In a recent full Tax Court opinion[1], the Tax Court set aside Notice 2017-10, holding IRC § 6662A penalties are not to be imposed upon the taxpayer.[2] The Court’s reasoning was that the IRS failed to properly follow the notice-and-comment procedure, required under the Administrative Procedure Act. On December 23, 2016, the IRS issued Notice 2017-10 (“Notice”). The Notice identified all syndicated conservation easement transactions, beginning January 1, 2010, including any substantially similar transactions, as “listed transaction” for the purposes of Treas. Reg. § 1.6011-4(b)(2). For the unfamiliar, the Notice resulted in a tremendous amount of additional compliance for participants of the described transactions as well as immense penalties for failure to comply. Since issuance of the Notice, penalties have been imposed on quite a few unfortunate taxpayers, leading to a deluge of litigation of the subject. With each new case, taxpayers and material advisors are growing more attentive as to the future of the Notice 2017-10.
Effect of the Notice
The Notice brought with it multiple duties, and penalties for instances of non-compliance. From a taxpayer perspective, taxpayers suddenly become obligated to undertake additional disclosure requirements. Specifically, Notice 2017-10 required taxpayers to make the appropriate disclosure on Form 8886 on the taxpayer’s tax return as well as filing such disclosure with the Office of Tax Shelter Analysis (“OTSA”).[3] The Notice required the disclosure and retention of a tremendous amount of information, much of which may not be readily accessible to taxpayers participating in syndicated structures.
Still looking through the lens of the taxpayer, failure to properly disclose, or to not adequately disclose as determined by the IRS, carried stiff penalties. The penalty in the case at hand was the enhanced accuracy penalty under IRC § 6662A, providing an accuracy related penalty of 20% of an understatement of tax relating to a reportable transaction understatement. In the event the transaction is not disclosed, the amount increases to 30%. Beyond the accuracy related penalty, there are also additional penalties for failing to disclose. Specifically, this is the penalty under IRC § 6707A, providing for the greater of $10,000 ($5,000 in the case of an individual) or 75% of the decrease in tax attributable to the reportable transaction, up to a $200,000 maximum.
From the perspective of a material advisor[4], things are not much better. Material advisors are required to report to the OTSA at the end of the quarter following the quarter in which they become a material advisor.[5] Additionally, material advisors are required to keep a substantial amount of information in the form of material advisor lists with respect to the transaction.[6]
The penalties for a material advisor’s failure to comply with reporting requirements are incredibly onerous. For failing to report to the OTSA as a material advisor with respect to a listed transaction, there is a penalty equal to the greater of (1) $200,000 and (2) 50-75% (pending whether failure to report was intentional) of the gross income derived by such person with respect to the aid or assistance given with respect to the reportable transaction.[7] With respect to failure to furnish a material advisor list, the penalty can be assessed at an amount equal to $10,000 per day. It is also worth mentioning that many states require reporting as well with such reporting requirements hinging on the classification of a transaction being a reportable transaction.
Facts
At issue in the case at hand are four qualified conservation contributions made pursuant to IRC § 170(h). Three of these occurred in the 2014 tax year, one in 2015. Following disallowance, the IRS sought to assess penalties under IRC § 6662A. While the battle of the disallowance is still at play, the opinion focused on the IRC § 6662A penalty.
Procedural History
The opinion is the Tax Court’s ruling on the parties’ motions for partial summary judgment as to the assessment and applicability of the penalty sought to be imposed under IRC § 6662A. While the remainder of the case is still before the Court, the matter of whether the IRC § 6662A penalty applied and the validity of the Notice were adjudicated by the Tax Court in a full Tax Court opinion (i.e. not a non-precedential memorandum opinion).
Relevant Cases Leading to Decision[8]
Many practitioners likely saw something along the lines of this ruling coming. I, however, did not expect such coming from the Tax Court as it did. Instead, I expected a ruling from a Federal District Court or an Appellate Court directly addressing Notice 2017-10. There have been a few recent cases, including Mann Construction, Inc. v. U.S.[9] and CIC Services, LLC v. Comm’r[10], addressing the validity of other Notice issuances by the IRS designating certain transactions as transactions of interest (other reportable transactions) or listed transactions.
In Mann Construction, the United States Federal District Court for the Eastern District of Michigan held that Congress authorized the IRS to promulgate Notice 2007-83 without the requirement of having to first provide notice and comment under the Administrative Procedure Act. Ultimately the Sixth Circuit overturned the ruling, holding the opposite.
In CIC Services, LLC, the Federal District Court for the Eastern District of Tennessee granted a preliminary injunction in favor of the taxpayer, finding that the taxpayer was likely to prevail on its challenge of a sister notice to Notice 2017-10, Notice 2016-66, the designation of IRC § 831(b) micro-captives as transactions of interest for reasons similar to Mann Construction.
IRS Arguments
The government argued that (1) the Notice was an interpretive rule rather than a legislative rule, and (2) even if the Notice were a legislative rule, Congress authorized its issuance by procedure other than the notice-and-comment requirements under the Administrative Procedure Act.
Holding
The Tax Court ultimately held that Notice 2017-10 was invalid with respect to the taxpayer.[11] Specifically, the Tax Court held that the Notice was a legislative rule. The Court analyzed the difference between an interpretive and legislative rule and drew a particularly distinguishable line between the two. Citing to Mann Construction, “Creating new substantive duties and exposing taxpayers to penalties for non-compliance ‘are hallmarks of a legislative, not an interpretive rule.’” Thus, with a duty to disclose and penalties for non-compliance, the Court held strongly that the Notice was indeed a legislative rule, arriving virtually the same conclusion reached in both Mann Construction, Inc. and CIC Services, LLC. While legislative rules can be adopted, the Administrative Procedure Act requires notice-and-comment, which did not occur in the case of the Notice.
The Court found the government’s arguments unavailing, noting that to circumvent the Administrative Procedure Act there had to be either a good cause exception invoked or the statute with respect to which the rule related had to expressly override the notice-and-comment requirement. The Court held that neither such exception applied in this case.
Impact of Ruling to Reportable Transaction Regime
The holding in this case, in tandem with those in Mann Construction, Inc. and CIC Services, LLC, can have a massive impact on the IRS’ ability to streamline its efforts to curtail certain transactions it feels ought be more heavily scrutinized. Put in easier to digest terms (in my own words) the “TBD transactions” (i.e. listed transaction and transactions of interest – designated by notice) are on the chopping block. The Service is no longer able to, at a whim, designate certain transactions it feels it does not like. Instead, the Service will be required to follow the appropriate notice-and-comment procedure. In my eyes, this does not mean the Service will be hamstrung in its ability to scrutinize these transactions. Instead, it is required to comply with a mere procedural hurdle which it should be able to easily overcome but also provides the public with an opportunity to participate rather than making such designations the sole providence of the IRS. While the ultimate effect of this ruling beyond just current invalidation of the Notice is mostly unknown, this is not a complete win for syndicated conservation. The IRS could still list, adhering to notice-and-comment requirements.
[1] It is worth noting here that a full Tax Court opinion, as opposed to a memorandum opinion, is binding precedential authority in the Tax Court.
[2] Green Valley Investors, LLC v. Comm’r, 159 T.C. No. 5 (Nov. 9, 2022). See also FN 22.
[3] S Treas. Reg. § 1.6011-4(d),(e).
[4] A material advisor is any person who provides any material aid, assistance, or advice with respect to organizing, managing, promoting, selling, implementing, insuring, or carrying out any reportable transaction and who directly or indirectly derives gross income in excess of the threshold amount (or such other amount as may be prescribed by the Secretary) for such aid, assistance, or advice. See IRC § 6111(b)(1).
[5] IRC § 6111(a).
[6] IRC § 6112.
[7] IRC § 6707(b)(2).
[8] See also Joshua W. Sage, J.D., LL.M., Injunctive Relief Hiding in Plain Sight? CIC Services, LLC v. IRS, Edmondson Sage Allen, PLLC (Oct. 1, 2021) and A. Parker Durham, J.D., LL.M., Notice 2017-10’s Demise May be Imminent: Current Litigation Involving the Controversial IRS Rule, Edmondson Sage Allen, PLLC (Nov. 9, 2022).
[9] Mann Constr., Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022).
[10] CIC Services, LLC v. IRS, 2022 WL 985619 (E.D. Tenn. 2022).
[11] Per FN 22 in the Opinion, the Tax Court intends to apply a similar ruling to other similarly situation taxpayers petitioning the Court.
