Academic journal article Journal of Accountancy

Rescinding Transactions

Academic journal article Journal of Accountancy

Rescinding Transactions

Article excerpt

Fixing ill-advised or unsuccessful dealings.

CPAs often are asked to "fix" (or, at the very least, lessen) the tax effects of improperly thought-out or ill-advised sales, exchanges or elections. While they are certainly not able to remedy all the mistakes their clients make, there are some situations when they can be instrumental in helping clients rescind transactions and avoid potentially negative consequences.

RESCISSION

Legally, rescission refers to the canceling or voiding of a contract, with the legal effect of releasing the contracting parties from further obligations to each other and of restoring them to the relative positions they would have occupied had no contract been made. A rescission of a contract may be made by mutual agreement of the parties, by one of the parties without the consent of

the other party (if sufficient grounds exist) or by applying to a court for a decree of rescission.

Under certain circumstances, a taxpayer can ask the IRS to ignore a transaction and rescind his or her actions; if the IRS agrees, the transaction or election will be treated as having never occurred.

Two conditions must be satisfied for a rescission to be available. First, the parties to the transaction must be returned to the status quo; that is, both the buyer and the seller must be put back to their original legal and financial positions. Note that a taxpayer doing all in his or her power to restore both parties to their original positions will not meet this requirement if the parties are not restored completely to those original positions.

Second, the restoration must be completed in the tax year of the transaction. This requirement is based on Internal Revenue Code section 451, which provides that a taxpayer must determine his or her income as of the close of the current tax year without regard to subsequent events. Thus, if a transaction occurs in one year and a restoration occurs in the following year--or if conditions prevent a full settlement from occurring in the same year as the original transaction--a valid rescission will not have occurred. …

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