Tax Return Insurance: A New Path to Peace of Mind for Officers and Investors

Directors and officers might get some relief if their firm picks up tax return insurance. It could serve as a good compliment to D&O insurance.
By: | May 14, 2020

Ever considered insuring your tax returns? For some corporations, it’s a necessity, especially if they’re looking at a merger.

“Since tax insurance started in the 1980s, it has been largely used as part of mergers and acquisitions [M&A],” said Gary Blitz, co-chief executive officer of Aon’s M&A and transaction practice, and global head of Aon’s tax practice.

“In recent years, other growth drivers have emerged, and now about a third of our activity is in M&A transactions; a third is driven by tax credits for investments like renewable energy; and a third is from non-transactional business, where there is no third party, such as a corporation managing its own tax risk and tax reserves for situations like an internal reorganization or transfer pricing.”

An Ever-Growing Segment

Underwriters in the segment include several of the global multi-line carriers, including AIG, Berkshire Hathaway and Chubb.

Everest Re Group and Great American are active, along with several managing general underwriters such as Vale, Ambridge Partners, Euclid Transactional and Concord, a subsidiary of Ryan Specialty Group.

There are now about a dozen underwriters in the sector, Blitz estimated.

Gary Blitz, global head of Aon’s Tax Practice

“The growth driver for the sector, especially for non-transactional policies, has been insureds seeking to add certainty to their tax reserves and other position. Many internal initiatives, such as reorganizations, debt restructuring and so forth, have material tax ramifications,” he explained.

“For entities operating on thin margins or temporarily short of cash, particularly in the current economy, that creates a risk, because it could be years before they know the validity of their tax position, and in the meantime, their cash flow and operating income is at risk,” said Blitz.

The growth in use and capacity have supported each other, and limits of $1 to $2 billion are not unknown.

“This has all been supported by the growth of reps and warranties,” he added.

“There are a lot of applications for this type of coverage.”

An Opportunity for D&O?

Another important point is that tax insurance indirectly limits exposure to directors and officers by covering a company directly for a tax risk that would not typically be protected by a D&O policy.

“There is a lot of growth potential in tax insurance, particularly with the Fortune 1000,” Blitz said, but he did not believe comprehensive tax return insurance (TRI) has current market support or would be the source of that growth.

“The idea is not a new one; we have yet to see [TRI] offered at scale with economic pricing, nil deductibles like traditional tax insurance or a manageable diligence process given the complexity of large multi-national corporations,” he said.

“If it has any applicability in today’s market, it would be for small- to mid-sized firms and partnerships with simple tax profiles.”

What Would TRI Do?

As implied by the specificity, TRI covers all tax positions taken on a U.S. federal income tax return that will soon be, or already has been, filed with the Internal Revenue Service (IRS).

It is intended to make the insured whole in the event the IRS disagrees with a position and imposes additional tax, interest or penalties.

Any such payments may also have further repercussions. Generally Accepted Accounting Principles require taxpayers to analyze and disclose uncertain tax positions. Thus, tax assessments for undisclosed tax positions could result in shareholder or investor lawsuits.

Dave De Berry, chief executive officer, Concord Specialty Risk

And most recently, under partnership audit rules for taxable years beginning in 2018, the IRS may now collect tax adjustments made to a partnership tax return from the partnership itself.

That means the partnership either collects such assessment from current partners, some of which may not have been partners in the audited tax year, or from the partners from the audited tax year, some of which may no longer be partners.

“The coverage is new in that it covers multiple positions,” said Jordan Tamchin, head of the tax-insurance practice of brokerage CAC Specialty.

“There has been coverage as part of reps and warranties for years, but having coverage for the whole tax return on a standalone basis, outside of reps and warranties or M&A, is new.”

Underwriting is efficient.

“We need to see current and historic tax returns, financial statements and related documents,” said Dave De Berry, chief executive officer of managing general underwriter Concord Specialty Risk.

“We also may interview financial, legal or executive personnel.”

To be sure TRI “is not promoting aggressive positions,” De Berry stressed.

“Quite to the contrary, the IRS has condoned the use of tax return insurance. It gives officers and investors peace of mind, because the entity is no longer relying just on an opinion letter from a lawyer.”

Addressing the knock-on implications, De Berry added, “D&O coverage often excludes tax liability. Moreover, tax liabilities impact a company’s financial condition, results of operations and cash flow. TRI shows that even if a company is ultimately found to owe taxes, it exercised good faith and prudence.

“Moreover, if additional taxes are owed, the insurance reduces or eliminates loss, thus reducing the risk of claims of mismanagement, securities fraud or financial misrepresentation.” &

Gregory DL Morris is an independent business journalist currently based in New York with 25 years’ experience in industry, energy, finance and transportation. He can be reached at [email protected].

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