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Insuring tax liabilities.

A new insurance product was recently introduced to provide assistance to financial officers in managing tax liabilities. Tax Opinion Guarantee Insurance permits a company or individual to insure that the tax benefits of a particular transaction will be received. If the IRS denies the tax treatment taken on the return, the policy pays the denied benefits to the taxpayer. As explained below, the premium range for this coverage is approximately 3% to 10% of the policy limit; the carriers underwriting this coverage are reputable and highly rated.

Tax Opinion Guarantee Coverage

Businesses and individuals strive to structure transactions to minimize taxes. But the ever-evolving tax code, coupled with the complexity of business today, results in varying levels of risk about the Service's positions. While letter rulings are a viable option to eliminate this risk, they may not be timely issued; further, the IRS will not issue a ruling for many issues, or no precedent may exist. Further, a taxpayer might not want to disclose a strategy to the Service in a letter ruling request. Tax Opinion Guarantee Coverage provides that if the IRS rejects a taxpayer's position, the insurance company will reimburse the taxpayer for the additional taxes paid.

Coverage

The policy is structured around a particular transaction for which an accountant or attorney has issued an opinion. The opinion need not conclude the Service "will" or "should" allow the position, and may be useful when its level of certitude hovers around "more likely than not" the IRS will decide as concluded in the opinion. The policy is tailored for a single transaction and covers only that. A one-time premium is paid at inception of the policy. The policy period runs until the tax year of the transaction has closed and either the Service accepts the taxpayer's position or the policy pays the insured benefits. Besides paying a benefit equal to the tax benefit denied, the policy may be structured to provide separate limits for interest and penalties, adjustments to state and local taxes and a gross-up for additional taxes owed as a result of receiving payment under the policy.

Coverage is also available for the costs of contesting an IRS determination after a 30-day letter is received. The taxpayer chooses its representative before the Service, as long as the representative is also acceptable to the insurance company.

While each transaction is evaluated separately, a guideline for premium range is 3% to 10% of the limit purchased.

Insurable Transactions

Tax coverage is a recent innovation and a large sample from which to draw conclusions about the insurability of different types of transactions does not yet exist. However, the goal is to provide coverage for transactions in which uncertainty exists. On the other hand, even if the predictability of the Service's position is relatively clear, a taxpayer may want the additional certainty of insurance when the cost/benefit analysis of tax coverage is attractive. To the extent the tax treatment is clear, the premium will be lower. While not a comprehensive list, transactions involving the following issues may be insurable:

* Capital gain versus ordinary income.

* Debt or equity status of a security.

* Payments received as interest or dividends.

* Qualification of a corporate reorganization for tax-free treatment.

* Qualification of assets for a like-kind exchange.

* Foreign taxes.

* Sales taxes.

* Excise taxes.

Tax coverage is not designed to cover tax shelters or similar transactions.

Obtaining a Quote

The first step is for a taxpayer to obtain an opinion from an attorney or accountant on the tax consequences of a transaction. This opinion may be in either final or draft form; in some instances, a memo from the adviser will suffice. The adviser may be either an in-house employee or outside adviser. Approximately two weeks after receiving the tax opinion, the underwriter will respond as follows: (1) whether or not it will insure the transaction; (2) the maximum limit it is willing to underwrite; and (3) a specific dollar range for the policy premium. There is no charge for this preliminary quote.

Depending on the transaction's complexity, to' obtain a final quote, the taxpayer may need to deposit with the underwriter approximately 10% to 20% of the premium quoted to defer the underwriter's costs in reviewing the opinion. If the final premium quote is higher than the preliminary quote, the taxpayer is entitled to a full refund of the deposit. If the final quote is within the preliminary range and the policy is purchased, the deposit is credited to the premium. However, if the final premium is within the preliminarily quoted range and the policy is not purchased, the deposit is forfeited.

Miscellaneous

The coverage is by no means designed to replace the need for an opinion by an outside adviser; an opinion is prerequisite for coverage. At the same time, to trigger policy coverage, the taxpayer need not show negligence by the adviser who prepared the opinion. Coverage is triggered only by the IRS's denial of benefits.

Questions have been raised about whether the potential of insurance coverage will encourage tax advisers to draft (and their clients to encourage) more aggressive opinions. Notwithstanding the tax adviser's understandable self-interest in maintaining a consistent and ethical reputation, such practice would be counterproductive. In each case, the underwriter makes its own determination about the riskiness of the tax treatment at issue; the tax adviser's opinion is only a starting point. If either the opinion or the transaction is overly aggressive, coverage may not be available.

Conclusion

Tax coverage is a powerful tool for financial officers, tax planners and risk managers who seek to bring more certainty to the tax treatment of business transactions. The insurance is broad and flexible, with substantial limits available. There is no cost to obtain a preliminary quote, which will be received shortly after the underwriter receives the tax opinion.

FROM GEOFFREY D. FALLON, J.D., SENIOR VICE PRESIDENT, J&H MARSH & MCLENNAN, COLUMBUS, OH
COPYRIGHT 1999 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1999, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

Article Details
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Author:Fallon, Geoffrey D.
Publication:The Tax Adviser
Geographic Code:1USA
Date:May 1, 1999
Words:982
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