Question

US Tax laws are based on several important doctrines. •The assignment of income doctrine - states that income must be taxed to the entity that renders the service or owns the capital with respect to which the income is paid. •The economic substance doctrine - holds that a transaction that changes the taxpayer’s economic situation only for the tax savings from the transaction can be disregarded by the IRS. •The business purpose doctrine - a transaction should not be effective or allowed for tax purposes unless it has a business purpose other than tax avoidance. •The step transaction doctrine - allows the IRS to collapse a series of intermediate transactions into a single transaction to determine the tax consequences of the arrangement in its entirety. To perform professional tax planning, we adhere to several maxims. First we need to analyze the variables that determine the tax consequences of a transaction. Then we apply one or more of the following tax planning maxim strategies that reduce tax and enhance cash flows: •Generate income in a lower tax rate entity – tax costs decrease. •Defer taxes - shift income to a future year when rates are lower, or move expenses forward to the current year when tax rates are higher or they can decrease income. •Generate income in a lower tax jurisdiction - tax costs decrease when income is taxed at a lower tax rate. •Change the character of the revenue - tax costs decrease when income is taxed at a preferential rate because of its character. Specific discussion question: Conduct tax research and provide a tax court case that disallowed one of the strategies described above and explain what happened, what tax strategy maxim was applied to try and reduce the tax, what doctrine was used to deny the tax strategy, and what were the Internal Revenue Code sections cited.

Answer 1

Principles of Application of the Federal Tax Laws With Emphasis on the Opinions of the Supreme Court of the United States By Jasper L. Cummings, Jr. CummingsRound3.indd 1 5/5/2010 9:29:56 AM APPLICATION OF THE FEDERAL TAX LAWS ii The views and opinions expressed herein are entirely those of the author. Nothing contained herein is to be considered as the rendering of legal advice, nor should it be construed as representing the opinions, views, or actions of the American Bar Association or the Section of Taxation, unless duly approved by the Association or the Section. This book is intended for educational and informational purposes only. The views expressed herein have not been approved by the House of Delegates nor the Board of Governors, nor the Section of Taxation of the American Bar Association and, accordingly, should not be construed as representing the policy of the American Bar Association. Printed in the United States of America. Published by the American Bar Association Section of Taxation 740 15th Street, N.W., Washington, DC 20005-1009. © Copyright 2010 American Bar Association. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the American Bar Association. 10-Digit ISBN: 1-60442-756-6 13-Digit ISBN: 978-1-60442-756-1 Price: $135 for members of the Section of Taxation of the American Bar Association and $155 for non-members. To order additional copies, contact the ABA Service Center at (800) 285-2221 and request product code 5470744. CummingsRound3.indd 2 5/5/2010 9:29:57 AM PREFACE xi Preface This book is for practitioners and other students of the federal tax laws. It addresses all issues arising in the application of the Internal Revenue Code that are outside of the operation of the substantive law and tax procedure. Therefore, this book explores statutory interpretation and construction and methods of fact finding used in the application of the Code to taxpayers’ facts. In addition it collects, categorizes and explains the significant statements of the United States Supreme Court on these subjects. Many of the subjects here addressed have escaped careful analysis; for them this book provides such analysis, with surprising results in many cases. For other more discussed subjects this book collects and organizes sources that can be hard to find, and states truisms established in those sources that have been overlooked. This book makes existing knowledge accessible and organizes and presents the disparate but integrated issues in a way not elsewhere available, somewhat akin to a restatement. Some subjects may seem obvious when presented, but are not necessarily part of many tax lawyers’ tool kits simply because they have never focused on them; this book identifies such subjects and places them in familiar context. Therefore, this book has some of the characteristics of a (very long) law review article, and also aspires to be a black letter law treatise. This book is organized with a detailed Table of Contents and is heavily footnoted so that it can serve as a resource. In the age of electronic word searches, it is easy to forget that not all useful information can be found that way. CummingsRound3.indd 11 5/5/2010 9:29:58 AM APPLICATION OF THE FEDERAL TAX LAWS xii This book is organized around three premises: (1) the federal tax laws are not different from the rest of the law, and do not require special legal processes, apart from standard statutory interpretation and fact finding; (2) a wealth of usually untapped guidance can be derived from the Supreme Court’s extensive federal tax opinions; and (3) rather than episodically picking out phrases from Supreme Court (and other) opinions for citation, practitioners and students need a firm grasp of the progress of the Supreme Court’s federal tax jurisprudence and the meaning of certain high profile decisions of the Court, including particularly those that have established base line concepts, such as Eisner v. Macomber, Gregory v. Helvering, Higgins v. Smith, Court Holding, Knetsch, and Frank Lyon. The lower federal courts have developed what they consider to be special legal processes for federal tax cases (called herein “tax specific doctrines”), which with one exception are only applications of standard law methods of fact finding or legal interpretation; the one exception is the economic substance doctrine, which since the 1980s has come to be treated as a positive rule of law, seemingly enacted by the lower federal courts. The tax specific doctrines are variously described as assessing business purpose, substance over form, economic substance, step transactions, sham transactions and related tax specific concerns. The economic substance doctrine functions like an uncodified preamble to the Code, albeit applied in episodic and unpredictable ways. Bittker & Lokken applied the term “preamble” for this purpose and stated: “[T]ransactions are to be taken at face value for tax purposes only if they are imbued with a ‘business purpose or reflect economic reality’ . . .”1 Throughout, this book contrasts and compares what the Supreme Court actually has done versus tax specific doctrines, and otherwise comments on the doctrines’ wisdom. Many of the doctrines are just names for common fact finding techniques (for example, stepping related transactions together for analysis). But the economic substance doctrine has evolved into a positive rule of law. Moreover, a careful focus on the Supreme Court’s tax opinions is justified by its huge federal tax caselaw of well over 900 opinions. That body of opinions is sufficiently large and authoritative to be the principal source of guidance on the application of the Code. Advocates can and will always find and cite the recent relevant opinions of the lower courts; this book helps them find the better Supreme Court authority that can overcome adverse lower court rulings. This book is an objective reference book with two differences: its analyses aim to go deeper than the standard reference works, by identifying the most pertinent among competing authorities and questioning spurious authorities; also, it has a stated point of view. 1Bittker & Lokken, Federal Taxation of Income, Estates and Gifts ¶4.3.1 (2010) (Warren Gorham & Lamont 3d ed. 1999 & Supp. 2010). CummingsRound3.indd 12 5/5/2010 9:29:58 AM PREFACE xiii In going deeper, this books integrates three sources of information not directly related to tax: (1) general legal principles as applied outside the tax law, (2) legal history both generally and in the tax law, and (3) academic viewpoints on statutory interpretation. Ordinarily tax treatises do not attempt to integrate any, much less all, of these sources. They are included here because they are useful to the understanding of the current tax law, because they are often hard to find, and because the tax law has suffered from isolation and from ignoring its own history. The summaries of academic debates (for example, about Chevron deference and strict construction) may seem abstract, but should serve the purpose of alerting the practitioner to otherwise foreign territory and permitting an evaluation of the debates. As a reference this book contains in depth analyses of several sub topics related to the application of the Code, such as section 269, the Chevron Doctrine, the economic substance doctrine in the courts, and the several frequently cited Supreme Court opinions. Admittedly, herein the discussions of some court opinions and certain issues (like Chevron deference and tax equity) are quite detailed and heavily footnoted. That unusual detail is provided either to support a counterintuitive point or as evidence of one of the fundamental assumptions that underpins this book: too often the real tax law is overwhelmed by gloss and cliché thus necessitating a careful and discerning reading of the apt authorities. The book’s point of view is one of not necessarily assuming that the current state of the law is the most advantageous, or that current understandings of the law are correct, or that (in some cases) even Supreme Court opinions are correct in all of their reasoning. This book aims for a fresh look at many accepted truths in the tax laws. This book draws inspiration from the three volumes of Studies in Federal Taxation written by Randolph E. Paul between 1937 and 1940. Paul was the consummate practitioner, administrator and scholar, who had little patience for the inscrutable. He set a matchless standard in extracting concrete meaning from tax case law, and in stating both what the law was and what it should be. I urge you to use this book to understand the origin and place in the tax law of the tax specific doctrines, to understand the role and views of the Supreme Court in federal tax cases, and to find support for more lawyerly approaches to legal interpretation and fact finding in tax cases. That notwithstanding, in the end it may be necessary to develop systemic changes to address the more intractable difficulties of the interpretation and construction of the Code. Finally, I thank Professor Michael Mulroney for reading the manuscript and offering many useful suggestions, and the American Bar Association Section of Taxation for publishing this book. Jasper L. Cummings, Jr. Raleigh, North Carolina April, 2010