Health care reconciliation package codifies economic substance doctrine

The Patient Protection and Affordable Care Act became law on March 23, 2010. The Reconciliation Act of 2010, a companion package of "fixes" to the larger health care bill was enacted on March 30, 2010 (the Patient Protection and Affordable Care Act as modified by the Reconciliation Act of 2010 is referred to collectively as "the Act"). The Act raises nearly $438 billion over 10 years through various tax increases. One significant corporate revenue raiser is the codification of the economic substance doctrine.


Codification of economic substance doctrine

The Act codifies the economic substance doctrine in Section 7701(o) of the IRC. This provision mandates a conjunctive analysis of economic substance under which taxpayers would have to show both that (1) a transaction changed their economic position in a meaningful way apart from the federal income tax effects and (2) they had a substantial purpose apart from federal income tax effects for entering into the transaction.

Section 6662 codifies penalties attributable to transactions lacking economic substance. A 40 percent strict-liability penalty applies to tax understatements attributable to undisclosed noneconomic substance transactions. The penalty is reduced to 20 percent if a transaction is adequately disclosed. There is no reasonable-cause exception to the penalty. Additionally, the Act provides that noneconomic substance transactions are deemed to lack reasonable basis for purposes of the 20 percent penalty under section 6676 for erroneous claims for refunds or credits.

The new economic substance provisions apply to transactions entered into after the date of enactment.