"Tax insurance" premiums covering a charitable-deduction adjustment are not deductible

Plain-English summary

The IRS Office of Chief Counsel advised on whether a partnership can
deduct premiums it pays for a "tax insurance" policy. The policy would
reimburse the partners if the IRS later reduced the tax benefits they
claimed from a charitable contribution the partnership made. Chief
Counsel concluded the premiums are not deductible under any of three
theories. Under § 162(a) (trade or business expenses), the premiums
have nothing to do with carrying on the partnership's business; they
protect against a tax adjustment regardless of business activity. Under
§ 212(1)-(2) (expenses to produce income), the same reasoning applies,
because § 162 and § 212 are read together. Under § 212(3) (expenses to
determine or contest a tax), the policy funds no return-preparation or
tax-controversy services; it simply reimburses the partners for their
correct minimum federal income tax, which § 275 makes nondeductible.
The memo matters because "tax insurance" tied to contested charitable
deductions has been marketed to partnerships, and this advice signals
the IRS view that the premiums cannot be written off.

Ruling snapshot

• Question: May a partnership deduct premiums for a "tax insurance"
  policy that reimburses partners for a reduction in charitable-
  contribution tax benefits?
• Outcome: Advice (premiums not deductible under § 162(a) or § 212)
• Key authorities: IRC §§ 162(a), 212(1)-(3), 275, 702(b); Treas.
  Reg. §§ 1.162-1(a), 1.212-1(d), 1.212-1(l); United States v. Gilmore,
  372 U.S. 39 (1963)

Full text (IRS public release)

Office of Chief Counsel
Internal Revenue Service
Memorandum

Number: 202050015
Release Date: 12/11/2020

CC:ITA:B03:JWilliford
POSTN-125613-20

UILC:   162.00-00, 212.00-00

date:   November 09, 2020

to:     James C. Fee, Jr.
        Senior Level Counsel
        (Large Business & International)

from:   John P. Moriarty
        Associate Chief Counsel
        (Income Tax & Accounting)

subject: Deductibility of Certain "Tax Insurance" Premiums

This memorandum addresses the deductibility of certain "tax insurance"1 premiums
under sections 162(a) and 212 of the Internal Revenue Code.

QUESTION PRESENTED

Can a partnership deduct the cost of premiums paid for an insurance policy that
contemplates reimbursing the partners for an adjustment that reduces the tax benefits
they are entitled to claim for a charitable contribution made by the partnership (i.e., a
"tax insurance" policy)?

LAW AND ANALYSIS

A. Section 162(a)

Section 162(a) allows as a deduction all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or business. Section § 1.162–
1(a) of the Income Tax Regulations provides that deductible trade or business expenses
include the ordinary and necessary expenditures directly connected with or pertaining to
the taxpayer's trade or business.

    1 Whether the "tax insurance" described in this memorandum constitutes insurance for federal income tax
    purposes is beyond the scope of this memorandum. Consequently, the use of such terms as "insurance,"
    "policy," and "premium" is for linguistic economy only and should not be regarded as indicating or
    recommending a legal conclusion with respect to this or any related question.

Whether an expense is deductible under section 162(a) is determined at the level of the
partnership. See Brannen v. Commissioner, 78 T.C. 471, 502–05 (1982) (discussing
Madison Gas & Electric Co. v. Commissioner, 72 T.C. 521, 564–65 (1979), aff'd 633
F.2d 512 (7th Cir. 1980); Goodwin v. Commissioner, 75 T.C. 424, 434–39 (1980)).

Where an expense involves a contractual arrangement for reimbursement in the event
of specified contingencies, the terms of the arrangement determine whether the
expense is sufficiently related to activities recognized under section 162(a) to support a
deduction. Rev. Rul. 55-264; Rev. Rul. 58-480; Blaess v. Commissioner, 28 T.C. 710,
714–15 (1957).

The "tax insurance" premiums described above are not sufficiently related to the
partnership's trade or business to support a deduction under section 162(a). In the
event of an adjustment to a deduction claimed for a charitable contribution, the policy
will reimburse the partners for any difference between the tax benefits they claimed and
the tax benefits they are entitled to receive, regardless of any trade or business activity
of the partnership. For this reason, the partnership may not deduct its "tax insurance"
premiums under section 162(a).

B. Section 212(1)–(2)

Section 212(1)–(2) allows individuals to deduct ordinary and necessary expenses paid
or incurred for the production or collection of income, or for the management,
conservation, or maintenance of property held for the production of income. Section
1.212–1(d) provides that, to be deductible under section 212, an expense must be
reasonable in amount and must bear a reasonable and proximate relation to the
production or collection of taxable income or to the management, conservation, or
maintenance of property held for the production of income.

Section 702(b) provides that the character of any item of income, gain, loss, deduction,
or credit included in a partner's distributive share shall be determined as if such item
were realized directly from the source from which realized by the partnership, or
incurred in the same manner as incurred by the partnership.

Sections 162(a) and 212 are generally considered in pari materia, and the restrictions
and qualifications applicable to the deductibility of trade or business expenses are also
applicable to income-production expenses covered by section 212(1)–(2). See United
States v. Gilmore, 372 U.S. 39, 45 (1963). Consequently, the deductibility under section
212(1)–(2) of an expense involving a contractual arrangement for reimbursement is
determined by the terms of the arrangement. See Rev. Rul. 55-264; Rev. Rul. 58-480;
Blaess, 28 T.C. at 714–15.

The "tax insurance" premiums described above are not sufficiently related to the
partnership's income-producing activities to support a deduction under section 212(1)–
(2). In the event of an adjustment to the deduction claimed under section 170, the policy
will reimburse the partners for any difference between the tax benefits they claimed and
the tax benefits they are entitled to receive, regardless of any income producing activity
of the partnership. For this reason, the partnership may not deduct its "tax insurance"
premiums under section 212(1)–(2).

C. Section 212(3)

Section 212(3) allows the deduction of expenses related to the determination, collection,
or refund of any tax. Section 1.212–1(l) provides that expenses paid or incurred by a
taxpayer for tax counsel or expenses paid or incurred in connection with the preparation
of his tax returns or in connection with any proceedings involved in determining the
extent of his tax liability or in contesting his tax liability are deductible.

Section 275 prohibits the deduction of federal income taxes.

The "tax insurance" premiums described above are not deductible as an expense
related to the determination, collection, or refund of any tax under section 212(3). The
policy does not provide, fund, or reimburse any services or materials related to
preparing returns, determining a tax liability, or contesting such liability; it reimburses
the partners for their minimum proper federal income tax, an amount not deductible
under section 275. For this reason, the partnership may not deduct its "tax insurance"
premiums under section 212(3).

CONCLUSIONS

For the reasons given above, the "tax insurance" premiums described above are not
deductible under sections 162(a) or 212. Please call (202) 317-3225 if you have any
questions.