Concerns about the growth of abusive tax-avoidance transactions led the IRS and Treasury to issue Regs. Sec. 1.6011- 4 in 2003, which allowed the Service to quickly identify and deal with abusive or potentially abusive transactions.
Because of a recent series of court decisions — Mann Construction, Inc., 27 F.4th 1138 (6th Cir. 2022); CIC Services, LLC, No. 3:17-cv-110 (E.D. Tenn. 3/21/22); and Green Valley Investors, LLC, 159 T.C. No. 5 (2022) — it is worth revisiting Regs. Sec. 1.6011-4. Those courts have invalidated the IRS’s efforts to designate certain transactions as reportable, because the agency failed to follow proper procedures under the Administrative Procedure Act (APA).
This column first provides some background on reportable transactions, then discusses these three court rulings and what they may mean for clients that have reportable transactions.
Under Regs. Sec. 1.6011-4, taxpayers that have participated in reportable transactions must disclose them on Form 8886, Reportable Transaction Disclosure Statement. Material advisers with respect to these reportable transactions must also disclose such information on Form 8918, Material Advisor Disclosure Statement.
Five types of transactions are reportable under Regs. Sec. 1.6011-4:
- Listed transactions;
- Confidential transactions;
- Transactions with contractual protection;
- Loss transactions; and
- Transactions of interest.
Listed transactions: A listed transaction is a transaction that is the same as or substantially similar to one the IRS has determined to be a tax-avoidance transaction and that has been identified in a notice, regulation, or other form of published guidance as a listed transaction (Regs. Sec. 1.6011-4(b)(2)). Listed transactions arguably are the most potentially abusive transactions. Many of them relate to the tax shelter days of the early 2000s.
The IRS has identified 36 listed transactions, only two of them since 2008. Practitioners recognize listed transactions as those that the IRS closely monitors.
Confidential transactions: A confidential transaction is offered to a taxpayer by an adviser under conditions of confidentiality and for which the taxpayer has paid the adviser a fee of at least a minimum amount prescribed in the regulations (Regs. Sec. 1.6011- 4(b)(3)). Most practitioners recognize that confidential tax transactions should be avoided. Tax transparency is important to a well-functioning tax system. It is not surprising that case law is absent in the area of confidential tax transactions.
Transactions with contractual protection: A transaction with contractual protection is one for which the taxpayer or a related party (as described in Sec. 267(b) or 707(b)) has the right to a full or partial refund of fees if all or part of the intended tax consequences from the transaction are not sustained (Regs. Sec. 1.6011-4(b)(4)). Transactions with contractual protection continue to be a topic of discussion (and litigation) among tax practitioners and regulators. When can tax practitioners charge their clients contingent fees? Should these transactions be included as reportable transactions? Practitioners must be careful when considering what transactions must be reported under this provision.
Loss transactions: In a loss transaction, the taxpayer reports a loss under Sec. 165 that exceeds certain thresholds (Regs. Sec. 1.6011-4(b)(5)):
- C corporations and partnerships with only C corporation partners: $10 million in any one year or $20 million in any combination of years (initial year of the loss and the next five succeeding tax years);
- All other partnerships: $2 million in any one year or $4 million in any combination of years (initial year of the loss and the next five succeeding tax years);
- Individuals, S corporations, and trusts: $2 million in any one year or $4 million in any combination of years (initial year of the loss and the next five succeeding tax years); and
- Sec. 988 losses for individuals and trusts: $50,000 in any single year.
Practitioners are very familiar with the loss transaction regulation. Anecdotal evidence suggests that much of the reporting under this regulation is made on a protective basis, particularly of Sec. 988 losses, which frequently are more cost-effective to disclose on Form 8886 than to determine whether a loss actually exceeds $50,000.
Transactions of interest: A transaction of interest is the same as or substantially similar to one the IRS has identified as a transaction of interest in a notice, regulation, or other form of published guidance (Regs. Sec. 1.6011-4(b)(6)).
The IRS has identified six transactions of interest, only two of them since 2009. Practitioners recognize that the IRS closely monitors transactions of interest.
Recent compliance update
While activity related to the disclosure of confidential transactions, transactions with contractual protection, and loss transactions has been limited, a recent bustle of activity has been related to listed transactions and transactions of interest.
In the last two years, the IRS has lost three cases on the issue of the validity of its notices. In particular, the courts invalidated certain notices designating specific transactions as reportable, ruling that the IRS had failed to comply with the APA’s notice-and-comment rulemaking procedures.
In Mann Construction, the Sixth Circuit invalidated Notice 2007-83 (requiring reporting about abusive trust arrangements utilizing cash-value life insurance policies purportedly to provide welfare benefits), holding that the IRS failed to provide the necessary notice and opportunity for comment under the APA.
In CIC Services, a taxpayer challenged the validity of Notice 2016-66 (requiring reporting about Sec. 831(b) microcaptive insurance). After the U.S. Supreme Court ruled that the Anti-Injunction Act did not bar the lawsuit, the case was remanded to the U.S. District Court for the Eastern District of Tennessee, which held that the IRS’s promulgation of Notice 2016-66 violated the APA. (See Newkirk and Webber, “Microcaptive Insurance Arrangements After CIC Services,” 53 The Tax Adviser 18 (September 2022).)
In Green Valley, a November 2022 decision, the Tax Court invalidated Notice 2017-10, which identified certain syndicated conservation easement transactions as listed transactions and imposed penalties under Secs. 6662A, 6707, and 6707A on taxpayers that failed to disclose them. The court concluded in a reported decision that was reviewed by the full court that the IRS had failed to comply with APA notice-and-comment procedures.
What Green Valley means for clients: While the IRS can no longer assess listed-transaction-related penalties (i.e., penalties under Sec. 6707A (nondisclosure); Sec. 6662A(a) (reportable-transaction understatement); or Sec. 6662A(c) (nondisclosed reportabletransaction understatement)) with respect to certain syndicated conservation easements, the IRS can still assess other penalties against taxpayers that invest in syndicated conservation easements, including accuracy-related penalties equal to 20% of the tax underpayment (or 40% of the tax underpayment if there is a gross valuation misstatement).
Also, the IRS may decide to appeal the Green Valley decision. A government win on appeal would reinstate the IRS’s ability to assess these penalties, and clients with open statutes of limitation at the time would be at risk.
Editor’s note: While this column was in press, a district court in Alabama agreed with the Tax Court in Green Valley that Notice 2017-10 is invalid; see Green Rock LLC, No. 2:21-cv-1320 (N.D. Ala. 2/2/23). In another related development, the SECURE 2.0 Act, enacted in December, imposes new limitations that make it more difficult for passthrough entities to take charitable deductions for conservation easement contributions. See Section 605 of the SECURE 2.0 Act of 2022 (Division T of the Consolidated Appropriations Act, 2023, P.L. 117-328).
A note of caution for the future
The IRS’s issuance of a notice, regulation, or other form of guidance imposes significant reporting obligations on taxpayers when it involves a reportable transaction. If taxpayers fail to report such transactions, the IRS can assess significant penalties. Over the years, the IRS has identified 36 transactions as listed transactions and six transactions as transactions of interest and issued notices detailing them. In response, taxpayers and tax practitioners have generally based their decision to disclose listed transactions and transactions of interest on (1) the validity of the IRS’s notices and (2) the potential applicability of penalties for nondisclosure.
While the courts’ holdings are significant wins for all taxpayers, tax practitioners should advise their clients to continue to proceed with caution when deciding whether to disclose listed transactions or transactions of interest. Noncompliance with the reportable-transaction rules comes with substantial risk, since the remedies in Mann Construction, CIC Services, and Green Valley are limited in their application.
While tax practitioners should continue to exercise care when advising their clients, there are also ways to mitigate risks. For example, for certain syndicated conservation easements under Notice 2017-10, tax practitioners can recommend that clients obtain a quality valuation and make sure a reasonable person would conclude that the real property in question warrants conservation. When it comes to reportable transactions, less is not more.
Mark Heroux, J.D., is a partner in the Tax Advocacy and Controversy Services practice at Baker Tilly US LLP in Chicago and a member of the AICPA IRS Advocacy & Relations Committee. Mai Chao Thao, J.D., is a senior associate with Baker Tilly US LLP in Madison, Wis. For more information on this column, contact firstname.lastname@example.org.