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December 21, 2022 At Court

The APA and Reportable Transactions: Notice 2017-10 and Green Valley Investors

David J. Slenn

The Administrative Procedures Act (APA) continues to be a distraction for the IRS as it maintains its aggressive offensive against abusive tax transactions. In  Green Valley Investors v. Commissioner, the Tax Court held Notice 2017-10 (making certain syndicated conservation easements listed transactions) was improperly issued and set the Notice aside. By doing so, the Tax Court joins the Sixth Circuit in finding procedural defects with the way the IRS designated listed transactions and transactions of interest. Specifically, the courts are holding that Notices identifying these types of reportable transactions are “legislative” rules. These legislative rules trigger APA rulemaking requirements that—according to the Tax Court and Sixth Circuit—Congress did not intend to override when it enacted the American Jobs Creation Act and Sections 6707A, 6662A and 6501(c)(10). Consequently, the courts are finding the IRS was required to provide notice and an opportunity for public comment prior to designating a category transaction (listed or “transaction of interest”) as reportable. This has caused some to question whether they should report their participation in certain transactions.

The APA and Reportable Transactions

The IRS’s reportable transaction penalty woes recently started with the Supreme Court’s decision in CIC Services, LLC v. IRS, where the Supreme Court upheld a material advisor’s right to challenge Notice 2016-66 (making certain micro-captives transactions of interest). Shortly thereafter, the Sixth Circuit in Mann Construction, Inc. v. United States found Notice 2007-83 (making certain transactions using trust arrangements involving cash value life insurance policies listed transactions) improperly issued for lack of APA compliance.

Once a transaction becomes reportable, certain parties are required to report their participation in the transaction. Failure to report a transaction can result in penalties. In Green Valley, the penalties at stake were those imposed under Section 6662A. Under 6662A, if a taxpayer has a “reportable transaction understatement” for any taxable year, a penalty of 20% applies to the understatement. The penalty is increased from 20% to 30% if the transaction was not disclosed. In CIC Services, the advisors successfully challenged their reporting obligations as material advisors to certain micro-captive transactions. Material advisors who fail to provide a required list are subject to a list maintenance penalty under Section 6708, which is in addition to any other penalties. CIC subsequently obtained an injunction prohibiting the IRS from enforcing the disclosure requirements set forth in Notice 2016-66.

Disregarding Disclosure Requirements Due to APA Non-compliance

With the flurry of rulings finding identification of certain transactions as reportable improperly determined, some might consider not reporting those particular transactions. If the IRS cannot enforce the penalty for certain reportable transactions, why file? Before deciding not to file, one must consider whether the reporting form protects against the imposition of another penalty, the cost-benefit analysis associated with contesting the reporting requirement given the IRS’s announcement that it intends to continue the fight, and the IRS’s strategy to deal with the APA “speedbump” via proposed regulations.

Protection from Other Penalties

Chief Counsel Advice was recently issued wherein Chief Counsel acknowledged that Form 8886 should obviate the necessity of filing Form 8275 or 8275-R.

Therefore, where Form 8886 is timely filed with a return or a qualified amended return and provides a complete description of the relevant facts of a noneconomic substance transaction, taxpayers have a strong argument that they have adequately informed the IRS of the transaction consistent with the requirements of section 6662(i).

This means that Form 8886 could protect a client from the imposition of a penalty under Section 6662(i). Although there is scant case law involving this penalty, the recent surge of docketed cases involving syndicated conservation easements and micro-captives could result in this penalty’s case law development.

Cost to Challenge Versus Cost to Report

Whereas the cost to prepare Form 8886 for procedurally defective reportable transactions might seem bothersome, one must consider that the IRS may seek to enforce compliance outside the Sixth Circuit. The cost to challenge the IRS would be far more expensive than preparing the form, especially if the forum to challenge the IRS excludes the potentially more cost-efficient Tax Court. In another case the court explained the limits of Tax Court jurisdiction over the section 6707 penalties.

Here respondent issued a deficiency notice, which is a condition precedent to Tax Court jurisdiction. The notice, however, did not determine the section 6707A penalties. Respondent assessed penalties based on his determinations that petitioners failed to report a listed transaction as required by section 6011. Sec. 6707A(a). The section 6707A penalty is not within our deficiency jurisdiction. See sec. 7442. Respondent may therefore assess and collect the penalty without issuing a deficiency notice. We accordingly conclude that we lack jurisdiction to redetermine the section 6707A penalties and shall grant respondent’s motion to dismiss and to strike as to the section 6707A penalties.

The IRS May Cure the Procedural Defect

Even if Congress did not intend to override APA compliance by allowing the IRS to identify reportable transactions by issuing Notices, the IRS may amend the Treasury Regulations to satisfy the required notice and comment rulemaking requirement. Green Valley appeared to be the final straw, as the IRS has now taken this approach with respect to the transaction identified in Notice 2017-10 (involving certain syndicated conservation easements). On December 8, 2022, the IRS announced it would not seek to enforce Notice 2017-10 in the Sixth Circuit. On that same day, IRS and Treasury also issued proposed regulations to provide notice of proposed rulemaking and of a public hearing. In its issuance of the proposed regulation (which amends section 1.6011 of the regulations by adding section 1.6011-9), the IRS explained why it was taking such steps, pointing to Mann Construction, GBX Associates (also in the Sixth Circuit) and Green Valley.

In the explanation for the proposed regulation (as well as in Announcement 2022-28), the IRS and Treasury express disagreement with the Sixth Circuit and the Tax Court. In so doing, the government warns taxpayers that the IRS will take a two-pronged attack by amending the regulation as well as continuing its enforcement measures in other Circuits.

The Treasury Department and the IRS disagree with the Sixth Circuit’s decision in Mann Construction and the Tax Court’s decision in Green Valley and are continuing to defend the validity of Notice 2017-10 and other notices identifying transactions as listed transactions in circuits other than the Sixth Circuit. At the same time, however, to eliminate any confusion and ensure consistent enforcement of the tax laws throughout the nation, the Treasury Department and the IRS are issuing these proposed regulations to identify certain syndicated conservation easement transactions as listed transactions for purposes of all relevant provisions of the Code and Treasury Regulations.

Even if other Circuits agree with the Sixth Circuit and the Tax Court, the IRS informs taxpayers that they may be required to file a disclosure statement sometime later due to the proposed regulation.

In addition, taxpayers, including taxpayers in the Sixth Circuit, who have filed a tax return reflecting their participation in a syndicated conservation easement transaction before the final regulations are published and who have not disclosed the transaction pursuant to Notice 2017-10 will be required to file a disclosure statement within 90 calendar days after the date on which the final regulations are published if the period of limitations for assessment for any taxable year in which the taxpayer participated in the transaction remains open. Material advisors also have disclosure and list maintenance obligations with respect to such transactions.

In this scenario, one must consider whether the information required for the disclosure will be more readily available now versus at a later date when information may be lost or more difficult to obtain if a transaction promoter (who might assist with preparation of the disclosure form) is no longer in business.

Of course, amending the regulations takes time, and one can expect a large number of public comments, especially from promoters. The IRS must be careful not to ignore “significant” comments as failure to do so could result in yet another procedural defect that could cause substantive problems down the road. For example, in the Hewitt case, the court invalidated a regulation dating from the 1980s.

Thus, the issue before us is whether Treasury’s failure to respond to NYLC’s and the other commenters’ concerns about the extinguishment proceeds regulation was in violation of the procedural requirements of the APA. … After careful consideration of the agency record before us, the several opinions in Oakbrook and precedent from the Supreme Court, and this Court’s interpretation of procedural validity under the APA, we conclude that §1.170A-14(g)(6)(ii)—as read by the Commissioner to prohibit subtracting the value of post-donation improvements to the easement property from the proceeds allocated to the donor and donee in the event of judicial extinguishment—is arbitrary and capricious under the APA for failing to comply with the APA’s procedural requirements and is thus invalid. See §§ 553(c), 706(2)(A).

Bottom Line

Although disclosing participation in a reportable transaction might be time consuming and costly, there are other factors to consider that might justify reporting. For many, the mere fact that a transaction attracts intense IRS scrutiny is reason enough to terminate participation and put the transaction behind them. For those in this process, filing final disclosure forms may provide peace of mind and a sense of finality that might be much quicker and cheaper to obtain now versus pursuant to the proposed regulation that acts retroactively as to open years.

    David J. Slenn

    Akerman LLP, Naples and Tampa, FL

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