Sixth Circuit Invalidates Notice Identifying Listed Transaction Requiring Reporting and Potential Penalties (3/3/22)

In Mann Construction, Inc. v. United States, 27 F.4th 1138 (6th Cir. 3/3/22) CA6 here and GS here, the Sixth Circuit panel held invalid IRS Notice 2007-83, 2007-2 C.B. 960, entitled “Abusive Trust Arrangements Utilizing Cash Value Life Insurance Policies Purportedly to Provide Welfare Benefits,” which identified the transactions as listed transaction requiring participants in various categories to report the transactions and be potentially subject to penalties if they did not. The company and two shareholders (“taxpayers”) failed to report. The IRS imposed § 6707A penalties for their failures. The taxpayers apparently made no claim that they did not know of the reporting requirement. Rather, they raised only administrative law issues under the Administrative Procedure Act (“APA”) that the IRS adopted the Notice requirement without following the APA’s procedural requirements or was otherwise outside the statutory authority. 

The Court of Appeals addressed only one issue raised by the taxpayers – whether the IRS’s promulgation of the reporting requirement with penalty regime by Notice, a subregulatory guidance document, was a legislative rule that could only be adopted by notice-and-comment rulemaking. The Court held that the reporting requirement was a legislative rule, thus requiring notice-and-comment rulemaking and thus invalid because the IRS had not undertaken notice-and-comment rulemaking.

I will not attempt a detailed analysis of the Court’s reasoning. One thing I am sure of is that there is a lot of confusion about what precisely is a legislative rule subject to or exempted from the notice-and-comment rulemaking requirement. I think the Court falls into some fallacies in that regard, but won’t go down that rabbit hole here because that is a long and complex discussion, principally because of misreadings of Chevron. 

My reading that, I think, is straight-line. 

 1.  Section 6707A(a), here, imposes the penalty for failure to file a return or statement providing information regarding a “reportable transaction” under § 6011.

2.  Section 6011(a), here, in turn provides

(a) General rule
When required by regulations prescribed by the Secretary any person made liable for any tax imposed by this title, or with respect to the collection thereof, shall make a return or statement according to the forms and regulations prescribed by the Secretary. Every person required to make a return or statement shall include therein the information required by such forms or regulations.

In APA lingo, that return or statement authority is a legislative delegation to the Treasury to make the law by regulation when a person is required to file a return or statement. The regulation in question, 26 CFR § 1.6011-4, “Requirement of statement disclosing participation in certain transactions by taxpayers,” here, requires reporting for “listed transactions . . . identified by notice, regulation, or other form of published guidance as a listed transaction.”  See § 4(b)(2). 

The question is whether the legislative rulemaking authority in § 6011(a) included the authority for Treasury to include reportable transactions identified by Notice rather than notice-and-comment regulation. There is no question that the Treasury made a rule by regulation that, under any fair reading, permits Treasury to identify listed transactions subject to the reporting requirement by guidance documents, such as Notices, without notice-and-comment regulations. Since Congress clearly intended Treasury to have law-making authority as to reporting transactions within the scope of § 6011(a) and, as a result, permitting penalties for failure to meet the requirements, it seems to me that the “law” is (or should be) that persons subject to the reporting requirement in the regulation by identification in the Notice is sufficient to sustain the penalties.

True, had the regulation not permitted further identification by some subregulatory document (i.e., one without notice-and-comment), I don’t think a Notice-imposed reporting requirement would be valid. But the regulation did permit transactions within the scope of the reporting authority to be identified in subregulatory guidance—specifically Notices—without notice-and-comment.

That is just my quick analysis. I caution that many of my views about the differences between legislative and interpretive regulations as a result of confusion about Chevron are not mainstream. I discourage readers from burrowing into my writings because I don’t think they will influence mainstream consideration the issue in Mann, but those having too much time on their hands might read the latest comprehensive article.  John A. Townsend, The Report of the Death of the Interpretive Regulation Is an Exaggeration (SSRN last revised 12/15/21), here.

Moreover, there is a practical issue here that courts really don’t seem to care about. Rules requiring reporting of abusive tax transactions require for maximum effect that the IRS notify taxpayers promptly in order for the possible application of penalties to discourage taxpayer behavior. Imposing a notice-and-comment requirement would take away the salutary effect of prompt notice to slow down raids on the Treasury. Of course, the solution will be in the future for Treasury to do the requirement by immediately effective regulation (prior to notice-and-comment) with a Good Cause Statement.  5 U.S.C. § 553(b)(B).