Monthly Tax Roundup (Volume 1, Issue 2)
Welcome to the second edition of Miller & Chevalier's Monthly Tax Roundup, providing you a quick overview of the most significant tax developments. This month we discuss recent developments in the courts, at the IRS and the OECD, and the halls of Congress.
APA Challenges Upend IRS Rules, with One Notable Exception
Last month, federal courts issued several important rulings applying the Administrative Procedure Act (APA) to Treasury and IRS rulemakings. Courts found that two IRS notices imposing disclosure obligations for certain "reportable transactions" are subject to the APA and struck down those notices due to the IRS's failure to comply with the notice-and-comment requirements in issuing the notices. Separately, the Sixth Circuit upheld a conservation easement regulation against APA and Chevron challenges, creating a circuit split on whether the regulation at issue is procedurally valid under the APA.
In Mann Construction, Inc. v. United States, No. 21-1500, 2022 WL 619822 (6th Cir. Mar. 3, 2022), the Sixth Circuit set aside Notice 2007-83 designating trust arrangements featuring cash-value life insurance policies as "listed transactions" because the IRS did not follow the APA's notice-and-comment process when it issued the Notice. The Sixth Circuit readily concluded that the Notice was a legislative rule subject to the APA because it imposed new duties on taxpayers (i.e., reporting obligations), and failure to comply with those duties could lead to penalties and sanctions, all hallmarks of legislative rules. The court also rejected the government's argument that Congress had exempted the IRS from following APA procedures when issuing the Notice, concluding that exemption required an express indication of congressional intent, and such indication was lacking in this case. See our alert on Mann Construction here.
A couple of weeks after the Sixth Circuit's decision in Mann Construction, a federal court in Tennessee set aside Notice 2016-66 designating certain micro-captive transactions as "transactions of interest" subject to reporting obligations. In CIC Services, LLC v. IRS, No. 3:17-cv-110 (E.D. Tenn. Mar. 21, 2022), the court followed Mann Construction (which is binding on the court) and similarly held that Notice 2016-66 is invalid because the IRS did not follow notice-and-comment procedures. Further compelling the court to set aside Notice 2016-66 was the court's conclusion that the IRS acted arbitrarily and capriciously under the APA in issuing the Notice because the administrative record lacked evidence that the IRS examined relevant data and facts supporting the IRS's decision to designate micro-captive transactions as transactions of interest. The court also analyzed the appropriate relief warranted in the case, ultimately deciding to vacate Notice 2016-66 in its entirety and granting some of the injunctive relief CIC Services had requested. For more details, see our alert here.
The ramifications of Mann Construction go well beyond CIC Services. We may see APA challenges to other IRS notices identifying reportable transactions. For example, shortly after the Sixth Circuit's decision in Mann Construction, a real estate firm filed a complaint in federal court in Ohio challenging the validity of Notice 2017-10 (which designates syndicated conservation easements as a listed transaction) because the IRS did not follow the APA notice-and-comment procedures. See GBX Assocs. LLC v. United States, No. 1:22-cv-00401 (N.D. Ohio filed Mar. 11, 2022). The APA principles in Mann Construction may also inform other cases involving challenges to IRS guidance. For instance, in Liberty Global, Inc. v. United States, No. 20-cv-03501 (D. Colo.), where the validity of Temporary Treasury Regulations under section 245A is at issue, the plaintiff filed a notice of supplemental authority to bring the court's attention to Mann Construction.
More broadly, Mann Construction and CIC Services raise difficult questions for taxpayers (and material advisors) subject to obligations under similar notices. How should taxpayers assess disclosure obligations under similar notices when the validity of those notices appears uncertain in light of these recent cases? For taxpayers that paid penalties for failure to comply with disclosure requirements under similar notices, what steps should they take to preserve their ability to recoup those penalties? The courts' decisions also raise complex questions for taxpayers subject to the notices at issue in Mann Construction and CIC Services. It is possible that the government seeks further review of either or both of these decisions, bringing into question the finality of the rulings. As the fallout from Mann Construction and CIC Services plays out, taxpayers will need to assess their strategy with respect to continued compliance with disclosure obligations imposed by the notices invalidated in these cases.
On the government's side, these cases represent a fundamental disruption in how Treasury and the IRS identify transactions the government views as having a potential for tax avoidance or evasion. These developments may also have implications for how the IRS uses published sub-regulatory guidance beyond the reportable transaction regime.
There were also important developments last month with respect to challenges to Treasury regulations on APA and administrative law principles. In Oakbrook Land Holdings, LLC v. Commissioner, No. 20-2117, 2022 WL 766050 (6th Cir. Mar. 14, 2022), the Sixth Circuit upheld the conservation easement "proceeds regulation" against procedural APA challenges and substantive challenges under Chevron. The two-judge majority in Oakbrook found that Treasury satisfied the requirement to include a concise statement of basis and purpose because the rationale behind the proceeds regulation was apparent from the context in which Treasury issued it. Further, the majority found that Treasury did not violate the APA's notice-and-comment requirements because the comments at issue were not "significant" and therefore Treasury was not obligated to respond to them. On this point, the majority declined to follow the Eleventh Circuit's recent holding on the same issue in Hewitt v. Commissioner, 21 F.4th 1336 (11th Cir. 2021), resulting in a circuit split. See our alerts for more on Oakbrook and Hewitt.
A Lot at Stake in Jarrett Case
Holders of certain cryptocurrencies can "stake" – that is, put up their virtual coins as collateral to further the development of a blockchain network – and receive additional coins in return for this action. While the IRS has issued no guidance on this subject, the government's argument is fairly clear: payments on staked currency are an accession to wealth over which the taxpayer has complete dominion and, therefore, income.
Enter Jessica and Josh Jarrett, who hold Tezos tokens. According to the pleadings, "Josh employed both his Tezos tokens and his computing power to create 8,876 new tokens on the Tezos public blockchain" but did not sell or exchange these tokens during the year at issue. The Jarretts argue that the mere receipt of the tokens isn't taxable income any more than a cow giving birth to a calf is taxable income to a rancher. Rather, income tax applies only when the newly created property is sold or exchanged.
The amount of money at issue in the Jarretts' refund suit is only $3,793, a tiny link on the proverbial block chain. But there is a tangle: after the refund suit was filed, the government issued the requested refund check (with interest). The government then filed a motion to dismiss, arguing that the Jessica and Josh received the full refund requested and that no further relief is available to them under 26 U.S.C. § 7422 and 28 U.S.C. §1346(a)(1).
The taxpayers' response? Under recent Supreme Court precedent, the government cannot unilaterally moot the case by sending a refund check, especially when the taxpayers have not cashed the refund check and do not intend to. Based on those precedents, the Jarretts demanded a judicial resolution of their rights, which they argue would ensure that they do not need to return to court year after year to argue the same exact discrete legal issue and would prevent the IRS from penalizing them for taking similar positions on future tax returns.
The Jarretts stressed that the government's motion to dismiss must be denied because "judgements matter."
The case has garnered significant public interest as staking cryptocurrency has become increasingly popular in recent years and various crypto stakeholders have been vocal about a desire for clarity on the subject. For instance, Coin Center, an independent, non-profit research center focused on digital currency policy issues, filed an amicus brief on March 14 opposing the government's motion to dismiss. This amicus brief sought to demonstrate the "great public importance" that a final decision in this case would carry.
No doubt there's a lot at stake and we will continue to monitor the case.
Tax Policy – Signs of Life on BBBA Part of a Surprisingly Active Tax Policy Landscape
Although progress on the Build Back Better Act (BBBA) have stalled since mid-December, a number of recent events may drive the Administration and Congressional Democrats back to the bargaining table. President Biden's endorsement of including deficit reduction in BBBA during his State of the Union address, followed in short order by a proposed "slimmed down" BBBA package by Senator Manchin (D-WV) (here and here) suggest that there may be the beginnings of a deal to be had.
In addition, the Administration issued its Greenbook revenue proposals which, in addition to assuming the House-passed BBBA tax provisions have been enacted, provides a new menu of revenue raisers, including a so-called "Billionaire Minimum Income Tax" that could potentially be developed into alternative sources of revenue if needed. In the interim, tax policy observers are looking at the pending U.S. competitiveness bill (United States Innovation and Competition Act (USICA)/America COMPETES) as a potential alternative vehicle for items such as the research and development amortization fix. Such activity on the tax policy front is virtually unprecedented in a mid-term election year, although whether anything is actually enacted is yet to be seen.
Rev. Proc. 94-69 Disclosures to Survive in Some Form
After receiving spirited comments from stakeholders advocating that the IRS preserve Rev. Proc. 94-69's penalty protection disclosure procedures for certain large corporate taxpayers, the IRS recently announced that it will be replacing – rather than obsoleting – Rev. Proc. 94-69. The IRS announcement solicits comments on a new draft Form 15307, which aims to standardize disclosures under this new process, and provides that further IRS guidance will be forthcoming as to which taxpayers will be eligible to use the new process.
This news is a welcome update to a saga that began in the summer of 2020, when, as we reported at the time, a request for comments from the Large Business & International (LB&I) Division indicated that Rev. Proc. 94-69 may be a thing of the past. For decades, Rev. Proc. 94-69 has allowed large corporate taxpayers under continuous audit to disclose potential adjustments to their tax returns after an audit commences and still receive protection from accuracy-related penalties. Ordinarily, disclosure after an audit commences cannot be a "qualified amended return" that brings with it protection from the accuracy-related penalties. The 2020 announcement came after the IRS replaced the Coordinated Industry Case (CIC) program (the last in a line of several continuous audit programs) with the Large Corporate Compliance (LCC) risk-based audit program. In their 2020 request for comments, the IRS noted their concern that Rev. Proc. 94-69 provided large taxpayers a benefit not offered to the vast majority of taxpayers, who may only use the qualified amended return process.
Following the 2020 request, the IRS received a deluge of comments supporting keeping Rev. Proc. 94-69 (including from the ABA Section of Taxation and the Tax Executives Institute) for myriad reasons, including the cost and complexity of filing federal and sometimes multiple state amended returns. The IRS appears to have been receptive to these comments. In their recent announcement, the IRS acknowledged that there is a "small subset of taxpayers who will likely be in some form of continuous audit posture with LB&I because of the nature of their transactions and return filings" and observed that some form of disclosure process for this group "may be appropriate."
According to the IRS announcement, Form 15307, titled "Post-filing Disclosure for Specific Large Business Taxpayers," is intended to standardize the disclosure process by ensuring that eligible taxpayers and revenue agents are working with consistent guidelines as to what constitutes a disclosure that is sufficient to afford penalty protection. The form and instructions detail the information required for a disclosure and provide several examples of acceptable and unacceptable disclosure descriptions. Importantly, the draft form does not define the "continuous audit population" that will be eligible to take advantage of a final Form 15307. The IRS plans to define this population in future guidance and does not expect the population to be limited to taxpayers in any one program (such as the LCC).
The IRS did not indicate when guidance will be issued on which taxpayers will be eligible to use the final version of Form 15307. Affected taxpayers may send their comments on draft Form 15307 to LBI.firstname.lastname@example.org through June 3, 2022.
OECD Pillar Two Implementation Process Grinds Forward as Administration Embraces Project in Greenbook
On March 14, the Organisation for Economic Cooperation and Development (OECD) issued Commentary and Illustrative Examples related to the Pillar Two global minimum tax Model Rules. The Model Rules, published in December 2021, provide for a system of top-up taxes designed to ensure that multinational enterprises (MNEs) with consolidated annual revenues above €750 million pay a minimum level of tax on income earned in each country in which they operate. The Commentary includes an introduction that emphasizes the need for coordination and consistency, then follows the chapter structure of the Model Rules, providing technical guidance on rule scope and order, computation of income or loss, adjusted covered taxes, effective tax rate, top-up tax, and administration and transition rules.
On the same date, the OECD also announced a public consultation with respect to the Implementation Framework intended to address administrative, compliance, and coordination issues related to the top-up tax rules. The OECD is accepting comments by April 11, 2022 and plans to hold a virtual public consultation at the end of April.
The lengthy and technically complex Commentary highlights the challenges of the global minimum tax rules and the resources that will be required of in-scope MNEs and tax authorities to understand, administer, and comply with these new rules when they take effect. The current consultation will be important to framing and addressing implementation issues, many of which stem from policy decisions that the participating countries seem reluctant to revisit. The timing of any new rules is uncertain. For example, a proposal for a one-year delay of the implementation timeline has emerged in negotiations among EU member states and relevant U.S. legislative developments may or may not occur within the current timeline. A major outstanding issue for U.S. MNEs is how the U.S. global intangible low-taxed income (GILTI) regime, either in its current form or as modified by pending legislation, will co-exist with the global minimum tax rules. In addition, the Biden Administration has proposed replacing the base erosion and anti-abuse tax (BEAT) with an undertaxed profits rule (UTPR) and domestic minimum tax as part of its FY 2023 revenue proposals. In-scope MNEs should continue to evaluate the potential impact of these developments and consider engaging with policymakers as the work moves forward.
*Former Miller & Chevalier attorney
The information contained in this communication is not intended as legal advice or as an opinion on specific facts. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. For more information, please contact one of the senders or your existing Miller & Chevalier lawyer contact. The invitation to contact the firm and its lawyers is not to be construed as a solicitation for legal work. Any new lawyer-client relationship will be confirmed in writing.
This, and related communications, are protected by copyright laws and treaties. You may make a single copy for personal use. You may make copies for others, but not for commercial purposes. If you give a copy to anyone else, it must be in its original, unmodified form, and must include all attributions of authorship, copyright notices, and republication notices. Except as described above, it is unlawful to copy, republish, redistribute, and/or alter this presentation without prior written consent of the copyright holder.