In 2001 Emilio Rodriguez was born and suffered some sort of tortuous injury for which he recovered over $400,000. Meanwhile his parents bought a small house but could not keep up the mortgage payments. His guardian, an accountant with 25 years experience and 12 employees, conceived a plan to pay off the mortgage using Emilio's money this way: (1) Emilio's money paid off the mortgage; (2) Emilio's parents conveyed the house to the guardian in his private capacity; (3) the guardian conveyed the house to himself as guardian. Presumably, Emilio (now age 8) lived in the house with his parents.
The reason for the convoluted plan was that the $8,000 first time home buyer's credit was not available for sales between related parties. The 25 year veteran accountant thought the insertion of his "purchase" from the parents would insulate Emilio from the charge that Emilio had bought the house from his parents. Also, shortly after these events the law was changed to establish a minimum age of 18 for a credit.
Evidently, Emilio owed no taxes but could claim the $8,000 credit. So the guardian filed a late return for 2008 claiming the credit, which would be non refundable. The IRS denied the credit and assessed a late filing penalty of $29.70. So the credit and the penalty were the issues on appeal.
The Special Trial Judge ruled that Emilio bought the house from his parents and was not entitled to the first time home buyer's credit under the statute.
Rather than simply stating that there was no credible evidence that the guardian was doing anything other than serving as a conduit between Emilio and his parents, the special trial court judge managed to invoke the economic substance doctrine and cite three Supreme Court opinions (including Gregory v. Helvering, a corporate reorganization statutory construction case), along with numerous lower court opinions.
The accountant did not claim to have paid any of his own money for the house. The only money that moved was Emilio's. The transaction could be characterized as involving steps, which the opinion did. It also could be characterized as not having the substance as a matter of economics of the accountant buying the house and reselling it. But it has nothing do with the "economic substance doctrine" as recently codified by congress, unless the Tax Court wants to turn every $29.70 dispute into a (major) federal case.
Perhaps the IRS examines every nonrefundable credit claim very carefully. But it is likely that the late filing of the return caused it to be more closely examined. The transaction at issue occurred in 2009, less than 12 months before the effective date of section 7701(o). For those who have been thinking that the new statute is year's off in being effective, think again.