Economic Substance Doctrine: How Codification Changes Decided Cases

Abstract

Health care reform mesmerized the nation last spring and created strong rhetoric on all sides. In climatic fashion, on March 25, 2010, Congress passed H.R. 4872, the Health Care and Education Reconciliation Act of 2010 (the Reconciliation Act). This legislation modified legislation that was signed into law several days earlier in H.R. 3590, the Patient Protection and Affordable Care Act (P.L. 111-148). President Obama stated that the passage of these bills represents a major accomplishment for his administration.
Although this legislation will be remembered in the popular press for starting a new chapter in the country’s health care system, the passage of the Reconciliation Act also starts an important new chapter in the nation’s tax jurisprudence. In this regard, section 1409 of the Reconciliation Act adds a new section 7701(o) to the Internal Revenue Code. This provision seeks to codify and clarify the judicially-created economic substance doctrine. From its inception, the economic substance doctrine has been used to prevent taxpayers from subverting the purpose of the tax code by engaging in transactions that are fictitious or lack economic reality simply to reap a tax benefit. In this respect, the economic substance doctrine is similar to other common law canons of construction that are employed in circumstances where the literal terms of a statute can undermine the ultimate purpose of the statute. Congress had debated for years whether to codify the judicially created economic substance and business purpose doctrines, and now that debate is over.