I have posted a draft of my latest article, Hedging the IRS - A Policy Justification for Excluding Liability and Tax Insurance Proceeds, on SSRN.
Basically, uncertainty as to tax results is an ever-present obstacle to many business transactions. Private insurance companies now provide an insurance product to protect the insured party against adverse tax consequences from proposed transactions. Ironically, this new insurance product, labeled "tax insurance," poses uncertain tax consequences itself. If the adverse tax consequences arise (that is, if the taxpayer has the additional tax liability) and the insurance company is required to cover that liability, are the insurance proceeds included in the insured's gross income?
Commentators have concluded that the proceeds are taxable. Insurance companies also appear to adopt that view as evidenced by the fact that tax insurance policies generally include gross-up provisions to cover the tax that might be imposed on the disbursement of the proceeds. Contrary to that general opinion, I argue that the tax insurance proceeds are not includible in the insured's gross income.
As part of the reasoning that underlies my conclusion concerning tax insurance, the article examines the tax treatment of general liability insurance. The proceeds of general liability insurance have not been treated as taxable when paid to satisfy a laibility of the insured. Some commentators have questions whether there is a policy justification for that treatment under tax policy. I address that question and develop an approach that provides a tax policy justification for excluding those proceeds from the insured's income.
The piece is still a draft so, if you have a chance to read it, any comments, suggestions or criticisms are welcome.