Walking a Fine Line: A Theory of Line Drawing in Tax Law

In many contexts, tax law grants favorable tax treatment to transactions
of one type and adverse treatment to transactions of another type. The task
of tax authorities is to draw lines in legally gray areas to distinguish
between economically similar transactions that should receive different
treatment. Despite tax law's propensity for line drawing, the manner in
which tax authorities draw legal lines has received little attention. This
article aims to fill this gap by providing guidance to tax authorities on how
to select the best line-drawing instrument in a given situation. First, the
article demonstrates that tax authorities employ four different line-drawing
instruments: rulemaking, adjudication, private letter rulings, and licensing.
Second, the article develops a theory of line drawing in tax law, which
identifies three criteria by which tax authorities should choose line-drawing
instruments: the ideal policy, the effect on taxpayers, and the effect on tax
authorities. Finally, the article applies this theory of line drawing to explain
line-drawing instruments currently in use.