The rescission principle.

• Author: Luchs, Lorin D.
• Position: Tax advisers attempts to adjust failed transactions

Often, tax advisers are asked to fix the tax effects of an ill-tax advised or unsuccessful transaction. Letter Ruling 9829044 serves as a reminder of the rescission principle described in Rev. Rul. 80-58, which, under the proper facts, can be a useful remedy.

Rev. Rul. 80-58

In Rev. Rul. 80-58, a calendar-year taxpayer sold land to a buyer for cash, agreeing that, if the buyer could not have the land rezoned within nine months after the sale, it would be reconveyed for the amount originally expended. Based on the annual accounting concept, the IRS ruled that if, for Federal income tax purposes, the rescission of the sale occurred before the end of the taxpayer's year in which the sale occurs, it would be treated as never having occurred. However, if the reconveyance occurred in a subsequent tax year, both the sale and reconveyance would be respected as separate transactions, resulting in the taxpayer recognizing gain on the sale and a new cost basis on the subsequent repurchase. Rev. Rul. 80-58 describes the legal concept of rescission as follows:

The legal concept of rescission refers to the abrogation, canceling, or voiding of a contract that has the effect of releasing the contracting parties from further obligations to each other and restoring the parties to the relative positions that they would have occupied had no contract been made. A rescission may be effected by mutual agreement of the parties, by one of the parties declaring a rescission of the contract without the consent of the other if sufficient grounds exist, or by applying to the court for a decree of rescission.

Letter Ruling 9829044

In Letter Ruling 9829044, the shareholders of an S corporation (X) contributed their stock to Y, another S corporation owned by the same shareholders. Y intended to make a timely qualified subchapter S subsidiary (QSSS) election for X following the contribution. However, after becoming concerned that X's suspended loss could disappear if a QSSS election was nude, Y distributed the X stock to the shareholders in the same proportions it had been contributed by them. The distribution was made in the same tax year of the shareholders in which the original contribution was made; all parties were returned to the same legal and financial position as before the contribution.

On these facts, the Service concluded that the rescission doctrine applied to disregard the original transfer of the X stock to Y and prevent the termination of X's 8 status.

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