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Contracting in Anticipation of Tax Reform—Can a Tax Transaction Really Be Rescinded?

Tax reform is on the horizon. It’s in the press every day, but until US Congress can get together and make a final decision, it’s all conjecture. So what can taxpayers do to prepare for the inevitable? One idea is to enter into a transaction now with the expectation that certain tax provisions will be enacted, and if those tax provisions are not enacted by December 31, 2021, unwind the transaction as if nothing ever happened—the proverbial tax “do-over,” “mulligan,” or “oopsie.” There is basis for this strategy under the doctrine of rescission.

A transaction rescission occurs when all parties agree to void the transaction as if nothing occurred. (Think of the parties physically ripping up the formal, executed contracts.) This may sound a bit silly, but if the parties can enter into a transaction, why shouldn’t they be able to decide to void it?

The doctrine of rescission is well-entrenched in the law and finds its roots in contract law, but it can also be applicable (and effective) in tax law. While the doctrine of rescission is nowhere to be found in the Internal Revenue Code or the Treasury Regulations, case law ensures taxpayers that the doctrine is available in a tax context. (See: e.g., Penn v. Robertson, 115 F.2d 167 (4th Cir. 1940).)

Likewise, in Revenue Ruling 80-58, the Internal Revenue Service (IRS) endorsed the doctrine of rescission, and the facts in that ruling demonstrate the boundaries of the doctrine. In February 1978, A (a calendar year taxpayer) sold a tract of land to B and received cash for the entire purchase price. The contract of sale obligated A, at the request of B, to accept reconveyance of the land from B if at any time within nine months of the date of sale B was unable to have the land rezoned for B‘s business purposes. If there was a reconveyance under the contract, A and B would be placed in the same positions they were prior to the sale. The IRS ruled that “the original sale is to be disregarded for federal income tax purposes because the rescission extinguished any taxable income for that year with regard to that transaction.” There are numerous private letter rulings that provide additional examples of the IRS’s approval of the doctrine of rescission.

Importantly, the doctrine of rescission as applicable to tax issues is governed by the “annual accounting concept.” This concept pervades tax law and measures behavior for tax purposes based upon the tax year of the taxpayer. As the Supreme Court of the United States held, each taxable year is a separate unit for tax accounting purposes. (See: Security Flour Mills Co. v. Comm’r, 321 U.S. 281 (1944).) So the idea is if a taxpayer enters into a transaction and the transaction is voided before the end of the year, for tax purposes, it’s as if the transaction never occurred.

So, if any taxpayers are thinking about engaging in a transaction they may want to rescind later, there are at least two considerations to the strategy:

  • The rescission (in whatever form achieved) must put the parties back in the same positions they had prior to contracting

  • The rescission must occur in the same tax year as to when the transaction was entered

Practice Point: Whether the doctrine of rescission is applicable to a transaction is a highly factual question. We recommend anyone considering this strategy to thoroughly analyze the issue and facts and consult with a tax professional.

© 2022 McDermott Will & EmeryNational Law Review, Volume XI, Number 302
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About this Author

Andrew R. Roberson tax attorney McDermott Will. Andy handles tax cases in Federal court, United States Tax Court
Partner

Andrew R. Roberson is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Chicago office.  Andy specializes in tax controversy and litigation matters, and has been involved in over 30 matters at all levels of the Federal court system, including the United States Tax Court, several US Courts of Appeal and the Supreme Court. 

Andy also represents clients, including participants in the CAP program, before the Internal Revenue Service Examination Division and Appeals Office, and has been successful in settling...

312-984-2732
Kevin Spencer, McDermott Will & Emery LLP , Tax Litigation Attorney
Partner

Kevin Spencer focuses his practice on tax controversy issues. Kevin represents clients in complicated tax disputes in court and before the Internal Revenue Service (IRS) at the IRS Appeals and Examination divisions.

 

In addition to his tax controversy practice, Kevin has broad experience advising clients on various tax issues, including tax accounting, employment and reasonable compensation, civil and criminal tax penalties, IRS procedures, reportable transactions and tax shelters, renewable energy, state and local tax, and private client matters. After earning his Master of...

202-756-8203
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