Tax insurance protects tax payers against adverse, or unexpected, tax liabilities in business transactions, including recapture, possible fines, penalties, interest, legal costs and taxes due to tax authorities.
Renewable energy developers and tax equity investors may choose tax insurance not only to reduce risk, but also as a more efficient and cost-effective alternative to a “private letter ruling”1 from the IRS.
What Is A Tax Liability?
A tax liability is money owed by a business, individual or other entity, to a tax authority, such as the Internal Revenue Service (IRS).
Tax liabilities are incurred in many ways, including but not limited to, income taxes, sales taxes, capital gains taxes and property taxes.
Business transactions can have significant tax implications and it is wise to minimize tax liabilities in accordance with the tax code…
However, the accounting treatment of a business transaction may be challenged by a tax authority based on differences in interpretation of the Internal Revenue Code, or state or local tax law.Â
If the IRS, state or local tax authorities to disagree on the tax treatment of your business transaction, you may incur an unexpected tax liability.
What Is Tax Insurance?
Tax insurance, also known as “tax liability insurance”, “tax equity insurance” or “tax opinion insurance”, transfers the risk of a tax liability to an insurance company.
If a tax authority disagrees with the intended tax treatment of a transaction, or a tax position you have taken in the past, tax liability insurance steps in if an unexpected tax liability arises.
A tax liability insurance policy allows a deal to proceed while protecting you against tax recapture, possible fines, penalties, interest, legal contest costs and taxes due to federal or state tax authorities.
Tax liability insurance may be purchased on its own, or along with representations and warranties insurance, to broaden the coverage of the latter.2
Tax insurance may be used to reduce risk in day to day corporate operations as well as business transactions and M&A including, but not limited to:
- Risk management in tax treatment of routine corporate business operations
- Historical tax treatment by a target entity in an M&A transaction
- Insuring the qualified basis on a solar investment tax credit (ITC) transaction
- Wind production tax credit (PTC) characterization
- REIT characterization
- Partnership characterization
- Capital gains treatment vs. ordinary income
- Foreign tax credits
- Opportunity zone tax compliance
- Capitalization vs. deduction of expenses
Tax opinion insurance may be used by renewable energy project developers and tax equity investors as a risk management tool to protect tax treatment of commercial and industrial solar, wind and energy storage projects.
Tax liability insurance provides comfort to lenders and regulatory, compliance and credit committees when managing risk.
What Does Tax Liability Insurance Cost?
Tax liability insurance costs typically range from 1.5%-6% of the policy limit.
For instance, for a $50,000,000 limit of insurance, a client would expect to incur a one-time premium of $750,000-$3,000,000.
The policy requires an up front underwriting fee and the premium is paid once, prior to binding.
The tax liability insurance policy term is multi-year, similar in length to a runoff policy, and may be written for up to seven years.
A tax liability insurance policy includes a self-insured retention and may be triggered by the challenge by a tax authority to a corporation or individual’s tax position.
The coverage protects an insured against any additional taxes due, penalties, interest, claims expenses…
However, a tax insurance policy will not cover general tax payer inquiries, or a routine audit by the IRS or other tax authority.
Footnotes
- A private letter ruling, or PLR, is a written statement issued to a taxpayer that interprets and applies tax laws to the taxpayer’s represented set of facts. A PLR is issued in response to a written request submitted by a taxpayer. A PLR may not be relied on as precedent by other taxpayers or by IRS personnel. Here is an example of a residential solar system purchaser renewable energy credit (REC) private letter ruling.
- Tax related representations and warranties in a merger or acquisition are often excluded from a representations and warranties insurance policy.
