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TAX PRACTICE & PROCEDURES

judicial doctrine is more appro- addressing whether the doctrine should
This penalty is priate to challenge a transaction, be applied to the transaction at issue.
an examiner should seek the ad-
Finally, IRM Exhibit 4.46.4-4
strict-liability, with vice of the examiner’s manager in required that the taxpayer be notified
no reasonable-cause consultation with local counsel. as soon as possible that an examiner
defense and no 6. Does recharacterizing a trans- was considering whether to apply the
action (e.g., recharacterizing
economic substance doctrine to a par-
penalty relief even if debt as equity, recharacterizing ticular transaction, but not later than
a taxpayer receives someone as an agent of another, when the examiner began the four-
recharacterizing a partnership
step analysis.
an opinion on the interest as another kind of
transaction. interest, or recharacterizing a April 2022 memorandum
collection of financial products In the April 2022 memorandum, the
as another kind of interest) IRS has quietly but markedly departed
without specific approval of the more appropriately address the from its previously established pro-
examiner’s manager in consulta- noncompliance that is being cedure for raising the economic sub-
tion with local counsel. examined? If so, recharacteriza- stance doctrine argument and asserting
3. Does precedent exist (judicial or tion should be applied and not related penalties under Secs. 6662(b)
administrative) that either rejects the economic substance doctrine. (6) and 6662(i). Specifically, the Ser-
the application of the economic To determine whether rechar- vice has removed the requirement that
substance doctrine to the type acterization is more appropriate examiners follow the four-step process,
of transaction or a substantially to challenge a transaction, an including obtaining executive-level ap-
similar transaction or upholds examiner should seek the advice proval by the examiner’s territory man-
the transaction and makes no of the examiner’s manager in ager and the DFO. Instead, LB&I or
reference to the doctrine when consultation with local counsel. SB/SE examiners need only obtain ap-
considering the transaction? If 7. In considering all the arguments proval from their immediate supervisor
so, then the application of the available to challenge a claimed to assert a penalty under the economic
doctrine should not be pursued tax result, is the application of substance doctrine.
without specific approval of the the doctrine among the strongest The memorandum also removes
examiner’s manager in consulta- arguments available? If not, then the list of transactions for which the
tion with local counsel. the application of the doctrine economic substance doctrine is likely
4. Does the transaction involve tax should not be pursued without not appropriate and eliminates the re-
credits (e.g., low-income housing specific approval of the exam- quirement that the taxpayer be notified
credit, alternative energy credits) iner’s manager in consultation that the examiner is considering apply-
that are designed by Congress to with local counsel. ing the economic substance doctrine.
encourage certain transactions (LB&I senior officials have confirmed,
that would not be undertaken IRM Exhibit 4.46.4-4 provided however, that providing taxpayers with
but for the credits? If so, then the that, to comply with Step 4 (DFO notice would be considered a best
application of the doctrine should approval), the examiner, in consulta- practice even if no longer formally
not be pursued without specific tion with his or her manager and required.)
approval of the examiner’s man- territory manager, “should describe The only long-standing require-
ager in consultation with local for the appropriate DFO in writing ments that remain in place are the
counsel. how the analysis … was completed.” requirement under Sec. 6751(b) that
5. Does another judicial doctrine The DFO was required to review the penalties be timely approved in writ-
(e.g., substance over form or step written material provided and consult ing by the immediate supervisor of
transaction) more appropriately with Counsel before a decision was the person who initially determines
address the noncompliance that is made. If the DFO believed the request the penalty, and the mandatory in-
being examined? If so, those doc- to impose the economic substance volvement of Counsel. In addition,
trines should be applied and not penalty was appropriate, the DFO was Attachment 1 to the April 2022 mem-
the economic substance doctrine. instructed to provide the taxpayer an orandum lists facts and circumstances
To determine whether another opportunity to explain their position, that tend to show that application of

36 January 2023 The Tax Adviser