On November 9, 2022, the U.S. Tax Court dealt a powerful blow to the IRS’s ongoing attacks on charitable deductions related to syndicated conservation easements. In Green Valley Investors, LLC, et al. v. Comm’r, 159 T.C. No. 5, a ruling supported 15-2 by the Court’s judges struck down IRS Notice 2017-10, in which the IRS identified these transactions as “listed transactions” under Treas. Reg. § 1.6011-4(b)(2), as violating the Administrative Procedure Act (APA). 5 U.S.C. §§ 551-559, 701-706. In consolidated cases, the Court ruled that the IRS violated APA’s notice and comment requirements when it issued Notice 2017-10 on December 23, 2016. The opinion will likely have ripple effects beyond syndicated conservation easements, moreover, because the Court held that the IRS may not identify any “listed transaction” without prior notice and comment under the APA.
Notice 2017-10 purported to identify syndicated conservation easements as “listed transactions” under Treas. Reg. § 1.6011-4(b)(2), i.e., transactions that are “the same or substantially similar” to a transaction that the IRS has “determined to be a tax avoidance transaction and identified by notice, regulation, or other form of published guidance as a listed transaction.” (A “listed transaction” is a form of “reportable transaction,” i.e., a transaction identified “as having a potential for tax avoidance or evasion.” Id. § (b)(1).)
Under Treas. Reg. § 1.6011-4(a), taxpayers must disclose on Form 8886, Reportable Transaction Disclosure Statement, their participation in any reportable transaction and are considered to have participated in a listed transaction if their return reflects tax consequences or a tax strategy described in published guidance as a listed transaction. Id. § (c)(3)(i)(A). Unlike most tax forms, Form 8886 requires narrative descriptions of a taxpayer’s conduct that are not related to the computation of tax. The form is also not only attached to a tax return but is also sent to the Office of Tax Shelter Analysis. Treas. Reg. § 1.6011-4(e)(1).
IRC § 6707A(c)(1) & (2) delegates to the IRS the authority to require a report or statement identifying a “reportable transaction.” The question in Green Valley was whether Notice 2017-10 was authorized under this delegation, and the Tax Court held resoundingly that it was not. The IRS sought summary judgment on its imposition of penalties, including the reportable transaction penalty under IRC § 6662A, which applies to an item attributable to any “listed transaction.” This penalty is 20 percent of the amount of “reportable transaction understatement amount,” increased to 30% if the disclosure requirements of Treas. Reg. § 1.6011-4 are not met. This penalty may apply whether or not there is a tax deficiency since the starting point for calculating the “reportable transaction understatement amount” is not the amount of tax owed. IRC § 6662A(b)(1)(A)(i)
The Court noted that if Notice 2017-10 was merely an “interpretative rule “that advises the public of the IRS’s construction of the statutes it administers,” as the IRS contended,” the IRS would not have been required to comply with the APA’s notice and comment requirements. If, on the other hand, as the Court held, Notice 2017-10 was instead a “legislative rule” that has the effect of law, it was invalid because the IRS failed to comply with these APA requirements.
In a ruling that will extend to “listed transactions” beyond syndicated conservation easements, the Court wrote that: “The act of identifying a listed transaction by the IRS, by its very nature, is the creation of a substantive (i.e., legislative) rule and not merely an interpretative rule.” The Court explained:
Identifying a transaction as a listed transaction does not merely provide the IRS’s interpretation of the law or remind taxpayers of preexisting duties. Rather … identifying a transaction as a listed transaction imposes new duties in the form of reporting obligations and recordkeeping requirements on both taxpayers and their advisors. Notice 2017 exposes these individuals to additional reporting obligations and penalties to which they would not otherwise be exposed but for the notice.
Without the IRS identifying the transaction as a listed transaction, no such reporting obligations exist.
The APA provides a three-step procedure for “notice and comment rulemaking” under which agencies are required (1) to issue a general notice of proposed rulemaking, (2) allow interested persons an opportunity to participate, and (3) include in the final rule a “concise general statement of [its] basis and purpose.” 5 U.S.C. § 553(c). The Court noted that IRC § 6707A contains no express indication from Congress exempting it from the APA’s notice and comment rulemaking. Nor does IRC § 6011, referenced in § 6707A, and on which Treas. Reg. 6011-4 is based. The Court was not persuaded that Congress understood the reference to a “notice” determining a tax avoidance transaction in the language of Treas. Reg. § 1.6011-4 as a “clearly defined procedure for identifying listed transactions separate from traditional SPA procedures, particularly when Congress’s statutory text in no way authorizes such a course.”
The Court, therefore, determined summary adjudication was appropriate in the petitioner’s favor, setting aside Notice 2017-10 (and doing so “to the benefit of all similarly situated taxpayers who come before us”) and prohibiting imposition of section 6662A penalties against the syndicates in the consolidated cases before it.
The Tax Court’s reasoning joins that of a recent decision of the Sixth Circuit in Mann Construction, Inc. v. U.S., 27 F.4th 1138 (2022), where the court voided an IRS notice regarding potentially abusive benefit trust arrangements as violating the APA.