Duvall & Associates, Inc.
BUSINESS ADVISOR NEWSLETTER
 

Things aren't always what they seem

- by Alan Duvall 

Published in Dayton Daily News   September 10, 2006 

“If I had a world of my own...Nothing would be what it is, because everything would be what it isn’t.” Alice from Alice's Adventures in Wonderland.   

Alice should have been an IRS agent.  Congress has bestowed upon the Internal Revenue Service (IRS) the authority to literally re-construct economic deals to reflect its own interpretation of tax fairness.  This power – often labeled the ‘substance over form doctrine’ – is a powerful tool used with increasing approval by the Courts. 

To illustrate, assume a wealthy father wishes to form a family limited partnership to gradually transfer lifetime ownership of investments to his children, thus avoiding estate taxes upon death.  Marginal interests are annually gifted to each child with ultimate control and (in reality) economic benefits remain with the father.

 Valid transaction?  Maybe not.  The IRS is attacking these tax avoidance schemes on the basis that despite the ‘form’ of the transaction, ‘in substance’ the father has transferred nothing since he retains control and financial benefit of the trust assets. 

Wielding this legal club, the IRS has successfully unraveled many such deals across the land.  

Never content to languish on limited laurels, the IRS has also battered other related party transactions into submission.  Hence, owner’s compensation, corporate mergers and acquisitions, tax shelters and property transfers have all been besieged by the 'fairness' weapon. 

“Now, I give you fair warning, either you or your head must be off...”  -The Queen. 

Taxpayer fortifications against this assault lie grounded in written documentation of non-tax economic justification for the transaction.  To explain – if a transaction has an economic purpose beyond mere tax avoidance – the taxpayer may be able to survive the legal attack. 

Common examples are often found in business acquisitions whereby buyer and seller agree to an allocation of price among company assets.  In the absence of overt tax-manipulation, the IRS will typically respect such written agreements since an allocation benefiting the buyer will generally prove a tax-detriment to the seller - and vice versa.   

Alternatively, if there is no written consent to price allocation the IRS will not allow each party to select individual tax preferences and will thereby impose its own interpretation into the agreement.  Definitely an option to be avoided by taxpayers. 

“I’m afraid I can’t explain myself, you see, because I’m not myself, you know.”  -Alice. 

Alan Duvall is a certified public accountant in Dayton.  Contact him at Alan@Duvallcpa.com.