Sec. 482 and the sham-transaction doctrine.

• Author: Sair, Edward A.
• Position: Corporate taxation

The last few years have seen a surge in the IRS's successful assertion of the sham-transaction doctrine against corporate taxpayers (ACM Partnership, 157 F3d 231 (3rd Cir. 1998), aff'g in relevant part TC Memo 1997-115; Compaq Computer Corp., 113 TC 363 (1999); United Parcel Service of America (UPS), TC Memo 1999-268; Winn-Dixie, 113 TC 254 (1999); and Medieval Attractions N.V., TC Memo 1996-455). In addition, the Service has been successful in using Sec. 482 in the corporate context and in imposing penalties (DHL Corp., TC Memo 1998-461). The clear message of these victories is the willingness of the IRS and the Tax Court to apply Sec. 482 in conjunction with the sham-transaction doctrine, to ignore the form of a taxpayer's transaction and impose not only tax liabilities but also penalties.

Sec. 482 has always been an amalgam of several important tax policies, including tax-avoidance principles, assignment-of-income notions, general deduction theories and clear-reflection-of-income principles; see Foster, 80 TC 34 (1983), aff'd in relevant part 756 F2d 1430 (9th Cir. 1985). The overall purpose of Sec. 482 is to prevent the artificial shifting, milking or distorting of true net incomes of commonly controlled enterprises. It specifically allows the Service to allocate income or deductions between commonly controlled entities, to prevent evasion of taxes or to clearly reflect income. Although the general sham-transaction and assignment-of-income doctrines can achieve the same result, Sec. 482 is designed to enable the IRS to prevent the distortion of income even when a taxpayer has acted in good faith and without a tax-avoidance motive. As can be seen from the recent spate of cases, however, this is most successful when it is supported by the other more general and broad-based doctrines that rely on demonstrating a taxpayer's attempt to avoid taxes.

UPS most clearly demonstrates the choice between a (1) general disallowance of deductions using the economic-substance doctrine and (2) reallocation of deductions under Sec. 482. The Service determined that amounts UPS collected as excess value charges and paid over to its captive insurance company as premium payments had to be included in its income. The court upheld the IRS's position and imposed substantial penalties, concluding that the taxpayer failed to prove that the structuring of its transaction as the purchase of insurance from its captive was motivated by nontax business reasons or had...