Overview
On November 9, 2022, the United States Tax Court in Green Valley Investors v. Commissioner1, held that the Internal Revenue Service (IRS) violated the Administrative Procedure Act (APA) when it issued Notice 2017-10 without complying with the APA’s notice and comment provisions. The Tax Court set aside Notice 2017-10 as invalid and vacated the imposition of section 6662A penalties (tax shelter penalties for non-reporting) with respect to the syndicated conservation easement transactions identified in Notice 2017-10. The opinion falls on the heels of Mann Construction2, where another federal court held that the IRS’s issuance of a Notice ran afoul of the APA, and is an important decision applying administrative law principles to IRS guidance.
Facts and Procedural History
In 2011, the taxpayers purchased 607 acres of land in North Carolina in two transactions for a total price of $2,237,600. After transferring the land to a single-member limited liability company, 151 acres of the land were donated as a conservation easement to Triangle Land Conservancy (TLC). In 2013, appraisals were prepared (V&W Appraisals) valuing the entire 607-acre tract at $22 million immediately prior to the easement grant and $1,520,000 after the easement grant.
A charitable contribution deduction of approximately $22.5 million was claimed for the easement donation. The IRS disallowed the deductions by Notices of Final Partnership Administrative Adjustment (FPAA). The FPAAs determined that the taxpayers had not complied with the requirements of section 170 and had not established that the value of the transferred conservation easements exceeded $0. The IRS argued that as a matter of law, the V&W Appraisals were not qualified appraisals because the V&W Appraisals (i) do not provide a fair market value for the property contributed and (ii) were not prepared in accordance with the Generally Accepted Appraisal Standards (GAAS). The IRS asserted accuracy-related penalties for gross valuation misstatements, substantial valuation misstatements, substantial understatements of tax, and negligence under section 6662, and a penalty for a reportable transaction understatement under section 6662A.
Motion practice ensued and in December 2021 petitioner filed a cross motion for summary judgment regarding the IRS' assertion of two penalties— sections 6662(h) and 6662A. In the cross-motion for summary judgment petitioner asserted, in part, that the issuance of Notice 2017-10 failed to comply with the notice-and-comment provisions of the APA.3
Notice-and-Comment Rulemaking Requirements
The APA provides a three-step procedure for "notice and comment rulemaking" whereby 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."4However, "not all 'rules' must be issued through the notice-and-comment process. . . . The notice and comment requirement 'does not apply to 'interpretative rules, general statements of policy, or rules of agency organization, procedure, or practice.'"5The IRS argued, similar to its arguments in Mann Construction, that (1) Notice 2017-10 was an interpretative rather than legislative rule and (2) even if Notice 2017-10 were a legislative rule, Congress authorized its issuance by sub-regulatory guidance.
Is Notice 2017-10 an Interpretative Rule?
The Tax Court concluded that Notice 2017- 10 was not an interpretative rule because "identifying a transaction as a listed transaction does not merely provide the IRS's interpretation of the law or remind taxpayers of pre-existing duties." By identifying a transaction as a listed transaction, the Notice imposed new duties in the form of reporting obligations and recordkeeping requirements on both taxpayers and their advisors. Accordingly, Notice 2017-10 exposes taxpayers to additional reporting obligations and penalties to which they would not otherwise be exposed but for the notice. According to the Court, "creating new substantive duties and exposing taxpayers to penalties for noncompliance 'are hallmarks of a legislative, not an interpretive, rule.'"
Is Notice 2017-10 Otherwise Exempt from the Notice and Comment Requirements Found Under the APA?
The IRS argued that Congress clearly exempted the IRS from following the APA's normal procedures when it enacted section 6707A and that Notice 2017-10 thus was properly issued without notice-and-comment rulemaking. The Court rejected the IRS' position.
To be exempted from the APA's normal procedures of notice and comment, the Tax Court stated that an "express" indication of congressional intent is needed. The Court found that section 6707A offered no express indication from Congress exempting the IRS from the standard notice-and-comment rulemaking of the APA. Likewise, the Court noted that section 6011 (which is referenced by section 6707A) and the regulations thereunder were also silent on any express congressional intent. Thus, considering the statutory text, the Court held that the IRS had failed to establish that Congress expressed any alternative procedures "so clearly different from those required by the APA that it must have intended to displace the norm." The Tax Court noted that the Supreme Court has emphasized that “exemptions from the terms of the Administrative Procedure Act are not lightly to be presumed in view of the statement in 5 U.S.C. § 559 that modifications must be express."6
Not willing to concede the issue, the IRS further asserted that Congress is "presumed to have been aware" of the IRS's actions when it amended section 6707A to enhance the monetary penalties for taxpayers through subsequent enactment. But the Tax Court agreed with the Sixth Circuit in Mann Construction and rejected the contention that Congress' subsequent inaction means that it was "endorsing and ratifying" the IRS's practice of bypassing the notice and comment requirements for future reportable transactions. As was stated by the Sixth Circuit, "inaction 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."7
Accordingly, the Tax Court held that Notice 2017-10 was issued without notice and comment as required under the APA. As a result, the Court invalidated the application of the penalty in the case and 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."
Conclusion
Green Valley Investors is a significate setback for the IRS and adds to a growing body of law invalidating listing notices for noncompliance with the APA and rejecting the IRS' claim that tax regulations and guidance are interpretive rules exempt from notice and comment under the APA. Given the scope of the court’s ruling, Notice 2017-10 is arguably invalidated as to all possible deficiency actions that could come before the Tax Court.
Endnotes
1 159 T.C. 5 (November 9, 2022). The opinion was joined by 11 of the 17 judges of the Tax Court. Four judges concurred in the result, with two judges writing separate opinions. Two judges dissented, with each writing a separate opinion.
2 Mann Construction v. United States, 539 F. Supp. 3d 745 (E.D. Mich. 2021)
3 5 USC §§ 551- 559, 701 – 706.
4 Perez v. Mortg Bankers Assn, 575 U.S. 92, 96 (2015)
5 Id.
6 Marcello v. Bonds, 349 U.S. 302 (1985)
7 Mann Construction v. United States, 27 F.4th 1138, 1147 (6th Cir. 2022).