Should Insurance Income Be Taxable? Unrelated Business Taxable Income
Wright, P. Bruce, Risk Management
The Revenue Reconciliation Bill of 1995, if enacted, would clarify the treatment of Subpart F income earned by a controlled foreign corporation (CFC) in which a tax-exempt organization is a U.S. shareholder as defined in section 951(b) of the Internal Revenue Code (IRC). The bill would amend IRC section 512(b) to specifically include certain insurance income as defined in IRC section 953 earned by the CFC as unrelated business taxable income (UBTI).
Tax-exempt entities are subject to tax on UBTI, i.e., income derived from an unrelated trade or business. Dividends received by a tax-exempt organization, however, are excluded from the definition of UBTI. Generally, income of a corporation that is required under the code to be included in the income of a shareholder (such as Subpart F income) is considered to be a "deemed" or "constructive" dividend and is treated as such for purposes of applying other sections of the code. Consistent with this characterization, the IRS position regarding Subpart F income was that Subpart F income received by a tax-exempt organization should be treated as a dividend and, consequently, excluded from UBTI.
The IRS, in Private Letter Rating 9043039, issued July 30, 1990, appears to have wavered on this position by concluding that the Subpart F income inclusion of a tax-exempt entity resulting from its ownership of a foreign captive insurance company must be characterized by the income that makes up the inclusion, thereby treating the Subpart F income inclusion as if it had been earned directly by the tax-exempt organization for UBT1 purposes.
Section 13642 of the Revenue Reconciliation Bill of 1995, which was passed by the House on October 26, would modify IRC section 512(b) by adding a paragraph defining "Treatment of Certain Amounts Derived from Foreign Corporations." This modification provides a "look-through" rule in determining whether certain insurance income currently includable in gross income under the Subpart F rules should be treated as UBTI. Deductions directly connected with amounts so included in gross income are also allowed. …