ataxingmatter

TaxReturn Preparer Penalty

The IRS has released to the federal register (with a June 17 release date) proposed rules under the more-likely-than-not change to the tax return preparer penalty provision.  They are available at this link.

Congress, of course, has been heavily lobbied by accounting firms and practitioners to undo the change made just over a year ago.  Practitioners complain about being held to a standard that is higher than the taxpayer "substantial authority" standard.  Of course, prior to the change, taxpayers were held to a higher standard than tax advisers.  The solution is obvious--require a more likely than not level of confidence from taxpayers and all advisers throughout the tax planning and return preparation stage.  the "substantial authority" standard leaves too much leeway to taxpayers to  pick the interpretation they want to use to reduce their taxes and hope for the audit lottery to mean they never have to defend their choice in court.

Dealers Marking to Market under section 475: Is a safer harbor really needed?

In June of 2007, the IRS finalized regulations providing a "safe harbor" for valuation for dealers that mark their securities to market under section 475 for purposes of determining their taxable income.  I had written extensively about the issue to note my concerns with the industry's proposals for book-tax conformity--i.e., for using their financial accounting income and loss determinations as their tax determinations.  See Book-Tax Conformity and the corporate Tax Shelter Debate: Assessing the Proposed Section 475 Safe Harbor.  My concerns stem from the importance of a coherent interpretation of the tax code and worries about dealers' ability to manipulate values to achieve financial and tax goals.  Although the IRS did adopt regulations providing for a book-tax safe harbor, those final regulations did include a number of provisions that at least helped to counter those concerns.

Now, less than a year after the finalization of the safe harbor regulations, the securities industry is pressing for broadening of the safe harbor along the lines that the industry originally proposed (basically a "trust our business judgment" approach).  See Larkins et al, Safe Harbor or No Safe Harbor: A First Look at the Mark to Market Safe Harbor Regulations, 7 Journal of Taxation  57 (2008) (available on CCH at this link).  The authors assert review the workings of the regulatory safe harbor, and point out the verification and consistency requirements that impose limitations, asserting that the regulations "unduly limit" the kind of taxpayer, valuation methods and securities to which the safe harbor can apply.  They argue instead that the "compliance burdens" will only be addressed if the IRS makes the safe harbor "as broad as possible".

The article reiterates the old industry rationale of regulatory reliability in support of a broad safe harbor.  The claim is that the IRS need onlly look to a financial statement (selected according to priority criteria as already provided in the final regulations):  since the financial statement is (deemed) reliable for securities reporting, bank regulatory or other regulatory reasons, the IRS should treat it as appropriate for determining taxable income, without imposing any further limitations. 

Reliability may well be an insufficient criterion, however, as I argued in my article.  What is reliable for a particular regulatory purpose may nevertheless be inappropriate or manipulative for determining taxable income.  That is especially true if the regulatory purpose for which the statement is prepared encourages conservatism, deferral of inclusion until expenses can be booked, and other mechanisms that may understate the income as determined from the income tax's ability to pay concept.

The article also reasserts another rationale from the Securities Industry Association's original materials in support of book-tax conformity--that the "significant use" for a business purpose can insure that the right amount of taxable income would be reported.  The problem is that such "significant use for a business purpose" doesn't guarantee lack of distortion for tax purposes.  That is especially true in areas where businesses have proprietary software for making business determinations that permit very particularized determinations and where those determinations are adjusted further for different purposes.  Further, the many recent cases of financial statement manipulation (Enron, WorldCom, and various other earnings and stock option manipulation scandals) demonstrate that the numbers can be manipulated through various means in order to achieve a particular objective, even if that runs counter to the primary objective for which the numbers are intended.  Enron used off-balance-sheet vehicles and back-to-back arrangements to hide debt from those looking at its financial statements, so that it appeared to have more equity.  Managers' claims that these were activities of rogues personnel didn't wash.  The SIA claim that use of the mark-to-market valuations in a single activity--say, determining employee compensation for dealers--would be sufficient to ensure the appropriateness of the values is particularly suspect, since these valuations could be consistently marked down to defer income as long as the formula for determining compensation based on the numbers appropriately grossed the amount up for that purpose.

The industry complains about having to make one valuation determination for financial accounting purposes and another for tax purposes.  Yet the fact is that industries have often had to make separate determinations for various regulatory agencies that govern their activities.  It is not reasonable to insist that tax nonetheless is not entitled to an appropriate accounting but must follow whatever the financial accounting system allows.  This is perhaps even more true today than a year ago when the safe harbor was finalized, as the accounting standards boards are now very seriously considering convergence on an international standard that would be much more "standard" based rather than "rule" based and thus allow even more room for manipulation of the final numbers.

The article restates two other complaints lodged against the regulations when they were finalized--that subsidiaries of foreign banks are not allowed to use their valuations from their call reports to the Federal Reserve of the Comptroller of the Currency, and that businesses cannot use reports that are not filed in accord with U.S. GAAP.  There does not seem to be any new rationales offered against these reasonable limitations.

One thing has changed significantly since the regulations were finalized.  The current credit crunch stems from banks' taking on too much risk in the loans they issued and then securitized, and at least for some banks, failures in pricing the exotic derivatives that they held.  This experience suggests that the tax administration should be even more cautious about broadening the safe harbor to allow tax accounting to be tied, without limitation, to book valuations.   

The article comes back again and again to the goal of reducing compliance burdens.  While tax should not impose undue burdens on businesses, it is also not clear that reducing compliance burdens should drive these kinds of decisions.  That is a good secondary goal for tax administrators to bear in mind whenever rules are developed, but it is problematic when it becomes the primary goal.  No matter what relief is provided, taxpayers will always argue insatiably for more relief from compliance burdens, and any additional effort compared to their primary activity (satisfying other regulators, making money) will appear unreasonable to them.  Tax administrators, however, have a primary goal of facilitating collection of tax revenues appropriately and fairly from taxpayers.  They shouldn't turn a deaf ear to complaints about compliance burdens, but neither should they set aside reasonable constraints.

The result of the uncertainties, claim the authors, puts more importance on the outcome of the Bank One case.  The tax court's opinion ruled with the government that the taxpayer's methodology did not clearly reflect income,  but instead of then confirming the government's imposition of a methodology, as seems required under the section 446 provision, the court overruled the government and imposed its own valuation methodology.  The Seventh Circuit on appeal made clear that the government's method must be applied in the case of a taxpayer's failure to clearly reflect income, unless the government's method is arbitrary or unlawful, because of the statutory language that puts that decision at the discretion of the Secretary.

Testing taxpayer involvement in writing regs: if there is a right place to start, it isn't REMICs

Notice 2007-17 announced a controversial IRS program to allow regulated parties to write the regulations that govern their activities along with policy memorandums explaining their rationales.  IRS According to the BNA RealTime of 10/23/07, Commissioner Korb defended this proposal today at the Tax Executives Institute, indicating that it would get guidance to taxpayers faster than the IRS can otherwise do, especially in highly technical areas where taxpayers have considerable expertise.

Of course, that is just the problem with the proposal.  The wolves will be guarding the henhouse.  Korb's first go at the controversial mechanism for writing regulations is issuance, slated for October 29th, of proposed new regulations to permit REMICs to become more active financial vehicles able to modify commercial mortgage loans in the conduits in ways beyond those permitted now under the tightly restrained REMIC regulations. 

Here's the problem with this proposal.  First, there are very few tax lawyers in the country who even know what REMICs are (real estate mortgage investment conduits), much less understand the restrictions set out in the Code and regulations governing the kinds of interests that REMICs are permitted to issue without becoming subject to a corporate tax.  Very few tax lawyers are able to recognize whether and how a REMIC sponsor may be "playing" the system--whether in underdetermining the amount a REMIC residual holder is required to take into income, writing into mortgage loans swaps and other features that are not permitted to be entered into directly by the REMIC, or creating new classes of interests issued by a REMIC that may well result in the REMIC holding assets it is not permitted to hold or issuing interests it is not permitted to issue.  That means that the practitioner community that can comment knowledgeably on regulations is very limited, and it means that the IRS has limited expertise to draw on in its own behalf.

Second, because the IRS is suggesting this procedure be used most in the technical areas of the Code (such as REMICs), the tax administration will be subject to capture by the highly technical and specialized financial services industry that is most knowledgeable in this area.  This is a problem when the financial services industry is already able to game the system through innovative new derivatives and application of old rules to new financial products in ways that suit the tax-avoidance proclivities of customers rather than the revenue-generating needs of the Treasury.  While many tax lawyers do play an important public service role through their commentary as members of bar associations (the New York State Bar Association Tax Section comes to mind), this process removes the filtering role of working through a bar association, where the accepted importance of the role of lawyers in developing the law in accord with the public interest helps to restrain zealous advocate impulses on behalf of client positions.  The government's process doesn't retain those professionalism constraints. Practitioners may propose regulations that directly benefit their clients.

Third, if the practitioner community is invited to write regulations, one can expect that it will be tempting to overlook problems the practitioner community is aware of (but which the tax administration may not be aware of) that involve either overly aggressive interpretations of existing provisions or clearly abusive practices that have been undertaken by some practitioners.  In fact, the temptation will be to draft regulations in such a way as to condone practices that the practitioner community has some doubts about or wants to have blessed because it will permit more REMIC activity, whether or not it is sound policy to do so.

Fourth, with the tax administration taking a back seat in the development of the proposed regulations, it is not clear how the primary concern for the public interest will be expressed.  The current process involves a praiseworthy give-and-take, with the tax administration proposing regulations, various bar groups and private practitioners commenting, tax media discussing the pros and cons, and ultimately finalization of regulations based on consideration of the full commentary.  With practitioners writing the regulations and the tax administration stepping back to a facilitator role, there will, I think, be inadequate consideration of the public's perspective. 

All in all, the only thing favoring this procedure is the possibility of more rapid guidance.  That's too small a gain for the high price of quasi-privatization of the regulatory process.

Material Adviser Reporting: IRS Notice 2007-85

In Notice 2007-85 Download material_adviser_reporting. Forms.101607.doc , the IRS provided guidance today for material advisers who must begin filing reports under the expanded material adviser reporting requirements for reportable transactions.  The new form, Form 8918, is not yet available, yet material advisers are required to begin reporting October 31.  Until the new form is available, the IRS announced that advisers may satisfy disclosure requirements by filing Form 8264, the existing form that promoters use to register registration-required tax shelter transactions.

Proposed Circular 230 Rules for Tax Advisor Standards: Vancouver ABA Meeting

Deborah Butler and Michael Desmond spoke at a panel presentation for the Civil and Criminal Penalties Committee of the ABA Tax Section at the fall meeting in Vancouver regarding the freshly minted proposed regulations under Circular 230 for practice before the IRS.  The Proposed Regulations, issued last week, bring the standards applicable under Circular 230 into line with the standards applicable under the penalty provisions of the Code.  Congress changed those standards (section 6694) in the May 2007 Small Business and Work Opportunity Tax bill to require that the advisor hold a reasonable belief that a position is more likely than not to be sustained on the merits if the position is not disclosed by the taxpayer and that there be a reasonable basis for the position if the position is adequately disclosed.  Tax advisors formerly were held to a lower standard of "realistic possibility of success on the merits" for non-disclosed positions and not "frivolous" for disclosed positions.

Tax practitioners who didn't like the increase in the standard for tax advisors attacked the legal change made by Congress for its inconsistency with the standards for taxpayers.  Under section 6662, taxpayers are merely required to have substantal authority to avoid a "substantial understatement" penalty for a non-disclosed position.  The standard for disclosed positions for taxpayers is the same reasonable basis standard now also applicable for tax advisors and tax return preparers.

The inconsistency attack is weak, since the standards were inconsistent before the Congressional change, with tax advisors being able to advise positions that taxpayers couldn't take without risking a penalty.  That inconsistency (lower standards for tax advisors than for taxpayers) perhaps encouraged tax advisors to provide more aggressive tax advice, at least in some situations.  Congress can solve the new inconsistency (higher standard for tax advisors than for taxpayers) for non-disclosed standards by heightening the standard for taxpayers rather than reversing the change made to tax advisor standards to return to the weaker standard.  I've argued that such a change would be a good idea.

There has been transitional relief on the application of the new standards under Code section 6694, but the new standards will need to be applied after the end of the year.  The government officials at the Vancouver meeting made clear that rules for making the new standard work will need to be out by the end of the year, and that practitioners should not expect the transitional relief to be extended.  Comments are due by October 26.

Final Circular 230 Regulations

The IRS issued final rules under Circular 230 governing practice before the IRS on September 26 (T.D. 9359).  See this CCH description of the changes in the final rules.

The final regulations adopt the proposed change to the definition of practice before the Internal Revenue Service, so that it covers all matters connected with a presentation to the IRS or any of its officers or employees relating to a taxpayer's rights, privileges or liabilities under the tax laws administered by the IRS.  Even though some commentators had stated that the provision of tax advice could not, in and of itself, constitute practice before the IRS, the Treasury and IRS have concluded that providing written advice is practice before the IRS subject to Circular 230 when it is provided by a practitioner, and attorneys or CPAs who provide written advice covered under sections 10.35 or 10.37 of Circular 230 are not required to file a Form 2848 to the IRS before rendering covered advice.

The regulations change the proposed rules regarding contingent fees set forth in section 10.27.  The Preamble states that tax administrators "continue to believe that a rule restricting contingent fees for preparing tax returns supports voluntary compliance with the Federal tax laws by discouraging return positions that exploit the audit selection process.   The rules permit contingent fees for services in connection with the IRS examination of (i) an original tax return or an amended return or claim for refund or credit, where the amended return or claim was filed within 120 days of receipt of a written notice of exam or of a written challenge to the original tax return or (ii) interest and penalty reviews, or (iii) services rendered in connection with a judicial proceeding arising under the Code.

The final regulations also adopt the proposed amendments on conflict of interest with some modifications.  A practitioner has to obtain consent in writing from each client to represent conflicting interests.  Unlike the ABA model rule 1.7, a verbal consent followed by a confirmatory letter from the practitioner is insufficient--the client must countersign the confirmatory letter within 30 days of the verbal agreement. 

The final regulations do not conform the Circular 230 standards to the new Code standards for advice applicable to return positions under section 10.34.  The "Small Business and Work Opportunity Tax Act of 2007" applied the tax return preparer penalties to all tax return preparers, increased the penalty and altered the standard to avoid imposition of penalties to a more likely than not (MLTN) standard.  The IRS issued transitional relief under Notice 2007-54 for the section 6694 standards.  Therefore these regulations reserve section 10.34 (a) and (e) and a notice of proposed rulemaking is concurrently issued to amend this part to reflect the tax law changes. The regulations clarify that "a practitioner may not advise a client to submit a document to the IRS that contains or omits information in a manner that demonstrates an intentional disregard of a rule or regulation unless the practitioner also advises the client to submit a document showing a good faith challenge to the rule or regulation."

The Notice of Proposed Rulemaking  (REG-138637-07; RIN 1545-BH01) states that Treasury and IRS have concluded that section 10.34 of Circular 230 should conform to the civil penalty provisions in the Code, including the 2007 changes made to section 6694(a).  Therefor, a practitioner may not sign a tax return without a reasonable belief that the treatment of each position "would more likely than not be sustained on its merits, or there is a reasonable basis for each position and each position is adequately disclosed."  A similar standard applies to advice to a client to take a position on a return.  The NPRM also modifies the definitions of "more likely than not" and "reasonable basis" to reflect the understanding of these termms under the section 6662 penalty regulations.  Conforming wiht Notice 2007-54, these rules are proposed to apply when the regulations are finalized, but no earlier than January 1, 2008.

Consolidated Return Regulations: intercompany obligations and insurance

The Federal Register tomorrow will carry new intercompany obligation and intercompany insurance regulations under section 1502 (1.1502-13(g) and 1.1502-13(e)), available on BNA at this link.

The preamble to the regulations discusses the consideration of eliminating the deemed satisfaction-deemed reissuance model of the current regulations for intercompany obligations.  After consideration of a matching and acceleration model, tax administrators concluded that the deemed satisfaction-reissuance model provides a better approach of minimizing the effects of intercompany obligations on a consolidated group's income and providing mechanisms closer to a single-entity approach.  The deemed satisfaction-deemed reissuance model maintains creditor and debtor items at their original site, matches  timing , and ensures correspondence between creditor and debtor for future amounts and timing of discount or premium.  The acceleration and matching rules, on the other hand, would have required a number of special rules to provide adjustments to the way original issue discount (OID) and other rules work in the consolidated return context.

The new regulations, however, are intended to simplify the mechanisms for satisfaction and reissuance for intragroup and outbound transactions, as follows.

In general, the new model deems the following sequence of events to occur immediately before, and independently of, the actual transaction: (1) the debtor is deemed to satisfy the obligation for a cash amount equal to the obligation’s fair market value; and (2) the debtor is deemed to immediately reissue the obligation to the original creditor for that same cash amount.  The parties are then treated as engaging in the actual transaction but with the new obligation. 

...

The new model operates to trigger all built-in items arising from the obligation, and then reissue the obligation with an issue price equal to its basis (and generally, its fair market value) before the actual transaction.  Thus, no further gain, loss, income, or deduction with respect to the obligation will result from the actual transaction.

Unlike the current regulations, however, these regulations determine the amount of the deemed satisfaction and reissuance based on fair market value rather than through application of the OID rules.  However, if the transaction is not an intragroup transaction and the creditor's amount realized differs from the fair market value, the amount used will be the amount realized by the creditor.

A number of further special rules are provided, and of course intergroup insurance transactions are treated.  This appears to be a regulatory project that both clarifies and simplifies in ways that most taxpayers will find reasonable.

The final reportable transaction regulations

The IRS released today (July 31, 2007) a set of three final "reportable transaction" regulations on tax shelter disclosure and registration:  TD 9350; TD 9351 (section 6111 material advisor rules); TD 9352 ( list maintenance rules) (all available on BNA's service).  The regulations are generally effective August 3, 2007, except that the "transactions of interest" reporting requirements apply to transactions entered into on or after November 2, 2006.

The transactions of interest regulations retain the fairly broad defining language of the proposed regulations:

"A transaction of interest is a transaction that is the same as or substantially similar to one of the types of transactions that the IRS has identified by notice, regulation, or other form of published guidance as a transaction of interest."

The preamble notes that commentators asked for "clear" language and complained that the category appeared overbroad.

"The IRS and Treasury Department believe that providing a specific definition for the transactions of interest category in the regulations would unduly limit the IRS and Treasury Department’s ability to identify transactions that have the potential for tax avoidance or evasion. In order to maintain flexibility in identifying a transaction of interest, the description of a transaction of interest will be provided in the published guidance  that identifies the transaction of interest. The published guidance identifying a transaction of interest will provide taxpayers with the information necessary to determine whether a particular transaction is the same as or substantially similar to the transaction described in the published guidance and to determine who participated in the transaction."  TD 9350

Similarly, the government rejected a comment suggesting that the transactions of interest designation should be viable for only 24 months.  Commentators had also argued that owners of pass-through entities should not be required to disclose, at least in the case that they were unaware of the reportable transaction.  The government amended the regulations to provide some flexibility in dealing with pass-through entity reporting.  The time for filing a disclosure statement after a transaction has been identified as a reportable transaction or a transaction of interest was also lengthened from 60 days to 90 days in response to commentary.

The regulations eliminate the brief asset holding period category of reportable transactions.

The material advisor regulations in TD 9351 lower the gross income threshold for reporting when a reportable transaction provides "substantially all of the tax  benefits" to natural persons.  The regulations indicate in 301.6111-3(b)(3)(i)(D) that this is a "facts and circumstances" test that will generally be satisfied if 70 percent or more of the benefits go to natural persons. The gross income  includes all fees for a tax strategy or for services for advice or implementation of the transation--including services not related to tax advice (documentation, analysis, preparation of tax returns).  But the regulations provide that the fees taken into account do not include amounts paid to the advisor in his capacity as a party to the transaction (e.g., reasonable charges for use of capital).  The regulation provides a broad definition of tax benefit, including deductions, exclusions, adjustments to basis, nonrecognition, and "any other tax consequences that may reduce a taxpayer's Federal tax liability by affecting the amount, timing, character, or source of any item of income, gain, expense, loss or credit."

When a material advisor reports a transaction to the IRS, the IRS will issue a "reportable transaction number" and the material advisor must provide that number to anyone to whom the material advisor acted as a material advisor in respect of the transaction.

The final regulations permit various material advisors to contractually agree that a particular advisor will be the one to disclose the transaction to the IRS.  The preamble notes that a commentator's suggestion that a "good faith" participation in a designation agreement should be enough to relieve a material advisor of any reporting obligation.  The IRS did not accept that comment.   

"Inherent  in the language is the assumption that the designated material advisor will comply with the requirements.  Absolving the non-designated material advisors from the obligations... for good faith designation agreements would require the IRS to determine whether the designation agreement was entered into in good faith and would increase the burdens on tax administration."  TD 9351

The list maintenance proposed regulations required that a material advisor furnish information on the list to the IRS within 20 business days of a request for such information.  Commentators suggested that this was too rigid, and that the RIS should permit a phased disclosure or give advisors an opportunityh to gather the required information.  The preamble of TD 9352 indicates that the idea of an alternative schedule would be developed in separate guidance under Section 6708 and thus the final regulations remove the 20-day period for providing the list information.

 

Administrative Grace: IRS will allow lodging deduction in some cases where not connected with "travel away from home"

Current § 1.262-1(b)(5) of the income tax regulations provides that lodging expenses that are not covered by the "travel away from home" provision are personal expenses and not deductible if not covered under the special provision in section 217 (moving expenses).  In Notice 2007-47, however, the IRS announced today that its treatment of such expenses is changing.  The IRS intends now to permit a deduction for lodging even though employees live in the vicinity of the lodging if the lodging is "temporary",  "necessary or available for" the employee to attend a "bona fide business meeting", and the expense would otherwise have been deductible by the employee under section 162(a).  In other words, the IRS is now going to let taxpayers subsidize lodging expenses for employee retreats, even when the employees live in the same city where the retreat is held. 

I suppose someone might label this some kind of fairness initiative.  For an international company, for example, most employees might come from far, far away while some will live in the headquarters city.  If the travelers can stay in fancy retreat lodgings tax-free, you might argue that it isn't "fair" to tell employees whose homes are nearby that they can't enjoy the same perc of a nice night on the boss at taxpayer expense. 

This is not the kind of fairness I care about.  I worry about all the homeless people who will still be on the streets, without any taxpayer assistance.  I worry about the lower-income city worker who works a long, hard shift in the city but has to commute from outside the city, at considerable unreimbursed expense (not deductible because it is a commuting expense) because he can't afford to live in the city on the low pay he receives for the hard work he does.  I worry about the companies that arrange retreats for their high-level employees at five-star hotels but don't typically include the janitors, the secretaries or even the low-level managers.  I worry, in other words, that this expense is just one more perc for the well-heeled elite who already get the best treatment under the tax code for their investment income and whose rates on their marginal salary income are too low, given the compressed rate structures of today compared to those of yesteryears (when high incomes were taxed at 50 or 60 or 70 percent or more).

I personally think the Code is already much too generous in covering employee fringes such as meals and lodging.   It ultimately amounts to a taxpayer subsidy of hotels and restaurants--especially high-end ones in conference cities like New York, DC, and Las Vegas--and of the businesses that typically use those fringes the most.   

Insurance or Prepaid Services Contract: environmental remediation liabilities

The IRS has issued field attorney advice (20071801F,  released May 4, 2007) that nixes a strategy used by large corporations to deal with environmental liabilities.  The situation discussed in the guidance involves a large corporation (let's call it Polluter for short) that enters into a contractual arrangement for a fixed term of years that transfers a cleanup liability to another company (Cleaner, for short).  In return, Cleaner agrees to clean up the polluted site and indemnify Polluter for the cleanup liabilities.   Polluter has to buy an "insurance policy" under the agreement that protect Cleaner.  Under the contract, Polluter pays over an amount, called the "experience account", that is the expected cost of the cleanup.  Polluter also pays a premium for a "cost cap" policy--that policy covers any costs over the "experience account" amount.  The benefit to Polluter is that the environmental cleanup reserves can be removed from its financial statement, and the media attention in connection with the polluted site can also be eliminated.  The desired tax benefit is an upfront deduction for the "insurance" payment. 

The facts in the ruling, as noted in the RIA analysis, are similar to exit strategies entered into between Tecumseh Products Company and cleanup companies.  See, e.g., Tecumseh's 2004 fourth quarter report (describing an "exit strategy" agreement whereby TRC Environmental Corporation assumed Tecumseh's cleanup responsibilities and Tecumseh purchased a 20-year cost cap insurance contract in connection with the arrangement).

The IRS rejects the claim for a full deduction for the costs for the arrangement. Instead, it treats the exit strategy arrangement as a prepaid services contract, requiring Polluter to take the payment into account as the services are rendered over the term of the contract.  The IRS noted that the arrangement was not insurance since there was no risk of fortuitous loss (the only risk is that the cost of remediation will exceed the compensation paid to the company to take it on), no distribution of insurance risk, no protection to the insurance purchaser (Polluter), and the "insurance"  (which was a pre-condition for the arrangement) constituted the sole compensation to Cleaner for the arrangement.  If Polluter had kept the experience account in its own name, it clearly would not have been entitled to deduct it, since it would merely constitute a reserve for future expenses.  It should not be able to achieve the same by merely labelling its contract "insurance."