Property & Casualty

How Can Tax Insurance Help Renewable Energy Projects?

By Rob Freeman Jr.,
LEED AP

Insurance Producer, Energy & Climate Technology Practice
Risk Solutions

[email protected]
(914) 649-0007

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Tax insurance protects tax equity investors and clean energy developers against adverse or unexpected tax liabilities in clean energy investments and business transactions.

Its purpose is to reduce or eliminate the risk of recapture, fines, penalties, interest, legal costs and taxes due to tax authorities.

Tax insurance is also often considered a more efficient and cost-effective alternative to a “private letter ruling” (note) from the IRS.i

As described below, renewable energy developers and tax equity investors may choose tax insurance not only to reduce risk but also to enhance the sale of clean energy investments.

What is Tax Liability?

A tax liability is money owed by a business, individual or other entity to a tax authority, such as the Internal Revenue Service (IRS).

Tax liabilities are incurred in many ways, including but not limited to income taxes, sales taxes, capital gains taxes and property taxes.

Business transactions can have significant tax implications, and it is wise to minimize tax liabilities in accordance with the tax code. However, the accounting treatment of a business transaction may be challenged by a tax authority based on differences in interpretation of the Internal Revenue Code or state or local tax law.

If the IRS, state or local tax authorities disagree on the tax treatment of your business transaction, you may incur an unexpected tax liability.

What is Tax Insurance?

Tax insurance, also known as “tax liability insurance,” “tax equity insurance” or “tax opinion insurance,” transfers the risk of a tax liability to an insurance company.

If a tax authority disagrees with the intended tax treatment of a business transaction or a tax position you have taken in the past, tax liability insurance steps in, helping to protect you against tax recapture, possible fines, penalties, interest, legal contest costs and taxes, due to federal or state tax authorities. The tax insurance policy should also cover what is called a “gross up,” or an additional amount for any taxes due on the insurance recovery arising from a paid loss.

Tax liability insurance may be purchased on its own or along with representations and warranties insurance to broaden the coverage of the latter.ii

Tax insurance is not limited to renewable energy transactions. It may be used to help reduce risk in day-to-day corporate operations as well as business transactions and M&A, including, but not limited to:

  • Risk management in the tax treatment of routine corporate business operations
  • Historical tax treatment by a target entity in an M&A transaction
  • Insuring the qualified basis on a solar investment tax credit (ITC) transaction
  • Wind production tax credit (PTC) characterization
  • Real estate investment trust (REIT) characterization
  • Partnership characterization
  • Capital gains treatment vs. ordinary income
  • Foreign tax credits
  • Opportunity zone tax compliance
  • Capitalization vs. deduction of expenses

Tax insurance may be used by renewable energy project developers and tax equity investors as a risk management tool to help protect tax treatment of tax credits and adders made possible by the Inflation Redution Act (IRA) for commercial and industrial solar, wind and energy storage projects.

Tax liability insurance also reassures lenders and regulatory, compliance and credit committees when managing risk.

What Does Tax Liability Insurance Cost?

Tax liability insurance cost typically ranges from 1.5%-6% of the policy limit.

For instance, for a $50,000,000 “insured value” limit, a customer would expect to incur a one-time premium of $750,000-$3,000,000.

The policy requires an up-front underwriting fee, and the premium is paid once prior to binding.

The tax liability insurance policy term is multi-year, similar to a runoff policy and may be written for up to seven years.

The multi-year nature of tax insurance implies that the cost may be amortized over several years, such as the five to six year term of exposure in an IRS recapture period.

A tax liability insurance policy includes self-insured retention and may be triggered by the challenge by a tax authority to a corporation or individual’s tax position.

While a tax insurance policy will not cover general taxpayer inquiries, such as a routine audit by the IRS or other tax authority, the coverage helps protect an insured against defense costs, any additional taxes due, penalties, interest and claims expenses in a range of business transactions that may carry an adverse tax exposure with them.

Brown & Brown has extensive experience researching and placing tax insurance and other transactional risk policies.

Schedule an appointment with me today to discuss.

Footnotes
i. A private letter ruling, or PLR, is a written statement issued to a taxpayer that interprets and applies tax laws to the taxpayer’s represented set of facts. A PLR is issued in response to a written request submitted by a taxpayer. A PLR may not be relied on as precedent by other taxpayers or by IRS personnel. Here is an example of a residential solar system purchaser renewable energy credit (REC) private letter ruling.

ii. Tax related representations and warranties in a merger or acquisition are often excluded from a representations and warranties insurance policy.