Tax Court: As To Listed Transaction, IRS Must Adhere To APA

Highlights

• The U.S. Court of Appeals for the Eleventh Circuit recently held in Green Rock LLC v. Internal Revenue Service that the IRS violated the Administrative Procedure Act (APA) by issuing Notice 2017-10 without public notice and comment.
• The IRS published the notice to designate certain conservation-easement transactions as presumptively tax-avoidance "listed" transactions, covering transactions in which certain criteria are present.
• This Holland & Knight alert reviews the court's decision and how it and other rulings could affect similar corporate practices.

In the late 1990s and early 2000s, the IRS was confronted with a proliferation of corporate transactions that it viewed as aggressive tax shelters. Relying on the authority Congress delegated through Section 6011(a), the IRS responded by constructing a comprehensive reporting regime that required these transactions to be identified by the various parties participating in the transaction.

In 2003, the final regulation enacting the reportable transaction regime was issued. See TD 9046. In 2004, Congress codified a new reportable transaction regime and enacted civil penalties for violators. Taxpayers must disclose their participation in "reportable transactions" – that is, transactions that the agency has determined have "a potential for tax avoidance or evasion." Section 6707A(c)(1). The failure to disclose the transaction triggers sanctions and monetary penalties. See id. §§ 6707A(b), 6011, 6662A. And a taxpayer's "material advisor" – one who provides "material aid, assistance, or advice" with respect to a reportable transaction – is also subject to penalties for violations of disclosure requirements. Id. § 6111(a), (b)(1)(A)(i); see id. §§ 6707(b), 6708(a), 6112.

The IRS typically identifies the reportable transaction, including a more serious subset referred to as a "listed" transaction, not through regulations but through informal guidance such as a notice. A notice is published in the Internal Revenue Bulletin but not subject to advance public notice and comment.

Green Rock LLC

Green Rock LLC sought investors to invest in a tax plan involving conservation-easement deductions. The IRS published Notice 2017-10 to designate certain conservation-easement transactions as presumptively tax-avoidance "listed" transactions. The notice covers transactions in which three criteria are present:

1. where a taxpayer purchases a property interest through a "syndicate" or pass-through entity
2. where the taxpayer is solicited through "promotional materials" that tout an available charitable deduction
3. where the taxpayer is promised a deduction that values the donated easement at or above "two and one-half times the amount" invested in the syndicate¹

In response, Green Rock successfully challenged the validity of Notice 2017-10 and won. See Green Rock, LLC v. IRS, 131 AFTR 2d 2023-562 (DC AL 2023). The IRS appealed.

Opinion

The issue before the Eleventh Circuit was whether the IRS violated the APA by issuing Notice 2017-10 in regard to a listed transaction without public notice and comment.

The court first discussed the APA in general and noted that to enact regulations that have the force of law, a federal agency ordinarily must abide by the notice-and-comment procedures prescribed in the APA. Thus, the agency must publish a notice of the proposed regulation, offer the public an opportunity to voice comments and concerns, consider and respond to feedback, and include in the final regulation a "concise general statement of" the basis and purpose of the regulation. But, Congress may choose to exempt an agency from notice and comment only if "it does so expressly." Thus, the exemptions are not to be presumed but must be clear from the statutory language. The Eleventh Circuit found that no such express language appears in Section 6707A.

The IRS argued that the regulation initially promulgated in 2003, Treas. Reg. § 1.6011-4, provides that the agency may list transactions "by notice, regulation, or other form of published guidance." Id. "Notice" refers to a revenue notice that is not subject to public notice and comment. The court rejected this argument, stating that "an agency regulation alone cannot displace the notice-and-comment requirements of the Administrative Procedure Act."

The IRS then argued that the language in Section 6707A(c)(1), "as determined under regulations prescribed under section 6011," provides the clear statutory language regarding the exception to overcome the requirement of notice and comment. After all, the IRS claimed, Congress must be deemed to be aware of the regulatory language it was incorporating into the statute. The court again rejected this position, noting that when it comes to the APA, "the presumption of acquiescence is not enough – something more is needed to overcome "expressly" the requirements of the Act."

Finally, the IRS argued that if the court did not agree with its position, then every notice-based listing would be eliminated, which is something Congress never intended. The court again rejected this proposition, as it found that the pre-2004 listed transactions – i.e., 28 of the 34 existing listed transactions – were not subject to the statutory penalties in question at the time they were identified as "listed." It is those penalties, and even potential criminal sanctions, that "render a listing notice a "legislative" rule subject to notice and comment to begin with."

Rejecting the IRS arguments and finding no express language in the statute that exempts the IRS from notice and comment, the court held that Notice 2017-10 was invalid and not binding on Green Rock.

Observations

• Once Congress attached substantive penalties to the listing rules in 2004, those rules acquired the force and effect of law and, therefore, had to be in the form of regulations.
• As a result of CIC Servs., LLC v. IRS, 141 S. Ct. 1582 (2021), the Eleventh Circuit joined the U.S. Court of Appeals for the Sixth Circuit in finding notices that designate transactions as "listed" under Section 6707A are unlawfully promulgated without notice and comment. Mann Constr., Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022).
• The IRS appears to have accepted this. The most recent listed transactions (including certain captive insurance arrangements, monetized installment sales, Malta trust transactions and charitable remainder annuity trusts) have been identified in proposed regulations. Likewise, the IRS has issued proposed regulations that impose an obligation to disclose participation in the same type of a conservation easement transaction as was at issue in Green Rock within 90 days after the regulations are finalized.
• The IRS may have come to realize that its justification for listing transactions only by notice – to get something out and require reporting practically immediately – isn't a problem. Section 7805(b)(1) permits retroactivity to the date of the initial proposed regulation or other guidance.
• Similarly, Congress knows how to create exceptions to the APA. Section 7805 provides a range of other exceptions to the general limitation on retroactivity. However, Congress did not exempt the IRS from notice-and-comment.
• It should be anticipated that there will be more of these sorts of retroactive reportable transaction regulations in the future.
• For Employee Retention Credits and other listed transactions that are currently only identified by notices, taxpayers, advisors and promotors may benefit from cases such as Green Rock and Mann Constr.
• Green Rock and Mann Constr. provide another defense for anyone, such as a material advisors or a taxpayer, who's been assessed a penalty for not complying with existing reportable transaction rules. However, if they have already paid the penalty, they should pay close attention to the limitations period on a refund claim, which is generally two years from the date of payment.

Footnote

1 In December 2022, Congress amended Section 170(h) in order to prevent excess easement donations. See Consolidated Appropriations Act, Pub. L. No. 117-328, 136 Stat. 4459, 5393 ("A contribution by a partnership ... shall not be treated as a qualified conservation contribution for purposes of [section 170(h)] if the amount of such contribution exceeds 2.5 times the sum of each partner's relevant basis in such partnership.").

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