Does Your Client's Estate Plan Need Tax Insurance?

As a strategic tool, such a policy can be used to resolve disputes or conflicting agendas with potential tax implications in any number of settings. It is a solution that is gaining awareness in all areas of tax planning, and wills and estates is no exception.

For example, despite significant upfront planning by experienced tax professionals, beneficiaries can find themselves at a standstill while their advisors are faced with respecting the intent of the deceased and simultaneously preserving intended tax benefits. When family members split an estate, they might discover, for instance, that the terms in the will conflict with other documents governing the underlying property, such as court-approved agreements made in connection with a divorce settlement.

Enforcing those agreements, however, may or may not trigger gift tax depending on interpretation. To overcome this uncertainty, the beneficiaries could insure themselves against an adverse tax determination by the IRS and avoid the need to set aside million in reserves or an escrow.

Insurance can also be used to create a layer of protection from an underlying tax exposure discovered in settlement negotiations. Family members could, for example, discover a prior tax position taken by the author of the will that, if reviewed and successfully challenged, could result in a significant tax assessment to beneficiaries in the future. Negotiation and settlement of the estate could thus be on hold until a solution is presented to overcome this risk. In this case, tax insurance serves as a replacement for an indemnity agreement against any future challenges to the tax position, allowing the estate to be settled.

Insurance can also cover a defect discovered in an estate plan. Circumstances shift and family dynamics often change in the years after a will is written and before it’s executed, but the correction of these “errors” can be insured.

That situation could be a case, for instance, where one sibling inherits a family business, leaving a second with a prominent management position but no ownership stake. The family might choose to change the ownership structure to retain the sibling as the manager of the business.

Though we frequently see family members with the common goal of finding a solution to an insurmountable issue, alternatively when relationships have gone sour, tax insurance can be a helpful tool to help ease negotiations. For example, siblings may seek to split the inherited business, requiring a complicated restructuring for tax purposes. Advisors may have differing views on the proposed structure and likely tax outcome of a restructuring, and depending on the relationship of the parties, an indemnity may not be an efficient solution.

Insurance is ultimately a powerful tool capable of much more than traditional downside protection — one that helps attorneys and wealth managers enhance plans to minimize taxes, preserve assets, and keep settlements on course while forging stronger, more productive ties among parties. Expanding their network to include these tax insurance resources can also help position them as the center of an extended advisory team prepared to address any number of eventualities. 

Gary Blitz is co-CEO of Aon Mergers & Acquisitions and Transaction Solutions and heads its Transactions Solutions and Tax Insurance practices. Jessica Harger is managing director of Aon’s Tax Insurance practice, part of its Transaction Solutions team. Aon plc (NYSE: AON) is, a leading global professional services firm providing a broad range of risk, retirement and health solutions.