Insurance has been a long-established, reliable tool that estate planners use to manage future tax burdens. Life insurance is often part of the plan, and tax insurance can be a valuable tool to manage the tax uncertainty of estate settlements and family business restructuring.
While widely used in M&A transactions and by tax credit investors to bring certainty to their investments, many wealth managers and tax and estate attorneys are unaware that insurance can play a similar role with estate plans that veer off track — adding a layer of certainty to an uncertain outcome for high-net-worth families trying to avert an unanticipated and significant tax hit.
Estate settlements can hit any number of roadblocks, whether contentious or amicable, including disagreements over settlement terms, unforeseen circumstances that alter family dynamics, or even mistakes.
Parties can restructure a will to solve these problems, but often with unintended consequences — such as a tax bill in the tens to hundreds of millions of dollars. When families seek to restructure an estate plan, concerns over who will bear the burden of adverse tax consequences can be an impediment to amicable settlements and sensible go-forward business plans.
Families don't have to endure prolonged conflicts, large exposures or the high costs of traditional indemnity agreements, though — they have another option. Tax insurance can cover certain losses such as additional gift taxes payable from a position that fails to qualify for its intended tax treatment, all while keeping the settlement on track.
So, what is tax insurance? It is an insurance solution that offers programs over $500 million, and with the entrance of additional "A" rated or better insurers to the market, the ability to place programs over $1.5 billion per risk has been enhanced.
Tax insurance can be considered the insurance version of a private letter ruling. A policy will clearly define the intended tax treatment of the situation at hand — for example, that the restructuring of an estate will not give rise to income or gift taxes. Down the road, if the IRS successfully challenges that position, the insurers will pay certain assessed amounts (for example, tax and interest), contest costs and a gross-up for any tax due on the insurance proceeds themselves.
The policies are customized to fit each situation but contain few exclusions and are generally straightforward, if the insured does not misrepresent the situation and acts consistently with the requirements of the policy, that insured can expect to be protected against these future covered losses.
