A "step-transaction" is a transaction in which various components or steps in the process or matter are consolidated or condensed to arrive at a different single integrated transaction. The theory underlying this doctrine is that a taxpayer, for example, should not be able to arbitrarily break a single transaction into separate parts and achieve a better result simply becuase of the form of the steps, rather than based on the substance of what has really occurred. For example, Dad gifts $12,000 to each of his nephews and each of his children and grandchildren. Dad does this to take advantage of the annual gift tax exclusion. This is the tax benefit of being able to make gifts without incurring a gift tax or using your lifetime gift exemption. After these gifts are made the nephews give te $12,000 they each got to Dad's children. If the two steps the transaction are collapsed, gift to nephew followed by a pre-arranged gift to children, Dad will be subject to gift tax. The gifts to the nephews were not really a separate transaction or independent gift when the two legs of the transaction are collapsed. The step transaction doctrine can be advanced by the IRS in many different types of transactions. For example, if a parent gives assets to a grantor retained annuity trust (GRAT -- see separate definition) and the children who are remainder beneficiaires of te GRAT immediately sell their remainder interests in the GRAT to a dynasty trust, the IRS may argue that the step transaction doctrine should be applied and the two step collapsed to reveal the substance of the parent having made a gift to the dynasty trust. The step transaction doctrine can be applied in corporate and business tax situations, personal income tax matters and estate planning techniques.
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