Use of Judicial Doctrines in Federal Tax Cases Decided by Trial Courts, 1993-2006: A Quantitative Assessment

Abstract

This paper examines the use of judicial doctrines in federal tax trial controversies. Despite a taxpayer's strict compliance with the terms of a statute, a judge may still justify deciding for the government by applying a judicial doctrine. The common wisdom, derived from traditional tax scholarship about these doctrines, is that the doctrines are raised only by the government or the court and can only favor decisions in behalf of the government. A taxpayer may argue that the form of a transaction be set aside in limited circumstances such as fraud, so negating form is a one way street, available only to the government. The literature does not contain any empirical research. The five most common judicial doctrines, which were analyzed, are: business purpose, economic substance, sham transaction, step transaction, and substance over form. The hypothesis of this article is that the common wisdom is incorrect. A database was created for this article and consists of those federal trial decisions rendered by the district court, the Tax Court, and the Court of Federal Claims between 1993 and 2006 in which one or more of the doctrines were raised. Data was culled from on-line sources for these cases and for the accompanying briefs, if they were available. The evidence sustains the hypothesis. Judicial doctrines were raised in a much richer manner than the common wisdom would suggest. Among the results gleaned from the data are: -All three parties raised doctrines, the court more than the government or the taxpayer. The taxpayer raised doctrines half as much as the government, suggesting the taxpayer's active interest in judicial doctrines. The court's predominant role in raising doctrines appears to have occurred because litigants made more focused arguments, depending upon more specific authorities in their briefs, such as cases or legislative history. -All three parties raised doctrines, expecting that they would be applied, but the taxpayer argued much more frequently than the court or government that a doctrine it had raised should not be applied. -Three doctrines could be raised by the taxpayer to its advantage - economic substance, step transaction and substance over form - but the other two could be raised only to benefit the government - business purpose and sham transaction. The litigants, however, did not raise doctrine in a manner resonant with this model. -The areas of tax law in which doctrines were raised were inconsistent with traditional observations about the areas in which they should have been raised. -Despite the absolute nature of the one way rule, it was largely ignored when the taxpayer raised a doctrine. -Doctrines' use in the database could be associated with specific causes. More generally, a party's argument that the doctrine that it had raised be applied in behalf of a specific litigant was predictive of the doctrine being applied in that litigant's behalf. More specifically, and quite robustly, the taxpayer's prevailing in a doctrine's application was associated with use of substance over form and the government's prevailing was associated with the use of the business purpose doctrine. In addition to the paper's presentation of its result, it underscores the gap between traditional legal scholarship and empirical research. As this paper illustrates, more quantitative analysis can and needs to be done, in law and especially in tax.