Administering Facts-And-Circumstances-Based Tax Tests

Abstract

Oftentimes, the appropriate tax treatment of a transaction or event depends on a holistic analysis of relevant facts and circumstances. Facts-and-circumstances-based tests are challenging to administer because they are challenging to enforce and because they address challenging topics on which to provide useful administrative guidance. When a taxpayer claims tax treatment that depends on application of such a test, the IRS cannot determine whether the taxpayer's claimed position is correct without knowing the relevant facts and circumstances. Yet, often, taxpayers are not required to disclose the relevant facts and circumstances when filing a tax return, making enforcement difficult. Likewise, providing administrative guidance on facts-and-circumstances-based tests is daunting. If the IRS provides concrete examples of the application of such a test, there is a risk the concrete examples will mislead taxpayers. Taxpayers may come away with the impression that the concrete examples illustrate universal rules, which is not the case given the facts-and-circumstances-based nature of the test. If the IRS steers away from offering concrete examples, however, taxpayers will face uncertainty when attempting to determine their tax treatment. This Article proposes a new, two-fold approach to administering facts-and-circumstances-based tests. First, lawmakers ought to require more detailed, standardized disclosure from taxpayers who claim tax positions based upon certain facts-and-circumstances-based tests. Second, when offering examples that illustrate the likely application of such tests, the IRS should steer taxpayers towards claiming the likely outcome but also supplying the relevant disclosure in case the taxpayer's facts warrant departure from the likely outcome. Making facts-and-circumstances-based tests more administrable aligns with the IRS's recent pledge to focus additional auditing resources on taxpayers with higher incomes.

Keywords: tax administration, tax disclosure, tax guidance