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May 11, 2012
What's Next After Codification Falls?

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By Monte A. Jackel

Monte A. Jackel is a managing director at PricewaterhouseCoopers LLP, Washington, and a contributing columnist for Tax Notes.

In this article, Jackel raises the question whether Congress should reenact the economic substance doctrine statute if the Supreme Court declares it unconstitutional as part of the healthcare legislation. Assuming congressional reenactment, Jackel then discusses what a reenacted statute should contain to support sound tax policy, revenue considerations notwithstanding.

Copyright 2012 Monte A. Jackel.
All rights reserved.

Introduction and Background

Monte A. Jackel The Patient Protection and Affordable Care Act1 and the Health Care and Education Reconciliation Act of 20102 together constitute the broad-based healthcare legislation enacted into law a little over two years ago. As is well known, the healthcare act is under siege. The Supreme Court will soon decide whether the healthcare mandate under the act is unconstitutional and, if it is, whether it is severable from the rest of the legislation.

Why do we care in taxland? Because if the entire act falls, section 7701(o) -- the codified economic substance doctrine -- falls as well, because it is part of that legislation.3 The effect of the unconstitutionality of section 7701(o) would be as if the statute had never been enacted. The purpose of this article is to discuss what, if anything, should happen next if that occurs.

Next Steps

There would be some -- perhaps many -- who would say "good riddance." They would say that codification of the economic substance doctrine was a bad idea and that now that the statute is gone, it should stay gone. Of course, the IRS chief counsel would need to revoke its recent notice detailing the procedures regarding section 7701(o),4 and the Large Business and International Division would need to revoke its two directives on section 7701(o).5 The IRS would also need to revoke Notice 2010-62,6 which said that no guidance will be issued on section 7701(o). But that is minor coordinating stuff.

Other commentators would say that section 7701(o) should be reenacted as written. I disagree with that approach, but if Congress is so inclined under those circumstances, I believe that a new statute must provide for three items.

First and foremost, the penalty for violations of the codified economic substance doctrine should have a reasonable cause and good-faith defense under section 6664(c). The notices and directives previously issued by the IRS and Treasury were helpful in saying that the government will appropriately enforce the economic substance doctrine statute evenhandedly. In my view, however, the preferred route is to write guidance with standards that hold the government accountable and provide statutory authority to not apply the penalty in appropriate cases.

Second, I believe the statute should mandate the issuance of regulations providing guidance and meaning to the provisions of the codified doctrine.7 No excuses, just substantive guidance. The legislative history should reinforce that directive in clear and unmistakable terms.

Third, if the government ignores the congressional directive to provide guidance, the statute should clearly state that in that circumstance no penalty may be imposed by the government for violation of the codified economic substance doctrine.

If these three provisions are not part of a new codified economic substance statute, no such statute should be reenacted by Congress, notwithstanding the Joint Committee on Taxation revenue estimates. The new statute should be enacted on tax policy grounds and not be based on revenue estimates. Maybe that is naïve, but I believe tax policy should come first, and revenue second.


It is entirely possible that the healthcare mandate will be upheld by the Supreme Court or, if it is not, that the remaining parts of the legislation, of which section 7701(o) is a part, will remain good law because the mandate is held to be severable from the rest of the legislation. But anything is possible these days. It is possible that by early summer, section 7701(o) as we know it will no longer be part of the code. If that is the case and a new statute is considered for enactment, I hope that the suggestions in this article are taken into account.


1 P.L. 111-148.

2 P.L. 111-152.

3 Section 7701(o) was enacted as part of P.L. 111-152.

4 CC-2012-008, Doc 2012-7209, 2012 TNT 67-8.

5 LMSB-04-0910-024, Doc 2010-20089, 2010 TNT 178-47; LB&I-04-0711-015, Doc 2011-15491, 2011 TNT 137-17.

6 2010-1 C.B. 411, Doc 2010-20020, 2010 TNT 177-14.

7 See Monte A. Jackel, "Dawn of a New Era: Congress Codifies Economic Substance," Tax Notes, Apr. 19, 2010, p. 289, Doc 2010-6878, or 2010 TNT 75-3.


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