The Value of Tax Liability Insurance in M&A

Tax liability is among the major issues for the parties involved in a merger or acquisition transaction, given the inherent complexity and ambiguity of certain tax laws. The impact of a tax challenge by the IRS, state or federal authorities can significantly compromise the value of a deal, stall or even derail it altogether. Tax Liability insurance provides the parties involved in a transaction with an insurance solution to reduce or eliminate their exposure to a specific, identified risk of a tax-related loss. Consider Tax insurance as an addition to Representations and Warranty insurance, which offers coverage against financial losses (including expenses related to defending claims) for certain unintentional and unknown breaches of the seller’s representations and warranties made in an M&A purchase agreement. Tax Liability insurance, conversely, insures against potential tax issues known to the parties.

Tax Liability insurance offers a number benefits: It can be used to provide peace of mind to companies/individuals that they will not be exposed to an adverse tax ruling; remove a questionable tax issue from negotiations during an acquisition; offer certainty where tax authorities do not provide advance rulings to taxpayers on certain identified tax matters, or where an unfavorable ruling will not have a negative financial impact on the parties to the transaction; avoid the need for seller indemnities and/or escrows for potential tax exposures known to the buyer and seller, facilitating the seller’s smooth exit from specific businesses; and cover uncertainties as a result of group restructuring and reorganizations. 

Tax Liability insurance can cover losses arising from federal, state, local, or foreign tax treatments, paying gross-up of taxes in the event of a loss and interest and non-criminal fines or penalties related to the determined tax liability. The policy can also pay the expenses for legal and financial advisors to assist in resolving disputes with the IRS and/or other taxing authorities.

The cost of Tax Liability insurance is a one-time premium that ranges between 3% and 6% of the limit that is purchased, with a typical policy term of six years. There typically is, though not always, a self-insured retention level, which varies depending on each situation. Coverage is generally triggered when a taxpayer is notified by a taxing authority that a covered tax position is being investigated. 

To determine an initial indication of price and insurability, underwriters will need:  

  • Name and address of the insured.
  • The tax position being covered, including detailed descriptions of the underlying transaction and the relevant tax issues to be insured.
  • Draft opinion from a tax advisor or an analysis of the tax issue.
  • The tax backgrounds of the buyer and seller.
  • Limit of liability the insured would desire.
  • A potential loss calculation, including additional taxes, interest, penalties, claim expenses, and gross-up.

Owens Group has the expertise and experience to assist clients with structuring and implementing the coverages needed to achieve their unique transaction goals. To discuss how to protect yourself with Tax Liability insurance and how it coordinates with R&W coverage, please contact Joe Ehrlich at 201-408-3512 or Dorene Stockman at 201-408-3504.