under the MBT.
► Oregon
► ORS 314.606 specifically provides that when the Compact
provisions are inconsistent with the Uniform Division of Income for
Tax Purposes Act, the Oregon statutory provisions “shall control.”
► Litigation (HealthNet) is currently before the Tax Court.
Page 46 State and local tax and insurance tax update

47. Texas margins, Compact developments and
other updates
► In three recent rulings — Decision Nos. 106,503 (August 10, 2012), 106,298
(September 6, 2012) and 106,149 (September 11, 2012), the Comptroller of
Public Accounts continues to reject taxpayers’ use of the three-factor
apportionment formula under Article IV of the Compact.
► The Comptroller has determined that when apportioning taxable margin to Texas,
the taxpayer is required to use the single gross receipts factor provided under Tex.
Tax Code Ann. § 171.106(a).
► A taxpayer whose attempted use of the Compact’s three-factor formula was
rejected by the Comptroller is challenging the rejection and has filed a lawsuit in a
Texas district court (Graphic Packaging Corp. v. Combs, Doc. 2012-22096 (Tex.
Dist. Ct., Travis County, filed Oct 2012)).
► The Texas Supreme Court has held that the state franchise tax does not
violate the Texas Constitution’s Equal and Uniform Clause and the federal
Equal Protection, Due Process and Commerce Clauses. As an initial matter,
the court determined that it has original jurisdiction over challenges to the
constitutionality of the tax. (In re: Nestle USA, Inc., Tex. S. Ct., Dkt. No.
12-0518, 10/19/2012.)
Page 47 State and local tax and insurance tax update

48. State taxation of premiums paid to captives

49. State taxation of premiums
► Premium tax
► Assessed against admitted insurance company
► Based on premiums allocable to state
► Surplus lines
► Insurance company not licensed to sell insurance in state
► Insurance placed by lines broker with non-admitted company
► Surplus lines tax assessed against surplus lines broker
► Independently procured insurance
► Insured acquires insurance directly from non-admitted company
► Most states assess tax against insured
Page 49 State and local tax and insurance tax update

50. Independently procured insurance tax
► Imposed by a majority of states
► Statute varies state by state
► Historically, has not been rigorously enforced by most
states
► California, New York, Texas and Florida have been more active
► Generally applies when insurance is purchased from
non-admitted insurance company
► May apply to insurance from captive insurance companies as they
are only licensed in state of domicile
Page 50 State and local tax and insurance tax update

51. Pre-Dodd–Frank contracts in effect prior to
July 21, 2011
► The typical statute applies tax when insurance is procured
from an insurance company not admitted to do business
in the state.
► NYS: “There is hereby imposed on any person who purchases or
renews a taxable insurance contract from an insurer not authorized
to transact business in this state under a certificate of authority
from the superintendent of insurance …”
► CA: “Every person who effects insurance with a non-admitted
insurance carrier is required to pay a tax of 3% of net premiums.”
► The tax only applies to risks located in that state
Page 51 State and local tax and insurance tax update

52. Limitation on independently procured
insurance tax — Todd Shipyards
► Todd Shipyards 370 U.S. 451 (1962)
► A New York corporation did business and owned property
in Texas.
► All transactions regarding the insurance occurred outside of
Texas; the insurance was purchased, the premiums were paid,
and any claims were to be adjusted and paid in New York.
► The insurers were located in London, were not licensed in Texas,
had no agents in Texas and did no business in Texas.
► The broad Texas self-procurement statute contained no limitations
requiring actions in the state to give rise to the tax.
► The Supreme Court invalidated the tax levied.
► Texas tax may not be constitutionally imposed when the only
connection between the insurance transaction and the state is that the
insured risk is located in Texas.
Page 52 State and local tax and insurance tax update

53. Is Todd Shipyards still valid?
► Associated Electric & Gas Insurance Services, Ltd. 676
A.2d 1357 (RI 1996) AEGIS
► Premium taxes assessed by Rhode Island against Bermuda
insurance company
► Todd Shipyards had been superseded
► Dow Chemical Co. 38 S.W.3d 741 (Tex. Ct. App. 2001)
► Attempt by Texas to impose essentially the same self-procurement
tax statute at issue in Todd Shipyards
► Texas court rejected argument used in AEGIS
► Todd Shipyards still valid
Page 53 State and local tax and insurance tax update

54. Limitation on Todd Shipyards
► STP Nuclear Operating Company 239 S.W.3d 264 (Tex.
App. Austin 2007)
► Application of Texas Independently Procured Tax upheld
► Factual difference with Todd Shipyards
► Insured headquartered in Texas
► Supervisor of corporate insurance was located in Texas
► Direct communications via email and letters between the corporation
and the nonadmitted insurer
► Insurance contracts negotiated and approved by the corporation’s
employees in Texas
► Premium payments originated in Texas
► Losses were payable to insureds in Texas
Page 54 State and local tax and insurance tax update

55. Non-admitted and Reinsurance Reform Act
(NRRA)
► NRRA part of Dodd–Frank legislation
► Enacted into law in July 2010, with most provisions
effective July 21, 2011
► Reforms the taxation and regulation of insurance between
an insured and an insurance company
► Focuses on surplus lines but includes directly procured insurance
► Only the “home state” can tax or regulate insurance with a non-
admitted insurance company
► NRRA provides several key definitions
Page 55 State and local tax and insurance tax update

56. Key definitions
► Home state
► The state in which an insured maintains its principal place of
business
► If 100% of the insured risk is located out of that state, the state to
which the greatest percentage of the insured’s taxable premium for
that insurance contract is allocated (this method of allocation is
commonly referred to as the “cost of performance”)
► If there are more than one insureds from an affiliated group
identified as named insureds on a single non-admitted insurance
contract, the “home state” means the home state of the member of
the affiliated group that has the largest percentage of premium
attributed to it under such insurance contract. “Affiliated group”
means any group of entities that share common control. An
affiliated group may include entities that share parent-subsidiary
and/or brother-sister corporate relationships
Page 56 State and local tax and insurance tax update

57. Key definitions
► Independently procured insurance
► Insurance procured directly by an insured from a non-admitted insurer
► Non-admitted insurance
► Any property and casualty insurance permitted to be placed directly or
through a surplus lines broker with a non-admitted insurer eligible to
accept such insurance
► Non-admitted insurer
► An insurer not licensed to engage in the business of insurance in a
particular state. A non-admitted insurer does not include a risk retention
group, as defined in the Liability Risk Retention Act of 1986, 15 U.S.C.
3901(a)(4)
Page 57 State and local tax and insurance tax update

58. States adoption of NRRA
► Adoption of NRRA varies by state
► Generally, states have adopted NRRA definitions and
modified law to use those definitions
► States adopting NRRA definitions also tax 100% of
premiums, e.g., New York and Texas
► Prior to NRRA, generally only premiums allocable to state were
subject to tax
► Current status of tax is very confusing
► For example, Virginia has legislative procedure to collect tax but
has not placed tax on its books
► Not all states have adopted NRRA definitions, e.g., Alabama
Page 58 State and local tax and insurance tax update

59. States adoption of NRRA — reaction
► Vermont Captive Insurance Association
► White paper concludes that NRRA was not intended to apply to
captive insurance companies
► Does not address changes in state law
Page 59 State and local tax and insurance tax update

60. What to do
► Benchmark IPT
► Prepare analysis of location of risks being insured and premium
allocable to those locations
► Determine home state under NRRA
► Determine law of home state — does home state impose IPT?
► Determine if any risks are in states that have not adopted NRRA
► Planning considerations
► Re-domesticate captive to home state
► Control determination of home state, e.g., multiple contracts or
contracts with varying coverages
► Move insurance functions in order to invoke Todd Shipyards
► Possible legal arguments
► Contest tax on 100% of premiums on constitutional grounds
► Determine whether arrangement insurance is for IPT purposes
Page 60 State and local tax and insurance tax update

61. State income tax issues
► Consolidated returns
► Entity included by virtue of inclusion in federal consolidated return
► Consider income classification and possible non-business
treatment (e.g., investment income)
► Unitary returns
► Alaska and Idaho — sales factor based on premiums plus property
factor for investments
► New Hampshire — separate apportionment method and then
combine post-apportioned income with the group
► California — statutory exclusion
Page 61 State and local tax and insurance tax update

62. State income tax issues
► Partnership investments in insurance subs — NY example
► Aggregate basis — corporate entity combines its income, capital
and factors with its distributive share of the partnership’s income,
capital and factors
► Entity basis — corporation reports distributive share of partnership
income and capital but apportions based on the corporation’s
factors (favorable if the corporate partner’s NY apportionment
would be zero)
► Foreign corporate partner election — the corporate partner reports
its share of partnership income and capital as apportioned at the
partnership level
► Regulations governing this election may or may not apply to insurance
companies that are subject to Article 33. The regulations are
ambiguous on this point and the Department has informally granted
leeway with similar fact patterns
Page 62 State and local tax and insurance tax update

63. Partnership investments in insurance subs:
aggregate basis
► Aggregate theory must be used if any of the following apply:
► The corporate partner is conducting a unitary business with
the partnership
► The corporate partner is a general partner of the partnership or a managing
member of an LLC treated as a partnership
► The corporate partner has a 5% or greater interest in the partnership
► The partnership interest constitutes more than 50% of its
total assets
Or
► Any member of the corporate partner’s affiliated group has the information
necessary to perform an aggregate computation
► For this test, a corporate partner that receives a complete Form
IT-2-04-CP must file using the aggregate method
Page 63 State and local tax and insurance tax update