Tax Court Rejects IRS Conservation Easement Notice for APA
The Tax Court dealt the IRS reportable transaction regime another blow, invalidating Notice 2017-10, which designates syndicated conservation easement transactions as "listed transactions." In Green Valley Investors, LLC v. Commissioner, 159 T.C. No. 9 (2022), a
Listed transactions are subject to reporting requirements and penalties for non-compliance under Internal Revenue Code section 6707A. Section 6707A defines reportable transactions by reference to section 6011, which in turn authorizes Treasury to define and establish reporting requirements by regulation. Treas. Reg. § 1.6011-4(b)(2) provides that the IRS can identify listed transactions in a notice, regulation, or other form of published guidance. In Notice 2017-10, the IRS identified syndicated conservation easement transactions, in which "a promoter offers prospective investors in a partnership or other pass-through entity . . . the possibility of a charitable contribution deduction for donation of a conservation easement," and substantially similar transactions as tax avoidance transactions and designated them as listed transactions. Notice 2017-10 became effective December 23, 2016 and applies to transactions entered into on or after January 1, 2010.
Green Valley Investors, LLC and three other partnerships each engaged in a syndicated conservation easement transaction in either the 2014 or 2015 tax year. The IRS audited the returns on which they claimed a charitable contribution deduction and determined that the taxpayers were not entitled to deductions because the taxpayers (1) failed to meet all requirements for a charitable deduction under section 170 and (2) could not establish the value of the donated easements. The IRS also asserted accuracy-related penalties under section 6662. The taxpayers petitioned for review in the Tax Court. In its answer in each case, the IRS asserted reportable transaction penalties under section 6662A.
The parties filed cross motions for partial summary judgment requesting judgment as a matter of law on the taxpayers' liability for the section 6662A penalties. The taxpayers argued, in relevant part, that Notice 2017-10 was procedurally invalid under the APA. The Sixth Circuit Court of Appeals addressed a very similar question in Mann Construction, Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022), in which it invalidated Notice 2007-83 designating certain trust arrangements as listed transactions. The IRS offered the same two arguments in Green Valley that the Sixth Circuit rejected in Mann Construction. First, the IRS argued that Notice 2017-10 is an interpretive rule that is not subject to the APA's notice-and-comment rulemaking procedures under 5 U.S.C. § 553(b)(3)(A). Second, the IRS argued that even if Notice 2017-10 were a legislative rule, Congress nevertheless intended to exempt such notices from notice-and-comment rulemaking under the APA. Like the Sixth Circuit in Mann Construction, the Tax Court rejected both arguments and found Notice 2017-10 invalid.
Notice 2017-10 is a Legislative Rule
The Tax Court held that Notice 2017-10 is a legislative rule and, therefore, is subject to notice-and-comment procedures under the APA. The court explained that legislative rules, which have the force and effect of law, "impose new rights or duties and change the legal status of regulated parties." Interpretative rules, on the other hand, "merely advise the public of an agency's construction of the statutes it administers." Following the Sixth Circuit's reasoning in Mann Construction, the Tax Court held that the reporting obligations imposed on taxpayers and material advisors because of Notice 2017-10, non-compliance with which results in the imposition of penalties, amount to substantive duties imposed on regulated parties. Therefore, the court held that Notice 2017-10 is a legislative rule subject to the APA's notice-and-comment requirements.
Congress Did Not Expressly Exempt the IRS from APA Requirements When Identifying Listed Transactions
The court also rejected the IRS's arguments that Congress exempted the IRS from following APA procedures when designating listed transactions by establishing a separate procedure under which the IRS properly issued Notice 2017-10. The court explained that an agency must clear a high bar to show that Congress has prescribed an alternative to the APA. While Congress need not "employ magical passwords in order to effectuate an exemption," an agency must show more than "mere differences between a statutory scheme and the APA." Rather, there must be an "express indication of congressional intent."
The court found no express indications of congressional intention to displace the APA in either section 6707A or 6011, nor did the court find any such indications of congressional intent in a subsequently enacted provision referencing the regulations under section 6011 that contained the definition of "reportable transaction." It found that those provisions define relevant transactions rather than set out the relevant procedure for designating them. The court also rejected the argument that congressional silence with respect to the designation procedure in subsequent amendments of section 6707A amounts to an express indication of congressional intent to exempt the IRS from the APA in this context.
Four judges wrote separately. Judge Cary Douglas Pugh, while agreeing that the IRS failed to show that Congress meant to displace the APA in this context, disagreed with the majority's analysis, finding that it imposes too high a bar to displace the APA and effectively requires a "magic password." Judge Emin Toro wrote separately to express doubt that section 6707A(c)(1), on which the IRS supports much of its argument, incorporates procedural rules to a meaningful extent at all. Judge Joseph H. Gale, writing in dissent, concluded that Congress did intend to displace the APA by allowing the IRS to designate listed transactions by issuing a notice, which he contends is irreconcilable with the APA. Finally Judge Joseph W. Nega concludes in his dissenting opinion that legislative history to section 6707 demonstrates that Congress intended to displace the APA in the context of identifying listed transactions.
The Tax Court's holding in Green Valley effectively nullifies two penalties for taxpayers that participate in syndicated conservation easements or substantially similar transactions. First, accuracy-related penalties with respect to reportable transaction under section 6662A, which was the underlying issue addressed in these motions, cannot apply with respect to syndicated conservation easement transactions. Second, the notice can no longer be the basis for imposing penalties for failure to disclose participation in or material advice related to reportable transactions under sections 6707A and 6707, respectively. Notice 2017-10 is the third such notice designating a transaction as a listed or reportable transaction that a court has found to be procedurally invalid — Notice 2007-83 (regarding certain trust arrangements) was invalidated in Mann Construction and Notice 2016-66 (regarding micro-captive insurance arrangements) was invalidated in CIC Services, LLC v. IRS, No. 3:17-cv-110 (E.D. Tenn. Mar. 21, 2022). We are likely to see additional challenges with similar results in connection with other such notices.
This case also highlights questions about the appropriate remedy when a court invalidates a rule under the APA. One question is whether the court should vacate the rule as to the taxpayer before the court, or as to all taxpayers. The Tax Court specified that it intends to apply its decision vacating Notice 2017-10 with respect to all taxpayers that come before them. But the federal district court for the Northern District of Ohio recently held that it would vacate Notice 2017-10 with respect to only the taxpayer before the court, allowing the government to dispute the issue before other courts in other jurisdictions. GBX Assocs. LLC v. United States, No. 1:22-cv-00401-PAB (N.D. Ohio Nov. 14, 2022). Another question is whether injunctive relief, beyond vacatur, is appropriate in this situation. The Tax Court is a court of limited jurisdiction and lacks the authority to grant injunctive relief in all but certain cases. If a taxpayer injunctive relief, such as an order that the IRS return all documents submitted as disclosures under the notice, it likely must seek that relief in a federal district court.
Taking a step back, this is yet another instance in which Treasury and the IRS must reckon with the importance of the APA when making, applying, and defending their rules. Of particular relevance for this case, the historical stance taken by Treasury and the IRS on what is a legislative or interpretive rule has been rejected by courts in a growing number of cases. See, e.g., CIC Services; Mann Construction; Oakbrook Land Holdings, LLC v. Comm'r, 154 T.C. 180, 189 (2020); Chamber of Commerce of U.S.A. v. IRS, 2017 BL 358853 (W.D. Tex. Sept. 29, 2017); Altera Corp. v. Comm'r, 145 T.C. 81, 116-17 (2015), rev'd on other grounds, 926 F.3d 1061. Treasury and the IRS's stance towards the APA and notice-and-comment procedures has gained importance as taxpayers increasingly consider to regulatory challenges in addition to technical challenges in tax disputes. Expect to see similar challenges to Treasury and IRS guidance for the foreseeable future.
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