Buying and selling companies can be risky business, especially in today’s economy. Both the buyer and seller want to make sure they are protected during the process, and a seller wants to know that cash will be generated from the sale.
Buying tax insurance is one way to give comfort to both parties during these transactions as to potential tax exposures.
“It’s a way to make a transaction more economically efficient,” says Gary P. Blitz, managing director with Aon Financial Solutions. “While there are certainly fewer mergers and acquisitions taking place in the down economy, the dollars spent and received are precious. Sellers want to make sure they generate some cash from the sale, and cannot afford to have funds tied up in escrow accounts for as long as seven years to protect a buyer against a potential tax exposure.”
Smart Business spoke with Blitz about how to use tax insurance and the risks that business owners can face if they choose not to purchase it.
What is tax insurance, and why is it important to have it?
Tax insurance allows the insured party to transfer the risk of a tax authority, like the IRS, challenging the intended tax treatment of a transaction or business situation. Even companies that handle their taxes very responsibly seek certainty and assurance that their (and, importantly, a target’s) federal, state and local, and foreign tax houses are in order.
The IRS can provide that certainty, in certain circumstances, through the private letter ruling process, but there are many areas where rulings are not provided and the ruling process can be excruciatingly slow when a transaction is pending. Tax insurance brings certainty to the system, assuring that a specific tax treatment will be received. For example, it might provide assurance that a tax-free reorganization or restructuring will be respected as tax free or that the limitations on net operating loss carry forwards have been properly applied.
Many business owners are selling companies or assets to generate funds, and it makes the transaction inefficient if some of that cash will be tied up in escrow. It’s a question of tying up assets or spending a relatively small amount to transfer that risk to an insurer. That’s where tax insurance becomes very effective, especially in this economy.
