Recent litigation has focused on the “relevancy” threshold embedded in §7701(o)(1) when determining if a transaction should be analyzed for lacking economic substance. The determination of whether the economic substance doctrine is “relevant” to a transaction follows common law economic substance doctrine principles that have evolved for over more than 90 years. (See §7701(o)(5)(C), which states that determining if the economic substance doctrine is relevant to a transaction is “made in the same manner as if this subsection had never been enacted.”)
Now let’s turn our attention to the recent litigation. In the Tax Court’s first case since the codification of economic substance concept, Patel v. Commissioner, 165 TC No. 10 (2025), the Tax Court held that Congress “could hardly have been clearer” that §7701(o)(1) requires courts to first determine whether the economic substance doctrine is “relevant” before proceeding to the two-part test in §7701(o)(1)(A) and (B) to determine (a) if the transaction changed the taxpayer’s economic position in a meaningful way and (b) that the taxpayer had a substantial non-tax purpose for entering into the transaction. (In Patel, the Tax Court found the economic substance doctrine to be relevant to the transaction because of a prior court case that was on point.) The holding in Patel is inconsistent with the majority decision in the Tenth Circuit case of Liberty Global v. United States, 174 F.4d 1208 (10th Cir. 2026), which applied a broader approach and held that the relevancy requirement is “coextensive with the two-part test.” (Note that a strong dissent was issued in Liberty Global where the view of the dissenting judge is that the economic substance doctrine cannot be used to “rescue Congress” from a gap in the relevant statute and only applies when the relevant Code provision makes economic reality or taxpayer motive relevant, not when the taxpayer follows mechanical rules such as timing, reorganizations, and entity classification.)
This brings us to Harty v. Commissioner, Dkt. No. 19159-23 (Dec. 4, 2023), a case currently pending in the Tax Court that may further shape the contours of the economic substance doctrine. The facts involve a transaction that utilizes a deferral of income by using the §453 installment method combined with an integrated borrowing transaction, which is considered abusive by the IRS. The taxpayer and the IRS are now sparring over the application of “relevancy,” with the IRS asserting that the relevancy inquiry “is designed to sort real transactions from fabricated ones,” and with the Hartys contending that §7701(o) is not relevant to timing provisions permitted by the Code (such as §453), and that “Congress deliberately chose to permit taxpayers who sell property on deferred-payment terms to recognize gain as payments are received rather than entirely in the year of sale.” The case has sparked several amicus curia briefs that urge the Tax Court to provide more clarity with respect to when the “relevancy” requirement is satisfied.
How Judge Kerrigan and the Tax Court ultimately decide this case has tax practitioners on the edge of their seats. We will be discussing the codification of the economic substance doctrine and the Patel and Liberty Global cases at this year’s Forum program.
Register for our fall programs – in-person, virtual, and self-study!
The best flow-through tax planning and training programs are now better than ever. Our flagship program, Tax Planning Forum®, is available in both in-person (Las Vegas and Orlando) and virtual formats. Fundamentals of Flow-Through® offers even more flexibility with in-person, virtual, and QAS self-study options. Register now and get the training you need in the format that best fits your learning style and your schedule.