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.

GAO Report on Virtual Currency Guidance (2/13/20)

The Government Accountability Office (“GAO”) issued a report titled:  Virtual Currencies: Additional Information Reporting and Clarified Guidance Could Improve Tax Compliance (2/20), here.  The Report is addressed "to the Ranking Member, Committee on Ways and Means, House of Representatives.”  The ranking member is the minority ranking member, Kevin Brady (R.-TX).  (I suspect that all members of Congress have received complaints about the IRS initiatives against virtual currencies, so favored by crooks and tax cheats, but also suspect that Republican members are more sympathetic to the complaints from people whose real or hidden agenda is not to pay tax).

At any rate, the Report summarily describes virtual currencies, including cryptocurrencies such as Bitcoin, generally, estimates the size of the market, the regulation by agencies (such as CFTC, FinCEN and SEC), the tax treatment of virtual currency and the IRS’s compliance efforts for virtual currencies, including sharing of information with other agencies.

I focus here on what the Report says about IRS guidance for tax reporting requirements for virtual currency transactions.  The guidance includes principally Notice 2014-21 (including public comments), Revenue Ruling 2019-24 and Frequently Asked Questions (FAQs) released in October 2019.  The principal guidance is Notice 2014-21 which the GAO Report describes as follows (p. 8 n. 15):

According to IRS Notice 2014-21, a taxpayer generally realizes a capital gain or loss on the sale or exchange of virtual currency that is a capital asset in the hands of the taxpayer. For example, stocks, bonds, and other investment property are generally capital assets. A taxpayer generally realizes ordinary gain or loss on the sale or exchange of virtual currency that is not a capital asset in the hands of the taxpayer. Inventory and other property held mainly for sale to customers in a trade or business are examples of property that is not a capital asset. Capital gains may be subject to lower tax rates than ordinary gains. Capital gains and losses are classified as long-term or short-term. Generally, if a taxpayer holds the asset for more than one year before disposing of it, the capital gain or loss is long-term. If a taxpayer holds it one year or less, the capital gain or loss is short-term. For more information, see IRS Publication 544, Sales and Other Dispositions of Assets.

The Report has a section titled: “IRS’s 2019 Virtual Currency Guidance Answers Some Taxpayer Concerns, but Presents Additional Challenges for Taxpayers.”  See pp. 18-20.  This sections reports concerns and complaints about the published guidance.

The Report then has a section titled: “IRS Did Not Include That the 2019 FAQs Are Not Legally Binding.” See pp. 20-21.  Since I focus the rest of this blog to that portion of the report, I will just excerpt it in full here (some footnotes omitted):

Treasury and IRS Policy Statement on Tax Regulatory Process (3/17/19; 4/19/20)

Treasury and the IRS have issued a joint Policy Statement on the Tax Regulatory Process (3/5/19), here.

I am in the midst of finalizing an article titled:  The Report of the Death of the Interpretive Regulation Is an Exaggeration.  I have just included a discussion of this new policy.  I thought I would offer my discussion although framed in the context of the article.  Here is a cut and paste of the discussion.  This discussion in the article has only a few short(er) footnotes, so I omit the footnotes.

I offer this short introduction so that readers will have some context offered by the article.

In the article, I argue that the Administrative Procedure Act ("APA") permits two types of regulations (those published as regulations in the Federal Register) -- (i)  legislative regulations and (ii) interpretive regulations.  The distinction between the two categories is:

(i) a legislative regulation is promulgated pursuant to express statutory authority to set the law where the regulation functions like a statute because, within the scope of the delegation, the regulation is the law.  The classic tax example of a legislative regulation is the consolidated return rules promulgated by regulation under § 1502. 

(ii) an interpretive regulation is promulgated as an interpretation of a statute Congress enacted (in the case of tax, generally in the Internal Revenue Code (Title 26)).  There is no classic tax example of an interpretive regulation; I use the example of the away from home regulation addressed in United States v. Correll, 389 U.S. 299 (1967), here.  

As Kenneth Culp Davis, the leading authority on administrative law said shortly after enactment of the APA:  "According to the theory, legislative rules are the product of a power to create new law, and interpretative rules are the product of interpretation of previously existing law."

Basically, as the Courts have said, legislative regulations are the law (and thus, in the jargon, have the "force of law"), whereas interpretive regulations simply interpret to law (and do not have the force of law, even if courts give the agency interpretation deference under the Chevron framework).

The distinction between legislative and interpretive regulations has a lot of nuance which I develop in the article.  Indeed, I develop that nuance in  the article, perhaps at too great a length in the article (which I post on SSRN after I offer for comments in a conference in April 2019)  Still, the foregoing is the essence of the argument.  [Addendum 9/25/19, the article is here:  Townsend, John A., The Report of the Death of the Interpretive Regulation Is an Exaggeration (June 6, 2019). Available at SSRN: https://ssrn.com/abstract=3400489.]

With the foregoing, readers with some background in administrative law and the APA specifically should be able to understand the general concepts in the new Policy Statement and my comments below [Addendum as of 4/19/20:  the following is from my working draft of the article for revision later; hence, some of it may reflect developments or thinking after I posted the original of this blog entry on 3/27/19; my footnotes are not included.]