The Danielson Rule and The Substance-Over-Form Doctrine

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A recent Tax Court decision turned on the so-called Danielson rule–a case that takes its name from the eponymous case of Commissioner v. Danielson, 378 F.2d 771, 775 (3d Cir. 1967).  The court’s decision discussed the contours of the rule, which governs a taxpayer’s invocation of the substance-over-form doctrine.  A summary of the key aspects of the case follows:


Watts v. Comm’r, T.C. Memo. 2020-143 | October 15, 2020 | Nega, J. | Docket Nos. 18882-13, 19973-13

Short Summary: On remand from the 11th Circuit, the Court re-examined whether the loss on petitioners’ interests in a partnership were capital losses.  Specifically, the Tax Court analyzed whether the Danielson rule should be applied.  The Court determined that it did.

Key Issues: Whether the Danielson rule applies in a scenario where parties to a transaction expressly agree to a characterization of a transaction in a particular form or intentionally structure a transaction in a particular form for tax purposes, and it is intended to prevent any party from unduly enriching itself by claiming a unilateral alteration of the agreed-upon consequences after the consummation of the transaction?

Primary Holdings:

Key Points of Law:

Insight: Watts reinforces the application of the Danielson rule, which states that a taxpayer cannot argue substance over form for a transaction where the agreement for a transaction unambiguously indicates how the transaction should be treated for tax purposes. If a taxpayer intends to argue that the Danielson does not apply (and where the agreement is unambiguous), the taxpayer will need to provide evidence demonstrating that the agreement is unenforceable due to mistake, undue influence, fraud, or duress.

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