NTUF’s Taxpayer Defense Center filed an amicus curiae (“friend of the court”) brief with the U.S. Tax Court in Patel v. Commissioner of Internal Revenue, which involves the scope of the Economic Substance Doctrine, a principle used by courts to assess the legitimacy of tax-related transactions. Like we did before the U.S. Court of Appeals for the Tenth Circuit, we argue against the IRS misapplying the Economic Substance Doctrine as a weapon against any taxpayer who does something that results in lower taxes.
In this case, the U.S. Tax Court denied tax deductions claimed by Sunil S. Patel and Laurie McAnally Patel for captive insurance payments. A captive insurance company, explicitly allowed for in the tax code, pools resources for small businesses to self-insure on things like property insurance. The Tax Court agreed with the IRS’s argument that the deductions should be disallowed because the transactions were primarily designed to obtain tax benefits. The Tax Court then asked for more briefing on the scope of the Economic Substance Doctrine and whether it applied to the whole of the Patels’ business arrangements.
Our brief explains that the Economic Substance Doctrine should only be applied after a threshold relevance inquiry under Section 7701(o) of the Internal Revenue Code. Otherwise, the doctrine could be misused to invalidate tax benefits that are clearly enacted by Congress.
Congress often creates tax incentives to encourage specific economic behaviors, such as small business investments, historical preservation, and home ownership. Captive insurance plans are similarly tax-advantaged, and taxpayers should not be punished for using what Congress explicitly allowed. It is entirely appropriate for taxpayers to try to maximize these tax savings, and doing so should not be viewed as lacking “economic substance” or somehow misapplying the tax laws.
We therefore warn against allowing the government to second-guess these taxpayer decisions simply because they were motivated by tax advantages, as this could undermine the legislative intent behind these provisions. By adopting this approach, the court can protect taxpayers’ rights to utilize Congressionally-sanctioned tax benefits without fear of undue scrutiny.
The case is Patel et al. v. Commissioner of Internal Revenue, T.C. Nos. 24344-17, 11352-18, and 25268-18.