The current state of the rescission doctrine.

• Author: Van Leuven, Mary

If the tax result of a business transaction creates an undesirable outcome, the rules of federal income taxation might allow an opportunity for the taxpayer effectively to erase the transaction. The IRS has demonstrated flexibility in its application of the rescission doctrine to unwind transactions. Letter Ruling 201021002 is one in a series of rulings in which the IRS has applied the rescission doctrine more liberally than many tax advisers thought possible. However, tax advisers should be aware that the IRS has placed the rescission doctrine on its Priority Guidance Plan, so other guidance may be forthcoming soon.

Rev. Rul. 80-58

Rev. Rul. 80-58 sets forth the IRS's public position on rescission. In that ruling, A sells land to B. Under the sales contract, A is obligated to take back the land at B's option if the land cannot be re-zoned. When rezoning is not possible, the parties rescind the sale--B transfers the land back to A during the same tax year as the sale and receives the purchase price in return. The ruling concludes that the rescission is respected for tax purposes; therefore, A does not recognize gain on the initial sale, and B does not recognize gain on the rescinding transfer.

The tax doctrine of rescission stems from the contractual right of rescission and is based in part on Penn v. Robertson, 115 F.2d 167 (4th Cir. 1940), a claim of right case that allowed taxpayers to reverse a transaction without recognizing any tax consequences from the initial transaction or its nullification. Based on Rev. Rul. 80-58, the IRS generally requires four elements for a valid rescission: (1) the transaction must occur under an agreement or contract that (2) during the same tax year is (3) rescinded in a formally proper manner (such as by agreement of the parties) so that (4) the parties are returned to the same position as if that transaction had never occurred.

Letter Ruling 201021002

The facts of Letter Ruling 201021002 are complicated, so a simplified description follows. Prior to implementing a restructuring plan, a parent company owned interests in several disregarded entities. Because these subsidiaries were disregarded, debt issued by certain of them to the parent was also disregarded for federal tax purposes. The parent engaged in a series of steps through which it contributed the disregarded entities to a regarded corporate subsidiary. Although the parent intended to contribute its creditor positions for the receivables along...