SeeSALT Blog
On February 10, 2026, Assembly Bill 1790 (AB 1790) was introduced in the California Legislature. Although recently placed in the suspense file, AB 1790 could still be put up for a vote this budget cycle or influence later budget proposals. While public reporting about AB 1790 has focused on its proposed elimination of the water’s-edge election, the bill also includes a less-discussed but significant change to California’s treatment of captive insurers—one that may raise concerns under the California Constitution.
Under current law, taxpayers engaged in a unitary business may elect water’s-edge reporting, which generally limits the combined group to U.S. entities and certain affiliated foreign entities. Insurers, however, are typically excluded from combined reports because they are not subject to the corporate franchise tax and are instead taxed under a separate constitutional regime. AB 1790 would alter this structure by requiring captive insurers to be included in combined reports, but that raises significant questions about whether that treatment is consistent with California’s constitutional limits on the taxation of insurers.
California’s Constitutional Insurance Tax Regime
Under the California Constitution, insurers are subject to a tax system that differs from the corporate franchise tax applied to most businesses. Article XIII, section 28 imposes a gross premiums tax—currently 2.35% on premiums from business conducted in the state—that applies “in lieu of” most other state taxes, including the corporate franchise tax.[i] As a result, insurers are generally exempt from the corporate franchise tax and, under longstanding California Franchise Tax Board (FTB) guidance, excluded from combined reports regardless of whether they are doing business in the state.[ii]
The constitutional regime also includes a retaliatory component. If another state imposes higher taxes or regulatory burdens on California insurers, California may impose a comparable burden on insurers from that state. This system is not designed to maximize revenue, but to promote reciprocal treatment among states.[iii]
Consistent with this framework, FTB guidance applies a regulatory-based understanding of what constitutes an “insurer,” focusing on whether an entity is licensed as an insurance company and regularly conducts an insurance business. Nothing in this framework categorically precludes captive insurers from meeting this definition.
AB 1790 and the Inclusion of Captive Insurers
AB 1790 would depart from this longstanding framework by requiring captive insurers that are part of a unitary business to be included in a combined report. The bill defines a captive insurer as an insurance company “owned or controlled by a member or members of the unitary group” and used to insure the risks of the parent organization and its affiliates.
California insurance law generally recognizes insurance arrangements between related parties, including captive insurance arrangements, suggesting that captive insurers fall within the state’s definition of “insurer.” Accordingly, they may fall under the California Constitution’s protections for insurers.
Is the Proposal Constitutional?
The core issue is how “insurers” are defined—and how California’s constitutional framework interacts with federal income tax principles. Nothing in California insurance law excludes insurance arrangements between related parties, and administrative guidance suggests captive insurers may be treated as insurers.[iv]
Federal income tax law is arguably more restrictive. Courts require risk shifting and risk distribution and apply technical rules designed to prevent taxpayers from accelerating deductions. Although the definition is narrower, captive insurance companies can and have satisfied the federal definition of insurance.[v]
The interaction between these two regimes is not clearly defined. Neither the California Constitution nor AB 1790 addresses how differences between state regulatory definitions and federal tax standards should be reconciled. Existing administrative guidance suggests captive insurers may be treated as “insurers,” but does not address whether they may be excluded from that classification for California income and franchise tax purposes.
This gap is significant. Under California’s constitutional regime, entities that qualify as insurers are subject to the gross premiums tax and exempt from the corporate franchise tax. If captive insurers fall within that definition—as California’s regulatory approach suggests—then requiring their inclusion in combined reporting may conflict with the California Constitution. Captive insurers that satisfy the federal income tax definition of insurance present a clearer case for treatment as insurers under any applicable standard.
Practical Implications
Taxpayers may argue that AB 1790 effectively subjects insurers to direct or indirect taxation through the combined reporting system, contrary to the “in lieu of” limitation in Article XIII, section 28.
The bill attempts to mitigate this issue by providing a credit for members of a unitary group subject to a net income tax (or a tax measured by net income) under other California law. However, the credit may not fully offset the gross premiums tax or cure the underlying issue, which is whether insurers may be subjected to the corporate franchise tax at all.
The bill also introduces uncertainty for taxpayers that have historically relied on the exclusion of insurers from combined reporting. It does not clearly address how existing captive structures will be treated or how conflicts between the constitutional insurance tax regime and the corporate franchise tax will be resolved. This uncertainty is heightened by the lack of clarity around which definition of “insurance” governs, but the inclusion requirement could reach at least some captive insurers under any standard.
Although much of the attention has focused on the bill’s water’s-edge provisions, this less-discussed aspect of AB 1790 could become an even greater focal point if enacted.
Because AB 1790 would result in a tax increase, it requires approval by a two-thirds vote of each house of the Legislature. Any modification to the constitutional framework governing insurer taxation would require voter approval.