The Codification of “Economic Substance”

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On March 25, 2010, both the U.S. House of Representatives and the U.S. Senate passed the final piece of the health care package, the Health Care and Education Reconciliation Act of 2010 (the Act). Included in the bill is a statutory codification of the “economic substance” doctrine. Various forms of codification of the doctrine have been under consideration by Congress since 1999 and have been on the verge of enactment on several occasions during the last decade, but it will now be a reality as soon as the President applies the necessary signature.

The Act adds new Internal Revenue Code § 7701(o), which provides that if the economic substance doctrine is relevant to a transaction, the transaction will be considered to have economic substance only if two tests are satisfied: (1) the transaction must change the taxpayer’s economic position in a “meaningful way” (apart from the Federal income tax effects); and (2) the taxpayer must have a “substantial purpose” for entering into the transaction (again, apart from the Federal income tax effects).

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