On July 6, 2017, the Illinois Legislature voted to override Governor Rauner's veto and enacted SB 9, which became Public Act 100-0022 (Public Act). In addition to raising overall corporate tax rates by 33% (from 7.75% to 9.5% overall),¹  the Public Act significantly alters the way insurance corporate groups will compute and report their Illinois income tax. While the tax rate changes are effective July 1, 2017, the combined reporting changes become effective for tax years ending on or after December 31, 2017.

Background

Illinois is one of the few states that subject insurance companies to both a state corporate income tax and a premium tax. Foreign authorized insurance companies writing insurance in the state are also subject to the insurance premium tax and may claim a credit for premium tax paid against their income and replacement tax liability.

Moreover, Illinois corporate income taxpayers are subject to mandatory unitary combined reporting. Historically, Illinois has had a "like-apportionment" non-combination rule whereby corporations subject to differing apportionment systems, such as financial organizations, general corporations and insurance companies, could not be included in the same combined reporting group.² The non-combination rule frequently applies to insurance industry taxpayers, especially when they also have non-insurance subsidiaries or affiliates. Such non-insurance unitary members cannot be included in the same unitary group with insurance companies because they were subject to a different apportionment regime.³

The new law repeals the "like-apportionment" non-combination rule⁴ for tax years ending on or after December 31, 2017. As such, insurance companies now must be combined with their commonly owned, unitary non-insurance affiliates.

Implications

The implications of including insurance companies in the same combined return are complex and varied. Potential considerations include the following.

Tax base and apportionment

Non-insurance company Illinois taxable "base income" corresponds to federal taxable income, with certain modifications for state purposes. Similarly, Illinois taxable "base income" corresponds to insurance company taxable income for federal income tax purposes. For an insurance company, the tax base will include income from insurance premiums as well other income such as from investment partnerships or other non-insurance business income an insurance company might earn via a disregarded single member LLC, for example.

For apportionment purposes, however, while a general corporation's receipts factor will generally correspond with its total base income, an insurance company's taxable income will be apportioned only by reference to its insurance business — by use of an insurance premium factor. Its non-insurance business income, on the other hand, will have no representation in the apportionment factor, giving rise to potential distortion, which will vary under the expanded combined reporting computation.

Expanded combined group computational considerations

Intercompany transactions are generally eliminated. Thus, former items of income and expense between insurance and non-insurance companies in a combined return may be eliminated.⁵ One potential advantage of combined reporting is the ability to offset income with losses from other members of the same unitary reporting group. Thus, to the extent insurance businesses had "trapped" loss companies in their insurance business, or vice versa, they should now be able to offset those losses from 2017 forward with income of their other affiliates which previously were expressly excluded from the group by statute. On the other hand, if a group is newly combining highly profitable members with members that have high Illinois apportionment, the tax impact could be adverse.

Unitary business requirement

Regardless of the law change, all of the members being joined in the combined reporting group must be engaged in a "unitary business" in order for combined reporting to apply. Whether a group of corporations constitute a unitary business is a fact-intensive, technical inquiry based on all of the facts and circumstances and guided by a complex body of law described in numerous US Supreme Court constitutional rulings. Taxpayers, in consultation with their tax advisors, should consider whether their separate insurance and non-insurance group members are in fact engaged in a unitary business before merging the two separate Illinois combined groups into one return. Given that New Hampshire is the only other state that requires insurance companies to join in combined unitary returns with non-insurance subsidiaries and affiliates, many insurance industry taxpayers may not have undertaken the required unitary business analysis necessary under this new Illinois rule.

Net operating losses (NOLs) and other tax attributes

If either or both of the insurance and non-insurance groups carry over any Illinois NOLs, taxpayers will need to consider whether the new mixed groups will be able to fully share and utilize these NOL carryforwards or whether members or sub-groups will need to segregate the application of the NOLs in future returns. Fortunately, while Illinois NOLs are computed and tracked by each individual member on a post-apportioned basis, current law still allows the members of the same group to generally share NOLs without restriction. For example, the current (pre-law change) combined reporting instructions to Illinois Form UB/NLD (the Illinois schedule upon which NOLs must be reported annually) generally provide that members entering the group may share losses with new group members and confirms that Illinois does not follow either the federal loss limitation rules under IRC Section 382 or any of the "separate return limitation year" (SRLY) rules.⁶

Premium tax credits and insurance company tax rate reductions

Unitary business groups that include foreign insurers from other states or countries that impose a retaliatory tax on Illinois-domiciled insurers may be allowed a credit reducing the group's Illinois income and replacement tax liability by way of a tax rate reduction.⁷ (This rate reduction effectively functions as premium tax credit, although the mechanics are more complicated than those associated with a "typical" credit and are provided as a protective measure for Illinois domestic insurers against the unique and unusual retaliatory taxes imposed by other states.) The intent is to reduce the tax rates to the point where the total Illinois tax imposed on an insurance company equals the hypothetical tax the state or country of domicile would impose on the foreign insurer member's Illinois net income, thus vitiating the retaliatory taxes of the other states that could be imposed on Illinois domestic insurers doing business in other states.⁸

These computations are extremely complicated, unusual and intricate. The amount of Illinois premium tax paid by the insurance company members on their Illinois insurance company privilege and retaliatory tax return (Form U-1) is taken into account in the calculation, among other things. Although this rate reduction is intended to apply only to insurance companies in order to address tax policy and fairness issues inherent in the manner in which premium, replacement and income taxes are imposed on insurance companies by other states, the computation of the rate reduction may now be influenced by the inclusion of non-insurance members in a combined group return.⁹

The combined rate reduction calculation begins by determining each foreign insurer's share of: 1) base income (combined group income before apportionment); and 2) Illinois income (combined group income after apportionment and credits). This is determined by multiplying the group's base income and Illinois net income respectively by an individual insurance company's apportionment factor computed on Illinois Form UB/INS. This individual Form UB/INS apportionment percentage is computed by taking each foreign insurance company member's individual numerator over the group's denominator. With the repeal of the "like-insurance" rule, insurance companies can be combined with non-insurance companies. As such, non-insurance companies would presumably now influence both the group's apportionment denominators as well as the group's total base income under the current Form UB/INS computation, further complicating the determination of the overall retaliatory taxes that domestic Illinois insurers may have to pay in other states (as well as the determination of the overall taxes imposed by Illinois on foreign insurers and their subsidiaries and affiliates joined in a combined reporting group).

Although the rate reduction is computed on Illinois Form UB/INS, it also comes into play when computing the unitary member income tax offset on the Illinois privilege and retaliatory tax return (Form U-1). This offset seeks to allocate to each insurance member the total corporate income tax payments and refunds based on each member's Illinois premiums ratio. The income tax payments/refunds will be derived based on the taxes computed on the group's Form IL-1120, including the Illinois Form UB/INS. (The offset is the amount by which the corporate income and replacement taxes exceed 1.5% of Illinois premium). Thus, the amount of tax paid will be directly influenced by the composition of the unitary group to now include non-insurance companies.

Overall, the elimination of the "like-apportionment" rule will make the determination of the Illinois taxes of a unitary group including an insurance company exceedingly complex. Careful consideration of the nuances of these rules will demand great attention by insurance companies and their advisors.

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ENDNOTES

¹ Income before July 1, 2017 is taxed at 7.75%, and income on or after July 1 is taxed at 9.5%. See 35 ILCS 201(b)(13), as amended, citing 35 ILCS 5/202.5, as amended, for purposes of determining how income for a period that straddles July 1 is allocated to pre- and post- July 1 periods. Illinois imposes two income-based taxes on corporations: 1) the general Illinois corporate income tax; and 2) the personal property tax replacement income tax. The latter is imposed at the rate of 2.5% but was not affected by enactment of the Public Act. The Public Act increased the rate of the former (i.e., the general Illinois corporate income tax) from 5.25% to 7.00%. For more on the 2017 Illinois tax law changes brought about by the Public Act, see Tax Alert 2017-1227.

² See 35 ILCS 5/1501(a)(27)(B).

³ Illinois also has a special rule for holding companies (as defined). In short, assuming a unitary group is comprised of general non-insurance corporations along with insurance corporations with a common holding company parent, the group would have to be split into two separate combined groups for Illinois purposes, one including the insurance company members and the other the non-insurance members. The income and factors of the holding company must be split between the two groups on a prorated basis. See IL Schedule UB Instructions, p. 1.

⁴ 35 ILCS 5/1501(a)(27)(B).

⁵ Under the previous combined reporting regime, non-insurance groups were required to add back insurance premium deductions attributable to premiums paid to unitary insurance companies that filed separately due to the like-apportionment non-combination rule. This addback would presumably no longer apply under full combination of insurance companies with their noninsurance unitary affiliates and subsidiaries. See 35 ILCS 5/203(a)(2)(D-19).

⁶ Other items taxpayers should consider include capital loss carrybacks and credits in the expanded combined reporting context.

⁷ See 35 ILCS 5/201(d-1) (This rate reduction is not available for insurance companies primarily engaged in a reinsurance business).

⁸ See Illinois Schedule UB/INS Instructions (2016); also see Illinois Department of Revenue, General Information Letter IT 11-0019-GIL (September 30, 2011).

⁹ See id.