IRS Issues Directive on Applying Codified Economic Substance Doctrine

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IRS issues a long-awaited directive (LB&I-4-0711-015) for examiners to use in determining whether and when to seek high-level review in asserting the codified economic substance doctrine and its associated strict liability penalty, bringing praise from practitioners. The guidance, which requires examiners to undertake a four-step inquiry before asking an IRS director of field operations to assert the penalty, gives constructive answers to questions taxpayers have been raising for more than a year since Congress put the doctrine into law last March, practitioners say. It sets out lists of factors to delineate cases where it likely would be appropriate to assert the economic substance doctrine and cases where it would be unlikely, after many months of questions on how taxpayers can identify transactions that would fall under the aegis of new tax code Section 7701(o).