IRS Says It Won't Give Advance Guidance on Transactions Under Codified Economic Substance Doctrine

The IRS issued its first guidance on the newly codified economic substance doctrine on Monday ( Notice 2010-62 ). In general, the IRS says it will enforce the two-prong test mandated in the Code and will not issue guidance on whether specific transactions pass muster.


The economic substance doctrine was originally created by the courts to disallow a transaction’s tax benefits if the transaction does not have economic substance. In March, the Health Care and Education Reconciliation Act of 2010, PL 111-152, codified the doctrine in IRC § 7701(o). Under the Code, a transaction will be treated as having economic substance only if (1) the transaction changes the taxpayer’s economic position in a meaningful way (apart from the federal income tax effects), and (2) the taxpayer has a substantial purpose (apart from federal income tax effects) for entering into the  transaction. This two-prong test applies to transactions entered into after March 31, 2010.


The notice says that the IRS will continue to rely on relevant case law interpreting the common law economic substance doctrine when applying the two-prong test under section 7701. However, the IRS says that taxpayers cannot rely on prior case law that held that transactions had economic substance if they satisfied either prong of the test—the Code mandates a conjunctive test, requiring both prongs to be met.


The notice also says that the IRS’ analysis of when the economic substance doctrine applies will be the same is it was prior to the enactment of section 7701(o), consistent with the mandate of section 7701(o)(5)(C), which provides that the determination of whether a transaction is subject to the economic substance doctrine will be made in the same manner as if the doctrine had not been codified.


The IRS says it does not intend to issue general guidance on whether the economic substance doctrine applies to specific types of transactions and will not issue private letter rulings or determination letters on whether the economic substance doctrine is relevant to any transaction or whether any transaction complies with the requirements of section 7701(o).


The IRS has asked for comments on this notice, which should be submitted by Dec. 3, 2010. Comments can be e-mailed to and should include “Notice 2010-62” in the subject line.


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