Step transaction doctrine
The step transaction doctrine is a judicial doctrine in the United States that combines a series of formally separate steps, resulting in tax treatment as a single integrated event. The doctrine is often used in combination with other doctrines, such as substance over form. The doctrine is applied to prevent tax abuse, such as tax shelters or bailing assets out of a corporation. The step transaction doctrine originated from a common law principle in Gregory v. Helvering, 293 U.S. 465 (1935) that allowed the court to recharacterize a tax-motivated transaction.
The doctrine states that:
- interrelated yet formally distinct steps in an integrated transaction may not be considered independently of the overall transaction. By thus linking together all interdependent steps with legal or business significance, rather than taking them in isolation, federal tax liability may be based on a realistic view of the entire transaction.
There are three tests for applying the step transaction doctrine: (1) a "binding commitment"; (2) a "mutual interdependence" of steps; or (3) the intent of particular result.
Binding commitment test
The “binding commitment” test was established in Commissioner v. Gordon. Under this strict test, a court will combine a series of separate steps if the parties had a formal obligation to complete each step. This test is usually applied where there are long periods of time between steps in the transaction.
Mutual interdependence test
The “mutual interdependence” test combines a series of events if “the steps are so interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series.”
The “intent” or “end result” test combines a series of closely related events that do not have independent purposes. If the intent of a step was merely to serve the next step, the court may consider the steps together. This test is more concerned with subjective intent of each step than the "mutual interdependence" test.
- In Commissioner v. Court Holding Co., 324 U.S. 331 (1945) the Supreme Court affirmed the tax court's treatment of a liquidating dividend and sale by shareholder as a sale of the corporation.
- In Kimbell-Diamond Milling Co. v. Commissioner, 14 T.C. 74 (1950), the purchase of corporation and subsequent liquidation was disregarded and treated as purchase of assets.
- Keinan, Yoram (2007). "RETHINKING THE ROLE OF THE JUDICIAL STEP TRANSACTION PRINCIPLE AND A PROPOSAL FOR CODIFICATION". Akron Tax Journal 22: 45. "As early as 1938, the United States Supreme Court has indicated that “a given result at the end of a straight path is not made a different result because reached by following a devious path.”"
- Commissioner v. Clark, 489 U.S. 726, 738 (1989).
- Rosenberg, Joshua (November 1988). "Tax Avoidance and Income Measurement". Michigan Law Review 87: 365.
- Commissioner v. Gordon, 391 U.S. 83, 93 (1968).
- Paul, Randolph; Zimet, Phillip (1938). "Step Transaction". In 2nd Series. Selected Studies in Federal Taxation.
- Long-Term Capital Holdings v. United States, 330 F. Supp. 2d 122 (D. Conn. 2004).