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Careful / Close / Extra / Heightened / Rigid / Special / Strict Scrutiny For Related Party Transactions


Courts typically scrutinize transactions between related parties. They will often use different descriptions for the type of scrutiny that they are applying. For example, some courts will say that they are applying “careful” scrutiny, while others will indicate “close” or “extra” scrutiny. Other descriptions include: “heightened,” “rigid,” “special,” or “strict” scrutiny. These terms seem to be used interchangeably. Below are excerpts from some tax cases using these terms.

Beretta v. Commr., T.C. Memo 1997-570:

Courts apply strict scrutiny to transactions between related parties to prevent the shifting of income into lower tax brackets.

Joseph Radtke, S.C. v. U.S., 712 F. Supp. 143 (E.D. Wis. 1989), aff’d 895 F.2d 1196, 1197 (7th Cir. 1990) (per curiam):

Transactions between a closely held corporation and its principals, who may have multiple relationships with the corporation, are subject to particularly careful scrutiny.

K & K Veterinary Supply Inc. v. Commr., T.C. Memo 2013-84:

Special scrutiny is given in situations where a corporation is controlled by the employees to whom the compensation is paid because there is a lack of arm’s-length bargaining.

Kelley v. Commr., 63 T.C. 321 (1974):

We are not unmindful of the elementary proposition of tax law that family transactions are subject to rigid scrutiny.

Merck & Co., Inc. v. U.S., 652 F.3d 475 (3d Cir. 2011):

* * * transactions between related parties merit extra scrutiny.

Spicer Accounting, Inc. v. U.S., 918 F.2d 90 (9th Cir. 1990):

Taxpayer’s burden of proof in characterizing these payments as dividends rather than compensation is heavy, as salary arrangements between closely held corporations and its shareholders warrant close scrutiny.

Scott Singer Installations, Inc. v. Commr., T.C. Memo 2016-161:

Transfers to closely held corporations by controlling shareholders are subject to heightened scrutiny * * *.

Weaver v. Commr., 121 T.C. 14 (2003):

* * * we carefully scrutinize transactions between related parties * * *.

Trombetta v. Commr., T.C. Memo 2013-234:

* * * intrafamily transfers are subject to heightened scrutiny.

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