This week I was afforded the opportunity to review a tax liability insurance policy for the first time. Tax liability insurance is designed to protect a taxpayer in the event a tax position or investment fails to qualify for its intended tax treatment. It will typically involve a transaction, reorganization, accounting treatment, investment, or other type of taxable event. The policy will cover losses where the IRS or other taxing authority deems a greater tax liability applicable than what the taxpayer claimed.
Tax liability insurance can play an integral role in business transactions. For example, a buyer or seller of a company that has a unique tax status that is subject to change, can present a significant roadblock to the sale of the business. Potential buyers may be frightened by the potential change in tax status that can result in significant tax charges. In order to remove this impediment, and in lieu of an indemnification holdback in a purchase agreement, the parties may agree to purchase a tax liability insurance policy to cover the potential change in tax status that could result in additional tax liabilities.