Demystifying Tax Insurance
The existence of a legal ambiguity slows down a transaction. Tax law is not immune to this sentiment and is frequently the cause of it. Taxpayers strive for as much certainty as possible in their business dealings, not only to be able to sleep at night, but to assuage the concerns and misgivings of their investors, partners, lenders, and other deal participants. Tax issues should not stand in the way of an otherwise favorable business deal. Enter tax insurance.
Tax insurance is a bespoke insurance product designed to mitigate risk associated with an uncertain or ambiguous tax position. [1] The aim of the tax insurance industry is to provide a solution for taxpayers facing challenges caused by a shifting and sometimes nebulous tax landscape. The Treasury Department and the Internal Revenue Service ("IRS"), as well as non-US tax authorities, are constantly issuing and enacting voluminous new laws, regulations, rulings, and other pronouncements, each of which can lead to interpretive challenges for taxpayers. New tax statutes often require interpretive or implementing Treasury Regulations which can take years to be issued in final form (if at all). Taxpayers relying on new laws invariably face at least some degree of uncertainty in how a statute will be interpreted by the IRS and courts, and thus taking a position on a tax return or engaging in a transaction governed by a new tax law often brings with it a degree of risk. That said, even seemingly well-trodden tax law can present interpretive ambiguities. [2] Tax insurance policies provide protection to an insured taxpayer for additional taxes owed, including interest and penalties, defense costs, and a gross-up to account for any tax due on the receipt of the insurance proceeds.
While tax insurance has existed for decades, the recent success of the representations and warranties insurance ("RWI") market has motivated new underwriters and brokers to enter the market and existing underwriters and brokers to expand their market presence. The success seen with RWI has instilled confidence in the broader tax insurance industry that the consumer demand will justify the additional resources devoted to it. In addition, due to the nature of the products, RWI promotes and creates space for the tax insurance industry to thrive and highlights its raison d'etre.
[1] This is not to be confused with an "uncertain tax position" as defined for financial statement reporting purposes under ASC 740 or otherwise required to reported on IRS Schedule UTP (Uncertain Tax Position Statement). Tax insurance is by no means restricted to covering such "uncertain tax positions." It could, however, impact how a company reports tax reserves on its financial statements.
[2] For example, Section 965 of the Internal Revenue Code of 1986, as amended (the "Code"), which provides rules under the so-called transition tax, was enacted on December 22, 2017, as part of the Tax Cuts and Jobs Act, Pub. L. No. 115-97. After seven years, a taxpayer challenge in Moore v. United States (docket number 22-800) has been set for hearing at the US Supreme Court in the fall term of 2023. One of the main issues involves the interpretation of principles discussed in Eisner v. Macomber, 252 U.S. 189 (1920). All references herein to a "Section" are to a Section of the Code unless otherwise stated.