Tax Court in Reviewed Opinion Invalidates Notice Identifying Reportable Transactions (11/10/22)

In Green Valley Investors, LLC v. Commissioner, 159 T.C. 80 (2022) (reviewed opinion), TCPamphlet here,, TN here and GS here, the Court held that Notice 2017-10, 2017-4 I.R.B. 544 was invalid because the Notice is a legislative rule improperly issued by the IRS without notice and comment. As a result, the Court “set aside” the Notice and prohibited the imposition of § 6662A (here) accuracy-related penalties for understatements for reportable transactions identified in the Notice. The case turns upon the application of the APA requirement that legislative rules be promulgated as notice-and-comment regulations except for contemporaneous “good cause” statement or congressional exception to the notice-and-comment, neither of which the Court found to apply.

In high level overview, the question was whether the IRS must identify transactions subject to the penalty in a regulation (either Final or Temporary (interim final)) or could identify transactions in a Notice which is subregulatory guidance. The statute referred to transactions identified in regulations under § 6011. The regulations under 6011 defined reportable transaction as a transaction that is the same or substantially similar to one of the types of transactions that the IRS has determined to be tax avoidance transactions and identified by notice, regulation, or other form of published guidance. Reg. § 1.6011-4(b)(2).

The Court reasoned that the Notice which clearly was not a regulation did not meet the statutory command that the transaction be identified in a regulation. Although it included a lot more words and reasons, that is the guts of the holding. As a result, the Court invalidated the application of the penalty in the case and stated (p. 24 n. 22): “Although this decision and subsequent order are applicable only to petitioner, the Court intends to apply this decision setting aside Notice 2017-10 to the benefit of all similarly situated taxpayers who come before us.” 

This holding is a big deal. Syndicated conservation easements as they have been reported in many cases are clearly the type of abusive transactions that Congress intended the penalty to apply once the IRS identified them. The Court held that the IRS improperly identified these transactions by subregulatory guidance rather than by regulation, a procedural footfault. A lot of people clearly abusing the system will escape penalties clearly meant to apply to them and that would have applied except that the Court held that  the IRS promulgated the rule in a procedurally incorrect way.

The starting point in that analysis was an APA issue: was the rule "legislative" or not? (See Slip Op. 8-15.)  Although the Court spent considerable words analyzing that issue, I think the reason it is a legislative rule boils down to the clear fact that the identification of reportable transactions imposes a new obligation–reporting for the identified transactions–that was not simply an interpretation of the words of the statute. I think the Court got it right in holding that it was a legislative rule. The concurring and dissenting opinions agree with the legislative rule conclusion. (As I analyze it, since the statute could not identify the transactions which, perforce must be identified episodically in the future by the IRS, Congress had to grant the IRS legislative rulemaking authority to identify the transactions; hence the Notice was a legislative rule; but see by contrast my comment 2 below regarding the Tax Court's and court's erroneous analysis in other cases of the legislative/interpretive distinction.)

Legislative rules must be promulgated by notice-and-comment regulation unless (i) excepted by a "good cause" statement which was not made here or (ii) otherwise exempted by statute. The latter was the focus of much of the discussion in the opinions. The question was whether, in enacting the penalty scheme, Congress meant to approve identifying transactions by Notice. If Congress had, then the next question is whether its method of doing so (by implication rather than expressly) violated the APA command in § 559 that exceptions to the APA requirements “expressly” stated. The opinions, as have the cases and scholarly comment over the years, thrash around about that issue. As I understand it, the § 559 requirement is interpreted to mean that, although there are no “magical passwords,” Congress somehow expressed an intent (perhaps clear intent) in subsequent legislation, to provide a different procedure than specified in the APA. And then, there is even the question of whether earlier legislation (here the APA) can limit how a subsequent Congress must act in providing an “exception.”  (I provide some references in my comments below.)  Suffice it to say that the Court and the concurring judges did not see anything in the § 6672A penalty scheme and regulations that excepted it from the normal APA requirement that legislative rules be adopted by regulation.

There will be much scholarly comment on the Green Valley opinions that will almost certainly go beyond what I provide here. I will try to amend the blog entry from time to time to post the ones I think particularly good as an addendum at the end of this blog entry.

JAT Comments:

1. The IRS could have done the same thing by Temporary or interim-final regulation with a "good cause" statement for immediate effect. The problem, of course, was that the IRS thought it had authority to do so by Notice. And that 'good cause" fix only applies in future, thus, if Green Valley stands, relieving past bad actors from the penalty under the now disapproved Notice procedure.

2. The resolution really does not implicate the legislative / interpretive regulation distinction that has been the subject of many Federal Tax Procedure blogs. The focus of those blogs, in major part, addressed regulations that interpret statutory text (rather than create new rules not within the interpretive scope of the statute); I argue that those regulations are interpretive rather than legislative. See The Report of the Death of the Interpretive Regulation Is an Exaggeration  (SSRN December 14, 2021), here. For example, in Altera Corp. v. Commissioner, 145 T.C. 91 (2015), ), rev’d 926 F.3d 1061 (9th Cir. 2019), reh. en banc den. 941 F.3d 1200 (9th Cir. 2019), cert. denied, 591 U.S. ___, 141 S.Ct. 131 (2020), the Tax Court concluded erroneously that the regulations interpreting § 482 were legislative even though they only interpreted the statute. See e.g., Ninth Circuit Reverses Unanimous Tax Court in Altera (Federal Tax Procedure Blog 6/7/19; 6/20/19; 7/2/19), here (at Comment 2); and More Thoughts on APA and Legislative and Interpretive Regulations Inspired by Recent Cases (Federal Tax Procedure Blog 4/8/21; 4/11/21), here. Many courts and scholars seem to continue that fuzzy notion which is the whole point of my article.

3. On the “expressly” APA “requirement” in § 559 for exceptions in subsequent legislation, see my foregoing article pp. 55-56, n. 223, where I discuss the “magical passwords” issue and cite to the following series of relatively recent blog entries:  Bernard Bell, Dead-Hand Control and “Magical Passwords”: Center for Investigative Reporting v. DOJ (Part I-III) (Yale J. Reg.: Notice & Comment 7/27/29, 8/2/21 and 8/20/21), links Part I, here, Part II, here, and Part III, here.

4. The opinions do not address the alternative analysis I offered in a prior blog. Sixth Circuit Invalidates Notice Identifying Listed Transaction Requiring Reporting and Potential Penalties (Federal Tax Procedure Blog 3/3/22), here, at paragraph 2 in the blog.  The analysis is that the reference to § 6011 is a reference to a legislative authority delegation to the Treasury. Treasury, arguably, acted on that authority in Reg § 1.6011-4 permitting identification by notice. While that would not be the type of express exception discussed in the opinions and paragraph 3 above, it might count for something in the mix. 

ADDENDA FOR OTHER TREATMENTS OF GREEN VALLEY

• Leslie Book, Tax Court Hands IRS Major Defeat In Its Battle Against Conservation Easement Transactions (Procedurally Taxing Blog 11/10/22), here. (Les cites a Tax Notes article by Kristen Parillo as doing "a bang-up job summarizing [$] and placing the opinions and dissents in that context."  I do not have a subscription to Tax Notes so can't comment.