Notice 2017-10, which identifies syndicated conservation easement transactions as listed transactions, was held invalid by the Tax Court because the IRS issued the notice without following Administrative Procedure Act (APA) notice-and-comment rulemaking.
Background
Green Valley Investors LLC, Big Hill Partners LLC, and Tick Creek Holdings LLC each granted a conservation easement to Triangle Land Conservancy (TLC) in 2014, and Vista Hill Investments LLC granted one to TLC in 2015. The first three limited liability companies (LLCs) each claimed a generous deduction (over $22 million) for their charitable easement contribution on their 2014 returns. Vista Hill claimed an equally generous deduction for its contribution in 2015.
On Dec. 23, 2016, the IRS issued Notice 2017-10, which identified all syndicated conservation easement transactions beginning Jan. 1, 2010, and all substantially similar transactions, as “listed transactions” as defined in Regs. Sec. 1.6011-4(b)(2).
The IRS conducted examinations of the partnership returns on which the LLCs took their charitable easement contribution deductions. As a result of these examinations, the IRS issued a Final Partnership Administrative Adjustment (FPAA) to each LLC disallowing its deduction. In addition, the IRS asserted a Sec. 6662(h) gross-valuationmisstatement penalty, a Sec. 6662(e) substantial-valuation-misstatement penalty, a Sec. 6662(b)(1) and (c) negligence penalty, and a Sec. 6662(b)(2) and (d) substantial-understatement penalty against each LLC.
The LLCs challenged the IRS’s determinations in Tax Court in a consolidated case. In its answer to the LLCs’ Tax Court petition, the IRS also asserted the reportable transaction penalty under Sec. 6662A against the LLCs.
The LLCs and the IRS made cross motions for summary judgment. In their motion, the LLCs argued that the IRS could not assert the Sec. 6662A penalties against them because, when it issued Notice 2017-10, the IRS failed to comply with the APA’s notice-andcomment provisions.
The Tax Court’s decision
The Tax Court held that Notice 2017-10 was invalid because it was issued without notice and comment as required under the APA. Therefore, as the LLCs argued, the IRS could not impose Sec. 6662A penalties against them.
APA notice-and-comment rulemaking: As the Supreme Court has described, the APA provides a three-step procedure for “notice-and-comment rulemaking.” Under the APA, agencies are required to (1) issue a general notice of proposed rulemaking; (2) allow interested persons an opportunity to participate; and (3) include in the final rule a “concise general statement of [its] basis and purpose.”
However, notice-and-comment rulemaking is only required for legislative rules and not for interpretative rules. Legislative rules, which have the force and effect of law, are rules that impose new rights or duties and change the legal status of parties. Interpretative rules are rules that merely advise the public of an agency’s construction of the statutes it administers, articulating what an agency believes a statute means or reminding parties of preexisting duties.
As the APA recognizes, Congress may modify the APA notice-andcomment rulemaking procedures in a statute. However, a statute will not be held to modify the procedures unless it does so expressly.
The IRS’s arguments: The IRS argued that notice-and-comment procedures were not required for Notice 2017-10 because it was an interpretative, rather than a legislative, rule. In addition, the IRS contended that, even if the notice was a legislative rule, Congress has authorized its issuance by procedure other than the notice-and-comment requirements under the APA.
Interpretative rather than legislative rule: Regarding whether Notice 2017-10 was a legislative rather than an interpretative rule, the Tax Court found that “[t]he act of identifying a transaction as a listed transaction by the IRS, by its very nature, is the creation of a substantive (i.e., legislative) rule and not merely an interpretative rule.” According to the court, identifying a transaction as a listed transaction did not, as an interpretative rule would do, merely provide the IRS’s interpretation of the law or remind taxpayers of preexisting duties.
Rather, as the court discussed in some detail, it imposes new duties in the form of reporting obligations and recordkeeping requirements on both taxpayers and their advisers. Consequently, Notice 2017-10 exposes taxpayers and advisers to additional reporting obligations and penalties to which they would not otherwise be exposed but for the notice. As the Sixth Circuit stated in Mann Construction, Inc., 27 F.4th 1138, 1144 (6th Cir. 2022), in which the court addressed whether Notice 2007-83 was a legislative rule: “Creating new substantive duties and exposing taxpayers to penalties for noncompliance ‘are hallmarks of a legislative, not an interpretive, rule.’ ”
Authorization of identification of listed transactions without notice and comment: The IRS pointed to the text of Sec. 6707A, Regs. Sec. 1.6011-4, and the history of Sec. 6707A as proof that Congress had knowingly authorized the IRS to identify listed transactions through subregulatory guidance. The Tax Court, however, determined that this was not the case.
Sec. 6707A imposes a penalty on “any person who fails to include on any return or statement any information with respect to a reportable transaction which is required under section 6011 to be included with such return or statement.” The Tax Court found that the statute had no effect on the application of notice-and-comment rulemaking because it offered no express indication that Congress was exempting the IRS from the standard APA notice-and-comment rulemaking and that Sec. 6011, referred to in Sec. 6707A, likewise was silent on any congressional intent to provide such an exemption. The court noted that the Sixth Circuit in Mann Construction had come to the same conclusion.
The IRS also argued that Regs. Sec. 1. 6011-4(b)(2) expressed Congress’s intent regarding listed transactions, because that regulation subsection, which was issued before Sec. 6707A was enacted, defined a listed transaction as a transaction “identified by notice, regulation, or other form of published guidance.” This language, in the IRS’s view, informed Congress that the IRS would operate outside of APA rulemaking by identifying listed transactions in the future in notices issued without notice and comment (such as Notice 2017-10). Therefore, when Congress later defined “reportable transaction” in Sec. 6707A(c)(1), it incorporated this procedure from Regs. Sec. 1.6011-4.
The Tax Court was not swayed by this argument, stating it was “less confident [than the IRS] that Congress understood that the IRS’s reference to the term ‘notice’ within [Regs. Sec.] 1. 6011-4 was a clearly defined procedure for identifying listed transactions separate from traditional APA procedures.” The court instead concluded that Congress expects that administrative agencies follow the APA notice-andcomment rulemaking procedures except when it expressly chooses different procedures for them to use.
The Tax Court also rejected the IRS’s argument that Congress had approved the IRS’s use of notices to identify listed transactions when it amended monetary penalties in Sec. 6707A but did nothing regarding the IRS’s practices for identifying listed transactions. The court noted that, as the Sixth Circuit had expressed, “[i]naction may, but does not always, mean ratification” and “rarely suffices to show express modification of the APA’s bedrock procedural guarantees given the raft of potential explanations for inaction on Capitol Hill” (Mann Constr., Inc., 27 F.4th at 1147) .
In a final argument, the IRS claimed that a committee print from 2020 relating to continued congressional oversight of syndicated conservation easement transactions was persuasive evidence that Congress intended to override the APA’s applicability to the IRS’s listing of transactions. However, the Tax Court refused to accept the idea that congressional oversight hearings, written statements by the respective chairs of the Senate Finance Committee at the oversight hearings, and testimony related to these transactions from executive branch members could serve as express congressional intent sufficient to override the requirements of the APA with respect to Notice 2017-10.
Reflections
In a footnote, the Tax Court stated: “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.” In response to this case and the Mann Construction case, the IRS relented to the court’s view. It issued proposed regulations (REG-106134-22), which will undergo notice-and-comment procedures (including, as the IRS stated, due consideration of public comments) that identify certain conservation syndicated easement transactions as listed transactions. The IRS stated it will also in the near future issue more proposed regulations that identify additional transactions as listed transactions.
Green Valley Investors, LLC, 159 T.C. No. 5 (2022)
Contributor
James A. Beavers, CPA, CGMA, J.D., LL.M., is The Tax Adviser’s tax technical content manager. For more information about this column, contact thetaxadviser@aicpa.org.
