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Tax II 01102008
There are various advantages to be a corporation. There are tax advantages. These
advantages are based in two categories:
(1) Liabilities of the entity
(2) Tax consequences
It is know that corporations are taxed as separated entities. Therefore, the transactions
between the corporations and the shareholders are protectable events for the most parts. Not
always, but for the most part they are. They are transcendent separate entities.
Then, let’s look at some tax events that relate to corporations. In particular, let’s focus on tax
benefits. Toward the end of last class it was said that doctor and other professionals create
professional corporations largely to get the tax benefits, which they could not get filled as sole
proprietorship or the members of partnership.
Therefore, what benefits are there for being a corporation, from the point of view of someone
who might be the employee and the owner of a company? One of them is simply what follows.
Just assume that the tax rate of an individual is 50%. If you look it up, you’d find that is close
to 36%. However, it does not come up with state taxes, social security taxes, med care taxes
and some other taxes. Hence, if you add all these taxes you are usually paying 50% as
individual, so let’s assume that for purpose of comparison.
If you want to buy something which costs $1.00 with that deduction, how much would you
have to earn? The answer is $2.00. This is the concept.
However, the minute it is deductable, it is cheated.
Here are the benefits: (00500)
(1) Suppose you are a partner or sole proprietor and you want to have income to share for
life. Is that deductable as a partnership or sole proprietor? No. It is not. But, if you are
an employee of a corporation and we check out Section 79, we could read:
§ 79. Group-term life insurance purchase for employees
(a) General rule. – There shall be included in the gross income of an employee for the
taxable year an amount equal to the cost of group-term life on his life ***; but only to the
extent that such cost exceeds the sum of–
(1) the cost of $50,000 ***
In other words, $50,000 of life insurance is tax free to the employee and deductable to
the corporation. There is no other benefit like that, except does an employee for a
corporation. Thus in words not it all latter with the previous plan, depending on the age,
whatever, he’ll probably worth a few hundred dollars.
(2) There is another advantage. People have dental and medical expenses. But, you would
say: you pay for life insurance. But other, not all of them are arrant. Many of them are
subject deductable. Now, we are talking about something rather valuable, rather
expensive. Let’s say blue cross, blue shield. It does not cover everything. To this extent,
suppose that you have an orthodontic bill of a couple of thousand dollars. If you are in
the 50% bracket, how much money would you have to earn in order to pay a $2,000
bill? The answer is $4,000.
However, if you are an employee of a corporation, you can adopt under section 106 of
the Internal Revenue Code, which says:
§ 106. Contributions by the employer to accident and health plans
(a) General rule. –***, gross income of an employee does not include employer-provided
coverage under an accident or health plan.
Are there any other sections?
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§ 125. Cafeteria plans

(a) In general. – ***[N]o amount shall be included in the gross income of a participant in a
cafeteria plan solely because, under the plan, the participant may choose among the
benefits of the plan.
***
There are some rules against discrimination. Essentially, if you combine that with
section 129, which states:
§ 129. Dependant care assistance programs
***
(d) Dependent care assistance program. –
***
What you can see is that you get your child care free-tax basis. Also, you can find
benefits. (01000) For example, under the section 132 there is what is called qualified
transportation plan. Let’s take a look at it:
§ 132. Certain fringe benefits
(a) Exclusion from gross income. – Gross income shall not include any fringe benefit which
qualifies as a–
***
(5) qualified transportation fringe,
***
As consequence, some costs related to transportation are totally tax free.
These are all interesting things. And you might say would I really incorporate for that?
Probably not, but one big benefit you would incorporate for is that related to ERISA
plan. What does the word ERISA mean? It is the acronym of what word?
The Employee Retirement Income Security Act of 1974 (ERISA) (Pub.L. 93-406, 88 Stat.
829, September 2, 1974) is an American federal statute that establishes minimum
standards for pension plans in private industry and provides for extensive rules on the
federal income tax effects of transactions associated with employee benefit plans. ERISA
was enacted to protect the interests of employee benefit plan participants and their
beneficiaries by requiring the disclosure to them of financial and other information
concerning the plan; by establishing standards of conduct for plan fiduciaries; and by
providing for appropriate remedies and access to the federal courts.1
It is a specialty in the law. ERISA is a tax specialty. You might say, wow what is that?
Isn’t that very sexy?
There are maybe torts, contracts, corporations and international law. Why would I more
care thinking about that?
First of all, ERISA is a tax specialty. It is a very complicated area. It is the perfect job
security. If you ever want to go up and get a job at a large law firm, they say sorry we
don’t have any room in our corporate tax department. Then, make an application for
ERISA. Almost invariably, they’ll take you. Why?
Because, they are always looking for people in this area, and what is it? Well, before
1974, year of the sanction of this law, the vehicle usually used for retirement worked
like this:
The employer corporation makes money. It has a lot of employees or maybe just one,
whatever. The corporation officers say that they need to find a way to help these
employees.

1
Wikipedia
Corporation $ Tax Exempt
Trust
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Employee 1 Employee 2 … Employee n

$
The corporation makes money and has a lot of employees or just one, whatever.
We need to find a way to help these employees and provide their retirement.
What would be a way to do it?
First of all, you want to do it because you want to keep the employees. You want
them to feel good about the company. Every time an employee starts working for
an organization and leaves it after a few years, that company has lost a lot of
value, because you trained that person. So what we are going to do is to find a
way to keep that person.
The company gets certain tax benefits for this arrangement. Why would
Congress do that? Why would Congress do a tax benefit to a privately owned
corporation to provide retirement for its employees?
It is very simple. That is deemed to be of public interest of the United States, so
when people retire, they do not become a burden for the welfare system.
Social security was never intended to be an exclusive sole retirement benefit.
And it is not satisfactory doing it by itself. Consequently, Congress gives a break
and here is the break.
The Congress says that if this corporation starts a trust, a tax exempt trust –
Congress made this trust tax exempt –, it is allowed to put money into this trust
and take a tax deduction for doing that. In other words, the company makes
money and gets a tax deduction putting that money aside in a trust for the
benefit of the employees. That means that money is not taxed, when was set
aside, which basically means your support this. You understand, don’t you?
Every time somebody gets a deduction, it means the revenue to provide resource
for the government has to come from some source. If they are not taxing this,
they are taxing something else. In this case, they are saying that they are not
taxing this.
So this company gets a deduction. It could be holding five thousand people or
one person. The plan that could work for 5,000 people could work also for one
person (01500).
Think about 3 people. A small business which is looking for some way to save
money and, though, provide retirement for the owners of the company, could be
an example. This is the perfect vehicle.
As a result, money is set aside over the vehicle. It is tax deductable and this trust
is also tax free. Can you build up money very quickly for retirement?
The answer is that you can and basically the arithmetic rule is that your money
doubles in every ten years (9% of annual interest).In turn, it is invested totally
tax free.
This is why doctor incorporate. When the doctors set aside the money they would
have used to pay taxes, they are raising funds. Some realize, when they retire,
that they have invested in investments than 30 million dollars.
A doctor who begun working in the 1920’s and, in the 1960’s, decided to retire,
there would not be any money in such a fund. The doctor would have paid for a
good life stile, the education of his children, a couple of cars and a house, but
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there would have not been any windows for investment, because taxes would
have taken everything.
This is a great benefit of the incorporation. You are allowed to have a major kind
of retirement plan with the taxes you save along your life.
(3) One more advantage to be a corporation. Imagine you are tired of your business. You
don’t want to work anymore. A publicly hold company may come to you and take it
over. Neither this is a partnership. Can it be done as an LLC? No. It can only be done as
a corporation, under code section 368.
(4) Another benefit of being a corporation is probable double taxation. The question is that
this double taxation aspect is probably as favorable as it has ever been. The dividend
paid as surplus out of the company is taxed at only 15%. Section 1H of the code.
*** If an owner holds the stock ***.
(5) Other advantage is the possibility to adjust the calendar year (02000). The taxes can be
deferred. Deferral of taxes can save a lot of money. Put it in perspective. If you think
about $20,000 and you have to pay taxes on it, this is an unimportant amount of
money. What if you make instead $5,000,000 and you can defer paying taxes on it? Or
5,000,000,000? It can be seen that the adoption of a different fiscal year can be a
virtue. You can vary your fiscal year when your inventories are low. It depends on how
you want to play that.
For professional corporations, under section 441, they are supposed to use calendar
year. Then, professional corporations (doctors, lawyers etc), under section 441(i), have
to follow what states the code:
§ 441. ***
(i) Taxable year of personal service corporations–
(1) In general – For purposes of this subtitle, the taxable year of any personal service
corporation shall be the calendar year unless the corporation establishes, to the
satisfaction of the Secretary, a business purpose for having a different period for its
taxable year.***
It is important to know the difference between realization and recognition of the gain. If I have
an asset that costs me $100 and I am able to sell it for $200. I will have a realized gain of
$100.

Do I have to pay taxes? Maybe, only if the code requires that you recognize that gain. The
difference is that realized gain is actual gain. Recognized gain is gain over which the code
requires you to pay taxes.
This is very important, because the very first thing we are going to study in depth is a code
section that deals with the realization and non-recognition of the gain. Consequently, this
concept must be understood.
This is the section 1045 (a), non-recognition.
In the case of any sale of a qualified small business stock [what is it? Other than corporation]
(02500), will be recognized only to the extent when the sale exceeds ***.
There is a break here. It is important to consider though the following question: should I be
incorporated?
The answer for this question will be given in the following classes.
Nonetheless, it is important to take an important definition of the code:
§ 1504. Definitions
(a) Affiliated group defined – For purposes of this subtitle – a
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(1) In general. – The term “affiliated group” means –

(A) 1 or more chains of includible corporations connected through stock ownership with a
common parent corporation which is an includible corporation, but only if –
(B) (i) ***
Long-Term Capital Gain X Short-Term Capital Gain. What is the difference between both?
If you have a capital asset and you sell it within a year, it is a short-term capital gain. Why
does the Congress say this? It is saying that the US wants you to invest; you should not trade
in back and forth like a jog. You’d better invest in the long run, which means more than a year.
Then, the Congress gives a break. Investments in the run are taxed at the rate of 15%.
70% low income tax payers act for 5% of all income.
There is the corporate dividend exclusion. What would that mean? It means that when one
corporation pays dividends to another, there will be an authorization to deduct the amount of
dividend paid from the basis. That avoids triple tax. When a corporation pays dividends to
another, this latter will use these same dividends to pay dividends to its shareholders. There
would be, though, three occasions to charge the income: (1) Corp A to Corp B, (2) Corp B to
shareholder and (3) shareholders alone.
There some drawbacks of being a corporation as well. Let’s talk about what they are.
BOUBLE TAXATION. The first one is double taxation.
Right now there is a tax of the rate of 15% on dividends.
Let’s suppose that a corporation makes money. What is it supposed to do with this money? It
can use it in its capital resource, to run its business, but it can retain its earnings to a certain
degree. In fact, it is also expected that it provide return to the shareholders, which is done by
the way of dividend. As said before, the dividend rate now is 15%, but may change by the end
of this year. Congress can maintain this rate or, obviously, do something different.
Let’s suppose that a corporation earns $100 (030000). Even though we know that it is
graduated, let’s just use the highest rate now, which is 35%. Therefore, it will pay $35, in
corporate tax. That sort of quick math then leaves $65, which the corporation can then either
utilize for retain earnings, surplus, by equipment, expand, whatever, or it can use that $65 to
pay dividends. Let’s suppose they chose to pay dividends. Then, I’ve just said you that
dividend rate is 15%. By the way, if the dividend rate changes, obviously this can have a huge
impact. Right now, 15% is $9.75 and if you take it and add to the other amount, you are
basically paying 44.75% of taxes. Look the diagram bellow:

$100.00 X 35% = $35.00 taxes 

profit $65.00 X 15% = $9.75 
taxes $35.00 + $9.75 = $44.75 
Net result  $57.75

There is a double taxation in the process. Not only the company, but also the shareholder will
have to pay taxes.
If we comparer with the partnership, we will that it is never taxed. An LLC is never taxed; only
its member. Or if you are an “S” corporation – a pass-thru corporation, a “C” corporation
elected to be a pass thru –, the entity is not taxed. Only “C” corporations get this double
taxation.
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On page 38, there are different objectives, claims or proposals people have evocated over a
period of time to throw away the double taxation. President Bush tried to do away with double
taxation, but the best he could get is the 15%, which is very good.
There are ways to solve the problem of double taxation:
1) Tax “C” corporations as if they were “S” corporation. However, this solution would be
tricky. `Think that you own stock of IBM and one day you receive a letter from the
company. It says, for instance, that you owe $600,000 in taxes. You might say that this
is not truth. The company never paid anything to you, because the earnings are only
potential, not concrete. There is a great difference between cash throwing through and
gain throwing through. Gain throws through, but not does money.
2) Or you might tax individuals only if they get the cash.
3) Or we could say that we would give shareholders some sort of credit.
This subject is not important, as long as it deals only with proposals (03500).
Disadvantages of “C” corporations:
The basis of shareholder “C” stock is not impacted by income or loss. In other words,
if I pay $100 for my shares and the company makes money, this fact will not change the value
of my shares. On the other hand, in a partnership or “S” corporation, the share’s value will
change automatically. How to solve then the problem with “C” corporation shares? One way to
prize the shareholders is through dividends. Another way is by redemption.
What are the taxes consequences of the redemption?
We shall se section 301 [actually, redemption is related to section 302]. Redemptions look like
dividends. If I am selling the capital of a company to someone else, I will be entitled to capital
gain. But, I may also sell to my own company. Am I not entitled to capital gain in such cases?
We will look at it for a moment.
I own a 100 shares and I will sell back 50 shares to my own company. I have only 50 shares
left. Next day, if I want to the company can declare stock dividends or stock split. This is a tax
free transaction. In other words, if there is not any law preventing me to doing this, I can keep
selling stock to my own company and keep refurnishing it in the same day. There is a law
against it.
Right now the corporate rate of 35% is no longer bigger than the individual rate. But, in the
past it has not be true. The corporate rate was lower than the individual. If it is lower, (04000)
people use corporations to do a number of things. One of the things they would do is transfer
all their earnings to the corporation. Then, the Congress passed what is stated in section 531.
Basically what says is:
If you keep unreasonably accumulating earnings, you may be imposed an accumulated
earnings tax.
The same mechanism is applicable to “holding companies” (section 541).
Now there is one of the most important sections of the code. This is the Million-Dollar
Section. It states:
§ 482. Allocation of income and deductions among taxpayers.
In any case of two or more organizations, trades, or business (whether or not incorporated,
whether or not organized in the United States, and whether or not affiliated) owned or controlled
directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate
gross income, deductions, credits, or allowances between or among such organizations, trades,
or businesses, if he determines that such distribution, apportionment, or allocation is necessary
in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations,
trades, or businesses. In the case of any transfer (or license) of intangible property (within the
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meaning of section 936(h)(3)(b)), the income with respect to such transfer or license shall be
commensurate with the income attributable to the intangible.
The IRS is an agency under the Treasury. Then, the Secretary of Treasury is the highest
authority with regard to federal income taxation.
There many countries in the world with more favorable taxes. For instance, there are
countries in which no taxes are paid, such as Cayman Islands, Netherlands Antilles (04500),
Principality of Liechtenstein, The Kingdom of Congo, and Bermuda.
Why would people have to pay taxes over what they make abroad?
First of all, US people have to pay tax in the US for their worldwide income. But there are
certain activities on which you don’t have to pay taxes in the US. You have only to pay, if you
bring this income to the US. For instance, you are the CEO of a billion-dollar company. If you
have the opportunity to avoid paying taxes, which we pay at the rate of 35%, you will hire a
bunch of lawyers, accountants and professionals to avoid this burden.
What the government is saying under section 482 is that it reserves the right to call and
evaluate those activities. The IRS can, though, reallocate gains and losses.
Example:
I am an inventor and then I create an intellectual property. Next, I create a foreign
corporation. Then, I lend it my intellectual property, so they will pay me royalties, for the use
of my property. I can set the price of this property very low, so I can maintain more money
abroad. By doing this, I am pushing my profits off. The IRS usually comes and takes a look at
it. There come lawsuits for 2, 3, 4 or more years.
There is a case called Glaxo which was settled for more than a billion dollars.
Point being, the IRS has the right to come in and evaluate what has been done in terms of
transnational business.
Now, take a look at section 267.
§ 267. Losses, expenses, and interest with respect to transactions between related
taxpayers.
(a) In general.-
(1) Deduction for losses disallowed. – No deduction shall be allowed in respect of any
loss from the sale or exchange of property, directly, or indirectly, between persons
specified in any of the paragraphs of subsection
(2) ***
It confirms that a corporation is a separated entity from its owners (05000). Take a lot at
section 269:
§ 269. Acquisitions made to evade or avoid income tax.
(a) In general.-
(1) any person or persons acquire, or acquired on or after October 8, 1940, directly or
indirectly, control of a corporation, or
(2) any corporation acquires, or acquired on or after October 8, 1940, directly or indirectly,
property of another corporation, not controlled, directly or indirectly, immediately before
such acquisition, by such acquiring corporation or its stockholders, the basis of which
property, in the hands of the acquiring corporation, is determined by reference to the
basis in the hands of the transferor corporation, and the principal purpose for which
such acquisition was made is evasion or avoidance of Federal income tax by securing the
benefit of a deduction, credit, or other allowance which such person or corporation would
not otherwise enjoy, then the Secretary may disallow such deduction, credit, or other
allowance. For purpose of paragraphs (1) and (2), control means the ownership of stock
possessing at least 50 percent of the total combined voting power of all classes of stock
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entitled to vote or at least 50 percent of the total value of shares of all classes of stock of
the corporation. ***
There are some important words. It was used the expression “principal purpose”. Each word
has a very specific purpose.
§ 269(A). Personal service corporations formed or availed of to avoid or evade income
tax.
(a) In general.- If –
(1) substantially all of the services of a personal service corporation are performed for (or on
behalf of) 1 other corporation, partnership, or other entity, and
(2) the principal purpose for forming, or availing of, such personal service corporation is the
avoidance or evasion of Federal income tax by reducing the income of, or securing the
benefit of any expense, deduction, credit, exclusion, or other allowance for, any
employee-owner which would not otherwise be available.
then the Secretary may allocate all income, deductions, credits, exclusions, and other
allowances between such personal service corporation and its employee-owners, if such
allocation is necessary to prevent avoidance or evasion of Federal income tax or clearly to
reflect the income of the personal service corporation or any of its employee-owners.
***
All it is saying is that if you are a corporation of doctors and you want to render service to
patients of virus, then that is fine. But, if you form a corporation to render service exclusively
to another part, and in this event your purpose is to avoid taxes, you may lose all your
benefits. The point is
“what about the radiology group that is situated in a hospital and performs services only to
the hospital?”
“what about the law firm which has only a single client (05500), a major client or whatever
else?”
It is important, before we answer these questions, to consider if the purpose is to evade or
avoid taxes.
Evasion X Avoidance = Illegal X Legal
The code is only part of the law. What are the sources in terms of corporate tax laws?
(1) Statutes (Michael Desman, Chief Legislator Councilor of the United States Treasury,
will be at USD, teaching Tax II, on February 19. He will talk about sections 119 and 108.
They have to do with deductions for productions).
• Starbucks  what would they do?  They pick some coffee beans  They tie them
up  They pour the coffee  They handle to you.  Do you believe that they are
involved in the production of coffee?
They went to Washington, made their lobby and now the graining of coffee by
Starbucks is deductable. If someone gets a deduction, someone else is pay for this
benefit. (10000)
• Hollywood porn movie maker  pornography is simulated, because if it is real there
is no deduction.
(2) Regulations
2.1 Legislator regulations: the statute usually says that the Treasury is authorized to
regulate certain issues and dispositions.
2.2 Interpret regulations: there is no specific add on by the legislator. It is implied
that the Treasury can interpret. The IRS job is to administer the law, and interpret it. For
instance: Revenue Rulings.
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(3) Cases
Cases coming from Tax Court, District Court, Circuit Courts, Supreme Court (3 taxes
cases a year), Bankruptcy Court, and Court of Federal Claims. All courts feeding the
body of corporate tax law. What happens if there is a conflict of decisions?
95% of all taxes litigation (10500) goes on to the US Tax Court. It takes more than
20,000 cases a year and it has exclusive jurisdiction over almost all tax matters.
The decisions from the Tax Court are appealable. In San Diego, decisions can be
appealed to the 9th Circuit. However, in Mew York, decisions are appealable to the 2sd
Circuit.
Which court has higher hierarchy? Whenever you evaluate a case, start by looking at
the court. It may make a great difference. With regard to the Tax Court, it is unique in
the US, but its decisions are appealable to the various circuits all over the country. In
most cases the Tax Court decision is final.

Let’s evaluate section 704:

$704 Partner’s distributive share
(a) ***
(b) Determination of distributive share. – A partner’s distributive share of income, gain,
loss, deduction, or credit (or item thereof) shall be determined in accordance with the
partner’s interest in the partnership (determined by taking into account all facts and
circumstances), if ***
(11000) It means that it can only be allocated if it has substantial economical fact. Example:
• Pablo Picasso  in many years, he made several paintings  he would pay his
expenses by check, so anybody would cash his checks, because they knew that
Picasso was famous and that it was his signature on the check. When he died, his
daughter didn’t know what to do with all his paintings. If sold in the market, it would
push down prices. Then, they hooked up with specialists from New York. It was, then,
elaborated the Picasso’s Estate, which sold the rights to produce the master’s
lithographs. An investor bought this right for $5,000,000, $500,000 in cash and
$4,500,000 in notes. Then, now there is a $5,000,000 basis. The $4,500,000 can be
easily ripped off among other investor in the first year. This operation is not allowed
any longer, but section 704 has partnership allocation provisions. Similar strategies
can create tax shelter for people.
Now take a look at section 721
$721 Nonrecognition of a gain or loss on contributions
(a) General rule – No gain or loss shall be recognized to a partnership or to any of its
partners in the case of a contribution of property to the partnership in exchange for an
interest in the partnership.
(b) ***
Now, compare sections 351 and 721. What are the differences? They are rules applicable to
different kind of business. The first one is a corporation, while the second, a partnership.
Now, take a look at section 731
$731 Extension of recognition of gain or loss on distribution
(a) Partners – In the case of a distribution by a partnership to a partners –
(1) gain shall not be recognized to such partner, except to the extent that any money
distributed exceeds the adjusted basis of such partner’s interest in the partnership
immediately before the distribution, and
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(2) ***
Let’s take a look at section 708. On Tuesday I asked you what were the characteristics of a
corporation. Now, we are going to see the characteristics of a partnership (11500):
$708 Continuation of a partnership
(a) General rule – For purposes of this subchapter, an existing partnership shall be
considered as continuing if it is not terminated.
(b) Termination. –
(1) General rule – For purposes of subsection (a), a partnership shall be considered as
terminated only if–
(A) no part of any business, financial operation, or venture of the partnership
continues to be carried on any of its partners in a partnership, or
(B) within 12-month period there is a sale or exchange of 50 percent or more of the
total interest in partnership capital and profits.
(2) ***

In a corporation you can 100% of it and the entity continues. However, in a partnership, if you
sell more than 50% within a year, the partnership is over.
Practical problem:
Imagine the case in which a client asks his lawyer to elaborate the documents for his
business. The lawyer prepares a partnership, but does not pay attention to these
restrictions in the code. Six months later, the client comes again and says that he will
sell 70% of his participation. The lawyer then prepares all documents and again does
not take a look at the code’s restrictions.
Three years later, the IRS comes and taxes the lawyer’s client, because he the
partnership terminated when he sold his participation and, consequently, the capital
should have been recognized. He would have to pay not only the taxes, but also
interest and all other associated penalties.
The next subject will be judicial doctrines in terms of corporate taxes.

JUDICIAL DOCTRINES:

First of all, the corporate provisions are those from 301 to 385. Everything under subchapter C
(Corporate Distributions and Adjustments)
For instance, sections 301 to 318 deal with distributions. In other words, Subchapter C has an
organization.
• Sham Transaction
A “sham” is a transaction that never occurred but it is represented by the taxpayer to have
transpired. It can be described as the transaction that never happened and for this reason has
to be disregarded (12000). It is almost like a fraud, but keeps some characteristics of
transaction. It is a sham; it happens; but it wasn’t legitimate.
Courts use it that way. They say that there is no legitimate reason.
• Assignment of Income
Income tax cannot be stated by anticipatory arrangements or contracts. This doctrine comes
from the case Lucas v. Earl.
Lucas v. Earl. The idea of avoiding tax liability by assigning the right to receive income earned
by the taxpayer to another is not new. As early as 1930, the Supreme Court of the United States
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ruled on this issue in Lucas v. Earl. In this landmark ruling, taxpayer and his spouse entered into
a valid contract stating that all property and earnings "shall be treated and considered . . . to be
. . . owned by us [taxpayer and spouse] as joint tenants . . . with rights of survivorship." The
question before the court was to whom should salary and fees earned by taxpayer be taxed. The
court ruled that "the statute could tax salaries to those who earned them and provide that the
tax could not be escaped by anticipatory arrangements and contracts . . . to prevent the salary
when paid from vesting even for a second in the man who earned it." The opinion concluded
with the often cited tree-and-fruit metaphor: The fruits cannot be attributed to a different tree
from that on which they grew.
(http://www.nysscpa.org/cpajournal/1997/1097/features/F301097.htm)

• Substance over Form

The form of a transaction frequently is determinative of its tax consequences. Courts can go
beyond the formal papers and evaluate the “substance” of a transaction. The economic
reality has to prevail, when the form has only tax purposes. In other words, the IRS is not
bounded by what the taxpayer did. It has the duty to exam the real purpose behind the
transaction’s form.
By the way, this is a very interesting aspect, because the operation it does not work in
reverse. The taxpayer is not allowed, if he chooses the wrong form, to come later and say that
he made a mistake. He cannot tell the IRS that he made something, but what he did mean
was should have taken a different form, in order to ask back-money. However, the IRS can
analyze the facts and change the transaction’s form.
• Business Purposes
The business purpose doctrine is conceptually linked to the sham and substance-versus-form
tests. It is generally applied to deny tax-free status to a transaction that would not have been
consummated but for tax savings that would result if form was respected.
Basically, it comes from a case in 1935 called Gregory v. Helvering, 293 U.S. 465 (1935). Miss
Gregory was married to a man who was Secretary in a Department Store. She owned the
company and that company owned stock. What she wanted to do was to be able to take and
sell the stock in a preferable rate (12500). Then, she settled up her way for reorganization. By
the use of different techniques and observing the forms, she was able to significantly her tax
burden. But, the IRS step in and say: wait a minute. The only reason that you did this
operation is to save taxes. You were only trying to avoid taxes. There was no other business
purpose. Thus, you have to be disallowed from tax benefits. Along other phases, different
people analyzed the issue and brought different evaluation in order to contribute to
interpretation of Mrs. Gregory bad conduct. The variety of opinions made this one of the most
important cases in the history of corporate taxation.
In general, a transaction cannot be done without any business purpose.
When you subjectively have no substance, purpose or utility other than tax savings, the
transaction is not valid, because there is no business purpose.
• Step Transaction Doctrine
It is used when formally distinctive transactions are combined to determine the tax treatment
of a single integrated series of events. If you do something once, and similarly disassociated
you do something else, to some extent related to the transaction, the IRS has the right to
come in and put all this steps together, in order to evaluate you purposes while doing it.
Most companies nowadays, in order to save taxes, split their operations along several years.
For example, in the year 1 the start the operation; in the year 3, they do step 2; in the year 5,
step 3; and so on. However, if you put all steps together, you have a tax avoidance
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transaction. The IRS audits year by year. And every two years a new different agent comes.
With this operation, companies avoid to being observed by tax authorities.
Economical substance – courts evaluate if there is an economical purpose in the whole
operation.