NTUF filed an amicus brief with the Tenth Circuit Court of Appeals on June 12 in Liberty Global v. United States, where we argue that the IRS cannot make up the law as it goes along. The case involves the economic substance doctrine, the idea that the IRS can disregard a taxpayer’s transaction if the taxpayer’s purpose was to avoid tax law. We urged the court to apply that doctrine narrowly, as many perfectly innocent economic decisions are tax-motivated in some way.
In Liberty Global, the District Court and a panel of the Tenth Circuit applied the economic substance doctrine without first explaining why it was relevant to the statutory text at issue. Over a strong dissent by Judge Allison Eid, on the short list for the U.S. Supreme Court, the panel allowed the IRS to disallow Liberty Global’s deductions without examining the relevant statute or explaining how the text implicated the economic substance doctrine. In contrast, Judge Eid wrote a powerful dissent that carefully parsed the statute and precedent before concluding that the economic substance doctrine was not relevant to the deduction at issue. Judge Eid warned that the majority opinion “effectively hand[ed] the government a blank check to declare any transactions it does not like to be within the doctrine.” Such a blank check is antithetical to the rule of law, which requires that the government, not just the citizens, be subject to the law as written.
NTUF filed as amicus curiae before the three-judge panel considering the case and was critical of the majority opinion as well. Liberty Global is now seeking review by the full Tenth Circuit, arguing that the economic substance doctrine applies only where the statutory text hinges on economic reality. NTUF supports this petition—the full court should take this opportunity to uphold the rule of law and clarify the narrow scope of the economic substance doctrine.
The economic substance doctrine is a judge-created principle of the tax law that allows the IRS to disregard a transaction unless it has a “substantial purpose” aside from reduction of tax liability. Key to the doctrine is that a decision not only saves on tax liability, it changes the economic position of the taxpayer in a “meaningful way.” In 2010, Congress codified the doctrine (26 U.S.C. § 7701(o)) and required that a Court determine the doctrine is “relevant” under prior case law before it can be applied.
But the doctrine cannot apply to every transaction—many ordinary business decisions are made entirely because of their tax consequences, and those transactions should not be disregarded. Indeed, Congress writes many tax laws intending that the tax consequences will influence individual and corporate behavior. Tax considerations may drive business decisions as basic as which corporate form to choose, whether to expand via debt or equity, or when to sell investments. A broad application of the doctrine would allow the IRS to disregard transactions at will—even if they meet the law’s requirements—simply because they were tax motivated. Not only is this contrary to the rule of law, but it would also virtually eliminate ordinary tax planning, a pastime that courts have recognized is “as American as apple pie.”
Accordingly, Congress required that a court determine that the doctrine is “relevant” under existing precedent before it applies the two-part test (26 U.S.C. § 7701(o)(5)(C)). In past cases, courts carefully parsed the statute creating the deduction or credit the taxpayer wishes to claim to determine whether the language of the statute hinges on a particular economic reality. If so, the court would then apply the test to see if the transaction met the statute.
The IRS’s current approach amounts to an “I know it when I see it” approach, and the courts need to step in to ensure that the tax collectors are bound by the law just as much as the taxpayers.
The case is Liberty Global, Inc. v. United States of America, 10th Cir. No. 23-1410.