Financial Loss · Insurance · Risk Management

Not Sure The IRS Agrees With a Tax Position Your Company Has Taken? Here is a Solution

I recently read that Illinois Tool Works (ITW) prevailed in a case against the IRS.  The IRS challenged that a loan from ITW’s foreign subsidiary to its parent company was a nontaxable return of capital as ITW contended.  The IRS dtermined that it was not a loan but a dividend and as a result a taxable event. ITW challenged the IRS and the case was brought to the US Tax Court.  In early August the court released their decision and sided with ITW.  A short write-up can be found here.

Why I bring this up is that many companies have tax positions they are aware of that could be challenged by the IRS.  Companies rely on their accountants to determine whether certain events have tax implications and then proceed accordingly.  Unfortunately, this is not foolproof strategy, the IRS can and will challenge these events even if you are using the best and biggest accountants.  What few companies are aware of is that there is an insurance policy that can protect them in these instances.

Tax Liability insurance can protect against many types of tax issues, including, but not limited to, spinoffs, M&A, multinationals, tax exempts, related party transactions, and foreign investors.  The policy can cover the taxes, interest, defense costs, in some cases fines and penalties, and gross-up.  What is different with this type of insurance compared to traditional property and casualty insurance is that we are covering a known event, or tax position, that may not be 100% clear cut but that we are confident is correct.

The underwriting process is specific to that event and coverage is tailored accordingly. Information is collected on the event and might include commentary from a tax attorney and/or an accountant.  After preliminary info is collected it is presented to the insurance market and the carriers come back with non-binding pricing and terms.  At that point a carrier usually identified that would be a good fit and a more exhaustive underwriting process commences.  At this stage an insured typically pays an underwriting fee that is used to pay for the due diligence (think lawyers and accountants that really dig into the info) that allows the insurer to put together the actual terms and pricing.  Assuming all is in order, the insured can then bind the policy that can have up to a 7 year policy term.

If you are a company and have uncertain tax issues then a tax liability policy is worth looking into.  There is no upfront cost to get a non-binding pricing indication, but be aware that policy pricing is in the 6 figures to start, however, it is a one-time premium and not annual.  The policy limits usually start at $5MM and can go up from there.

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