Why Is There Double Taxation for the Stock of an Insurance Company?
As with other types of corporations, insurance companies provide stock that gives its shareholders the opportunity to share in the corporation's profits. But as with all profits, it is subject to taxation by the government. The government imposes a special system of taxation on corporations that is known as double taxation. The system of double taxation for insurance companies is no different than it is for other corporations.
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Identification
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Double taxation of an insurance companies stock occurs when the corporation's earnings are taxed, then after those earnings are taxed, the remainder is then taxed once it is distributed to the shareholders. Income tax law requires all earnings must be taxed regardless of who or what earns it. Thus, individuals and corporations are taxed for their earnings. It is under this reasoning that double taxation for corporate stock is justified, that the tax on the stock's dividends are considered a separate tax on the shareholder's earnings.
Significance
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Insurance companies earn a significant amount of profits. Reports indicated that in 2007, they earned as much as $12.9 billion in profits. The government receives a significant amount of money in taxes from these corporations. Thus double taxation of these earnings permits the government to maximize its tax revenues.
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History
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When the founding fathers drafted the constitution, there was no provision in it that provided the federal government with any powers to tax income although the states were permitted to do so. But in 1913, the 16th Amendment to the Constitution was ratified that granted the federal government the right to impose an income tax.
Considerations
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The law provides some corporations, including some insurance companies, an exception to the system of double taxation. This exception is called the S corporation. The federal government taxes S corporations differently than a regular corporation by taxing the dividends paid to the corporation's shareholders but not taxing the corporate earnings. An insurance company becomes a S corporation only if it satisfies the conditions required to qualify for a S corporation as provided by federal law. These conditions include, but are not limited to, having to be a domestic (i.e. not a foreign) corporation, have a hundred shareholders or less and have only one class of stock.
Prevention
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The law provides another exception to the system of double taxation of stock of an insurance company. A corporation reinvesting its earnings is not taxed for those earnings. It is only when those earnings are paid out to the shareholders that they are taxed. Thus a CEO of an insurance company can decide to avoid double taxation by focusing corporate profits on reinvestments in the corporation that may yield capital gains for the shareholders.
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