Partnership Tax Insurance Premiums Are Nondeductible

(Parker Tax Publishing December 2020)

The Office of Chief Counsel advised that premiums paid by a partnership for an insurance policy that reimburses the partners for an adjustment that reduces the tax benefits they may claim for a charitable contribution made by the partnership (i.e., a tax insurance policy) are not deductible by the partnership under Code Sec. 162(a) or Code Sec. 212. The Chief Counsel's Office reasoned that the tax insurance premiums are not sufficiently related to the partnership's trade or business or income producing activity to support a deduction and the policy does not provide, fund, or reimburse any services or materials related to preparing returns, determining a tax liability, or contesting such liability, but only reimburses the partners for their minimum proper federal income tax, an amount not deductible under Code Sec. 275. CCA 202050015.

Background

The Office of Chief Counsel was asked to address the deductibility of certain "tax insurance" premiums under Code Sec. 162(a) and Code Sec. 212. The question presented was whether a partnership can deduct the cost of premiums paid for an insurance policy that contemplates reimbursing the partners for an adjustment by the IRS that reduces the tax benefits they are entitled to claim for a charitable contribution made by the partnership (i.e., a tax insurance policy).

Code Sec. 162(a) allows as a deduction all the ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business. Reg. Sec. 1.162-1(a) 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. Whether an expense is deductible under Code Sec. 162(a) is determined at the partnership level. Under Rev. Rul. 55-264, Rev. Rul. 58-480, and Blaess v. Comm'r, 28 T.C. 710 (1957), 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 Code Sec. 162(a) to support a deduction.

Code Sec. 212(1) and Code Sec. 212(2) allow 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. Reg. Sec. 1.212 - 1(d) provides that, to be deductible under Code Sec. 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.

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

Under U.S. v. Gilmore, 372 U.S. 39 (1963), Code Sec. 162(a) and Code Sec. 212 are generally construed together so that the restrictions and qualifications applicable to the deductibility of trade or business expenses are also applicable to income-production expenses covered by Code Sec. 212(1) and Code Sec. 212(2). Consequently, the deductibility under Code Sec. 212(1) and Code Sec. 212(2) of an expense involving a contractual arrangement for reimbursement is determined by the terms of the arrangement.

Code Sec. 212(3) allows the deduction of expenses related to the determination, collection, or refund of any tax. Reg. Sec. 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 or her tax returns or in connection with any proceedings involved in determining the extent of his or her tax liability or in contesting his or her tax liability are deductible. Code Sec. 275 prohibits the deduction of federal income taxes.

Office of Chief Counsel's Analysis

The Office of Chief Counsel advised that the tax insurance premiums described above are not deductible under Code Sec. 162(a) or Code Sec. 212. The Chief Counsel's Office found that the tax insurance premiums are not sufficiently related to the partnership's trade or business to support a deduction under Code Sec. 162(a). The Chief Counsel's Office reasoned that, 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, a partnership may not deduct its tax insurance premiums under Code Sec. 162(a).

The Office of Chief Counsel also found that the tax insurance premiums are not sufficiently related to the partnership's income-producing activities to support a deduction under Code Sec. 212(1) and Code Sec. 212(2) because 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 Chief Counsel's Office concluded, the partnership may not deduct its tax insurance premiums under Code Sec. 212(1) and Code Sec. 212(2).

In addition, the Office of Chief Counsel found that the tax insurance premiums are not deductible as an expense related to the determination, collection, or refund of any tax under Code Sec. 212(3) because the policy does not provide, fund, or reimburse any services or materials related to preparing returns, determining a tax liability, or contesting such liability; instead it reimburses the partners for their minimum proper federal income tax, an amount not deductible under Code Sec. 275. For this reason, the partnership may not deduct its tax insurance premiums under Code Sec. 212(3).

For a discussion of deductible partnership expenses, see Parker Tax ¶20,522. For a discussion of the deduction for ordinary and necessary trade or business expenses, see Parker Tax ¶90,101. For a discussion of deductible expenses for the production of income, see Parker Tax ¶85,115.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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