More about Economic Substance Doctrine
Recently, a student of mine brought up the “Economic Substance Doctrine.” The IRS has been using this as way to get more tax dollars from people for decades. Now, it’s officially law.
The IRS’ policy, and the courts has supported the notion, that if a person does something whose primary purpose is to save taxes, the IRS has the power to undo that something. But the fact of the matter is, people do things all the time for the sole purpose of paying less in taxes.
Tax laws in and of themselves are meant to get people to perform certain actions: driving electric vehicles, installing solar panels, going green, investing in oil. All of these actions are motivated by a savings or refund.
When a person accused of the Economic Substance Doctrine is brought to court, they will be asked things like: Was there a reason other than saving on taxes for performing the action? Was the business transaction done for non-tax purposes? Was the deal profit motivated?
Having the Economic Substance Doctrine put into law was like giving the bully a much bigger stick to hit us with to get our lunch money. However, we should have been on the lookout for said bully long before he had a bigger stick.
What’s vital here is the “window dressing,” i.e., when shuffling assets out of the reach of creditors, you also should be doing estate planning tasks, such as wills and trusts, simultaneously. Again, this is the “window dressing,” not the economic doctrine issue itself.
So when you’re asked if you moved your property around to get around the creditors you now have a good window dressing answer. If you don’t provide a good, non-tax saving answer, the judge will give you a rather hard and painful slap. But if you can prove that the motive was pure (by pure I mean non-tax saving) you’ll be alright.
Everything you do that has anything to do with estate planning, tax planning, and asset protection needs to be done with a “window dressing,” another motive. If you can prove that the transaction was done for estate planning or asset protection motives, and not just to save money on taxes, then you will be removed from the consequences of the Economic Substance Doctrine.
Falling prey to the Economic Substance Doctrine comes up most often in matter of estate planning and tax planning. Thinking ahead and creating a window dressing will save your butt down the road. The IRS’ main target is the guy who knows the investment will loose him a lot of money but save him a bundle in taxes.
You’ll get flagged if you cannot show a non-tax savings reason for your action, investment, or change in plan. The consequences are serious and the penalties stiff. You’ll loose all o your tax savings in addition to getting hit with a forty percent penalty, courtesy of the IRS.
Interested in learning more about the Economic Substance Doctrine or Wills and Trusts? Visit Phillips Estate Planning for free tips, videos, webinars, and other useful information.