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September 22, 2014 The Tax Lawyer

The Economic Substance Doctrine in Federal and State Taxation

Volume 67, No. 4 - Summer 2014

William Joel Kolarik II & Steven Nicholas John Wlodychak


    The Economic Substance Doctrine is both a fascinating and frustrating judicial tax avoidance doctrine. No other tax avoidance doctrine has generated a similar volume of controversy among the tax bar for such a sustained period … almost since the enactment of the federal income tax in 1913. The reason for the controversy is that the Economic Substance Doctrine asks a question that goes to the heart of legal philosophy: What role should the legislature’s intent play in interpreting the tax laws? 

    This Article attempts to describe the boundaries of the Economic Substance Doctrine. In so doing, it explains why the Doctrine came about and what Judge Learned Hand, who developed the Doctrine over the course of his career, designed it to accomplish. Because the Economic Substance Doctrine lacks a definite form, this Article attempts to determine the Doctrine’s scope by exploring the range of circumstances, in both federal and state taxation, to which the Doctrine cannot apply. For example, in the state tax context, the Article addresses the opposite conclusions reached by the same judge in Syms and Sherwin-Williams (MA) and draws conclusions about what types of transactions may withstand scrutiny under the Doctrine.

    The authors’ intent is to encourage discussion about the proper role of the Economic Substance Doctrine in federal and state taxation. That discussion requires an understanding of the development and the purpose of the Economic Substance Doctrine because that context delineates a set of the circumstances to which the Doctrine cannot apply without producing anomalous results, thereby inserting a tremendous amount of uncertainty into the simplest of tax compliance efforts. By defining the circumstances to which the Doctrine cannot apply, the authors hope to increase certainty in the tax law by limiting the Doctrine’s application to a more predictable set of circumstances.

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