U.S. CAPTIVE INSURANCE LAW
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The Step Transaction Doctrine

The step transaction doctrine represents a more particular manifestation of the substance over form doctrine, which is discussed below. The step transaction doctrine essentially allows a court to view a transaction as a whole, by collapsing otherwise separate transactions into a single transaction for tax analysis purposes.  Where a court determines the application of the step transaction doctrine is appropriate, the court may rearrange, or disregard completely, additional and unnecessary steps to a transaction taken by a taxpayer with the aim to lessen the tax consequences that would have been incurred without those additional steps. The Court Holding Co. court stated “a sale by one person cannot be transformed for tax purposes into a sale by another by using the latter as a conduit through which to pass title.”  The IRS will generally treat separate steps as a single transaction where such steps are integrated, interdependent, and focused towards a particular result.  Said another way, the doctrine generally applies “where a taxpayer seeks to get from point A to point D and does so stopping in between at points B and C . . . to achieve tax consequences differing from those which a direct path from A to D would have produced.” The courts have applied three basic tests to determine whether transactions are integrated: (1) the “binding commitment” test; (2) the “mutual interdependence” test; and, (3) the “end results” test.

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Courts will generally look to two factors in determining whether to apply the step transaction doctrine: (1) the intent of the taxpayer, and (2) the temporal proximity of the separate steps.   If the taxpayer can present evidence showing a lack of intent to carry out a later step of the transaction at the time of entering into an earlier step, then the transactions should not be viewed as an integrated whole. Absent a legally binding commitment to engage in subsequent steps or other clear evidence of a taxpayer’s intent, the span of time between the events is the key factor in determining whether the steps should be viewed as integrated.  Because clear evidence of taxpayer intent is often scarce (taxpayers typically do not document their unsavory intentions), the amount of time between the steps is for practical purposes likely the determinative factor. Thus, significant passage of time between transactions should preclude the application of the step transaction doctrine.  Moreover, absent a legally binding agreement, a transaction should not be viewed as integrated where each step has independent economic significance.

  • Welcome
  • Basic Information
    • Who Should Form a Captive?
    • Convert To A Pure Captive
    • How We Work
  • Following the Rules
    • Introduction to Anti-Avoidance Law
    • Substance Over Form
    • Sham Transaction
    • Step Transaction Doctrine
    • The Economic Substance Doctrine
  • Articles
  • Blog
  • About US