Sometimes a situation occurs when individuals and businesses complete a transaction or series of transactions, and inform their tax advisor after the fact. Then, when the advisor crunches the numbers, he/she determines that the seemingly benign transaction triggers a substantial amount of income tax. In fact, the size of the tax bill causes the taxpayer to question the economics of the transaction. Can anything be done to unwind this deal?
In the past, advisors were able to run this by the IRS through the process of a private letter ruling; however, the IRS no longer issues private letter rulings on these types of transactions. [Rev. Proc. 2016-3, Sec 3.02(8)]. Fortunately, thanks to the rescission doctrine that originated 75 years ago in a court case involving contract law, and the merits of that case were later used by the IRS in drafting Revenue Ruling 80-58, advisors can pretend that the transaction never happened. Rescission is a mechanism whereby parties agree to undo a contractual arrangement.
The IRS generally respects a rescission for tax purposes if:
- the original transaction and the rescission take place in the same taxable year
- the rescission is carried out by the original parties to the transaction
- the parties are restored to the positions they had before executing the agreement within the same taxable year as the original transaction
A rescission may be accomplished by mutual agreement of the parties, by one of the parties declaring a rescission of the contract without the consent of the other if sufficient grounds exist, or by applying to the court for a decree of rescission. However, we recommend you consult with your attorney and enter into a written rescission agreement with the buyer to properly document your intention to rescind the transaction.
Again, in order to be valid, the rescission must be completed in the same tax year in which the transaction took place. Consult with your attorney who will need to formulate the terms of the rescission agreement. Once the agreement has been drafted, review it together with your attorney and tax advisor to ensure that it meets the requirements set by the IRS. It’s not every day that taxpayers are allowed to pretend something didn’t happen.
If you have questions regarding rescission, and the rules surrounding this concept, please contact Andy Bertke by calling 859.344.6400, or have a member of the Barnes Dennig team contact you here.