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.
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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.
