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TAX PRACTICE & PROCEDURES
Updates and guidance on key
IRS practice developments.
Authors: authors describe the previous IRS ap-
Regina Clark, J.D. Practice & Procedures proach to the doctrine and then explain
Gloria Sullivan the changes set forth in the memoran-
John Dilorio, J.D., LL.M. Memo removes IRS dum, providing some practical tips.
procedural requirements
Editor: for economic substance Background on the economic
Uzell T. Williams-Freeman, CPA arguments substance doctrine
On April 22, 2022, the IRS issued a Though historically a judicial concept,
memorandum to all Large Business the economic substance doctrine was
The IRS no longer & International Division (LB&I) and codified by Congress in the Health
Care and Education Reconciliation Act
Small Business/Self-Employed Divi-
requires examiners sion (SB/SE) examination employees of 2010, P.L. 111-152, by adding Sec.
to follow a four- to communicate updated guidance for 7701(o), which defines the doctrine
examiners and managers on the eco-
as follows:
step process for nomic substance doctrine and related
determining whether a penalties (LB&I-04-0422-0014). The The term “economic substance
transaction complies memorandum makes it easier for the doctrine” means the common law
doctrine under which tax benefits
IRS to assert that a transaction lacks
with the economic economic substance or a business … with respect to a transaction
substance doctrine purpose by removing the previously are not allowable if the transaction
required four-step process for relying
does not have economic substance
before a penalty can on the economic substance doctrine, or lacks a business purpose. [Sec.
be asserted under including the requirement for execu- 7701(o)(5)(A)]
Secs. 6662(b)(6) tive approval. Sec. 7701(o)(1)(B) requires that the
The memorandum’s guidance su-
and 6662(i); a recent persedes the instructions in Internal taxpayer have a substantial purpose,
IRS Chief Counsel Revenue Manual (IRM) Section apart from any federal income tax ben-
efit, for entering into the transaction.
4.46.4.12.9, Economic Substance Doc-
memo clarifies trine; IRM Exhibit 4.46.4-4, Guidance Sec. 6662(b)(6) was also added to
the assessment for Examiners and Managers on the implement Sec. 7701(o) by imposing
Codified Economic Substance Doctrine
a 20% penalty on any underpayment
limitation period in and Related Penalties; and IRM Section attributable to tax benefits that were
multiyear Sec. 332(b) 20.1.5.13.2, Penalty Administration, and disallowed because a transaction PHOTO BY SEAN GLADWELL/HEMERA/THINKSTOCK
liquidations. will be added to IRM Section 4.10.13, lacks economic substance. Sec. 6676
Examination of Returns, Certain Techni-
extends the penalty to refund claims,
cal Issues. and Sec. 6662(i) increases the penalty
After first reviewing the background to 40% for nondisclosed transactions.
of the economic substance doctrine, the This penalty is strict-liability, with no
34 January 2023 The Tax Adviser
