Taxes and the rescission doctrine

By Alistair M. Nevius

A rescission occurs when parties to a transaction agree essentially to turn back the clock and simply void a transaction, treating the situation not as two events (the original deal and the subsequent "unwinding," each potentially with its own consequences) but as no transaction at all. Permitting the parties to walk away and pretend that the original deal never occurred can be advantageous, especially when it is prompted by a misunderstanding of the facts or law, the occurrence of unanticipated events, or the failure of anticipated events to occur.

The rescission doctrine has its genesis in contract law, but in certain circumstances has clear application in the tax world. Neither the Internal Revenue Code nor the Treasury regulations address when a rescission will be given effect for tax purposes, but the federal tax doctrine of rescission has a history reaching back three quarters of a century.

A taxpayer's ability to rescind transactions for tax purposes formally found expression in guidance issued by the IRS in Rev. Rul. 80-58, which sets out two prerequisites to a successful tax rescission:

The parties to the transaction must be returned to the relative positions they would have occupied had no contract been made, and

The restoration must be accomplished within the same tax year as the original transaction.

The ruling elaborates that a rescission "may be effected by mutual agreement of the parties, by one of the parties declaring a rescission of the contract without the consent of the other if sufficient grounds exist, or by applying to the court for a decree of rescission."

Whether the conditions for a valid rescission are satisfied is an inherently factual question. There are numerous letter rulings in which the IRS permitted the taxpayers to rescind a transaction to reverse engineer their way to better tax results; however, some questions exist over the full scope and current vitality of the tax-rescission doctrine, especially when the "unwind" has a principal purpose of tax reduction or when the parties void only some steps but not all of the original transaction.

The IRS will no longer issue letter rulings in this area, but the tax-rescission doctrine remains in effect by virtue of Rev. Rul. 80-58. What is more, the IRS itself has not signaled strong antipathy to the rescission doctrine as much as it suggested that in the current budget climate, scarce resources could not be devoted to providing "comfort" rulings on the topic. Thus, while a letter ruling might be preferred, an attempted but unsuccessful rescission may leave the taxpayer no worse off than it would have been if the rescission had not been attempted. In such a case, the taxpayer's ability to realize the results of the rescission for financial reporting purposes would depend on the confidence level of any advice it received, whether the IRS has examined the issue, or the running of the statute of limitation. (It might also affect the prudence of disclosing the rescission on its tax return.)

For a detailed discussion of the issues in this area, see "Rescission Doctrine Provides Opportunity for Tax Do-Overs," by Timothy J. McCormally, J.D., in the June 2015 issue of The Tax Adviser.

—By Alistair M. Nevius, editor-in-chief, The Tax Adviser


IRS definition of rescission

The legal concept of rescission refers to the abrogation, canceling, or voiding of a contract that has the effect of releasing the contracting parties from further obligations to each other and restoring the parties to the relative positions that they would have occupied had no contract been made. A rescission may be effected by mutual agreement of the parties, by one of the parties declaring a rescission of the contract without the consent of the other if sufficient grounds exist, or by applying to the court for a decree of rescission.

Source: Rev. Rul. 80-58.

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