TAX LAWYERS AS TAX INSURANCE.

• Author: Field, Heather M.

TABLE OF CONTENTS INTRODUCTION 2114 I. TAX ADVICE, TAX OPINIONS, AND THIRD-PARTY TAX INSURANCE 2120 A. Transactional Tax Advising 2120 1. In General 2120 2. Tax Opinion Practice 2122 B. Third-Party Tax Insurance 2126 II. THE SUBSTITUTABILITY OF TAX OPINIONS AND THIRD-PARTY TAX 2129 INSURANCE III. INDICIA OF INSURANCE INHERENT IN TAX OPINIONS 2135 A. Insurable Risk 2136 1. "Risk" 2136 2. "Insurable Interest" 2137 B. Transfer of Risk 2138 1. The Risk Transfer Is Implicit 2139 2. The Extent of the Risk Transferred Is Limited by 2140 Requirements for Malpractice Recovery a. Indemnification Is Conditional on Breach of 2141 Standard of Care b. Indemnification Is Limited in Amount to "Damages" 2149 3. Risk Transfer Is Not the "Principle Object and Purpose" 2153 C. Distribution of Risk 2155 D. Conclusion About the Applicability of the Insurance 2158 Construct to Tax Opinions IV. THE INDEMNITY FUNCTION OF TAX OPINIONS AND THE REALITY OF 2160 TAX PRACTICE A. Tax Malpractice Payouts as Evidence of the Indemnity 2161 Function B. Tax Lawyers' Perceptions About the Indemnity Function 2166 of Tax Opinions V. IMPLICATIONS OF THE INSURANCE ANALYSIS FOR TAX OPINIONS 2169 A. Tax Lawyers' Billing Practices 2169 1. Illustrations of the Relevance of Premium-Style Fees 2170 2. Questions Raised by Premium-Style Fees 2173 a. Are Premium-Style Fees for Tax Opinions Allowed? 2173 b. Other Concerns About Premium-Style Fees 2177 B. Terms of Client Engagements 2178 C. The Design of Tax Opinions 2179 D. The Market for Tax Advice 2181 E. Conclusion About the Consequences of the Insurance 2183 Construct for Tax Opinions CONCLUSION 2183 INTRODUCTION

Transactional tax lawyers, by rendering tax opinions, provide an element of insurance to clients. This insurance is clearly incomplete, but by providing a tax opinion, a lawyer conditionally agrees to indemnify the client for part of the potential loss the client incurs if the favorable tax treatment described in the opinion is successfully challenged. Thus, tax lawyers serve, at least partly, as tax insurers.

This insurance function is missing from the literature about the transactional tax lawyer's role. Ronald J. Gilson's seminal work, Value Creation by Business Lawyers: Legal Skills and Asset Pricing, explains that transactional lawyers add value for clients by being "transaction cost engineers." (1) The voluminous literature that followed Gilson's article provided various other explanations, conceiving transactional lawyers as reputational intermediaries, (2) regulatory cost reducers, (3) enterprise designers, (4) transaction quarterbacks, (5) "risk managers," (6) aggregators of information about market terms, (7) and more. (8) Considering transactional tax lawyers specifically, Victor Fleischer added the role of a "regulatory arbitrageur," (9) who "tweak[s] a deal structure to achieve better regulatory treatment [for example, better tax treatment, thereby shifting value from the government to the deal parties] without unduly altering the underlying business arrangements." (10)

The insurance-like aspect of the lawyer-client relationship, however, has been largely overlooked until now. When the insurance aspect of opinions (tax or nontax) is mentioned in the literature, it is most commonly with a brief comment to the effect that "[a] legal opinion is not an insurance policy." (11) These comments, however, are typically made to assert that an opinion does "not guarantee [ ] that a court will reach any particular result." (12) But insurance need not promise a particular result or provide for 100 percent loss coverage if that result is not achieved. Arrangements can have aspects of insurance without providing a full guarantee of results. Thus, the brief assertions in the literature about opinions not being insurance are too conclusory.

The literature includes rare acknowledgments of the possibility that opinions contain insurance-like features. In the tax area, commentators occasionally mention that tax opinions may serve as "'insurance' against penalties." (13) These commentators typically put the word "insurance" in quotations and imply that tax opinions create a form of government-provided insurance because having an opinion may protect a client from penalties that the client would otherwise owe to the government. (14) These commentators do not, however, seem to contemplate the possibility that the client will recover from the lawyer if penalties are imposed. (15)

Outside the tax area, few commentators acknowledge the possibility of an insurance-like role for opinion-writing lawyers. (16) Of the two commentators who come closest, albeit in a nontax context, to the assertions made in this Article, one briefly--in three sentences--raises and sets aside the possibility that business lawyers could add value for a client by taking on some of the client's risk via the possibility of a malpractice claim. (17) The other commentator, who provides a slightly longer discussion in two separate articles, (18) approached third-party closing opinion practice primarily through a sociological study rather than through a detailed legal analysis as provided herein. (19) His findings offer a relatively limited account of the insurance role of third-party closing opinions, (20) but he suggested that the insurance-like function of closing opinions may increase in the future. (21) Moreover, he implied that tax opinions, in contrast to third-party closing opinions that were his focus, might be a special case. (22)

The absence of meaningful scholarly attention to the insurance-like function of tax lawyers is surprising because, as this Article demonstrates, the risk shifting from clients to tax opinion-givers can be meaningful and can affect important aspects of the lawyer/client relationship. Specifically, understanding tax opinions through an insurance lens can affect tax advisers' billing practices, the terms of client engagements, the design of tax opinions, the market for tax advice, and more. Appreciating the tax lawyer's indemnification role is especially important now, after the enactment of the most sweeping tax changes in more than thirty years. (23) The new tax laws bring tremendous uncertainty, which means that clients will be even more dependent on guidance (including opinions) from their tax advisers. (24) Thus, this Article fills the gap in the literature by identifying, exploring, and explaining the consequences of the insurance-like aspect of the transactional tax lawyer's role.

This Article examines only transactional tax lawyers, and leaves for future study how the insurance-like paradigm resonates in other transactional practices. It is certainly possible that transactional lawyers in practice areas outside of tax may also serve an insurance-like function when they provide opinions. This Article, however, focuses on the tax context, both because of my expertise and because of features of tax law and tax practice (for example, the centrality of tax opinions to tax practice, (25) the history of professional liability payouts related to tax shelters and tax shelter opinions, (26) and Circular 230's detailed ethical obligations applicable only to tax practice (27)) that may cause the indemnity function of opinions to have particular resonance in the tax context.

To be clear, this Article does not argue that the primary or predominant function of transactional tax lawyers is to provide insurance, nor does this Article assert that tax opinions, or their providers, should be regulated as insurance (or insurers). Rather, this Article argues that indemnification (in other words, one element of insurance) is part of the economic relationship between a client and a lawyer who provides a tax opinion, and that the insurance paradigm is an important additional lens through which to understand the role of transactional tax lawyers and the value they provide.

Moreover, this Article acknowledges that the risk shifting accomplished by tax opinions is neither unidirectional nor complete. Tax opinions, by creating penalty-free zones in some cases, (28) can also shift some of the risks and costs of incorrect positions from the taxpayer to the government. And given the barriers to malpractice recoveries and how carefully tax opinions are often written to protect the opinion writer, a taxpayer does retain a significant portion of the risk for taking positions that are successfully challenged. (29) Yet, as this Article demonstrates, tax opinions do shift some portion of that risk from the taxpayer to the opinion writer.

In addition, this Article's claim is descriptive, not normative. Should tax lawyers be required (or allowed) to indemnify their clients for the liability arising from successful challenges to tax positions on which the lawyers opined? Should the law be adjusted to emphasize or deemphasize the tax lawyer's indemnification obligation? Would increasing the extent to which and frequency with which tax advisors indemnify their clients (for example, by lowering the hurdles to malpractice recoveries or increasing the damages that are recoverable) (30) cause advisors to give more conservative advice, thereby increasing tax compliance? Or would doing so hinder compliance by encouraging taxpayers to take riskier positions than they otherwise would because of their ability to recover the costs from their advisors if the positions are wrong? (31) Are tax lawyers effective at managing and distributing risks of client losses or should the large-scale transfer and distribution of tax risks be left to third-party tax insurers? If the latter, does that portend a rise in the market for third-party tax insurers and a decline in tax opinions? These important questions are outside the scope of this Article. They cannot be answered without first examining the extent to which transactional tax lawyers are currently serving an insurance-like role. Only once that baseline is understood can normative questions be...