Economic substance may be lacking.
The IRS warned in October that it remains free to pick apart transactions with more than one leg to deny tax benefits on any leg that is tax motivated while allowing the rest of the transaction to stand. It said it is not limited to accepting or rejecting the transaction as a whole.
The IRS warning is in Notice 2014-58.
The IRS had already used this approach successfully before the warning. (For example, see the April 2013 NewsWire article.)
The economic substance doctrine is one of several tools the IRS has available to attack transactions that it considers to be little more than a play for tax benefits. Congress wrote the doctrine into the US tax code in 2010. The doctrine as codified requires a transaction to change the taxpayer’s economic position in a meaningful way and for the taxpayer to have a substantial business purpose, other than federal income tax effects, for entering into the transaction.
The IRS warned that “[w]hen a series of steps include[s] a tax-motivated step that is not necessary to achieve a non-tax objective,” the government may deny tax benefits on the “tax-motivated steps that are not necessary to accomplish the non-tax goals.” It said the tax-motivated steps could take many forms, including interposing an intermediate entity whose involvement is unnecessary to achieve the real or purported business objective.