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The Tax Court and Seventh Circuit held that bail bonds are not insurance contracts in Allied Fidelity Corp. v. Commissioner. The Tax Court stated,
[i]n common understanding, an insurance contract is an agreement to protect the insured (or a third-party beneficiary) against a direct or indirect economic loss arising from a defined contingency. The insurer undertakes no present duty of performance but stands ready to assume the financial burden of any covered loss. In contrast, the principal obligation of the bail surety is to produce the
defendant at trial.
The Service concluded in Revenue Ruling 68-101, that bail bonds are not insurance contracts because they do not involve a monetary loss shifted and assumed by an accused or court. Surety bonds, however, can qualify as insurance contracts. "A surety is one who has agreed (in writing) to answer for the debt, default, or miscarriage of another." Surety bonds involve three parties. "The bond is the joint and several obligation of the principal and the surety in favor of the obligee named in the bond."
The Service concluded that the surety bonds at issue in General Counsel Memorandum 3 9,154202 qualified as insurance because the taxpayer, a surety, agreed to protect the obligee from the economic risk of loss arising from a default by the principal. The Service concluded that a risk of loss was present although the surety has a right of indemnity against a defaulting principal.
The Service distinguished the characterization of the surety bonds from that of the bail bonds in Allied Fidelity. It stated that the surety did not assume a duty to perform, but "stands ready to assume the financial burden of any covered loss." A bail bond, however, involves the duty to produce a defendant at trial so that it resembles a contract to perform a service.
