Frictions as a constraint on tax planning

The government often uses narrow tax reforms to target specific planning strategies. Sometimes the targeted transaction is stopped. But in other cases, taxpayers press on, tweaking the deal just enough to sidestep the reform. The difference often lies in transaction costs, financial accounting, and other "frictions,which are constraints on tax planning external to the tax law. This Article contributes a methodology for determining whether frictions will block end runs, and illustrates the effect of frictions by comparing the constructive sale rule of section 1259 with the constructive ownership rule of section 1260. These reforms use the same statutory language to target tax motivated derivatives transactions, but taxpayers have responded differently. Theoretically, taxpayers can avoid either rule through relatively modest changes in economic return. Although the strategy is common for section 1259, however, it is rarely used for section 1260 because securities dealers cannot supply the necessary derivative. Thus, if a friction blocks a transaction, the tax law does not have to block it, too. More attention to frictions is warranted, and legal academics should offer greater assistance. Without a grounding in frictions, narrow reforms are unlikely to play a constructive role.