Attacking Tax Shelters: Galloping Toward a Better Step Transaction Doctrine

Author:Jonathan D. Grossberg
Position:Practitioner-in-Residence, Janet R. Spragens Federal Tax Clinic, American University, Washington College of Law. LL.M. (Taxation), New York University School of Law; J.D., Cornell Law School; B.A., Cornell University.
Pages:369-436
 
FREE EXCERPT
Attacking Tax Shelters: Galloping Toward a Better
Step Transaction Doctrine
Jonathan D. Grossberg*
Since the beginning of the Internal Revenue Code, taxpayers have
sought to lower their tax bills through creative tax planning. The step
transaction doctrine is one of several tools used by the Internal Revenue
Service and courts to challenge tax shelters and tax evasion. The step
transaction doctrine provides that the courts may combine two or more
allegedly separate steps in a multi-step transaction into a single step to
better reflect the economic reality of the taxpayer’s actions. Derived from
Supreme Court decisions in the 1930s, the doctrine deserves renewed
scrutiny today because serious conceptual issues exist regarding the three
current tests that courts use to determine when to combine various steps in
a tax-motivated multiple-step transaction. This Article addresses two
perennial themes in tax law: the role of judicial doctrines in a statutory system
and the difficulty of taxing related-party transactions. This Article argues that
courts should reformulate the binding commitment, interdependence, and end
result tests as two objective tests: an objective test based on the law of offer and
acceptance for arms-length transactions and an economic reality test for
transactions between related parties. These new tests provide conceptual
clarity and promote predictability while protecting the public treasury. The
new tests borrow underlying concepts from contract and commercial law.
The new tests demonstrate the fruitful possibilities of borrowing across
areas of law. They also demonstrate that tax law shares similar concerns
Copyright 2017, by JONATHAN D. GROSSBERG.
* Practitioner-in-Residence, J anet R. Sprag ens Federal Tax Clinic,
American University, Washington College of Law. LL.M. (Taxation), New York
University School of Law; J.D., Cornell Law Sch ool; B.A., Cornell University. I
am grateful f or helpful comments and suggestions from Daniel Shaviro, Robert
Green, Robert Hillman, David Shipley, Patricia Lee, Nancy Abramowitz,
Benjamin Leff, Kenneth Anderson, Heather Hughes, Susan Carle, David
Shechtman, Kathleen Gordon, Dia ne Weinroth, Da vid Grossberg, Robyn
Grossberg, Nina Goldman Grossberg, and two anonymous readers, and from the
participants in the American University, Washington College of Law Business
Faculty Workshop, the Mid-Atlantic Clinical Writers’ Workshop, and the Sharing
Scholarship Building Teachers Conference at Albany Law Scho ol. I am also
thankful f or Margar et Hobbs’ excellent r esearch assista nce, Kevin Gustafson’s
editorial assistance, and additional research assistance from Sonja Balic a nd
Matthew Abbott. I am also grateful to the staff of the Pence Law Library at
American University Washington College of Law, especially Khelani Clay, for
finding sources and providing other research and reference assistance.
370 LOUISIANA LAW REVIEW [Vol. 78
with other areas of lawa proposition that is sometimes doubted. This
Article further contends that the step transaction doctrine, as reformulated,
should be available for assertion by taxpayers in transactions between
unrelated parties. Acknowledging the availability of the test for assertion
by taxpayers will have the salutary effect of aligning the letter of the
doctrine with its application.
TABLE OF CONTENTS
Introduction .................................................................................. 370
I. Background on Judicial Doctrines ............................................... 377
A. Common Roots of the Judicial Doctrines .............................. 378
B. The Step Transaction Doctrine .............................................. 381
1. The Binding Commitment Test ....................................... 382
2. The Interdependence Test ............................................... 383
3. The End Result Test ........................................................ 386
4. The Relationship Between the Three Tests ..................... 390
5. Recent Cases Applying the Doctrine .............................. 395
C. Critical Responses to the Step Transaction Doctrine ............. 397
1. Test Application Criticisms ............................................. 398
2. Criticism of the Existence of Specific Tests ................... 401
3. Critics Favoring an Entirely New Test ............................ 404
D. Recent Scholarship ................................................................ 408
II. A New Vision of the Step Transaction Doctrine .......................... 409
A. Objective Test ........................................................................ 412
B. Economic Reality Test ........................................................... 417
C. Why Two Tests? .................................................................... 423
D. Offensive Use of Judicial Doctrines ...................................... 424
E. Different Tests, Different Results .......................................... 431
III. Broader Themes and Open Questions: Borrowing Across
Areas of Law and Aligning Theory with Practice ........................ 433
Conclusion .................................................................................... 436
INTRODUCTION
The Internal Revenue Code (“IRC” or “Code) and the Treasury
Regulations (Regulations) consume volumes and volumes of provisions.
These provisions are worded carefully and often reflect competing policies
2018] ATTACKING TAX SHELTERS 371
beyond raising revenue, such as favoring or disfavoring certain taxpayer
behavior and advancing social policies. Since the beginning of the Code,
taxpayers have sought to lower their tax bills through creative tax planning.
This behavior often has been met with judicial approval.1 Congress, by
enacting the anti-abuse provisions of the Code, and the Internal Revenue
Service (IRS), by promulgating anti-abuse regulations, have sought to
combat this behavior.2
This Article addresses two of the perennial themes of tax law: the role of
judicial doctrines in a statutory system and the difficulty of taxing transactions
between related parties. These concerns link this Article to broader themes in
the law.
Tax law is governed primarily by code and regulation, as are intellectual
property law, immigration law, criminal law, and many other areas of law.
In each of these primarily statutory systems of law, when the courts perceive
a gap or deficiency in the statutory system, they augment the system with
judge-made common law.3
1. See infra notes 3539 and accompanying text.
2. In one recent case, the court noted that
much of the caselaw using the economic substance, sham transaction,
and other judicial doctrines in in terpreting and applying tax statutes,
represents an effort to reconcile two competing policy goals. On one
hand, having clear, concrete rules embodied in a written Code and
regulations that exclusively define a ta xpayers obligations (1) facilitates
smooth operation of our voluntary compliance system, (2) helps to
render that system transparent and administrable, and (3) furt hers the free
market economy by permitting taxpayers to know in advance the tax
consequences of their transactions. On the other side of the scales, the
Codes and the regulations fiendish complexity necessarily creates
space for attempts to achieve tax r esults that Congress and t he Treasury
plainly never c ontemplated, while nevertheless complying strictly with
the letter of the rules, at the expense of the fisc (and other taxpayers).
CNT Invrs, L.L.C. v. Commr, 144 T.C. 161, 198 (2015).
3. See generally Brett Fischman & Dan Moylan, The Evolving Common
Law Doctrine o f Copyright Misuse: A Unified Theory and its Application to
Softwa re, 15 BERK. TECH. L.J. 865 (2000) (discussing the emerging common law
doctrine of misuse in copyright law as a judicial attempt to prevent statutory
protection from being abused as an anticompetitive tactic); Alan Scott Rau,
Intellectual P roperty, 16 TEX. TECH L. REV. 355 (1985) ( discussing how and to
what extent the Fifth Circuit incorporated the common law doctrine of
functionality into its reading of the Lanham Ac t in Sicilia Di R. Biebow & Co. v.
Cox, 732 F.2d 417 (5th Cir. 1984)); Kiran H. Griffith, Comment, F ugitives in
Immigration: A Call for Legislative Guidelines on Disentitlement, 36 SEATTLE U.
L. REV. 209 (2 012) (discussing the use of the common law doctrine of fugitive
disentitlement in immigration law); John M. Mulcahey, Recent Decision , Res

To continue reading

FREE SIGN UP