You’re probably familiar with rep and warranty insurance in M&A transactions, but did you
know that you can get insurance against an undesired tax result in a transaction?
Tax insurance can apply to almost any transaction where there is a “known” tax question, but the result is uncertain. Tax insurance can cover a number of circumstances, including:
- Issues that arise during diligence in an M&A transaction and as a “known” issue,
are no longer covered by reps/warranties insurance (e.g., failure to file sales tax
returns in a state where the state has not audited).
- Transactions in which the authority is not altogether clear and the dollars at risk
are high enough that insurance is desirable to hedge risk (e.g., tax equity financing
in energy transactions)
- Transactions where it would be desirable to obtain a private letter ruling, but the
timeline cannot accommodate the necessary lead time for a ruling (e.g., nontaxable spinoffs).
- Transactions where the taxpayer has already received a negative result, but believes it can win on the merits in an appeal (e.g., appealing a penalty assessment).
In such situations, it may be desirable to purchase a policy that will insure against an adverse tax consequence or even the cost of defending an unsuccessful allegation of taxability by the IRS. Most tax insurance policies will insure against the potential tax liability as well as the contest costs (whether you win or lose the audit or tax case). As you might guess, the expense of contesting a tax assessment can be substantial even when you win. The cost of the policy is typically set as a small percentage of the potential tax exposure (e.g., ~2% to 6%, depending specifics of the tax matter at issue). The premium is paid up front or the cost can often be financed.
Bottom Line: Transaction insurance isn’t just for reps and warranties anymore. Keep this
in mind when a client needs more comfort than your opinion.
“Listen, smile, agree, and then do whatever you were gonna do anyway.” — Robert Downey Jr.