The recent inaugural Tax Insurance Forum (TIF) hosted by tax advisory firm Leo Berwick in New York provided an opportunity for tax insurance brokers and underwriters to engage in a lively discussion led by several panelists.

“The tax insurance market has grown substantially, beyond traditional M&A,” said Joe Volk, Managing Director at Leo Berwick. “It requires brokers, underwriters, and underwriter counsel to be creative in assessing non-traditional risks and to have deep expertise outside of M&A.”

The TIF was intended to be a collaborative event where brokers and underwriters in the tax insurance marketplace could discuss important issues and new challenges that have emerged in the field, with the conversation being led by recognized leaders in the industry. The agenda included:

    • The State of the Tax Insurance industry (Nick Kato, Leo Berwick; Joe Volk, Leo Berwick; Justin Pierce Berutich, Euclid Transactional; Austin Cahill, Alliant Insurance Services);
    • Green Energy (Kyle Kidd, Leo Berwick; Jordan Tamchin, CAC Specialty; Mark McTigue, Marsh);
    • Claims and Insuring Live Controversies (Sharon Katz Pearlman, Greenberg Traurig; Bill Kellogg, Ryan Transactional Risk);
    • Real Estate Investment Trusts (REITs) (David Brandon, Leo Berwick; Joe Volk, Leo Berwick; Devorah Pomerantz, Great American Insurance Group; Bill Kellogg, Ryan Transactional Risk); and
    • State and Local Tax Issues (Toni Lewis, Leo Berwick; Jeffrey Lash, Euclid Transactional; Alisha Soares, Marsh)

Addressing conference goers on the state of the market, Austin Cahill, a Managing Director and Tax Team Leader at Alliant Insurance Services said that there must be a willingness to turn over new rocks to help clients mitigate risk. “Our time in the spotlight is here,” he said. “There has never been a bigger need for collaboration. We must … perhaps divorce ourselves from just being players in the M&A market space.”

Echoing the need-for-collaboration sentiment, Leo Berwick’s Managing Partner Nick Kato said “insurance proposals that are submitted to an underwriter are occasionally ‘skinny’ or missing key analyses and facts.” Mark McTigue from Marsh shared that brokers explain to their clients that a well-written tax memorandum that summarizes the relevant facts and an analysis of the law, together with a “tax exposure calculation” that clearly shows the tax at risk if the IRS or other taxing authorities were to successfully challenge the insured tax position, can go a long way to getting strong terms and pricing.

Nick Kato added that without those key items, “many more hours may need to be spent by underwriters and underwriter counsel on the submission if it’s going to be effectively quoted, and ultimately underwritten.”

The group agreed that a potential tax submission must go beyond a high-level summary and cursory legal analysis. Unless that submission contains the information needed by an underwriter, it takes on a generic quality, potentially resulting in delay, higher premiums, higher underwriting fees, or even an inability to issue a non-binding indication letter (NBIL).

The group also addressed the recent slowdown in M&A activity, as a result of uncertainties surrounding valuations, inflation fears, increased interest rates, and decreased demand. This has caused a reset of public and private company valuations. As a result, it has been difficult for parties to reach an agreement on price. Notwithstanding the slowdown in M&A activity, tax insurance submissions continue to increase, supported by increased market acceptance of the product.

“The tax insurance market’s dedication to expanding product awareness and penetration has been unwavering and is really starting to pay dividends,” said Justin Pierce Berutich, Managing Director and Head of Tax at Euclid Transactional. “With our persistent efforts, the market successfully delivered insurance solutions for even the most intricate tax opportunities, including transfer pricing and non-U.S. risks in regions like Latin America. It’s incredibly exciting to be a part of the market’s continued progress and expansion.”

Turning to the green energy portion of the agenda, panel members discussed new opportunities for tax insurance coverage in the wake of the Inflation Reduction Act and the expansion of green energy tax credits.

As of January 1, taxpayers may elect to transfer credits to unrelated taxpayers in exchange for cash, opening up new opportunities for monetization of credits. Panel members discussed their observations of tax structuring trends in core renewables.

“Overall, we are still seeing tax equity partnership flips for larger scale wind and solar projects, despite the new transferability regime,” said Kyle Kidd, Partner and Renewables Leader at Leo Berwick, who has extensive experience advising renewable energy investment funds.

Kidd said that clients seem to be considering transferability of investment tax credits on less familiar green energy projects, like standalone battery storage and biogas. Smaller-scale wind and solar projects are also good candidates for transferability, since the transaction costs of transferability are less than a traditional tax equity partnership structure.

The role that tax insurance may play in the new transferability regime is an evolving debate. Kidd said that the expectation is that sellers of tax credits will provide indemnities to buyers to protect buyers from recapture risk and general credit qualification risk. In a scenario where the seller has a weak credit rating, we may see tax insurance playing a role.

One of the most common issues still being insured is valuation risk with respect to investment tax credits. With standalone battery storage, some valuations are significantly higher (relative to cost) than typical solar projects. It may become clear that tax insurance will play a role in this unfamiliar territory.

“Tax credit insurance is very important in this space,” said Jordan Tamchin of CAC Specialty “More times than not, it is the lynchpin in getting deals done, especially for companies that may have a weak credit rating. Moving to a broad policy to ensure transferability instead of listing every issue that may arise may be the way to go.”

After a brief break, a new panel discussed audits and tax controversy from a claims perspective as well as in connection with the industry’s ability to insure live controversies. The discussion centered on partnerships, and the elevated rate of audits in this area.

“The IRS moves very slowly and cautiously in the partnership space because the Bipartisan Budget Act of 2015 (BBA) procedures which now govern partnership examinations are relatively new,” said Sharon Katz Pearlman, a Shareholder with Greenberg Traurig LLP, where she is a member of the law firm’s Global Tax Practice focusing on US and cross-border tax controversy, and an adjunct professor of law at NYU Law School. “In addition, practitioners are seeing more strong collaboration with IRS National Office on a variety of issues. With respect to the BBA process and technical partnership issues, if examiners have specific questions, they can consult with an expert at the IRS national office. This has expedited the process somewhat but there is still a long way to go.”

“The IRS has put a lot of enforcement focus and funding into the partnership space and has hired tax professionals with partnership experience, but it is still a challenging area. And, although the BBA was enacted to help the IRS more easily manage partnership examinations, the IRS is still short staffed with a lot of training yet to be completed.”

The panel agreed that there is heightened risk as time marches on and the IRS becomes more attuned to what was taken lightly in years past. Education is another reason for the elevated instances of audits.

With regard to active tax controversies, the group noted that it seems more penalties are being asserted at the examination level, and that they are not automatically being dropped at Appeals. The panel commented that the penalty provisions exist to encourage voluntary compliance, and also serve to motivate taxpayers and their advisors to take and adequately document reasonable return positions.

The panel and audience discussed that the presence of tax insurance may be included in an IRS agent’s information document request. However, the presence of tax insurance doesn’t necessarily indicate a weak return position to the IRS. Rather, the presence of tax insurance could be seen as signal to the IRS that a position has been thoroughly vetted and that an insurance company has placed real capital at risk based on its underwriting.

The panel also indicated that settlements are still much more common than trials. However, there is increased IRS Office of Chief Counsel involvement, and certain matters proceed more slowly as a result. It can be more of a challenge to obtain an Appeals settlement that taxpayers believe fairly reflects the hazards of litigation. In a change from former Appeals process, Appeals does not always operate within the “80/20” parameters for resolution which it generally used in the past.

The next part of the forum involved REITs. Leo Berwick’s REIT Tax Leader, David Brandon kicked off the general discussion by mentioning three areas in which investors typically are interested in tax insurance for REIT transactions. These are REIT qualification, prohibited transactions, and Foreign Investment in Real Property Tax Act (FIRPTA).

He cautioned that the potential exposure in this space is very real, particularly with REIT qualification. “Although the question of REIT qualification has not been on the IRS radar screen for some time, problems in this area are often unearthed in connection with major REIT transactions, when a buyer’s due diligence team uncovers them” he said.

The panel agreed that most major REIT transactions should be backed with a REIT qualification opinion, and sufficient due diligence undertaken to support all the factual conditions of the opinion.

All were in agreement that prohibited transactions, which can be subject to confiscatory penalties, can be an excellent area for tax insurance when supported by appropriate factual development. As the economy deteriorates, particularly in the commercial real estate sector, REITs may look to raise funds by selling properties, raising the question of whether the properties are dealer properties subject to penalty taxes on disposition by a REIT.

Devorah Pomerantz noted that as an underwriter, she looks for a submission to clearly establish the factual background in such risk submissions. Volk noted that underwriters and underwriter counsel know the law, but appropriate facts and representations need to be present in a submission for the risk to be successfully underwritten.

Perhaps the largest takeaway from the REIT discussion was that prohibited transactions, which can be subject to confiscatory penalties, can be an excellent area for tax insurance when supported by appropriate factual development. Underwriters and underwriter counsel know the law, but appropriate facts and representations need to be present in a submission for the risk to be successfully underwritten.

The forum wrapped up with a discussion of payroll, and state and local tax issues, which could be an area of expansion for tax insurance.

Alisha Soares, Senior Vice President at Marsh, opened the dialogue by emphasizing that it takes a wary eye to bring an employee retention credits (ERC) risk to underwriters.

“When bringing a potential ERC risk to market you have to understand who was intended to receive these credits,” said Soares. “Then, go over the underlying documentation. We need to watch out for the ERC mills, or bad actors advising companies that they’re eligible to receive ERCs when they’re not. That’s not where we want to be. The IRS is in the position to enforce the rules aggressively.”

Jeff Lash, Senior Vice President and tax underwriter at Euclid Transactional noted that it is important for brokers, underwriters, and underwriter counsel to be stewards of the tax insurance product and exercise due caution in insuring risks like ERC eligibility, particularly when ERC eligibility is on the IRS Dirty Dozen list.

The IRS issued a renewed warning in March urging people to carefully review ERC guidelines before trying to claim the credit as promoters aggressively push ineligible taxpayers to file.

The IRS and tax professionals also continue to see third parties aggressively promoting these ERC schemes on the radio and online. These promoters charge large upfront fees or a fee that is contingent on the amount of the refund. The promoters may not inform taxpayers that wage deductions claimed on the business’ federal income tax return must be reduced by the amount of the credit.

“There is little appetite to insure these credits because of all the unreputable schemes out there that start with such things as banner ads and click bait,” said Toni Lewis, Partner and State and Local Tax Leader at Leo Berwick.

Notwithstanding the potential for bad actors, some forum attendees emphasized a willingness to consider insuring ERC eligibility given the right facts and situation.

The panel then shifted gears to developments and fallout that continue from the 2018 Supreme Court decision in South Dakota v. Wayfair.

Wayfair seems to have left an impression, particularly for state taxing authorities, that a nexus determination may be simplistic. Essentially, if you meet the economic threshold, you have a filing requirement regardless of the actual activity in a state. The US Supreme Court, in its Wayfair decision found that a business must “purposefully direct” its activities toward a state in order to be subject to its tax laws. The Court found that Wayfair’s advertising was purposefully directed toward South Dakota. It remains unclear what level of activity (active or passive) meets the Courts “purposefully direct” standard. This is just one of several questions that remain unanswered by the Supreme Court’s decision in Wayfair. These unanswered questions, along with the states’ inconsistencies in how they have adopted economic nexus and marketplace facilitator statutes mean that many state nexus issues are anything but simple, making tax insurance an important tool in the taxpayer playbook in addressing gaps or uncertainties in state statutes and regulations.

The lively discussions continued after the final panel session. There was a general sense in the room that this is somewhat of a new dawn in the tax insurance industry. There is a distinct need for robust collaboration when assessing new risks in emerging industries like green energy. Although the green or renewable energy industry is not new, certain industry offshoots, such as battery storage, are.

“All in all an exhilarating forum,” said Kato. “We accomplished what we set out to do: get a variety of views on the pressing tax insurance issues of the day. On behalf of Leo Berwick, we look forward to hosting the next TIF.”

Please contact a Leo Berwick team member to learn more.