Considering a tax transaction? Look beyond the tax result
Treasury and the IRS have recently focused on several transactions that may be viewed as abusive, including qualified small business stock (QSBS) stacking, certain tax-aware investment strategies and so-called tribal tax credits.
The three are not equivalent. Some QSBS and tax-focused investment strategies may reflect prudent planning. Others seek tax results that are not accompanied by meaningful changes in ownership, risk or economic interests, or that are inconsistent with the purpose of the underlying rules. Purported tribal tax credits, meanwhile, present a more fundamental problem: According to the IRS, they do not exist.
Government efforts to address abusive transactions can also affect legitimate planning. Taxpayers therefore need a framework for distinguishing legitimate planning from transactions that merely produce the desired tax result.
Three areas attracting attention
Using trusts to multiply tax benefits. Certain planning strategies use gifts or transfers to trusts to take advantage of tax benefits that are determined on a taxpayer-by-taxpayer basis. Examples may include QSBS planning and some state income tax planning involving separate trusts. The key question is whether the arrangement creates a meaningful change in ownership, control and economic interests, or whether it primarily seeks to multiply tax benefits while leaving the taxpayer in substantially the same economic position.
Tax-aware investing. Considering taxes when making investment decisions is not inherently problematic. Many strategies improve after-tax outcomes through recognized investment and tax principles. However, the government is more likely to view a strategy as abusive if it seeks tax results that appear disconnected from the investor’s economics, such as ordinary losses from investment-type activities, or outcomes that may not reflect what Congress intended when it enacted the rules. Notice 2026-62 and Rev. Rul. 2026-20, issued Sept. 28, reflect Treasury's concern that some investment strategies may generate tax results that are inconsistent with the purpose of existing tax rules.
Fraud. At the far extreme are arrangements that claim benefits not supported by existing authority. The IRS recently issued an alert about fraudulent transactions involving sales of nonexistent tribal tax credits to reduce taxes or generate refunds. Because these claims have no legal foundation, economic substance and congressional intent are irrelevant.
Although these transactions differ significantly, they each highlight one of the key questions taxpayers should ask when evaluating a tax strategy.
A better framework for evaluating tax-focused transactions
The fact that Treasury or the IRS is examining an area does not mean every transaction in that area is abusive. Likewise, technical compliance with selected provisions may not fully confirm that a transaction is supportable. Taxpayers should ask three questions:
- Does the claimed tax benefit exist? The sponsor should identify the statute, regulations, published guidance or other authority supporting the result. Confidential agreements, unverifiable opinions and previously accepted returns, such as those typically cited by tribal tax credit promoters, are not substitutes for legal authority.
- Has something economically changed? Taxpayers should consider whether ownership, risk, control, beneficial interests or investment exposure meaningfully changed as a result of a transaction. They should also ask whether the transaction would make sense apart from the tax benefit. A tax result supported by a real economic change is different from one created primarily through labels or offsetting steps.
- Is the result consistent with the purpose of the rule? Congress often uses tax law to encourage particular investments or behavior. Taxpayers should understand what the provision was designed to accomplish and whether the transaction advances that purpose or merely exploits an interaction among technical rules to create an unintended result.
Transparency is a threshold requirement
Taxpayers should be on high alert when a sponsor will not disclose the legal theory, material assumptions, economics, implementation requirements or return reporting; discourages review by the taxpayer’s existing advisors; or requires confidentiality before providing basic information.
How your tax advisor can help evaluate proposed transactions
Tax planning is not abusive merely because it produces a significant benefit, and government scrutiny should not cause taxpayers to abandon legitimate opportunities. But taxpayers should be able to explain why the benefit exists, what economically changed and why the result is consistent with the purpose of the law. If those questions cannot be clearly answered and independently verified, the taxpayer should pause before proceeding. A qualified tax advisor can help you distinguish between legitimate but complex tax planning strategies and excessively risky transactions unlikely to withstand government inquiry.
