The IRS in Announcement 2022-28[1] explained the reasons why it issued proposed regulations[2] involving certain syndicated conservation easement cases.

Administrative Procedures Act

The IRS took this action due to two recent losses in Court cases regarding the method the IRS used to add listed transactions under §6707A(c)(2) that would incur the penalties found in IRC §6707A(b) if such transactions were not properly disclosed on a taxpayer’s tax return.  IRC §6707A(c)(2) provides the following:

(2) Listed transaction. The term "listed transaction" means a reportable transaction which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of section 6011.

The penalty in this case, 75% of the reduction in tax claimed due to the transaction, subject to a maximum penalty of $200,000 (or $100,000 for a natural person) per return, is strictly based on the failure to disclose such a transaction properly, Thus, even if the taxpayer later prevails in an IRS challenge to obtain the tax benefit, the penalty would still need to be paid.

In the cases of Mann Construction Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022)[3] and Green Valley Investors LLC v. Commissioner, 159 T.C. No. 5 (2022)[4] the courts ruled that the IRS had not properly added two transactions to the list of listed transactions, thus holding that the penalty under §6707A(c) did not apply in those two cases even though the taxpayers had failed to disclose the transactions.

The Courts each found that the IRS had violated 5 USC §553, part of the Administrative Procedures Act.  That provision provides:

5 USC §553 Rule making

(a) This section applies, according to the provisions thereof, except to the extent that there is involved—

(1) a military or foreign affairs function of the United States; or

(2) a matter relating to agency management or personnel or to public property, loans, grants, benefits, or contracts.

(b) General notice of proposed rule making shall be published in the Federal Register, unless persons subject thereto are named and either personally served or otherwise have actual notice thereof in accordance with law. The notice shall include—

(1) a statement of the time, place, and nature of public rule making proceedings;

(2) reference to the legal authority under which the rule is proposed; and

(3) either the terms or substance of the proposed rule or a description of the subjects and issues involved.

Except when notice or hearing is required by statute, this subsection does not apply—

(A) to interpretative rules, general statements of policy, or rules of agency organization, procedure, or practice; or

(B) when the agency for good cause finds (and incorporates the finding and a brief statement of reasons therefor in the rules issued) that notice and public procedure thereon are impracticable, unnecessary, or contrary to the public interest.

(c) After notice required by this section, the agency shall give interested persons an opportunity to participate in the rule making through submission of written data, views, or arguments with or without opportunity for oral presentation. After consideration of the relevant matter presented, the agency shall incorporate in the rules adopted a concise general statement of their basis and purpose. When rules are required by statute to be made on the record after opportunity for an agency hearing, sections 556 and 557 of this title apply instead of this subsection.

(d) The required publication or service of a substantive rule shall be made not less than 30 days before its effective date, except—

(1) a substantive rule which grants or recognizes an exemption or relieves a restriction;

(2) interpretative rules and statements of policy; or

(3) as otherwise provided by the agency for good cause found and published with the rule.

(e) Each agency shall give an interested person the right to petition for the issuance, amendment, or repeal of a rule.

In both cases the courts found that identifying a transaction as a listed transaction was a rule covered by this section, rejecting the IRS’s view that either Congress had specifically exempted IRC §6707A(c)(2) actions from the APA by the language of the statute or this was a mere interpretative rule.

Notice 2017-10, dealing with syndicated conservation easements, was the topic of the Tax Court’s Green Valley Investors decision.  The IRS, despite still disputing the holdings of both courts, made the decision to go through a formal notice and comment process to add back the syndicated conservation easement transactions to the listed transaction list even if IRS in unable to convince other courts that Notice 2017-10 did add properly these transactions to the listed transaction list.

IRS Notice Procedures for Listed Transactions

The Announcement begins by noting that more than 30 listed transactions have been added since 2000 under Reg. §1.6011-4.

Since 2000, the Internal Revenue Service (IRS) has identified over 30 “listed transactions” — transactions that the IRS has determined to be abusive tax avoidance transactions within the meaning of § 1.6011-4(b)(2) of the Income Tax Regulations — by publishing a notice or other subregulatory guidance as provided in § 1.6011-4.[5]

The Announcement makes clear that the IRS disagrees with the courts’ rulings:

The Department of the Treasury (Treasury Department) and the IRS disagree with the Tax Court’s decision in Green Valley and the Sixth Circuit’s decision in Mann Construction, and are continuing to defend the validity of existing listing notices in circuits other than the Sixth Circuit.[6]

But the IRS has decided, while still contesting the view that the APA must be followed in this case, to start adding the listed transactions back into the law via the formal regulatory path:

At the same time, however, to eliminate any confusion and to ensure that these decisions do not disrupt the IRS’s ongoing efforts to combat abusive tax shelters throughout the nation, the Treasury Department and the IRS are today issuing proposed regulations to identify certain syndicated conservation easement transactions as listed transactions. The Treasury Department and the IRS intend to finalize these regulations, after due consideration of public comments, in 2023 and intend to issue proposed regulations identifying additional listed transactions in the near future.[7]

Congress Enacted IRC §6707A After Reg. §1.6011-4 Had Been Adopted

The Announcement notes that after the IRS had adopted Reg. §1.6011-4, Congress added IRC §6707A to the Code via the American Jobs Creation Act:

Following the promulgation of § 1.6011-4, Congress passed the American Jobs Creation Act (AJCA), which included section 6707A of the Code. Section 6707A imposes penalties on any person who fails to disclose participation in a reportable transaction, including a listed transaction. Consistent with the regulation, that statute defines a “reportable transaction” as “any transaction with respect to which information is required to be included with a return or statement because, as determined under regulations prescribed under section 6011, such transaction is of a type which the Secretary determines as having a potential for tax avoidance or evasion;” and a “listed transaction” as “a reportable transaction which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of section 6011.”[8]

IRS Position: These Remain Listed Transactions

The Announcement notes that while the IRS still takes the position that their actions were proper (and thus these remain listed transactions), they note that the Sixth Circuit decision can’t be ignored by the IRS for taxpayers subject to that Circuit’s jurisdiction:

The Treasury Department and the IRS continue to take the position that listed transactions can be identified by notice or other subregulatory guidance and that the APA’s notice-and-comment procedure does not apply to identification of such transactions. The Treasury Department and the IRS disagree with the Tax Court’s decision in Green Valley and the Sixth Circuit’s decision in Mann Construction and continue to defend the validity of existing listing notices in litigation. The Treasury Department and the IRS recognize, however, that Mann Construction is controlling law in the Sixth Circuit, and the IRS has ceased enforcing disclosure and list maintenance requirements with respect to Notice 2017-10 in the Sixth Circuit.[9]

Not stated, but implied by the paragraph, is that the IRS is likely going to continue to assert the penalties outside the Sixth Circuit.  While the published Tax Court decision means the IRS will not prevail should the taxpayer take the case to that venue (which seems likely to happen), the IRS likely will be looking to find a case to take to another Court of Appeals to look to create a split in the decisions of the Circuits.

Thus, those who reside outside the Sixth Circuit are taking more than zero level of risk by failing to report these transactions should the IRS prevail in their Circuit.  For this particular penalty there’s additional jeopardy, since the law provides that a listed transaction penalty is not subject to being rescinded by the IRS[10] and would not be subject to judicial appeal.[11] Thus, should the IRS ultimately prevail (not likely given two rulings against them, but still possible), the agency may argue it’s required to collect the penalty from any taxpayers outside the Sixth Circuit who failed to file disclosures following these cases.

The current cases succeeded because the taxpayers were able to persuade the Court that these weren’t listed transactions, thus working around the bar on judicial appeal of a penalty imposed on an actual listed transaction.

Problems Even in the Sixth Circuit if Valid Regulation Makes This a Listed Transaction

The IRS decided to add some saber rattling language to the announcement, noting that even if the Notice procedure is found to be an improper way to add a listed transaction, if the transaction is validly added after a notice and comment period the law will require reporting of the transaction within 90 days of it becoming listed with regard to any return for which the statute is open at the date it becomes listed:

Taxpayers should take note that, if a transaction becomes a listed transaction after a taxpayer files a return reflecting the tax effects of the transaction, § 1.6011-4(e)(2)(i) requires the participant to file a disclosure statement with OTSA within 90 days of the transaction becoming a listed transaction if the assessment limitations period remains open for any taxable year in which the taxpayer participated in the listed transaction. Accordingly, any taxpayer, including taxpayers who reside in the Sixth Circuit, who has participated in a transaction in any year for which the assessment limitation period remains open when the regulation identifying the transaction as a listed transaction is finalized will have an obligation to disclose the transaction. Failure to disclose will subject the taxpayer to the penalty under section 6707A. Participants required to disclose listed transactions who fail to do so are also subject to an extended period of limitations under section 6501(c)(10). That section provides that the time for assessment of any tax with respect to the transaction will not expire before the date that is one year after the earlier of the date the participant discloses the transaction or the date a material advisor discloses the participation pursuant to a written request under section 6112(b)(1)(A).[12]

There will also be impacts on material advisers of the finalization of the regulation:

Likewise, if a regulation identifying a transaction as a listed transaction is finalized after the occurrence of the events described in § 301.6111-3(b)(4)(i) of the Procedure and Administration Regulations, a material advisor will be treated as becoming a material advisor on the date the regulation is finalized pursuant to § 301.6111-3(b)(4)(iii) (if not deemed a material advisor earlier pursuant to a valid listing notice). A material advisor is required to file a Form 8918 by the last day of the month following the quarter in which the advisor became a material advisor with respect to the listed transaction. See § 301.6111-3(d) and (e).

In addition, a material advisor must maintain a list identifying each person with respect to whom the advisor acted as a material advisor with respect to a listed transaction, if the person advised by the material advisor entered into the listed transaction within six years before the transaction was identified as a listed transaction. See § 301.6112-1(b)(2).[13]

Quirky Nature of IRC §6707A and Impact of the Rulings

Advisers should note that the rulings only find that the transactions were not ones that had to be reported under IRC §6707A because the IRS had not properly adopted these rules per the requirements of the Administrative Procedure Act. 

It is important to note what was not decided:

• Neither Court ruled that these transactions are not ones of a type that could be added to the listed transaction list. Only after the IRS went through a proper notice and comment period and adopted the same rule would there be consideration of whether that resulting regulation is or isn’t valid.  The IRS clearly is betting that even if the court opinions are not overturned, the regulatory process will eventually put the list right back where it was before Mann Construction and Green Valley.

• Neither Court dealt with the merits (or lack of merits) of the underlying transactions, as that issue is not relevant with regard to the disclosure penalty under IRC §6707A. An absolutely meritless transaction would nevertheless fail to be a listed transaction under the rulings in question should they have been added to the list by the use of subregulatory Notices.

Both are important to note, since there is existing caselaw on the merits of similar transactions that advisers will need to consider before advising a client that such a transaction is one for which the adviser would be able to sign the tax return.

As well, some advisers are using these losses to bring into question every piece of IRS guidance issued via a subregulatory process, implying that such tax positions at odds with such guidance would gain the tax advantage claimed by the taxpayer.  That likely is overreaching for a couple of reasons.

First, the APA clearly allows the IRS to skip the comment period if the guidance is merely interpretative. The decisions in these cases take care to show why selecting specific transactions to add to the list goes beyond mere interpretation.

Second, this particular statute is one that gives each transaction a binary state—it either is on the list or it isn’t.  In other cases, even if the IRS guidance was found to be invalid, the taxpayer would still need to show that the tax benefits weren’t denied by the language of the statute. In this case, an invalid addition to the list would automatically mean the penalty would not apply.

Few statutes only apply to situations that the IRS has added to something like the listed transaction list.  Rather, most often the IRS is looking to outline the positions that are and aren’t acceptable based on statute that does not itself require any such IRS action before it could be applied against taxpayers.

It is true that the courts have become more likely to look at compliance with the Administrative Procedures Act and that it’s very possible more IRS guidance will be struck down for failure to comply with it.  But it does not flow from such a result that a court would have to find a transaction at odds with that not validly issued guidance would automatically gain the claimed tax benefits—at that point the taxpayer must be able to justify the result based on the law enacted by Congress.

[1] Announcement 2022-28, December 6, 2022, https://www.taxnotes.com/research/federal/irs-guidance/announcements/irs-explains-need-for-proposed-regs-listing-easement-transactions/7ffp7 (retrieved December 7, 2022)

[2] REG-106134-22, Proposed Reg. §1.6011-9, December 6, 2022, https://www.taxnotes.com/research/federal/proposed-regulations/proposed-regs-require-reporting-of-conservation-easement-deals/7ffp5 (retrieved December 7, 2022)

[3] Mann Construction Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022), March 3, 2022, https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/sixth-circuit-holds-irs-didn%e2%80%99t-comply-with-apa-in-issuing/7d7r1 (retrieved December 7, 2022)

[4] Green Valley Investors LLC v. Commissioner, 159 T.C. No. 5 (2022), November 9, 2022, https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/tax-court-holds-notice-in-conservation-easement-cases-is-invalid/7fcg2 (retrieved December 7, 2022)

[5] Announcement 2022-28, December 6, 2022

[6] Announcement 2022-28, December 6, 2022

[7] Announcement 2022-28, December 6, 2022

[8] Announcement 2022-28, December 6, 2022

[9] Announcement 2022-28, December 6, 2022

[10] IRC §6707A(d)(1)(A)

[11] IRC §6707A(d)(2)

[12] Announcement 2022-28, December 6, 2022

[13] Announcement 2022-28, December 6, 2022