Title Ins. Co. v. State Bd. of Equalization

Decision Date31 December 1992
Docket NumberNo. S022285,S022285
Citation14 Cal.Rptr.2d 822,842 P.2d 121,4 Cal.4th 715
CourtCalifornia Supreme Court
Parties, 842 P.2d 121 TITLE INSURANCE COMPANY OF MINNESOTA, Plaintiff and Respondent, v. STATE BOARD OF EQUALIZATION, Defendant and Appellant * .

John K. Van de Kamp and Daniel E. Lungren, Attys. Gen., Timothy G. Laddish, Asst. Atty. Gen., and Richard F. Finn, Deputy Atty. Gen., for defendant and appellant.

Atwood, Knox & Anderson, Atwood, Knox, Anderson, Uzzi & Dinapoli, Stanford H. Atwood, Jr., Robert Knox, John H. Blake, San Jose, White & Case, Harry G. Melkonian, David J. Wilson, Jill H. Silfen, Paul C. Rooney, Jr., Darren R. Fortunato, Gibson, Dunn & Crutcher, John A. Arguelles, Norman B. Barker and Maureen McGuirl, Los Angeles, for plaintiffs and respondents.

O'Melveny & Myers, Warren Christopher, Frederick A. Richman, Thomas M. McCoy, Los Angeles, Nielsen, Merksamer, Parrinello, Mueller & Naylor, John E. Mueller and Eric J. Miethke, Mill Valley, as amici curiae on behalf of plaintiffs and respondents.

PANELLI, Justice.

We granted review to decide whether title insurers may be taxed on claims paid by underwritten title companies pursuant to underwriting agreements between the two. We conclude that they may not be so taxed. Additionally, we find that the State Board of Equalization failed to properly raise the defense that the title insurers should have been taxed on the total premiums paid by the insureds to the underwritten title companies. Therefore, we do not reach the premiums issue. Accordingly, we reverse the judgment of the Court of Appeal.


These consolidated actions are for refunds of taxes levied against title insurers. The refund actions were submitted for decision on the basis of a written stipulation of facts. We summarize the stipulated facts below.

Plaintiffs are seven corporations licensed to do business in California as title insurers. The insurers issue all or some of their title policies through underwritten title companies (sometimes referred to hereafter as "title companies"). Pursuant to a written underwriting agreement with the title insurer, to which those seeking title insurance are not a party, the underwritten title company conducts a title search and examination and prepares a preliminary report on the conditions under which title insurance would be available. Acting as the title insurer's agent, the underwritten title company issues the title insurance policy using forms provided by the insurer, determines the premium from the insurer's rate schedule, and collects the premium. According to the terms of the underwriting agreement, the underwritten title company retains most of the premium fee (usually about 90 percent) for itself. The title company pays the remainder over to the title insurer for its acceptance of the risk of insuring title as set forth in the policy.

Although the title insurer and the insured are the only parties to the title insurance policy, the underwriting agreement obligates the underwritten title company to pay a portion of certain title insurance claims. In some circumstances and under some underwriting agreements, the underwritten title company makes such payment directly to the insured party; in others, the title company pays the title insurer.

Under the California insurance tax imposed by article XIII, section 28, of the California Constitution and Revenue and Taxation Code sections 12201 and 12231, the basis of the annual tax on title insurers is all income from business done in this state. During the years in question, the title insurers reported and paid taxes upon that portion of each title insurance premium received from the underwritten title company. They did not report or pay taxes on the portion of the premium that was retained by the underwritten title company or on the value of insurance claims paid by the underwritten title company.

In 1972, the California Department of Insurance (CDI) decided that payments made by an underwritten title company to satisfy its obligation to pay certain portions of policy claims were to be characterized as "income" for purposes of calculating the title insurer's tax burden. In 1973 the CDI

[842 P.2d 124] began proposing, and defendant State Board of Equalization (the Board) [4 Cal.4th 721] began issuing, tax assessments on that basis. No known change in statutory law, in the practices of the title insurance industry, in the terms of title insurance policies, or in the contractual relationships between title insurers and underwritten title companies caused the proposal and issuance of these assessments.


The Board issued deficiency assessments for various years between 1975 and 1984, which plaintiffs unsuccessfully contested in administrative proceedings before the Board. Plaintiffs then paid the assessments and filed separate actions for refunds. The actions were consolidated in the Superior Court of San Francisco.

The parties stipulated that "[t]he issue in this case concerns whether the amounts of payments made by the underwritten title companies as described in paragraph 4(d) above [relating to underwritten title companies' payment of claims], which were applied to reduce [title insurers'] liabilities under the title insurance contracts, should be included in the 'income' measure for purposes of calculating [title insurers'] tax burdens under the California Insurance Tax." However, shortly before trial, the Board informed the insurers that it would assert a new defense to the insurers' refund claims at trial. The Board claimed that the title insurers should have reported and paid taxes on the total amount of the premiums paid by the insureds, rather than only on the portion they received from the underwritten title companies. After a nonjury trial based on the stipulated facts, the trial court found in favor of the title insurers. In its memorandum opinion, the court held that neither the amount of the claims paid by the underwritten title companies nor the amount of the premiums retained by the title companies was income to the title insurers. A judgment was entered ordering refunds totaling approximately $93,000 plus interest.

The Board appealed the trial court's judgment. The Court of Appeal reversed. The court held that the claims paid by title companies were taxable income to title insurers. The court also held that the total amount of the premium, including that portion retained by the underwritten title company, was taxable to the title insurer. Therefore, the court rejected the title insurers' refund claims. Presiding Justice Anderson dissented, reasoning that the majority should not have reached the question of whether the entire premiums were taxable to the title insurers and that neither the portion of the premiums retained by the title companies nor the amount of the claims paid by the title companies was income to the title insurers.


California taxes insurance companies differently than it taxes all other corporations. With some exceptions not relevant to this case, the California Constitution requires insurers to pay an annual tax in lieu of all other state and local taxes. (Cal. Const., art. XIII, § 28, subds. (b), (f); see also Rev. & Tax.Code, §§ 12204, 12231.)

For title insurers, the basis of the annual tax is "all income upon business done in this State, except: [p] (1) Interest and dividends. [p] (2) Rents from real property. [p] (3) Profits from the sale or other disposition of investments. [p] (4) Income from investments." (Cal. Const., art. XIII, § 28, subd. (c).) Generally, all other insurance companies are taxed on the basis of gross premiums, less return premiums, received upon business done in California. (Ibid.)

The annual tax for title insurers is subject only to those deductions specified in article XIII, section 28. (Cal. Const., art. XIII, § 28, subd. (b).) These deductions do not include ordinary and necessary business expenses. Therefore, title insurers cannot deduct from their taxable income amounts paid out on claims. Underwritten title companies, on the other hand, are taxed as corporations and can deduct claims paid as ordinary and necessary business expenses to the extent the expenses are not reimbursed under a separate errors

[842 P.2d 125] and omissions insurance policy. (See Rev. & Tax.Code, §§ 12001 et seq. & 24343.)


As noted earlier, all of the underwriting agreements at issue in this case allocate to the underwritten title companies the obligation to pay a portion of certain title insurance claims. The provisions for payment of claims in the underwriting agreements vary; some contemplate that the underwritten title company will pay claims up to a certain sum, while others provide that the underwritten title company will pay some or all of the claims due to its negligence in searching title. Title insurance differs from other insurance in that the preliminary title search is designed to eliminate risk by identifying any possible clouds on the title and excluding them from the coverage of the policy. Thus, the obligation of the underwritten title company to pay some portion of claims made under the title policy appears to serve the purpose of increasing the title company's incentive to perform its title search carefully.

Although the title insurers 1 and the Board disagree vigorously on many issues in this case, they do agree that the characterization of any particular payment of a claim as income to the title insurer should not depend on whether the underwritten title company makes the payments directly to the insured or, instead, indirectly through the title insurer. We agree that the distinction between direct and indirect payment of claims has no legal significance. To hold otherwise would exalt form...

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