IRS Issues Guidance on Economic Substance Doctrine

The IRS has recently issued Notice 2014-58, which provides additional guidance on certain aspects of the economic substance doctrine. A transaction has economic substance if the transaction changes (in a meaningful way) the taxpayer’s economic position and the taxpayer also has a non-federal income tax business purpose for entering into the transaction. Taxpayers entering into transactions that lack economic substance may be assessed with accuracy related penalties.

The term transaction includes a series of interconnected steps taken in a plan that generated a tax benefit. However, if the steps include a tax-motivated step that is not necessary to achieve a non-tax objective, that step may be tested separately for economic substance.

The Notice states that the economic substance doctrine may be applied solely to one step in a series of steps such as the transfer or assumption of a specific liability or a review of steps or actions that were unnecessary to accomplish a non-tax objective.

The definitions within the Notice basically restates the IRS position and does not provide additional guidance as to whether a series of steps, a single transaction or one or more steps will be tested separately. Those issues will continue to be left to the courts to decide.

The Notice also clarifies how the IRS will impose penalties should a transaction not meet the economic substance requirements. The Notice is binding on IRS.

For more information, please contact your Marcum Tax Advisor.