New York State Seal
STATE OF NEW YORK
INSURANCE DEPARTMENT
25 BEAVER STREET
NEW YORK, NEW YORK 10004

The Office of General Counsel issued the following informal opinion on March 28, 2000.

Treatment of Tax Preparer’s Warranty

Question Presented:

Does Preparer, Inc.'s ("Preparer") current basic "guarantee" program or its proposed "Extra Guarantee Program" (the "Program") constitute the doing an insurance business within the meaning of the New York Insurance Law?

Conclusion:

Both the current basic program and the proposed Extra Program would constitute the doing of an insurance business. If the programs were to limit their obligation only to instances where additional taxes, penalties or interest were due because of an error by Preparer, the programs would not be regarded as the doing of an insurance business.

Facts:

Preparer is a corporation that provides tax return preparation services. It currently provides to its clients, at no charge, a "basic guarantee" under which clients are reimbursed for any penalty or interest owed as a result of either an error by Preparer in the preparation of the return or a change in the interpretation (presumably, by the IRS) of the tax law.

Preparer proposes instituting the "Extra Guarantee Program" to its clients. Under the Program, the client would pay a fee of $25.00 and would be guaranteed reimbursement of up to $5,000.00 of any additional tax liability determined to be owed by the taxpayer either as a result of an error by Preparer or because of a change in the interpretation of the tax law. The provisions of the Program are set forth in the "Certificate Guarantee," which provides, in pertinent part, as follows:

Accuracy of your tax return is of prime importance to Preparer. For this reason, Preparer provides a Basic Guarantee and also makes an enhanced Extra Guarantee available, as described below:

Basic Guarantee:

Preparer has unique tax preparation software, a computerized error checker, and training procedures designed to minimize the chance of an error in your tax return. However, in the event of a change in the interpretation of the tax laws, or if Preparer makes an error in your tax preparation, although Preparer does not pay any additional tax assessed, Preparer will reimburse you for any penalty or interest, which you must pay on such tax. Further, if your income tax return is audited, Preparer will appear with you at the audit. Although Preparer can not act as your legal counsel or representative, Preparer can explain how your return was prepared.

Extra Guarantee:

Preparer, Inc. also offers a Extra Guarantee available at participating locations. If this additional service is purchased, Preparer guarantees that in the event you must pay at any time additional tax over and above what your income tax return shows, as a result of a change in the interpretation of tax law, or as a result of an error by Preparer in the preparation of your individual tax return, you will be reimbursed for such additional tax up to a cumulative total of $5,000 for all tax returns covered hereunder. Federal, state and local returns that were prepared by Preparer are covered, but non-resident Federal returns are not. This reimbursement is over and above the Basic Guarantee of reimbursement for penalty and interest.

In order to be eligible for reimbursement, you must (a) notify Preparer within 21 days of when you receive any letter from any taxing authority concerning your tax return; (b) provide to Preparer copies of the documents related to your tax situation as well as any additional tax assessment; (c) allow and assist Preparer in an effort which it may decide to make at its expense to investigate, questions, or challenge the additional tax; and (d) provide to Preparer a signed copy of this Certificate of Guarantee as proof of your purchase of the Extra Guarantee. Reimbursement of an additional tax assessment will require you to include such payment as income of the tax return for the year in which such payment is made, and a Form 1099 will be furnished to you to reflect this payment. Subject to the $5,000 limit, Preparer will include in its payment under the Extra Guarantee its estimate of the income taxes, which you will owe on such income for the year in which the payment is made.

The Extra Guarantee does not apply to claims outside the definition of those covered under this program and also does not apply to situations where (i) you provided incorrect or incomplete information to Preparer; (ii) your tax refund was reduced or not received as a result of a tax lien, judgment, support order, unpaid student or government related loans, back taxes, or any other collection action; (iii) you had actual knowledge that additional tax would be owed on or before the date of purchase of the Extra Guarantee; (iv) you were unable to produce sufficient or appropriate records to support your tax position before the government; (v) you failed to timely file the tax return or pay the taxes shown as owing on such return; (vi) you intended to defraud Preparer or any taxing authority; and/or (vii) events subsequent to Preparer’s preparation of your return caused the additional tax assessment. In the event you receive a refund of monies that Preparer has paid to you under this Extra Guarantee, you agree to promptly reimburse such monies to Preparer.

Anasysis:

Under New York law, generally no person or entity may carry on an insurance business without a license. N.Y. Ins. Law § 1102(a) (McKinney, 1985). The "doing of an insurance business" is defined, inter alia, as "making, or proposing to make, as insurer, any insurance contract." N.Y. Ins. Law § 1101(b)(1)(A) (McKinney, 1985). "Insurance contract" is defined in N.Y. Ins. Law § 1101(a)(1) (McKinney, 1985) as follows:

"Insurance contract" means any agreement or other transaction whereby one party, the "insurer", is obligated to confer benefit of pecuniary value upon another party, "the insured" or "beneficiary", dependent upon the happening of a fortuitous event in which the insured or beneficiary has, or is expected to have at the time of such happening, a material interest which will be adversely affected by the happening of such event.

A "fortuitous event" is defined as "any occurrence or failure to occur which is, or is assumed by the parties to be, to a substantial extent beyond the control of either party." N.Y. Ins. Law § 1101(a)(2) (McKinney, 1985). The doing of an insurance business also includes "making, or proposing to make, as warrantor, guarantor, or surety, any contract of warranty, guaranty or suretyship as a vocation and not as merely incidental to any other legitimate business or activity of the warrantor, guarantor or surety." N.Y. Ins. Law § 1101(b)(1)(B) (McKinney, 1985).

In the instant case, under both the basic and the Extra programs, two separate obligations are undertaken. The first is to provide protection against errors committed by Preparer. The second is to provide protection against changes in the interpretation of the tax law. The only distinctions between the two programs are: 1. Under the Extra Program, a fee is charged, while the basic program is included within the tax preparation services; and 2. The amount of the benefits are different. We will discuss each obligation separately, because the nature of the separate obligations under each program is more significant than the distinctions between the programs.

Protection against errors committed by Preparer

Although termed a "guarantee", Preparer's promise to compensate the taxpayer client in the event that Preparer makes an error in preparing the tax return is actually a "warranty", and not a "guaranty", as those terms are used in § 1101. A warranty differs from a guaranty in that a warranty is an absolute undertaking of liability on the part of the warrantor; it is a promise that a proposition of fact is true, or will remain so. For § 1101 purposes, a warranty relates in some way to the nature or efficiency of a product or service. Typically, a warranty is described as covering a defect in materials or workmanship. The maker of the warranty must have some relationship to the product or service or do some act that imparts knowledge of the product or service to the extent of minimizing, if not eliminating, the element of chance or risk contemplated by § 1101(a). Otherwise, the maker of the contract undertakes an obligation involving a fortuitous risk, and the agreement is an insurance contract.

However, the making of warranties may nevertheless constitute an insurance contract, depending upon the status of the warrantor. If the warrantor is engaged in the making of the warranty as a vocation and not merely as an activity incidental to the other legitimate business activities of the warrantor, then the warranty will constitute the doing of an insurance business. N.Y. Ins. Law § 1101(b)(1) (B) (McKinney 1985).

The offering of the error protection provision of the agreement clearly relates to a deficiency in the services provided and is clearly within Preparer's control. Consequently, it would constitute a warranty under the Insurance Law. Because the agreement relates directly to Preparer's vocation of tax preparer, the obligation is incidental to its central business, and would not constitute the doing of an insurance business. The amount of the fee charged by Preparer under the Extra Program is not significant enough to alter the incidental nature of the obligation. While Preparer will become obligated to pay an amount that is greater than the amount of the actual damages sustained by the taxpayer (since the taxpayer owes the tax in any event), that factor does not change the above analysis.

Protection against changes in the interpretation of the tax law

To the extent either the basic or the Extra Program covers instances in which a tax adjustment is the result of a change in the interpretation of the tax law that occurs after the return was prepared, the Program is an insurance contract. This is because the change in interpretation of the tax law is entirely within the discretion of the Internal Revenue Service (or state tax agency). No tax return preparer can predict what the IRS, or state tax agency, will do in the future, and, therefore, changes in the interpretation of the tax law are beyond the control of the parties and would constitute "fortuitous events."

To the extent that Preparer knew, or reasonably should have known, of an existing IRS, or state agency, interpretation, and the return was deficient because Preparer failed to prepare the return in accord with the interpretation, Preparer could warrant against making such an error.

The fact that there is no separate fee under the basic program does not remove the obligation from being an insurance business. Rather, the cost for providing the benefit is built into, and part of, the cost of preparing the tax return.

Summary

For the reasons set forth above, both the basic and the Extra programs constitute the doing of an insurance business. If, however, the programs were amended so that reimbursements of penalties, interest and additional taxes were made only in the event of an error on the part of Preparer, the programs would not violate the Insurance Law.

For further information, contact Senior Attorney Michael Campanelli of the Department’s New York Office.