Tax Law Uncertainty and the Role of Tax Insurance

In the broadest sense, this is an article about legal or regulatory uncertainty and the role that private and public insurance can play in managing it. More narrowly, the article is about tax law enforcement and the familiar if ill-defined distinctions between tax evasion, tax avoidance, and abusive tax avoidance. Most specifically, the article is about a new type of tax risk insurance policy, sometimes called tax indemnity insurance or transactional tax risk insurance that provides coverage against the risk that the Internal Revenue Service (Service) will disallow a taxpayer-insured's tax treatment of a particular transaction. The question is whether this type of insurance coverage increases incentives for illegitimate tax avoidance or, alternatively, provides needed certainty to taxpayers - certainty that the Service is not able or willing to provide. Should tax insurance be banned? Encouraged? Ignored? To what extent should the government, instead of commercial insurance companies, provide such legal uncertainty insurance directly, either by increasing the use of private rulings or by selling the equivalent of tax indemnity insurance policies? On the question of commercially provided tax indemnity insurance, the article concludes that the appropriate regulatory response is probably (a) to allow the purchase of policies (and perhaps in some situations to subsidize their purchase) but (b) to compel taxpayers who purchase such policies to disclose this fact to the Service. Such a response allows the use of tax risk insurance as a supplement to private letter rulings while at the same time minimizing the possibility that the insurance will be sold to cover pure "detection risk."