Effective for transactions entered into after March 30, 2010, taxpayers who enter into tax motivated transactions, devoid of "economic substance," are now subject to penalties as high as 40% of the tax underpayment. This codification of the economic substance doctrine provides some uniformity amount the courts in applying the doctrine. Now, under new Section 7701(o) (1), a transaction will be respected for tax purposes only if (1) the transaction changes in a meaningful way, apart form the tax effects, the taxpayer’s economic position; and (2) the taxpayer has a substantial non-tax purpose for entering into the transaction.
Section 7701((o) does not apply to estate tax planning. Section 7701(o)(5)(A). (However, estate planning strategies that also provide income tax deductions could be partially subject to Section 7701(o)(1).) But there is no doubt that taxpayers seeking to reduce or eliminate gift and estate taxes must satisfy the economic substance doctrine as it has existed under the common law since the Supreme Court decision in Gregory v. Helvering, 293 U.S. 465 (1935). Thus, be wary of mass marketed tax transfer schemes that appear to fit all situations and not specifically vetted by your own counsel for your situation.
The problem is where you draw the line between transfers that are designed to reduce or eliminate gift and estate taxes and have a non-tax purpose, and transfers that have no non-tax purpose or economic reality. In the estate area, these latter transfers will always be suspect with or without a statute.
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