Economic Substance Doctrine (2010)

On March 30, 2010, the Health Care and Education Affordability Reconciliation Act of 2010 added Section 7701(o) to the Internal Revenue Code. Section 7701(o) codifies the judicially created economic substance doctrine (ESD) and requires that, for any transaction to which ESD is relevant, the transaction must change in a meaningful way (apart from Federal income tax effects) the taxpayer's economic position and the taxpayer must have a “substantial purpose” (apart from Federal income tax effects) for entering into such transaction. Significantly, a strict liability penalty may be imposed for any understatement associated with the failure to satisfy ESD.