PROTECTIVE TAX ELECTIONS

Abstract

            In many instances, taxpayers can select among various available tax outcomes by simply filing (or not filing) a tax election. Oftentimes, taxpayers file tax elections on a protective basis. When a taxpayer believes that filing an election may not be necessary but files it just in case, the taxpayer files a “protective tax election.” While existing academic literature explores various aspects of tax elections, the filing of tax elections on a protective basis has not been addressed. This Article begins to fill that gap.

            In some circumstances, the tax outcome that follows from making a protective tax election is not necessarily what the taxpayer intends to claim. A taxpayer might plan to claim a given tax outcome but be wary of a risk that the claim will fail. The taxpayer files a protective tax election to opt for the taxpayer’s second choice. In other words, the taxpayer uses the election to ensure that, if the taxpayer’s intended claim does fail, the alternative tax treatment imposed upon the taxpayer is more favorable than what would befall the taxpayer in the absence of the protective tax election. This Article adopts the phrase “Favorable Fallback Protective Tax Elections” to refer to protective tax elections filed under these circumstances.

            The policy implications of Favorable Fallback Protective Tax Elections are numerous. The policy disadvantages of such elections include their potential to trap unwary taxpayers as well as their propensity for encouraging well-advised taxpayers to take more aggressive reporting positions. One policy advantage of such elections is the possibility that they may encourage taxpayers to reveal useful information to the IRS.

            This Article explores the various uses of protective tax elections, assesses their policy advantages and disadvantages, and recommends ways to amplify their advantages and mitigate their disadvantages.