Economic Substance Doctrine and How to Beat the IRS
Recently I've been asked by clients and students alike about the "Economic Substance Doctrine," a tool the IRS has been using for years to suck more money out of us. Unfortunately, this doctrine has now been set into law by Mr. Obama.
The IRS' policy, and the courts has supported the notion, that if a person does something whose primary purpose is to save taxes, the IRS has the power to undo that something. But the fact of the matter is, people do things all the time for the sole purpose of paying less in taxes.
Interestedly enough, many tax laws are created with the idea that it will get people to do something: installing solar panels on a home, buying an electric vehicle, putting up a windmill on a farm. All of these undertaking are done primarily because of the tax benefits.
When a person accused of the Economic Substance Doctrine is brought to court, they will be asked things like: Was there a reason other than saving on taxes for performing the action? Was the business transaction done for non-tax purposes? Was the deal profit motivated?
Making the Economic Substance Doctrine has giving the IRS a much bigger stick to come after us with, however, you should have been ducking from it the whole time.
Creating a "window dressing" is vital in avoiding getting beaten with the IRS' big stick. I.E., when you want to move some assets out of the reach of your creditors, you need so make some changes in your estate planning - create a will or trust - at the same time. That way, it won't look like a tax saving strategy, and you have an answer, a secondary motive, as to why you made these changes. That's what I mean when I say window dressing.
By doing so, evasive questions can be asked, such as, was the property transferred in order to keep creditors at bay? If the answer to this question is not satisfactory, the judge will get you. However, if the transfer was done as a part of your estate planning tactics, then it is probably okay.
Everything you do that has anything to do with estate planning, tax planning, and asset protection needs to be done with a "window dressing," another motive. If you can prove that the transaction was done for estate planning or asset protection motives, and not just to save money on taxes, then you will be removed from the consequences of the Economic Substance Doctrine.
Most people get caught in the Economic Substance Doctrine when they make changes in their asset protection and estate planning system. Having other, non-tax reason for making such changes will CYA down the road. A big, bright red flag to the IRS is when someone makes an investment knowing full well that they will loose money, but gain huge tax savings.
If you can't prove that the motivation behind your transaction, action, investment, or other business deal was something other than saving money in taxes, you'll get hit by the big stick and it'll hurt. Your initial tax savings will be disallowed in addition to a 40 percent fine, courtesy of the IRS.
Interested in learning more about the Economic Substance Doctrine or Wills and Trusts? Visit Phillips Estate Planning for free tips, videos, webinars, and other useful information.
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