In connection with plans for minimizing taxes, it should be noted that there is nothing improper or immoral in reducing or avoiding taxes by lawful means. No apology is necessary for any legally acceptable plan that will enable you to minimize state and federal taxes. As long as the transaction is bona fide, as long as it is neither fraudulent nor fictitious, the mere fact that it reduces income tax or estate tax liability is neither illegal nor unethical.
Tax Evasion v. Tax Avoidance
The terms "avoidance" and "evasion" are words of art under federal tax law. Avoidance involves the legitimate and legally permissible choice of methods of arranging a taxpayer's affairs, all methods being bona fide and legal, but some of which will eliminate or reduce certain tax liabilities. Evasion involves the use of colorable, fictitious or concealed transactions to reduce taxes, and implies fraud, deceit and sham.
As the renowned Judge Learned Hand once stated:
Over and over again courts have said that there is nothing sinister in so arranging one's affairs as to keep taxes as low as possible.Everybody does so, rich and poor; and all do right, for nobody owes any public duty to pay more than the law demands; taxes are enforced exactions, not voluntary contributions. To demand more in the name of morals is mere cant" [Comm'r. v. Newman, 159 F.2d 848 (2nd Cir. 1947) (dissenting opinion at 850)].
A later opinion of the United States Court of Appeals, Sixth Circuit (citing three Supreme Court decisions), stated:
The general principle is well settled that a taxpayer has the legal right to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits...and that the taxpayer's motive to avoid taxation will not establish liability if the transaction does not do so without it" [Chamberlin v. Comm'r, 207F.2d 462, 468 (6th Cir. 1953), citing, e.g., Gregory v. Helvering, 293U.S. 465 (1935)].
Substance v. Form
Taxpayers may properly structure any legitimate transaction in order to save taxes, provided that the transaction is in fact what it appears to be in form. As stated by the United States Supreme Court:
The incidence of taxation depends upon the substance of a transaction... To permit the true nature of a transaction to be disguised by mere formalities, which exist solely to alter tax liabilities, wouldseriously impair the effective administration of the tax policies of Congress" [Comm'r v. Court Holding Co., 324 U.S. 331 (1945)].
The necessity for this rule is clear if tax laws are to be administered fairly, and the rule must be adhered to in the process of minimizing the impact of federal income, estate and gift taxes. This doctrine of "substance-over-form" must always be borne in mind by tax planners when tempted to structure transactions in a form, solely for tax purposes, which does not accord with the true economic substance of the matter at hand. Literal compliance with tax statutes may not insulate transactions against challenge. The IRS is able to recharacterize the form of a transaction to reflect its true economic substance.