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.