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Tax insurance is a type of business liability insurance that streamlines transactions by mitigating risks associated with tax liabilities. Rather than a business incurring uncertain liabilities on its own, tax insurance transfers the risk to the insurance company. Tax insurance is commonly requested before an M&A transaction by the seller, and during an M&A transaction by a buyer following due diligence, or by a seller who is being asked to give a specific indemnity.

However, this doesn’t mean that tax insurance is only limited to an M&A transaction or investment. It can also be used by a business outside of a transaction at any period of time. This includes when a corporation is undergoing an audit or in litigation with the IRS or other taxing authority.

There are several types of this insurance policy available, including:

• Tax liability insurance: Covers identified tax risks/position (within or without a transaction). Tax insurance and tax liability insurance are often used interchangeably.
• Tax return insurance: Covers unidentified tax risks associated within a given return filed by the insured.
• End of fund life insurance: Covers unidentified and identified tax risks to support the liquidation of a private equity fund structure.

Tax insurance is a solution for both addressing identified issues arising during an M&A transaction and general corporate tax risk management. It can be used for both income and non-income taxes and is available for U.S. and non-U.S. tax risks at any governmental level.

If a covered tax position fails to qualify for its intended tax treatment, tax insurance provides financial protection for taxpayers against the following:

• Losses (including interest and penalties) arising from federal, state, local and foreign tax assessments.
• Defense costs arising from legal and professional advisors’ fees in response to a challenge.
• Gross-up for any tax owed on the receipt of insurance proceeds.

You can insure multiple tax risks, including:

• Qualification and exemptions: REIT, S-Corp, ECI, USTB, Treaty Qualification, USRPHC, PFIC, Substance, Withholding Tax, FIRPTA, 338(h)(10), Indirect Transfer Tax LTCG
• Deductions: Debt/Equity, Worthless Stock Deduction, NOL Availability/382/384 Limitations, Ordinary Deduction Versus Capital Loss
• Credits: ITC, PTC, LIHTC, 45Q, FTC, State Tax Credits
• Reorganizations and deferral: Acquisitive/Divisive Reorganizations (Spin-offs/Split-offs/Split-ups), Like-kind Exchanges (1031), Deferred Compensation, 409A
• Transfer pricing: Operational, Financial, Intellectual Property
• Valuation: Valuation and Cost Segregation, 311(b) gain, NOL Carryforward/GILTI/Subpart F Inclusions, 83(b) Elections, Qualified Basis for Tax Credit

Tax insurance offers strategic benefits to both deal parties in a merger and acquisition, including:

• Replaces the need for specific indemnity or escrow, allowing the insured to redeploy proceeds immediately and avoid purchase price adjustments that overvalue the risk.
• Streamlines negotiations by replacing an unknown or uncertain tax liability with an inexpensive one-time premium.
• Reduces or eliminates financial risk to an acquirer for historic tax positions taken by the acquired company and tax issues arising from the transaction steps.

If tax insurance is not used and a business is exposed to unexpected tax liabilities, it can significantly set back a deal by years. In contrast, tax insurance seeks to bring more certainty to a deal by safeguarding each party’s assets and moving any potential risks to the insurance carrier. Tax liability insurance can also protect against known risks that are excluded from representations and warranties coverage, bringing peace of mind to both the buyer and seller.

A tax insurance policy can also provide many benefits outside of a transaction:

• Removes the financial uncertainty from the day-to-day tax planning and internal transactions that are part of a company’s operations.
• May replace the need for a private letter ruling and protects against an adverse determination from a pending tax audit.
• Shifts the financial impact form unknown tax risks associated with a corporation’s or partnership’s tax returns.

Outside M&A transactions, tax insurance helps to solidify a company’s tax position and mitigates their overall risk in everyday operations.

Tax liability insurance is applicable in a variety of circumstances, including but not limited to businesses that are:

• Undergoing a merger or acquisition that want to protect buyers while ensuring a sound closing that benefits the seller.
• Reorganizing their internal structure.
• Interested in mitigating their balance sheet risk.
• Transferring pricing from one division to another.
• Managing an incentive program and want to decrease any potential tax exposures.
• Tax equity investors that want to protect the investment structure and profit off the associated tax credits.

With tax insurance, these stakeholders can accomplish the following:

• Efficiently allocate the economic risk of a tax loss.
• Avoid or reverse the financial statements impact of FIN 48 reserves.
• Address the possibility of significant loss.
• Extend or add to the survival of the seller’s escrow and indemnity for a buyer’s benefit. • Achieve financial certainty absent a letter ruling from a tax authority.
• Mitigate counterparty credit risk in tax indemnity agreements.
• Unlock trapped cash by replacing or reducing escrows or holdbacks.
• Obtain approval needed to pass investment committee.

With the increasing complexity of tax rules across the globe, tax insurance is an invaluable tool for tax risk management and ensuring long-term financial stability. If you have a tax issue and want to explore a tax insurance solution, contact Alliant to learn more.