Guest Blog: Professors McGovern and Brewer on APA Status of Listed Transactions (12/12/24)

I offer the second of two guest blogs from Bruce McGovern, Professor teaching tax law at the South Texas College of Law Houston (school resume here) and Professor Cassady V. (“Cass”) Brewer teaching tax law at the Georgia State University College of Law (school resume here). The first offering, titled Guest Blog: Professors McGovern and Brewer on Developments in Hewitt Holding Regulation Procedurally Invalid (12/8/24) is here. I will do a shorter lead in and will cut to the chase. This offering deals with the APA status of IRS Notices:

           2. Yet another Green decision under the APA regarding listed transaction notices has the IRS and Treasury seeing red, but proposed and final regulations provide a blackletter law counterpunch. We previously have written about successful taxpayer challenges to the IRS process of issuing administrative notices identifying “listed transactions” (a subset of “reportable transactions”) under Reg. § 1.6011-4(b)(2), thereby potentially triggering enhanced penalties for noncompliance. Generally, taxpayers participating in such listed transactions must file special disclosures with the IRS under § 6011(a). See Form 8886, Reportable Transaction Disclosure Statement. Material advisors (as defined) to such participating taxpayers are also subject to special disclosure and list maintenance requirements under § 6112(a). See Form 8918, Material Advisor Disclosure Statement. In addition, taxpayers and their material advisors may be subject to enhanced penalties and criminal sanctions for failing to properly disclose, and for participating in, such transactions. See §§ 6662A; 6707; 6707A; 6708. At least three courts have held that the IRS violated the Administrative Procedure Act (“APA”) by issuing certain listed transaction notices. Specifically, the Sixth Circuit, the U.S. District Court for the Eastern District of Tennessee, and the U.S. Tax Court have determined that the three distinct listed transaction notices at issue in those cases were “legislative rules” subject to the notice-and-comment procedures of the APA. Further, because the IRS did not publish an advanced notice of proposed rulemaking inviting public comment before issuing the notices, the courts invalidated them. See Mann Construction, Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022) (invalidating Notice 2007-83, 2007-2 C.B. 960, which identified certain business trust arrangements utilizing cash value life insurance purportedly to provide welfare benefits as listed transactions); CIC Services, LLC v. Internal Revenue Service, 592 F. Supp. 3d 677 (E.D. Tenn. 2022), as modified by unpublished opinion, 2022 WL 2078036 (2022) (invalidating Notice 2016-66, 2016-47 I.R.B. 745, as modified by Notice 2017-8, 2017-3 I.R.B. 423, which identified certain micro-captive insurance arrangements as listed transactions); Green Valley Investors, LLC v. Commissioner, 159 T.C. 80 (2022) (invalidating Notice 2017-10, 2017-4 I.R.B. 544, which identified post-2009 syndicated conservation easements as listed transactions). After initially contesting the application of the APA to the listed transaction notices at issue in Mann Construction, CIC Services, and Green Valley Investors, the IRS and Treasury practically have conceded, responding in at least two instances with proposed APA-compliant listed transaction regulations in place of invalidated notices. See REG-109309-22, Micro-Captive Listed Transactions and Micro-Captive Transactions of Interest, 88 FR 21547 (4/11/23) and REG-106134-22, Syndicated Conservation Easements as Listed Transactions, 87 F.R. 75185 (12/8/22). The latter proposed regulations regarding syndicated conservation easements have been finalized and are discussed further below. For additional background, see Announcement 2023-11, 2023-17 I.R.B. 798. The recent developments summarized immediately below are another installment in the APA tug-of-war between taxpayers and the IRS concerning listed transaction notices under Reg. § 1.6011-4(b)(2) that may implicate enhanced penalties under §§ 6662A; 6707; 6707A; 6708.

                   a. IRS and Treasury see red after Green(s). Green Rock LLC v. Internal Revenue Service, 104 F.4th 220 (11th Cir. 6/4/24), aff’g 654 F. Supp. 3d 1249 (2023). The taxpayer in this case was a promoter/material advisor of syndicated conservation easements. As such, the taxpayer was subject to Notice 2017-10, 2017-4 I.R.B. 544, which identified post-2009 syndicated conservation easements as one type of listed transaction under Reg. § 1.6011-4(b)(2). [*13] Further, as a promoter/material advisor to a listed transaction, the taxpayer potentially was subject to enhanced penalties under § 6707A. The taxpayer complied with Notice 2017-10 and the reportable transaction regime throughout the relevant years, including filing Form 8886, Reportable Transaction Disclosure Statement, and Form 8918, Material Advisor Disclosure Statement. Nevertheless, the taxpayer filed suit in the U.S. District Court for the Northern District of Alabama in 2021, alleging that Notice 2017-10 was invalid under the APA. Like taxpayers in previous similar cases, the taxpayer argued that the IRS had failed to comply with the APA by issuing Notice 2017-10 without providing a formal notice of proposed rulemaking inviting public comment. The district court agreed, setting aside Notice 2017-10 as applied to the taxpayer. See Green Rock LLC v. Internal Revenue Service, 654 F. Supp. 3d 1249 (2023). The taxpayer undoubtedly was emboldened by the Tax Court’s 2022 decision against the IRS in another “Green” case, Green Valley Investors (cited above). By an 11-4-2 vote, the Tax Court invalidated Notice 2017-10 under the APA in that case.

Treasury Promulgates Syndicated Easement Listed Transaction Regulations (10/13/24)

The IRS long identified certain syndicated conservation easements as potentially abusive tax shelters. One prong of that attack Notice 2017-10 designating such transactions as “listed transactions” which carried certain reporting requirements with heavy potential penalties. Courts declared that designating a transaction as a “listed transaction” must be by notice and comment regulation rather than Notice or Revenue Ruling. E.g., Mann Constr., Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022), here; and Green Rock LLC v. IRS, 104 F. 4th 220 (11th Cir. 2024), here. The statutory path the courts followed to justify the holding is a feasible one but another feasible interpretation would have sustained the IRS use of Notices. See Sixth Circuit Invalidates Notice Identifying Listed Transaction Requiring Reporting and Potential Penalties (Federal Tax Procedure Blog 3/3/22); here, and Eleventh Circuit Invalidates IRS Designation of Listed Transaction by Notice; Designation Must be by Notice and Comment Regulation (Federal Tax Procedure Blog 6/16/24), here.

The IRS promulgated final regulations treating certain syndicated conservation easement transactions as listed transactions. Reg. § 1.6011-9, titled “Syndicated conservation easement listed transactions,” effective 10/8/24, TN here. The regulation grandfathers prior disclosures under Notice 2017-10. Reg § 1.6011-9(g). The regulations incorporate provisions fleshing out the addition § 170(h)(7)(A) in 2022 which limits the charitable deduction if the amount of the deduction exceeds 2.5  times the sum of each partner's relevant basis in such partnership or S Corporation.

I offer here only a general notice of the regulation. Those interested can parse the regulations for the details.

Eleventh Circuit Invalidates IRS Designation of Listed Transaction by Notice; Designation Must be by Notice and Comment Regulation (6/16/24)

In Green Rock LLC v. IRS, 104 F. 4th 220 (11th Cir. 6/4/24), CA11 here and GS here, the Court held invalid IRS use of subregulatory guidance—Notices—to designate listed transactions subject to reporting obligations and penalties. The statute says that reportable transactions are those “determined under regulations prescribed under section 6011.” The regulations define a “listed transaction” to include (Reg. § 1.6011-4(b)(2)):

 a transaction that is the same as or substantially similar to one of the types of transactions that the Internal Revenue Service (IRS) has determined to be a tax avoidance transaction and identified by notice, regulation, or other form of published guidance as a listed transaction. 

The Court said, in effect, that the § 6011 regulations authorizing the determination by subregulatory guidance was invalid because, as it read the statute, the listed transaction determination must be made  only in a notice and comment regulation and not, as the § 6011 regulations state, by “notice, regulation, or another form of published guidance.”

In APA-speak, the crux of the Court’s holding was a syllogism:

• Major Premise: Legislative rules must be promulgated by notice and comment regulation
• Minor Premise: The requirements of reporting and penalty imposed for listed transactions make the designation a legislative rule.
• Conclusion: the designation of a listed transaction must be made by notice and comment regulation; hence designation by Notice is invalid.

I think this is yet another hypertechnical textual holding because, in my view, the statute could be read another to support Treasury’s approving notice in the § 6011 regulations by subregulatory guidance. The Court quibbles to avoid a practical interpretation of the statutory word “under.” (Slip op. 15-17.) 

JAT Comments:

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.

IRS Designates Syndications Exploiting Improper Valuations for Conservation Easement Deductions (1/3/17)

This is a reposting of the same entry on my Federal Tax Crimes Blog.

I note at a couple of places in the Federal Tax Procedure Book that some of the most abusive tax shelters do not fail because the legal positions are faulty.  Rather, they fail because the legal positions are all based false facts, often a false valuation of property.  For example, in discussing the substantial and gross valuation misstatement penalties in §§ 6662(e) and (h), here, I state:

Section 6662(e)’s substantial valuation misstatement penalty and § 6662(h)’s gross valuation misstatement penalty are directed to return reporting positions where the law is correctly applied but a critical valuation is grossly erroneous, resulting in the substantial understatement of the tax liability.  In many of the abusive tax shelters over the years, the Achilles heel has been and continues to be inflated valuations.  The legal superstructure had some facial merit, but it was built on a factual house of cards because of gross overvaluation.  A facet of this problem was that, since tax professionals were not valuation experts, they could render their opinions without taking responsibility for the key valuation facts that supported the whole purported tax shelter superstructure.  For example, as to property otherwise qualifying for the old investment tax credit (10 percent of qualifying investment in property), tax shelter promoters would sometimes inflate the value of property to 10 or 20 times its true value and sell it to investment partnerships (where the partners were tax shelter investors) for the inflated value.  Of course, only crazy people would pay the inflated value, so the tax shelter investors paid only a small amount down and “paid” the balance by nonrecourse indebtedness (before the rules related to nonrecourse indebtedness and passive losses).  Assuming that the value was correct, the taxpayers would be entitled to the credit; the problem was in the valuation.  Many, many tax issues, not just tax shelter issues, rely upon valuations.  Thus, for example, estate and gift tax returns rely upon reasonably correct valuations.  The purpose of this penalty is to put some sting in overly aggressive valuations.

I have posted on variations of this theme.  Court Sustains Use of Regular Summons to Appraiser Investigated Even Though Third Party Taxpayers May be Identified (Federal Tax Crimes Blog 1/14/16), here.  See also Prominent and Very Rich Investor Indicted in SDNY (Federal Tax Crimes Blog 5/24/16), here.

Such overvaluations carry risk of criminal prosecution and significant civil penalties.

The IRS strikes again at a valuation shelter in a different package, this one syndications -- promoted "investments" -- offering conservation easement deductions.  Notice 2017-10, 2017-04 IRB, here.  The Notice describes the problem:

The promoters (i) identify a pass-through entity that owns real property, or (ii) form a pass-through entity to acquire real property. Additional tiers of pass-through entities may be formed. The promoters then syndicate ownership interests in the passthrough entity that owns the real property, or in one or more of the tiers of pass-through entities, using promotional materials suggesting to prospective investors that an investor may be entitled to a share of a charitable contribution deduction that equals or exceeds an amount that is two and one-half times the amount of the investor’s investment. The promoters obtain an appraisal that purports to be a qualified appraisal as defined in § 170(f)(11)(E)(i) but that greatly inflates the value of the conservation easement based on unreasonable conclusions about the development potential of the real property. After an investor invests in the pass-through entity, either directly or through one or more tiers of pass-through entities,  the pass-through entity donates a conservation easement encumbering the property to a tax-exempt  entity. Investors who held their direct or indirect interests in the pass-through entity for one year or less may rely on the pass-through entity’s holding period in the underlying real property to treat the donated conservation easement as long-term capital gain property under § 170(e)(1). The promoter receives a fee or other consideration with respect to the promotion, which may be in the form of an interest in the pass-through entity. The IRS intends to challenge the purported tax benefits from this transaction based on the overvaluation of the conservation easement. The IRS may also challenge the purported tax benefits from this transaction based on the partnership anti-abuse rule, economic substance, or other rules or doctrines.