Tax issues arising in an insurance-company conservation orliquidation proceeding can be as complex as regulatory and legalones—potentially blindsiding stakeholders at a time when they'renot focusing on the Internal Revenue Service.

Regulators and creditors, as well as managers and owners of thetroubled companies—and of healthy ones included on consolidated taxreturns—should be aware of some of the common tax issues, includingthe potential for consolidated filings and tax-sharing agreementsto impede the wind-down process.

AT The OUTset of liquidation

Regulators may not have an opportunity to become familiar withthe tax posture of a troubled insurance company before the actualconservation or liquidation order becomes effective. If timing isan issue, they will at least want to quickly assess the ownershipstructure and the location of critical tax data. Otherconsiderations include:

•  Evaluating tax uncertainties

If an organization is included in a consolidated federal incometax return, potential tax exposures may exist. The IRS can pursueclaims for unpaid tax liabilities from any of the members includedin a consolidated federal income tax return.

If practicable, a detailed review of prior-year consolidatedreturn filings is desirable in order to identify potentialexposures or tax risks that could lead to claims by the IRS orother members of the consolidated-return group, who can also pursueclaims under tax-sharing agreements.

While the IRS is not bound to any terms set forth in thetax-sharing agreement, it is important to obtain a copy of thisagreement to understand how members of the consolidated return aresupposed to share tax liabilities and benefits.

• Understanding tax attributes

During the conservation and liquidation proceedings, the companywill continue to have a filing obligation for both federal andstate income tax purposes. Therefore, organizations must understandthe tax basis of assets and liabilities, the various jurisdictionsin which the organization is operating and filing income taxreturns, the existence of any tax attributes, and the status of anytaxing-authority audits and tax years that remain open toexamination.

• Deconsolidation is an option

If the insurance company is a member of a consolidated-returngroup, then the parent company may be able under tax law to takecertain actions or make certain elections unilaterally that couldadversely impact the value of the insurance company's taxattributes.

Therefore, it may be advantageous to deconsolidate the companyfrom its parent so that the company no longer will be liable underthe joint-and-several provisions of the consolidated returnregulations.

During liquidation

Special tax rules apply to insurers with premium volume at orbelow certain thresholds. Additionally, there are specific electiveprovisions in the tax code that can provide benefits to insolventcompanies.

Currently, a non-life insurance company shall be tax-exemptunder IRC 501(a) provided: 1) its gross receipts (includinginvestment income) for the taxable year do not exceed $600,000; and2) more than 50 percent of such gross receipts consist ofpremiums. 

An insurance company in conservation or liquidation may,instead, be eligible to make an election under IRC Section 831(b)to be taxed solely on its investment income. To qualify, annualnet-written premium (or net-direct premium if greater) must notexceed $1.2 million.

The wind-down

Organizations should explore available administrative procedureswith the IRS to resolve potential tax uncertainty that can impedethe liquidation process.

Lastly, if the company is a member of a consolidated return, itmay be prudent to execute an indemnification agreement with theparent barring any future assertion of liability for unpaidtaxes.