The Case for Reviewing Debt/Equity Determinations for Abuse of Discretion

Abstract

For at least thirty-eight years, the circuit courts of appeals have been split over the proper standard of review for a trial court's distinc tion of debt from equity.1 Whether a financial disbursement counts as debt or equity is material to the tax treatment it receives. Underlying this split are two central disagreements. One is academic?whether the debt/equity distinction is ultimately a legal or factual determina tion. The other is practical?whether deferential or independent re view will strike the right balance between decisionmaking accuracy and costs. Courts commonly consider three options for standard of review: clearly erroneous, abuse of discretion, and de novo. But on this issue, the circuits are split four ways, with different circuits advocating for the three principal standards as well as a hybrid utilizing both clearly erroneous and de novo review. The inquiry is complex and dynamic, and clear resolution is needed.2 Courts of appeals have been resolving debt/equity cases for over fifty years. But the dust has not yet settled?just last year the Third Circuit formally adopted its position, joining the majority of circuits in classifying the question as factual and the review as for