Tax Court Invalidates Notice Identifying Conservation Easements as Listed Transactions

(Parker Tax Publishing December 2022)

The Tax Court held that Notice 2017-10, which identifies certain syndicated conservation easements as listed transactions, was improperly issued because the IRS did not follow the notice-and-comment requirements under the Administrative Procedure Act (APA). The court rejected the IRS's argument that Congress intended to exempt the IRS from the APA procedures when it enacted Code Sec. 6707A(c)(2), which imposes reportable transaction penalties and delegates authority to the IRS to determine which transactions are reportable transactions. Green Valley Investors, LLC, et al, v. Comm'r, 159 T.C. No. 5 (2022).

Background

Green Valley Investors, LLC (Green Valley), Big Hill Partners, LLC (Big Hill), Tick Creek Holdings, LLC (Tick Creek), and Vista Hill Investments, LLC (Vista Hill) each granted a conservation easement to Triangle Land Conservancy (TLC). Green Valley deducted $22,559,000 for its charitable easement contribution to TLC for the tax year 2014. Similarly, Big Hill and Tick Creek deducted contributions of charitable easements of $22,626,000 and $22,605,000, respectively. Vista Hill deducted $22,498,000 on its Form 1065 for its charitable easement contribution for tax year 2015.

The IRS conducted examinations of Green Valley's, Vista Hill's, Big Hill's, and Tick Creek's respective Forms 1065. By notices of final partnership administrative adjustment (FPAA), the IRS disallowed the claimed deductions because the LLCs (1) did not establish that the deductions met all requirements pursuant to Code Sec. 170 and (2) failed to establish that the values of the property interests contributed exceeded zero. In addition, each FPAA asserted various penalties, including the reportable transaction penalty under Code Sec. 6662A. Green Valley, Big Hill, Tick Creek, and Vista Hill petitioned the Tax Court challenging the FPAAs. The Tax Court consolidated the cases.

In Code Sec. 6011(a), Congress tasked the IRS with determining "by regulations" how taxpayers are to "make a return or statement" and the information they must provide to the IRS. Under Code Sec. 6707A, Congress likewise delegated authority to determine which transactions are reportable transactions as having "a potential for tax avoidance" or that are "the same as, or substantially similar to" a transaction deemed a tax avoidance transaction.

In 2004, Congress enacted Code Sec. 6662A as part of the American Jobs Creation Act of 2004 (AJCA). Code Sec. 6662A(a) provides that if a taxpayer has a "reportable transaction understatement" for any tax year, a penalty equal to 20 percent of the amount of the understatement will be applied. Under Code Sec. 6662A(c), the penalty is increased to 30 percent of the amount of the understatement if the disclosure requirements of Code Sec. 6664(d)(3)(A), which requires disclosure in accordance with the regulations prescribed under Code Sec. 6011, are not met. Code Sec. 6662A penalties apply to any item which is attributable to any "listed transaction" under Code Sec. 6662A(b)(2)(A).

In 2003, before the enactment of the AJCA, the IRS issued regulations under Code Sec. 6011, including Reg. Sec. 1.6011-4(b)(2) which defines the term "listed transaction" to include those types of transactions which the IRS has determined to be tax avoidance transactions and identified by notice, regulation, or other form of published guidance.

Notice 2017-10 purports to carry out the delegation of authority provided in Code Sec. 6707A. Notice 2017-10 identifies all syndicated conservation easement transactions beginning January 1, 2010, including all substantially similar transactions, as "listed transactions" (which are one type of reportable transaction) for purposes of Reg. Sec. 1.6011-4(b)(2). Under the notice, taxpayers who have entered into these transactions must disclose the transaction on Form 8886, Reportable Transaction Disclosure Statement. In addition, Notice 2017-10 requires material advisors to syndicated conservation easement transactions to file a Form 8918, Material Advisor Disclosure Statement, to disclose their involvement in the transaction. Material advisors must also maintain records and copies of written materials relating to the transaction.

In a motion for summary judgment, the partnerships argued that the IRS could not impose Code Sec. 6662A penalties because the IRS failed to comply with the notice-and-comment rulemaking procedures of the Administrative Procedure Act (APA) when issuing Notice 2017-10. The IRS responded that (1) Notice 2017-10 is an interpretative rather than a legislative rule, and thus exempt from the notice-and-comment requirement; and (2) even if Notice 2017-10 were a legislative rule, Congress authorized its issuance by procedure other than the notice-and comment requirements under the APA.

According to the IRS, Congress clearly exempted it from following the APA's normal procedures when it enacted Code Sec. 6707A. The IRS reasoned that Reg. Sec. 1.6011-4(b)(2), which was issued before the enactment of Code Sec. 6707A, defined a listed transaction as one "identified by notice, regulation, or other form of published guidance." This regulation, the IRS contended, apprised Congress that it would operate outside of the APA by issuing future notices (such as Notice 2017-10) without notice and comment. The IRS further maintained that when Congress defined "reportable transaction" in Code Sec. 6707A(c)(1), it incorporated the procedure set forth in Reg. Sec. 1.6011-4. The IRS contended that the phrase "as determined under regulations prescribed under section 6011" in Code Sec. 6707A refers to Reg. Sec. 1.6011-4 and implicitly blesses all processes contained therein, including the IRS's noncompliance with notice-and-comment rulemaking.

Analysis

In a divided opinion, a majority of the Tax Court held that Notice 2017-10 is a legislative rule that was improperly issued by the IRS without notice and comment as required under the APA. The court therefore set aside Notice 2017-10 and prohibited the imposition of Code Sec. 6662A penalties on the partnerships.

In the court's view, Notice 2017-10 is a legislative rule because it imposes new duties on both taxpayers and their advisors in the form of reporting obligations and recordkeeping requirements. Further, the court found that Notice 2017-10 exposes these individuals to penalties to which they would not otherwise be exposed but for the notice. The court quoted from the Sixth Circuit's opinion in Mann Construction, Inc. v. U.S., 2022 PTC 63 (6th Cir. 2022) (in which the Sixth Circuit invalidated Notice 2007-83), which said that creating new substantive duties and exposing taxpayers to penalties for noncompliance "are hallmarks of a legislative, not an interpretive, rule."

Next, the court found that Congress did not clearly exempt the IRS from following the APA's normal procedures when it enacted Code Sec. 6707A. The court noted that in 5 U.S.C. Section 559, the APA limits the ability of a subsequent statute to modify or supersede its procedures "except to the extent that it does so expressly." Code Sec. 6707A, the court observed, offers no express indication from Congress exempting the IRS from the standard notice and comment procedures. The court found that Code Sec. 6111 is also silent on any express congressional intent. Thus, the court rejected the IRS's attempt to "fill the void left by Congress" by arguing that Congress incorporated the definition of reportable transaction in Reg. Sec. 1.6011-4(b)(2) in Code Sec. 6707A. The court said that it was not confident that Congress understood the IRS's reference to the term "notice" in Reg. Sec. 1.6011-4 was a clearly defined procedure for identifying listed transactions separate from traditional APA procedures, particularly since Congress's statutory text in no way authorizes such a course. The court said that to the contrary, Congress operates under the expectation that administrative agencies respect their APA obligations except when Congress expressly chooses different procedures.

The court found that even if it were to look to the phrase "regulations prescribed under section 6011" in conjunction with Reg. Sec. 1.6011-4, the IRS's argument would fare no better. This was because Reg. Sec. 1.6011-4, in the court's view, is concerned not with setting up processes but rather with naming categories of transactions subject to IRS reporting requirements. The court acknowledged that Congress understood that the IRS had identified listed transactions before the enactment of the AJCA, and that the AJCA was intended to strengthen the efficacy of the IRS's disclosure framework already in place. However, the court said that it could not accept the enactment of the AJCA as Congress's blanket approval of the IRS's method of identifying a syndicated conservation easement as a listed transaction in Notice 2017-10 without notice and comment.

Observation: In separate dissenting opinions, two judges argued that Congress was aware of the IRS's rulemaking in this area when it enacted the AJCA and that Congress ratified the existing procedures for identifying these transactions without strict adherence to the APA's notice-and-comment requirements.

For a discussion of disclosures of reportable transactions, see Parker Tax ¶250,140.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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