By Jessica Harger
Estate planning and settlements present challenges, risks and can oftentimes result in additional discomfort and disputes. But it doesn’t have to be that way. With tax insurance, business succession implementation and estate administration after death can be less stressful and help reduce the risk during the emotional and legal journey of transactions.
Although the “tool” of tax insurance has been around for some time, many are still unaware of it—or at least unfamiliar with how it applies in the estate tax context. But that is starting to change. Tax insurance is gaining traction both in the popular consciousness and as an effective risk mitigation tool with a surprisingly diverse range of potential applications.
For tax attorneys, financial advisors, executive decision-makers, and families and estate representatives trying to make thoughtful decisions with potentially significant financial consequences, an increasingly important priority is understanding tax insurance and its uses, benefits, and best practices.
What follows is a general overview of tax insurance basics, including who might benefit from a tax insurance policy and how and when it can be advantageous to consider tax insurance.
What is it and why now?
The law is notoriously full of gray areas—and tax law is no exception. There are a lot of very smart and capable tax professionals and attorneys who are adept at helping their clients navigate those uncertainties, and tax insurance offers another arrow in the quiver they can use to do just that. Tax insurance can be utilized in a variety of situations where the prospect of a potentially significant tax liability in the future impacts current planning or decision-making.
This is not a new solution; the first tax insurance policies were written in the 1980s and the first users were predominantly hedge funds. For some time, however, it was a relatively niche tool, remaining somewhat obscure until recently. Tax insurance has become increasingly common in the last 5-7 years, primarily in mergers and acquisitions (M&A). That M&A usage has functionally created a broader market for tax insurance, with newfound popular awareness that has facilitated new applications. Today, education and awareness remain the biggest obstacles to growth, and have only begun to scratch the surface of the many scenarios where this could be helpful.
Who is using tax insurance and how?
While tax insurance can add critical flexibility and financial certainty in many different contexts, there are three primary areas where tax insurance policies are commonly used today.
The first is in M&A transactions, as a tool for corporate or private equity buyers to streamline deal negotiations. Tax insurance can be used to provide more certainty to tax positions and subsequently allow transactions to move forward more quickly and efficiently.
Another area where tax insurance is helpful is in the renewable energy space. As a growing sector with a relatively large number of opportunities to apply for tax credits—and, accordingly, lots of resulting tax uncertainty to investors—tax insurance can be utilized to great effect.
The third, most common, and perhaps fastest growing arena for tax insurance relates to regular tax planning, both in corporate settings and for family tax and estate planning. On the corporate side, it can be used as a risk management tool for companies taking tax positions on their returns as part of their day-to-day business processes to protect liquidity—especially in well-vetted tax scenarios with low risk but high exposure. Family offices and high-net-worth individuals utilize tax insurance in a similar context. When facing the settlement of an estate, there are often significant tax implications, whether specifically with respect to applicable estate/gift taxes or perhaps even corporate taxes related to a business restructuring or repositioning in the wake of a death.
For estate planning, tax insurance is exceptionally well-suited to addressing the tax questions that arise in next generation wealth and estate planning, as well as the often-messy complexity, uncertainty, and tax exposure that exists in the wake of a loved one’s passing. During an emotional and sometimes confusing and disruptive time, the last thing families need is additional questions about how potentially significant tax uncertainties factor into business changes and decisions about when and how to disburse property and assets. Those tax questions can delay settlement on an estate or even lead to conflict that further complicates an already fraught situation. Whether utilized by family offices, individual executors and/or beneficiaries, corporate entities, or the estate itself, tax insurance can mitigate the significant long-tail risk of future unanticipated tax burdens to streamline the estate settlement process.
What can we expect moving forward?
For legal and tax professionals considering tax insurance for their clients, the first step is to consult a trusted resource with experience in tax insurance options and policies. As a flexible and strategic risk management tool, both institutions and individuals are utilizing tax insurance to reduce exposure to tax authority challenges and provide much needed clarity and security when it comes to tax planning and decision-making with tax implications. In that context, it’s not particularly surprising that tax insurance popularity and prevalence is on the rise. With awareness of this previously underutilized tool steadily increasing, it seems likely that the tax insurance marketplace will continue to expand both in size and diversity of offerings in the months and years ahead.
This article does not address any specific fact pattern and should not be relied on as legal, investment or other advice.
Jessica Harger is the Aon Managing Director , M&A and Transaction Solutions.
