Clarifying (or Is It Codifying?) The “Notably Abstruse”: Step Transactions, Economic Substance, and the Tax Code
By: Philip Sancilio
The economic substance and step transaction doctrines are two specific examples of courts’ general willingness to sometimes look past transactions’ technical form and impose taxes based on their underlying substance. As judicial creations, the two doctrines served as complements and functional equivalents. However, they also generated a wide variety of vague, overlapping, and conflicting formulations.
In 2010, Congress incorporated the economic substance doctrine into the Internal Revenue Code by defining its content and tying it to a heightened strict liability penalty. When it did so, Congress did not address when the doctrine is available. Instead, it left that determination to the preexisting common law and articulated a functional definition of the doctrine to which its new statutory scheme applies. However, the definition of the codified economic substance doctrine creates uncertainty by encompassing some, but not all, of the various formulations of the step transaction doctrine. Terminological messiness that used to have little effect beyond confusing dicta could now control the imposition of statutory requirements and heightened liability.
After laying out the doctrinal background, this Note applies the definition of the newly codified economic substance doctrine to the various formulations of the step transaction doctrine and demonstrates problematic inconsistency in the results. It then traces that inconsistency to the uncertain relationship between the doctrines and argues for conceptual clarification. Finally, it proposes that the codified economic substance doctrine should apply first and that the step transaction doctrine should stand behind it as a backstop.
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