Sourcing Income From Issuing Guarantees

Abstract

The proper sourcing of income for writing guaranties for income tax purposes is an important matter. Five categories of guaranties may have different rules– performance bonds, loan guaranties, letters of credit, indemnities and auction guaranties. This paper argues that despite their differences, all guaranties except indemnities and some auction guaranties have essential similarities.  In return for a fee, one person guaranties that someone else or some group will do something. The guarantor is compensated for taking a risk. It is thus closer to an insurance premium than to interest or personal services income. This is true despite the fact that insurance involves risk distribution, while guaranties shift but do not distribute risk. While courts have analogized loan guaranty income to personal services and letter of credit guaranties to interest, Congress swiftly established a rule for loan guaranties based on the residence and activity of the debtor, and assimilated to the rules on the receipt of interest. This is not the best rule because there are differences between income from writing loan guaranties and interest income. The best rule is to source income from writing guaranties at the place where the risk occurs, on analogy to insurance premiums.

Keywords: performance bonds, auction, tax law, letters of credit, indemnities, loan guarantees