On October 11, 2022, the Florida District Court of Appeals, First District held oral arguments on State Farm Mutual Automobile Insurance Company v. Florida Department of Revenue, a case relating to the “add back” to Florida taxable income of interest earned on state and local bonds, for purposes of calculating Florida corporate income tax. The case specifically relates to whether Florida statutes require property-casualty insurance companies such as the taxpayer in State Farm to “add back” all tax exempt interest that is deducted from federal taxable income under IRC section 832(c)(7) without any adjustment to account for the inclusion of 15% of such interest in federal taxable income under IRC section 832(b)(5)(B).
As with most states, the calculation of taxable income subject to Florida corporate income tax begins with taxable income as computed for federal income tax purposes. Florida statutes then require adjustments that have the effect of adding back income that was excluded in the calculation of taxable income for federal purposes. The adjustment at issue in the case, Fl. Stat. 220.13(1)(a)2, requires a corporation to add the amount of interest “excluded” from taxable income under federal law. Fl. Stat. 220.13(1)(a)2 further provides that the amount added back may be reduced by “associated expenses” disallowed in the computation of taxable income under federal law. Both parties agreed that tax-exempt interest is not technically “excluded” by IRC section 103, as is contemplated by the plain language of the Florida statute.
The taxpayer in State Farm argued that under the net effect of the IRC sections governing the computation of a property-casualty insurance company’s federal taxable income, the taxpayer does not pay federal tax on 85% of tax-exempt interest, but does pay federal tax on 15% of such interest. The computation requires three steps. First, tax exempt interest is included in the taxpayer’s gross income under IRC section 832(b)(1)(A). This is because such interest is included in NAIC Annual Statement income which is the basis of the computation of insurance company taxable income. Second, IRC section 832(b)(5)(B) reduces the deduction for “losses incurred” used in computing the taxpayer’s gross income by 15% of tax-exempt interest, effectively adding that portion of the interest to gross income. Finally, in computing taxable income, a deduction is allowed under IRC section 832(c)(7) for 100% of tax-exempt interest. The net effect of these provisions is that an insurance company is required to pay federal tax on 15% of tax-exempt interest.
In applying Fl. Stat. 220.13(1)(a)2 to determine Florida taxable income, the taxpayer argued that only 85% of the interest income should be added back because that is the amount that is effectively “excluded” from federal taxable income. The taxpayer further argued in the alternative that IRC section 832(b)(5)(B) disallows the use of a federal deduction in an amount equal to 15% of the excluded interest and, thus, the amount added back to Florida taxable income should also be adjusted. In contrast, the Department argued that the adjustment provided in IRC section 832(b)(5)(B) is the reduction of a deduction and therefore not within the scope of “interest which is excluded from taxable income” under Fl. Stat. 220.13(1)(a)2. The Department argued that this interpretation gives the proper legal effect to the Florida statute regardless of the resulting economic effect, which they argued was the basis for the taxpayer’s claim. The circuit court ruled in favor of the Department and the taxpayer appealed.
At the oral argument, many of the judges’ questions focused on the Florida legislature’s use of the term “exclude” within Fl. Stat. 220.13(1)(a)2. The judges noted that Florida statutes give specific meaning to the terms exclusion and deduction. Therefore, based on a textual reading of the statute, the judges asked whether there would be any “excluded” interest to add back, since under IRC section 832(b)(1)(A), tax-exempt interest is included in gross income, rather than excluded as would be the case under IRC section 103. In the alternative, if “exclude” were to be read more broadly to capture the same economic effect, whether implemented by exclusion or deduction, then could it also be read to encompass not only the deduction permitted under IRC section 832(c)(7), but also the adjustment under IRC section 832(b)(5)(B). The taxpayer responded that they were not asking the court to read the statute so narrowly as to eliminate the interest add back entirely. However, they argued that a broader reading of the word “exclude” makes the language of Fl. Stat. 220.13(1)(a)2 ambiguous and therefore it should be read in favor of the taxpayer and against the taxing authority.
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