Upstream Tax Planning: A Case Study of Why Congress Should Institute a General Anti-Abuse Rule?

Abstract

Tax abuse—a process by which taxpayers secure tax outcomes that directly or indirectly contravene congressional intent—is a commonplace phenomenon that has plagued the nation’s economic fabric since Congress instituted the income tax. A typical pattern associated with tax abuse is as follows: one or more taxpayers devise a methodology to mitigate their tax burdens in a way that skirts their civic obligations, the practice becomes widespread, and Congress responds by instituting reform measures. Often, however, the legislative process takes years or, in some cases, decades to unfold; in the meantime, billions of dollars of tax revenue are lost. Consider the case of upstream tax planning. This is a process by which younger-generation taxpayers gift appreciated assets to older loved ones with the expectation of receiving such assets back in the form of outright bequests or in trust for their benefit. After the application of the Internal Revenue Code’s “basis equal to fair market value” rule, the transferred assets are cleansed of their former gains, making upstream tax planning very financially enticing. Using upstream tax planning as a case study, this analysis advocates that Congress enact a general anti-abuse rule that vests the Treasury Department with broad administrative authority to promulgate anti-abuse regulations whenever the agency perceives a tax-compliance problem. The grant of such administrative authority combined with its utilization would yield a vast improvement over the status quo: it would safeguard the nation’s coffers in a faster and more timely manner; enhance and invigorate taxpayer compliance; and, where necessary, strongly hue the Code to being more standard-based rather than rule-based in nature.