Four states (Florida, Illinois, New Hampshire, and New York) tax the profits of all property-casualty insurance companies underwriting within their borders. Connecticut, Kansas, and Oregon only tax the income of insurers incorporated in their states. The remaining states (and Connecticut, Kansas, and Oregon if the insurer is incorporated outside their borders) tax insurers’ premiums. For both income and premium taxes, the applicable tax rate is the greater of the tax rate in the state where the insurance is sold and the tax rate in the state where the insurer is incorporated. This unique feature of insurance company taxation is known as retaliatory taxes (Petroni and Shackelford 1995).
Both premium and income taxes encourage insurers to shift premiums to states where the tax burden is lighter. The income tax also creates incentives for insurers to overstate total claims and other deductions. Understatement of total premiums is not a primary tax avoidance option because state revenue officials can measure premiums with considerable precision. Similarly, shifting losses across states is a limited tax strategy because state auditors can usually identify the state where a loss occurs.
Tax avoidance through shifting premiums is facilitated by the industry’s reliance on inherently imprecise accounting allocations in the preparation of the statutory reports’ Schedule T. For single-state policies, the reporting process is straightforward. If the policy is sold in the same state where the property is located and the insurer is incorporated, that state has sole authority to tax the policy’s premiums or earnings. For multistate policies, insurers must allocate premiums across the states involved in the transaction. For example, if a group of affiliated hospitals in different states purchases a medical malpractice policy, the insurers must allocate the policy’s income across the states where the hospitals are located, the policy is sold, and the insurer is incorporated. Insurers specializing in lines with more multistate policies likely have greater opportunities to avoid insurer taxes than other insurers because their reports rely more heavily on the Schedule T allocation. credit