Interpretations of SSTS No.1, Tax Return Positions

By John C. Gardner, Ph.D., CPA; Barbara J. Eide, Ph.D., CPA; Bruce E. May, DBA, J.D.; and Diane R. May, J.D.




  • Recently issued revised and updated interpretations of the AICPA’s Statements on Standards for Tax Services No.1, Tax Return Positions, provide guidance to practitioners on tax reporting standards when recommending return positions or preparing or signing returns. The SSTS and interpretations are also important guides to AICPA members’ other professional responsibilities in tax practice.
  • The new interpretations provide examples applying the reporting standards to tax return positions in various situations. New Interpretation 1-1 includes the consideration of economic substance and business purpose as a step in the analysis of whether a member can properly recommend a position or sign a return including a position.
  • The increased emphasis on economic substance in the interpretations requires practitioners to fully understand the economic substance doctrine. In particular, practitioners must be aware of how the codification of the doctrine in Sec. 7701(o) may affect the analysis of whether a position has economic substance for federal tax purposes.

The Statements on Standards for Tax Services (SSTS) are based on the AICPA’s Statements on Responsibilities in Tax Practice (SRTP), which were originally issued between 1964 and 1977. The SRTP, considered advisory in nature, delineated members’ responsibilities to taxpayers, the public, the government, and the profession. In 2001, the AICPA s Tax Executive Committee (TEC), designated as a standard-setting body, issued enforceable standards of tax practice. Although the substance of SSTS Nos. 1–8 and Interpretation 1-1, “Realistic Possibility Standard,” remained the same as in the SRTP, the language was revised to clarify them and reflect the enforceable nature of the SSTS. These documents then applied to all levels of tax practice, and a second interpretation, 1-2, “Tax Planning,” was issued in 2003 to deal with tax shelters.

By 2008, it became apparent that the SSTS needed further revisions to eliminate some duplication and to update them in light of additional changes to tax law in various jurisdictions, including revisions to Sec. 6694 and Treasury Circular 230. 1 Effective January 2010, the TEC issued seven SSTS to supersede former SSTS Nos. 1–8. Proposed changes to the two existing interpretations to SSTS No. 1 were released on Feb. 3, 2011. Following a comment period, the revised interpretations became effective Jan. 31, 2012. 2

SSTS No. 1, Tax Return Positions , prescribes that a member should not recommend or take a position on a tax return unless the position satisfies applicable reporting and disclosure standards. Interpretation 1-1, renamed “Reporting and Disclosure Standards,” interprets SSTS No. 1. Together, they cover an AICPA member’s compliance with standards imposed by applicable taxing authorities related to recommending a tax return position or preparing or signing a tax return. Interpretation 1-2, “Tax Planning,” aims to clarify existing standards regarding a member’s responsibilities related to tax planning. This article selectively reviews and analyzes these revised interpretations, presents examples, and discusses the newly codified economic substance doctrine as it relates to the interpretations.

Professional Standard of Care

A brief overview of standards of care can help establish a framework for understanding a member’s professional obligations. When providing tax planning, practitioners must comply with a variety of regulations, ethical rules, and professional standards that govern their conduct. Besides the standards in the federal rules and regulations governing tax practice, such as those found in the Code and Circular 230, they include local, state, and professional conduct regulations. These vary based on the particular jurisdiction. Failure to comply can result in penalties and/or professional sanctions, including loss of license.

In addition, standards of care and standards of conduct guide the formulation of the basis for a tax position. The underpinning to these standards is reasonableness. A reasonable position taken on a tax return is “well grounded in fact, supported by the law, and satisfies the applicable standards of care.” 3 Substantiating a reasonable position is especially important to tax practitioners because one strategy the government uses to improve tax compliance rates is to “expand the scope of the tax preparer penalty statute, increase the applicable penalties, and raise the standard of care.” 4 This strategy continues to evolve 5 and is evidenced by the strict liability imposed in the codification of the economic substance rules that will be discussed later. Selected examples of standards of conduct and what constitutes a breach of those standards are provided in the exhibit.

Preface to the Interpretations

A preface has been added to the revised Interpretations 1-1 and 1-2 of SSTS No. 1. It contains a valuable and useful overview of the most common tax return reporting standards and issues for determining whether a tax return position meets applicable reporting standards and disclosure requirements. These standards range from the “more likely than not” (MLTN) standard at the high end of the reporting spectrum to “reasonable basis” (RB) at the lower end.

The MLTN standard is normally satisfied if one can reasonably conclude that there is a greater than 50% likelihood the position will be upheld on its merits. The second level, substantial authority (SA), is an objective reporting standard and is satisfied if the weight of authorities supporting a particular position is substantial in relation to the weight of authorities supporting a contrary position. In practice, SA normally requires at least an approximately 40% likelihood that the position will be upheld on its merits. For federal tax purposes and those of many other jurisdictions, any transaction classified as a tax shelter or reportable transaction must satisfy the subjective MLTN standard as well as the objective SA standard.

The remaining reporting standard levels include the “realistic possibility of success” (RPOS) and RB standards. The RPOS standard 6 normally requires a one-third likelihood that the position will be sustained on its merits. The RB standard is lower than RPOS, but it is “significantly higher than not frivolous or not patently improper . . . [and] is not satisfied by a return position that is merely arguable or that is merely a colorable claim.” 7 A position normally satisfies the RB standard if it is reasonably based on one or more authorities, considering the relevance and persuasiveness of those authorities. In practice, RB normally requires at least an approximately 20% likelihood that the position will be upheld on its merits. (See Reporting Standards Acronyms.)

All facts and circumstances, as well as authorities relevant to the tax treatment at issue, should be considered when determining whether a reporting standard has been satisfied. The weight given to a particular authority will depend upon its relevance and persuasiveness. For example, a ruling or case with facts similar to those at issue—especially one that provides an analysis of the facts and law—carries more weight than one whose facts differ significantly. Additionally, an appellate court decision carries more weight than one of a lower court within its jurisdiction, as does a revenue ruling over a private letter ruling issued to a third party. 8

It should be noted that what qualifies as “authority” for analysis purposes can vary. In determining whether the RPOS and RB standards under paragraph 5 of SSTS No. 1 are satisfied, a member may consider well-reasoned articles or treatises, or pronouncements issued by the applicable taxing authority, even if these materials would not be treated as authority for purposes of satisfying the SA or MLTN standards under Sec. 6662. 9

The preface also discusses the disclosure requirements. A member can satisfy the disclosure requirements of SSTS No. 1 if the tax position at issue is appropriately disclosed. The member should consider the facts and circumstances of the particular case and follow the laws and regulations of the applicable taxing authority in determining whether a position has been appropriately disclosed. In the case of a nonsigning preparer, the preface notes that, if a member advises the taxpayer regarding appropriate disclosure, the disclosure requirement is satisfied. CPAs may wish to review SSTS No. 7, Form and Content of Advice to Taxpayers, when communicating disclosure or tax return reporting matters with taxpayers.

Both signing and nonsigning preparers must follow provisions of Sec. 6694 to satisfy the disclosure requirement. A signing preparer satisfies the requirement if the tax return position is disclosed on Form 8275, Disclosure Statement, or Form 8275-R, Regulation Disclosure Statement, as appropriate, or on the tax return in accordance with the annual revenue procedure requirements for disclosure; or if the preparer provides the taxpayer with a return that includes adequate disclosure.

A nonsigning preparer satisfies the requirement if the tax return position is disclosed on Form 8275 or Form 8275-R, as appropriate, or on the tax return in accordance with the annual revenue procedure requirements for disclosure; or, if providing advice to a taxpayer, by advising the taxpayer of any opportunity to avoid ac curacy-related penalties that could apply to the position and of the requirements for any applicable disclosure and contemporaneously documenting that advice. If the nonsigning preparer is providing advice to another tax preparer, the nonsigning preparer can satisfy the requirement by advising the other tax return preparer that disclosure may be required and contemporaneously documenting the advice. 10

Interpretation 1-1, “Reporting and Disclosure Standards”

Interpretation 1-1, paragraph 8, states that, if the standard of the applicable taxing authority is higher than RPOS, the member should comply with the higher standard. If the applicable taxing authority’s standard is lower than RPOS, the member should comply with the RPOS standard. Paragraph 2 indicates that, if the applicable taxing authority does not have written standards that apply to rec ommending a tax return position or preparing or signing a tax return, a member should not take these actions unless the member has a good-faith belief that the position meets the RPOS standard. However, a member may recommend a tax return position, or prepare or sign a tax return that reflects a position, if there is a reasonable basis for the position and the member, in the first case, advises the taxpayer to appropriately disclose the position, or, in the second case, the position is appropriately disclosed on the return.

Paragraph 9 states that, when relying on authorities such as cases, rulings, regulations, and treatises, a member should comply with the applicable taxing authority rules. However, in determining whether a tax return position satisfies either the RPOS standard or RB standard with appropriate disclosure, a member may rely on authorities in addition to those used to determine whether SA exists under Sec. 6662. These additional authorities include articles in recognized professional tax publications, well-reasoned treatises, and other reference tools and sources of tax analyses commonly used by tax advisers and preparers. A member should exercise caution when relying on the above-mentioned authorities, as they may not be accepted in all situations, such as under federal tax law.

Under paragraph 11, to determine whether required reporting and disclosure standards have been satisfied, a member should:

  • Establish the relevant background facts;
  • Consider the reasonableness of the assumptions and representations;
  • Consider applicable regulations and standards regarding reliance on information and advice received from a third party;
  • Apply the pertinent authorities to the relevant facts;
  • Consider the business purpose and economic substance of the transaction, if relevant to its tax consequences (mere reliance on a representation that there is a business purpose or economic substance generally is insufficient);
  • Consider whether the issue involves a listed or reportable transaction (or their equivalents) as defined by the applicable taxing authority; and
  • Arrive at a conclusion supported by the authorities.

Determination of the Standards

Interpretation 1-1 provides several illustrations, including those described below (as numbered in the interpretation). Tax practitioners are encouraged to review all of the illustrations that apply to jurisdictions in which they practice.

Practice tip: It is essential for a member to review Secs. 6694 and 6662 plus related regulations, court cases, and other primary source documents in determining whether the tax return and reporting standards in a particular jurisdiction are met.

Illustration 1: While preparing a federal tax return, a member considers whether a particular expenditure is deductible on the return. The federal reporting standard is SA for undisclosed positions and RB for disclosed positions. The member must comply with the federal standard of SA for undisclosed tax return positions, since it is higher than the RPOS standard. If the member examines applicable authorities and the law regarding the deductibility of the expenditure and concludes that the SA standard is not met, the member should not prepare the tax return taking the deduction as an undisclosed tax return position. However, if the member concludes that there is sufficient authority to provide a reasonable basis to claim the deduction, the member may prepare the tax return if the position is properly disclosed (e.g., on a Form 8275 or 8275-R). A member should carefully research these issues and document compliance with either the SA or RB standard.

Practice tip: A member should review the reporting standards in the preface. Commentary in reputable secondary sources may be used to clarify the federal standards but is not authoritative for federal tax purposes (although the underlying primary source may be considered authoritative).

Illustration 2: A member prepares a state inheritance tax return that involves the potential deductibility of a particular expenditure. This state does not have specific applicable tax return reporting standards. The RPOS standard for an undisclosed position and the RB standard for an appropriately disclosed position apply because the taxing authority (the state) has no applicable written reporting standards for the deduction.

Practice tip: Members should check the reporting and tax return standards in any jurisdiction they are unfamiliar with. Also, it may be useful to contact a practitioner in that jurisdiction who can assist with interpretations of existing statutes or regulations.

Illustration 4: A taxpayer wants to take a tax return position on a federal return without disclosure. The member concludes that the tax return position will meet the SA standard if an assumption about an underlying nontax legal issue is appropriate. Therefore, the member recommends that the taxpayer seek legal counsel. The taxpayer’s attorney gives an opinion regarding the nontax legal issue that is consistent with the assumption. Generally, a member, using professional judgment, may rely on a legal opinion on a nontax legal issue. However, if, on its face, the attorney’s opinion appears to be unsubstantiated, unreasonable, or unwarranted, the member, with appropriate consent from the taxpayer, should consult the member’s own attorney before relying on the opinion. The member should also refer to the illustrations in Interpretation 1-2 regarding the circumstances under which it is appropriate to rely on an attorney’s opinion. It is essential in such situations to communicate in writing with the taxpayer, document the results of any oral discussions, and make sure that there are no miscommunications regarding complex issues.

Practice tip: Members should refer to SSTS No. 7 for the standards that apply to communicating tax advice to taxpayers.

Application of the Standards

Illustration 6: A taxpayer has engaged in a transaction that is adversely affected by a new statutory provision. Prior law supports a position favorable to the taxpayer. The taxpayer believes, and the member concurs, that the new statute is inequitable as applied to the taxpayer’s situation. The statute is constitutional, clearly drafted, and unambiguous. The legislative history discussing the new statute contains general comments that do not specifically address the taxpayer’s situation.

In this case, although prior law supported a favorable position for a taxpayer, if a new statutory provision now adversely affects the taxpayer, a member cannot recommend the prior return position. A position contrary to a constitutional, clear, and unambiguous statute would not sat isfy the RB standard, even if appropriately disclosed.

Illustration 8: Under the same facts as in Illustration 6, the legislative history can be interpreted to provide some evidence or authority in support of the taxpayer’s position but does not address the taxpayer’s specific situation. Because the legislative history does not specifically address the taxpayer’s situation, a contrary position still does not satisfy the RPOS standard. However, because the legislative history provides some support or evidence for the taxpayer’s position, a member may prepare a return reflecting the position or recommend it if there is a reasonable basis for the position and, respectively, the return appropriately discloses it or the member advises the taxpayer to do so. The member should advise the taxpayer regarding any potential penalty consequences of the tax return position and any opportunity to avoid penalties through disclosure.

Illustration 10: Following passage of a new statute, the statute is widely recognized to contain a drafting error, and a technical correction has been proposed. However, the taxing authority has made no pronouncement that interprets the statute in accordance with the proposed correction. Without such a pronouncement, only a return position based on existing statutory language will satisfy the RPOS standard. The RB standard may be satisfied if a return position is based on the proposed technical correction. A member may recommend the position or prepare a return for the taxpayer taking the position if the member determines that there is a reasonable basis for the position and the position is disclosed in the same manner as discussed in Illustration 8.

Practice tip: Members should review all recognized primary sources in a jurisdiction that might affect the situations presented in Illustrations 6, 8, and 10.

Illustrations 13 and 14: A statute is passed requiring the capitalization of certain expenditures. In Illustration 13, the taxpayer and member agree that the costs of full compliance will significantly exceed the resulting increase in tax due under the new provision. Due to the cost considerations, the taxpayer makes no effort to comply and wants the member to prepare and sign a return on which the new requirement is ignored. The desired return position is frivolous, a designation below RB, and the member should not prepare or sign the return.

In Illustration 14, the facts are the same, except that the taxpayer has made a good-faith effort to comply with the interpretation of the law by estimating the expenditures that should be capitalized under the new law. Because the taxpayer has made a good-faith effort to determine the appropriate amounts to be capitalized and those to be expensed, the RPOS standard is satisfied and perhaps the SA standard as well. When using estimates in preparing a return, a member should refer to SSTS No. 4, Use of Estimates.

Practice tip: A member should consider federal case law on estimates including the Cohan rule 11 (as well as exceptions to these cases in regulations or rulings), as well as any cases or other primary sources in a particular jurisdiction.

Illustration 15: A member has weighed two authorities concerning the treatment of an expenditure. One, an administrative ruling by the taxing authority, requires capitalization and amortization of the expenditure. The other, a court opinion, permits the expenditure to be expensed. The RPOS standard is met by either position. Based on an analysis of each authority’s source, relevance, and conclusion, either or both may also constitute substantial authority.

Practice tip: A member should verify that the particular reporting or tax return standards within a jurisdiction are met. If the item is clearly material, it may be prudent to have that position reviewed by an external firm or practitioner, especially if the member preparing the return is from another jurisdiction or a smaller practice unit that has limited experience with complex transactions or aspects of revenue laws in that jurisdiction.

Interpretation 1-2, “Tax Planning”

I nterpretation 1-2 contributes to the AICPA’s self-regulation goals and aims to provide adequate and professional guidance to its members who are engaged in tax planning, including situations involving tax shelters. Tax planning includes “recommending or expressing an opinion” on a tax position or developing a specific tax plan. When providing tax planning, a member must comply with the reporting and disclosure standards imposed by the applicable taxing authority. If the taxing authority does not have written standards, or if the standards are lower than the RPOS standard, the RPOS standard applies.

Paragraph 4 provides that a member may still recommend a position that does not satisfy the RPOS standard if there is a reasonable basis for the position, the member recommends appropriate disclosure, and a higher standard is not required under applicable taxing authority rules.

Paragraphs 6 and 7 outline important steps and information the practitioner should consider when issuing an opinion or evaluating an opinion the taxpayer has obtained from a third party. In addition to considering SSTS No. 7 and Circular 230, a practitioner must take the same steps as listed above under paragraph 11 of Interpretation 1-1, plus consider other regulations and standards applicable to written tax advice promulgated by the applicable taxing authority.

A member has an obligation to conduct the due diligence necessary to establish the relevant background facts and to examine the assumptions concerning the facts. Under paragraph 9, members must also assess whether assumptions and representations are reasonable, by considering their source and comparing them with other information known to the member.

The Codified Economic Substance Doctrine

Both interpretations require a member to understand the business purpose and economic substance of a transaction. 12 With Congress’s codification two years ago of the economic substance doctrine and the emphasis the new interpretations place on considerations of business purposes and economic substance, it is essential for members to understand these concepts. Nontax business reasons for a transaction may need to be specified and their basis stated. This is especially important because the codified economic substance doctrine imposes strict liability penalties on taxpayers, for which reasonable care and good faith is not a defense. 13

Although courts have rejected a variety of tax shelters as lacking economic substance, they had not previously agreed on specific standards for determining the presence of economic substance. 14 Although codification had been suggested previously, it had met with reservations from such groups as the American Bar Association’s Section of Taxation. 15 However, a revenue provision of the Health Care and Education Reconciliation Act of 2010 16 (the Reconciliation Act), signed into law on March 30, 2010, by President Barack Obama, included amendments to the Code codifying the economic substance doctrine and establishing the strict liability penalty for transactions that fail the economic substance test. 17 The codification can be found in new Sec. 7701(o) (“Clarification of Economic Substance Doctrine”) and is effective for transactions entered into after March 30, 2010.

As of this writing, little helpful guidance is publicly available to practitioners, although the IRS Large Business and International Division (LB&I) recently issued an internal directive with some guidelines to help examiners and managers determine when it is appropriate to apply the codified economic substance doctrine and the application of the related Sec. 6662 strict liability underpayment penalty. 18 However, the directive is not public guidance on which taxpayers may rely.

In the interim, the IRS has provided some public guidance in Notice 2010-62, 19 saying that the Service will rely on relevant case law in applying the common-law economic substance doctrine. However, the IRS adds that it does not intend “to issue general administrative guidance regarding the types of transactions to which the economic substance doctrine either applies or does not apply.” 20 In addition, the notice states the IRS “will not issue a private letter ruling or determination letter . . . regarding whether the economic substance doctrine is relevant to any transaction or whether any transaction complies with the requirements of section 7701(o).” Therefore, a basic understanding of the history of the doctrine is helpful for making reasonable evaluations.

Varying Court Tests

Under past legal analysis, business purpose and economic substance were often considered together, and the motives of the taxpayer were central to determining whether the transaction served a nontax business purpose. In making this determination, some courts applied the rule of Rice’s Toyota World, Inc. 21 “under which a transaction would be respected if it had either economic substance or a substantial business purpose.” 22 Other courts applied a conjunctive test that required the presence of both economic substance and business purpose for the transaction to survive judicial scrutiny. 23 The codification resolves past conflicts among various courts regarding how the doctrine should be applied by specifying a two-part conjunctive test (described below).

In one recent interpretation of economic substance, the Federal Circuit ruled that a spread transaction involving the contribution of euro call options lacked economic substance and should be disregarded for tax purposes. 24 This case involved a tax shelter designed to produce large artifi cial, noneconomic losses for tax purposes. The court held that the loss generated by the transaction was “purely fictional” and that the spread transaction was “virtually guaranteed to be unprofitable.” Quoting its own precedent in the 2006 Coltec case, 25 the court said the economic substance doctrine “‘require[s] disregarding, for tax purposes, transactions that comply with the literal terms of the tax code but lack economic reality,’” and explained that the doctrine, “‘[f]rom its inception, . . . has been used to prevent taxpayers from subverting the legislative purpose of the tax code by engaging in transactions that are fictitious or lack economic reality simply to reap a tax benefit.’” 26

In Coltec , after examining cases from the Supreme Court, various courts of appeals, and predecessor courts, the court had concluded that the economic substance doctrine incorporated five general principles: (1) The transaction cannot lack economic reality; (2) the taxpayer bears the burden of proving that the transaction has economic substance; (3) the economic substance of a transaction must be viewed objectively rather than subjectively; (4) the transaction to be analyzed is the one that gave rise to the alleged tax benefit; and (5) arrangements with subsidiaries that do not affect the economic interests of independent third parties deserve particularly close scrutiny. In the Coltec decision, the court also had explained that “a lack of economic substance is sufficient to disqualify the transaction without proof that the taxpayer’s sole motive is tax avoidance.” 27

Codified Two-Part Test

The two-part conjunctive test of the codified economic substance doctrine provides that any transaction to which the economic substance doctrine is relevant will be treated as having economic substance only if (1) the transaction changes a nontax economic position in a meaningful way, and (2) the taxpayer has a substantial purpose for entering into the transaction that is not related to its federal income tax effects. 28 The Reconciliation Act makes it clear that both provisions must be present and that an inquiry must be made into the impact of the transaction on the taxpayer’s economic position and motive for entering into the transaction. For individuals, the economic substance doctrine applies only to transactions entered into in connection with a trade or business or an activity engaged in for the production of income. 29 The determination of whether the economic substance doctrine is relevant to a transaction is made in the same manner as before the law’s enactment. 30

Strict Liability Penalty

Especially significant, the Reconciliation Act contains strict liability penalty provisions that add to the list of tax under­payments subject to the 20% accuracy-related penalty in Sec. 6662 those arising from transactions that lack economic substance as defined by Sec. 7701(o) or that fail to meet the requirements of any similar rule of law. 31 For transactions without economic substance where relevant facts affecting the tax treatment are not adequately disclosed in a tax return, the penalty is increased to 40% of the applicable portion of an underpayment. 32 Because the penalty is one of strict liability, the reasonable cause and good-faith exception of Sec. 6664(c) does not apply.

The exception does apply to other accuracy-related penalties under Sec. 6662 where a taxpayer can demonstrate an underpayment was caused by a reasonable reliance in good faith on an opinion of a professional tax adviser, based on the adviser’s analysis of the facts and authorities, among other applicable factors and in consideration of all pertinent facts and circumstances. 33

The codification’s full effect on practitioners will take some time to be realized. Concerns have been raised about the long-term effects and ramifications of the codification, because the stakes are high and the IRS has not provided sufficient guidance thus far. 34 In joint comments to the IRS by the AICPA and American Bar Association Section of Taxation, the organizations requested guidance on the Service’s implementation of the codified economic substance doctrine, warning that, without such guidance, the law “will have a chilling effect on transactions Congress intended to encourage.” 35 Others have suggested the codification causes such taxpayer uncertainty that it may be unconstitutionally vague. 36

Practice tip: The application of the doctrine to some transactions may be uncertain. Given the type and potential magnitude of the strict liability penalty, serious consideration should be given to structuring such transactions to clarify uncertainty or avoiding them entirely.

While strict liability under the economic substance doctrine applies to the taxpayer, not to the tax adviser, and does not change the professional’s standard of due care, practitioners should be mindful of the taxpayer’s potential for strict liability when communicating the details of their economic substance assessment. It is vital that the practitioner carefully explain to the client the probability (based on the assessment) of the transaction’s being found to have economic substance, the consequences if it is found not to have economic substance, and that there is no reasonable cause exception. 37


Interpretations 1-1 and 1-2 to SSTS No. 1 have been revised to provide more substantive guidance to practitioners. A new preface sets forth a brief description of the most common tax return reporting
standards, ranging from the MLTN standard at the high end of the reporting spectrum (used in many jurisdictions for tax shelters and reportable transactions) to RB at the lower end. The applicable standards when recommending tax return positions or preparing or signing tax returns have been updated and clarified. The importance and role of the transaction’s economic substance and business purpose have been integrated throughout the interpretations.

With the codification of the economic substance doctrine and the emphasis the new interpretations place on considerations of business purposes and economic substance, it is essential for members to understand the business purpose and economic substance of transactions. This is especially important because the codification of economic substance standards includes strict liability penalties. The Reconciliation Act makes it clear that both provisions must be present and that an inquiry must be made into the transaction’s impact on the economic position and the taxpayer’s motive for entering into the transaction.



1 Treasury Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10).

2 The current SSTS and Interpretations 1-1 and 1-2 are available on the AICPA website.

3 Placid and Pacini, “Tax Preparer Penalties: What Is Reasonable for Compliance Purposes?” 83 Practical Tax Strategies 264 (November 2009).

4 Id. at 270.

5 For a discussion of the evolution of the preparer penalty regime, see Desmond and Murphy, “Shifting Sands Under Preparers’ Feet: Waiting for the Last Word on Tax Return Preparer Penalties,” Taxes—The Tax Magazine 45 (July 1, 2009).

6 Regs. Sec. 1.6694-2(b) (before revisions made by T.D. 9436, effective Dec. 22, 2008).

7 Regs. Sec. 1.6662-3(b)(3).

8 Further examples are found in Regs. Sec. 1.6662-4(d)(3), which discusses the analysis by which the SA standard is satisfied relative to the substantial understatement penalty.

9 SSTS No. 1, ¶12.

10 Regs. Sec. 1.6694-2(d)(3).

11 Cohan, 39 F.2d 540 (2d Cir. 1930).

12 As noted above, mere reliance on a representation that there is a business purpose or economic substance generally is insufficient; the practitioner must consider (and therefore understand) the business purpose and economic substance of the transaction, if relevant to its tax consequences (Interpretation 1-1, ¶11; Interpretation 1-2, ¶6). Note that the interpretations themselves do not consider the effects of the codification of the economic substance doctrine.

13 Sec. 6662(b)(6).

14 Joint Committee on Taxation, Description of Revenue Provisions Contained in the President’s Fiscal Year 2010 Budget Proposal (JCS-3-09) (September 2009).

15 ABA Section on Taxation letter and comments to Sens. Charles Grassley and Max Baucus (April 24, 2003).

16 The Health Care and Education Reconciliation Act of 2010, P.L. 111-152, §1409.

17 For a good review and discussion of the law, including issues relating to lack of guidance, see Jackel, “Dawn of a New Era: Congress Codifies Economic Substance,” 2010 TNT 75-3 (April 20, 2010).

18 LB&I-4-0711-015 (7/15/11). See also Chase, Tello, Jones, and Kelley, “Economic Substance Directive: Some Substance, Many Questions,” 2011 TNT 163-5 (Aug. 22, 2011).

19 Notice 2010-62, 2010-40 I.R.B. 411.

20 Id. 

21 Rice’s Toyota World, Inc., 752 F.2d 89 (4th Cir. 1985).

22 ABA Tax Section letter. Emphasis in the original.

23 Id.

24 Jade Trading, LLC, 598 F.3d 1372 (Fed. Cir. 2010).

25 Coltec Indus., Inc., 454 F.3d 1340 (Fed. Cir. 2006).

26 Jade Trading, 598 F.3d at 1376, quoting Coltec, 454 F.3d at 1352, 1353–1354.

27 Coltec, 454 F.3d at 1355.

28 Sec. 7701(o)(1).

29 Sec. 7701(o)(5)(B).

30 Sec. 7701(o)(5)(C).

31 Sec. 6662(b)(6).

32 Sec. 6662(i).

33 See Regs. Sec. 1.6664-4.

34 Coder, “Tax Planning After Economic Substance Codification,” 2010 TNT 219-1 (Nov. 15, 2010).

35 AICPA Tax Executive Committee and ABA Tax Section, “Request for Guidance on Implementation of Economic Substance Legislation” (Jan. 18, 2011).

36 Cullinan and Lord, “Economic Substance Doctrine: Unconstitutionally Vague?” 2011 TNT 27-9 (Feb. 9, 2011).

37 SSTS No. 7, Form and Content of Advice to Taxpayers, provides the applicable standards for AICPA members for communicating tax advice to taxpayers.



John C. Gardner is a professor emeritus, Barbara Eide is a professor and chair of the Department of Accountancy, and Bruce May is associate dean in the College of Business Administration at the University of Wisconsin–La Crosse in La Crosse, Wis. Diane May is an associate professor at Winona State University in Winona, Minn.

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