In response to a September 16, 2012 letter by a taxpayer to the IRS requesting advice regarding whether a taxpayer can exploit the substance-over-form doctrine to recast a transaction, the IRS stated that taxpayers are bound by the form of the transactions they choose. ECC 201311023, 2013 TNT 52-67.
In its response letter, the IRS cited the Danielson, Fletcher, and National Alfalfa line of cases for the general proposition that taxpayers cannot disavow the form of the transactions they choose to enter into. Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967); United States v. Fletcher, 562 F.3d 839, 842 (7th Cir. 2009); Commissioner v. National Alfalfa Dehydrating and Milling Co., 417 U.S. 134 (1974). Nonetheless, the IRS recognized the fact that the Seventh Circuit has appeared to stop short of a full on prohibition against taxpayers disavowing their transactional forms, by permitting them to establish “strong proof” that the economic realities are something different than what they intended.
In the case at hand, based on facts that were not disclosed in the published letter, the IRS responded that the taxpayer was not able to meet this “strong proof” standard and concurred with the field’s overall conclusion: the taxpayer should not be entitled to utilize substance-over-form to recast the transaction now into a form that better suits it.
This is not a new IRS position. Nonetheless, it illustrates the care taxpayers need to take when planning transactions since taxpayers are often precluded from arguing the substance-over-form doctrine when trying to characterize the nature of a transaction for federal tax purposes. Accordingly, taxpayers need to ensure that they structure transactions in a manner to ensure that they will obtain the desired tax treatment not only when looking at the substance of the transaction, but they must also structure the form of the transaction in such a manner as to achieve the desired tax result. Generally this is not a problem, although in certain situations where local law restrictions prevent traditional forms used to structure deals, this issue can pose significant tax issues. Whenever such a situation comes up, taxpayers should make sure to avoid this potential tax trap. For more information contact Ruben Conitzer.
