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Partnership Challenges Denial of Charitable Contribution Deduction

OCT. 20, 2020

TS 27 Corp. et al. v. United States

DATED OCT. 20, 2020
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TS 27 Corp. et al. v. United States

TS 27 CORPORATION As Tax Matters Partner for SOUTH QUAIL RIDGE LLC,
Plaintiff,
v.
UNITED STATES OF AMERICA
Defendant.

IN THE UNITED STATES DISTRICT COURT
MIDDLE DISTRICT OF GEORGIA
ALBANY DIVISION

JUDGE:

MAGISTRATE JUDGE:

COMPLAINT

Plaintiff, TS 27 Corporation (“TS 27”), as the Tax Matters Partner (“TMP”) of South Quail Ridge, LLC (“South Quail”), by and through its attorneys, pursuant to 26 U.S.C. § 6226(a)(2),1 hereby complains against Defendant United States of America as follows:

NATURE OF THE ACTION

1. In December 2016, South Quail donated a significant and valuable real property interest to the North American Land Trust to preserve high-priority habitats for high-priority animal species in perpetuity. Contrary to Congress's efforts to incentivize such charitable giving, the IRS has not only disallowed South Quail's deduction in full based on unspecified technical foot-faults, but has also asserted penalties against the individual partners in South Quail.

2. This is a petition for readjustment of partnership items brought pursuant to 26 U.S.C. § 6226(a)(2) (the “Complaint”). At issue is (i) whether the IRS erroneously adjusted certain partnership items of South Quail for the taxable year ended December 31, 2016 (the “Taxable Year”), such partnership items arising out of a conservation easement donated by South Quail in 2016; (ii) whether the Internal Revenue Service (“IRS” or the “Service”) erroneously asserted that any underpayments of tax resulting from the adjustments are subject to accuracy-related penalties pursuant to 26 U.S.C. § 6662; (iii) whether the IRS erroneously asserted reportable transaction penalties pursuant to 26 U.S.C. § 6662A(b); and (iv) whether the taxpayers who reported the income and deduction of South Quail should be refunded their overpayments and/or deposits for the Taxable Year, together with interest and other amounts allowable by law.

3. As the designated TMP of South Quail, TS 27 has authority to serve as the representative of South Quail with respect to certain tax matters, including filing this Complaint. On behalf of South Quail, TS 27 disputes all of the proposed adjustments made by the IRS to the partnership items of South Quail, as reported on South Quail's federal income tax return (Form 1065, U.S. Return of Partnership Income) (“South Quail's Tax Return”) for the Taxable Year. The IRS's adjustments are set forth in the Notice of Final Partnership Administrative Adjustment (“FPAA”) dated July 22, 2020 issued by the Internal Revenue Service office located in Boston, Massachusetts. A true and correct copy of the FPAA is attached hereto as Exhibit A.

PARTIES

4. South Quail is a Georgia limited liability company with its principal office address at 253 Whigham Dairy Road, Bainbridge, Georgia, 39817. South Quail's employer identification number for federal income tax purposes is * * * 6623.

5. TS 27 is a 1% member of South Quail. TS 27 is a Georgia corporation with its principal office address at 253 Whigham Dairy Road, Bainbridge, Georgia, 39817.

6. As designated on the South Quail's Tax Return (Form 1065), TS 27 is also the TMP of South Quail within the meaning of 26 U.S.C. § 6231(a)(7) for the Taxable Year.

7. The Defendant is the United States of America. This is a dispute over positions taken by the IRS in the FPAA.

JURISDICTION AND VENUE

8. This Court has jurisdiction under 28 U.S.C. § 1346(e) and 28 U.S.C. § 1331.

9. Because South Quail's principal place of business is Bainbridge, Georgia, venue is appropriate in this district under 26 U.S.C. § 6226(a)(2) and 28 U.S.C. § 1391(e).

10. Pursuant to 26 U.S.C. § 6226(a)(2), TS 27, as TMP and on its behalf, timely brings this action to obtain judicial review of the FPAA.

11. The “deposit” requirement of 26 U.S.C. § 6226(e)(1) is satisfied. Under 26 U.S.C. § 6226(e)(1), a partner filing a petition for readjustment of partnership items in a district court of the United States is required to deposit with the Secretary of the Treasury the amount by which the tax liability would be increased if the treatment of partnership items on the partner's tax return was made consistent with the treatment of partnership items on the partnership return, as adjusted by the FPAA. A good faith calculation of this amount has been deposited on behalf of the TMP with the Secretary of the Treasury by check dated and postmarked October 19, 2020. A copy of the check is attached hereto as Exhibit B.

12. This Court has subject matter jurisdiction over this action for declaratory relief pursuant to 28 U.S.C. §§ 2201 and 2202, and Rule 57 of the Federal Rules of Civil Procedure.

13. An actual justiciable controversy between TS 27 and the United States exists within the meaning of 28 U.S.C. § 2201 regarding whether the IRS's, an executive agency or the United States, actions were correct or arbitrary and capricious.

FACTS

14. On December 30, 2016, South Quail granted a conservation easement (the “Conservation Easement”) to the North American Land Trust on property owned by South Quail located in Decatur County, Georgia.

15. The North American Land Trust is a “qualified donee” meeting the requirements of Code § 170(h)(1)(B).

The Property

16. The property underlying the donated Conservation Easement consists of approximately 169.33 acres of vacant land (the “Property”).

17. The only development on the land prior to the grant of the conservation easement was a well-developed secondary road system.

18. The Property is located off Attapulgas-Climax Road near Bainbridge in the southeastern portion of Decatur County. It is directly contiguous with the 2007 South Wind Plantation Conservation Area, and near the 2013 South Wind Plantation Conservation Easement and 2015 South Quail Point Conservation Easement also held by the North American Land Trust.

19. The Property contains a plethora of important conservation attributes, including high-quality remnants of the longleaf wiregrass/ecosystem and well-developed hardwood seepage forest. Longleaf Pine is recognized as “High Priority Habitat” by the Georgia State Wildlife Action Plan.

20. The Property is home to the Gopher Tortoise, a species that at the time of the grant was considered threatened and vulnerable. It is listed as a “High Priority Animal Species” by the Georgia State Wildlife Action Plan.

21. Furthermore, the Property is home to Bachman's Swallow, which is a “rare” species and listed as high-priority by the Georgia State Wildlife Plan.

22. The Easement protects these and other high-priority habitats and species.

The Easement Deed

23. On December 30, 2016, South Quail's donation of the Conservation Easement was effectuated through a Deed of Conservation Easement and Declaration of Restrictions and Covenants (“Easement Deed”), with respect to the Property to the North American Land Trust pursuant to 26 U.S.C. § 170(h).

24. The Easement Deed was properly recorded on December 30, 2016 in Decatur County, Georgia, and is recorded in Book 406, Page 872.

25. The Easement Deed preserves the land as open space, including farmland and forest land, in the land's relatively natural and relatively undeveloped condition.

26. The Easement Deed also protects the relatively natural habitat of fish, wildlife, and plants.

27. Under the Easement Deed, South Quail is prohibited, through a set of carefully crafted restrictions, from adversely impacting the natural habitats and conservation values of the property.

28. The North American Land Trust, as holder of the Easement, is responsible for enforcing the restrictions and covenants of the Easement and has the right to enforce the terms by proceedings at law or in equity.

29. The Easement Deed is granted in perpetuity and therefore also binds any subsequent owners of the Property.

30. The Conservation Easement is a restriction (granted in perpetuity) on the use which may be made of the Property.

31. The Conservation Easement is exclusively for “conservation purposes” as defined by § 170(h)(4)(A).

32. The conservation purposes protected by the Conservation Easement are protected in perpetuity within the meaning of § 170(h)(5) and the regulations thereunder.

33. The contribution of the Conservation Easement met all of the substation and recordkeeping requirements of §170(f)(11) and 26 C.F.R. § 1.170A-13(c).

Appraisal

34. In complying with the Internal Revenue Code and applicable Treasury Regulation, South Quail obtained an expert appraisal (“Taxpayer's Appraisal”) of the value of the Easement.

35. Taxpayer's Appraisal is a “qualified appraisal” as defined by 26 C.F.R. § 1.170A-13.

36. In addition to satisfying the qualified appraisal requirements, Taxpayer's Appraisal properly determined the Easement's fair market value to be $7,277,000 at the time of donation by using the “before” and “after” approach prescribed by 26 C.F.R. § 1.170A-14(h)(3)(i).

37. Taxpayer's Appraisal was prepared by Claud Clark III, of Clark & Davis, PC (“Taxpayer's Appraiser”).

38. Taxpayer's Appraiser is a “qualified appraiser” as defined by 26 C.F.R. § 1.170A-17(b).

IRS's Adjustments

39. For the Taxable Year, South Quail filed South Quail's Tax Return reporting a charitable contribution deduction equal to the value of the Easement.

40. For the Taxable Year, South Quail and its members each received a Schedule K-1 reporting their allocable shares of the contribution deduction.

41. The IRS conducted an examination of the South Quail Return and disputed South Quail's Easement deduction for federal income tax purposes.

42. On July 22, 2020, the IRS issues a Letter 1830-F, Notice of Final Partnership Administrative Adjustment (“FPAA”). Accompanying the Letter 1830-F was a Form 866-A, Explanation of Items, and Form 870-PT, Agreement for Partnership Items and Partnership Level Determination as to Penalties, Additions to Tax, and Additional Amounts. The IRS disallowed the Easement deduction. The IRS also assessed penalties under 26 U.S.C. § 6662 and 26 U.S.C. § 6662A.

43. The FPAA gave TS 27, as TMP, the option of agreeing to the adjustments and binding itself and non-notice partners, or the option to dispute the adjustment by filing a petition in court within ninety (90) days.

44. The IRS's adjustments and penalty assertions are erroneous and contrary to law.

45. The IRS has made adjustments to South Quail's Tax Return for the Taxable Year to disallow the charitable contribution deduction relating to the Easement in its entirety, maintaining that the charitable contribution does not satisfy all the requirements of 26 U.S.C. § 170 and corresponding Treasury Regulations. The IRS's position is not supported by the facts or the law, and is contrary to longstanding congressional support for conservation easement donations.

46. The IRS's assertions regarding South Quail's donation of the Easement are symptomatic of the IRS's overzealous approach to examining conservation easements. TS 27 brings this action on behalf of South Quail to challenge the IRS's tax adjustments and to have this Court declare that South Quail is entitled to the charitable contribution deduction claimed on its Tax Return in connection with its donation of the Easement.

Promulgation of IRS Notice 2017-10

47. IRS Notice 2017-10 designates certain, but not all, transactions involving the charitable donation of conservation easements as tax avoidance transactions and imposes certain responsibilities on taxpayers who participated in those transactions.

48. Pursuant to IRS Notice 2017-10 a transaction is classified as a listed transaction if an investor receives promotional materials offering the prospective investor in a pass-thru entity a charitable contribution deduction that equals or exceeds an amount that is two and one-half times the amount of the investor's investment. Furthermore, the investor must purchase an interest directly, or indirectly, in the pass-through entity that holds the real property and subsequently contributes a conservation easement to a tax-exempt entity allocating the charitable contribution donation to the investor through one or more tiers of the pass-through entities.

49. IRS Notice 2017-10 requires that transactions identified as tax avoidance transactions are “listed transactions” under Treasury Regulation §1.6011-4(b0(2) and §§ 6111 and 6112.

50. IRS Notice 2017-10 requires disclosure of these transactions for each taxable year in which the taxpayer participated in these transactions.

51. Notice 2017-10 authorizes substantial penalties for failure to disclose these transactions.

52. IRS Notice 2017-10 was issued on December 23, 2016 and took effect immediately. Indeed, the Notice applies retroactively to any transaction occurring after 2010 even if prior to the effective date of the Notice.

53. At the time Notice 2017-10 was issued, no Court had ruled that the transaction described in Notice 2017-10 was impermissible under any applicable tax laws, including I.R.C. §170(h).

54. IRS Notice 2017-10 provided no prior notice or mechanism for public comment.

COUNT I
THE IRS ERRED IN ITS DETERMINATION THAT THE EASMENT DID NOT SATISFY 26 U.S.C. § 170 AND THE CORRESPONDING TREASURY REGULATIONS

55. TS 27 incorporates by reference the preceding allegations contained in paragraphs 1 thru 33 as if fully set forth herein.

56. TS 27 disputes the adjustments made by the IRS in the FPAA.

57. The FPAA does not identify with specificity how the Easement fails to meet the requirements of 26 U.S.C. § 170. As such TS 27 is unable to respond with specificity as to how the Easement does not (in the IRS's view) meet the requirements of 26 U.S.C. § 170 and the corresponding Treasury Regulations.

58. South Quail and its members satisfied all the requirements of 26 U.S.C. § 170 and the applicable Treasury Regulations necessary to be entitled to a deduction in the amount of at least $7,277,000.

59. Consequently, South Quail seeks a determination pursuant to 26 U.S.C. § 6226 that it is entitled to the tax treatment it claimed on its Tax Return for the Taxable Year.

COUNT II
THE IRS ERRED IN ASSERTING ACCURACY RELATED PENALTIES UNDER 26 U.S.C. § 6662

60. TS 27 incorporates by reference the preceding allegations contained in paragraphs 1 thru 41 of this Complaint as if fully set forth herein.

61. The IRS erroneously determined there was an underpayment of tax resulting from the adjustment attributable to a gross valuation misstatement and accordingly that a 40% accuracy-related penalty shall be imposed as provided by 26 U.S.C. § 6662(h).

62. In addition, the IRS erroneously assessed penalties in the alternative if a gross valuation misstatement penalty was not applicable. Specifically, IRS erroneously determined that underpayments of tax from the adjustments were attributable to (1) negligence or disregard of rules and regulations, (2) substantial understatements of income tax, and (3) substantial valuation misstatements, as provided by 26 U.S.C. §§ 6662(c), (d), and (e) resulting in the imposition of a 20% penalty.

63. South Quail correctly reported the charitable contribution deduction in connection with the Easement donation on its Tax Return for the Taxable Year and therefore no underpayments exist.

64. South Quail has correctly valued the Easement and therefore no valuation misstatements exist.

65. South Quail and its members had substantial authority for the position taken on South Quail's Tax Return and as such had reasonable cause and acted in good faith.

66. Under 26 U.S.C. § 6751 no penalty may be assessed by the IRS, unless the initial determination of such assessment is approved in writing by an immediate supervisor of the person making such a determination.

67. The revenue agent failed to obtain written permission from his immediate supervisor.

68. Consequently, South Quail seeks a determination pursuant to 26 U.S.C. § 6226 that no accuracy-related penalties are appropriate under 26 U.S.C. § 6662 in connection with the Easement Donation.

COUNT III
THE IRS ERRED IN ASSERTING PENALTIES UNDER 26 U.S.C. § 6662A

69. TS 27 incorporates by reference the preceding allegations contained in this Complaint as if fully set forth herein.

70. The IRS erroneously determined that the adjustments to partnerships items were attributable to a listed transaction under 26 U.S.C. § 6707A(c) resulting in a 20% reportable transaction understatement penalty as defined by 26 U.S.C. § 6662A(b). Under 26 U.S.C. § 6662A(b), a penalty may be imposed on an understatement of tax arising from a reportable transaction, which includes listed transactions.

71. The IRS has treated South Quail's conservation easement donation as a listed transaction under Notice 2017-10.

72. The IRS failed to promulgate Notice 2017-10 in compliance with the Administrative Procedures Act (“APA”) as it did not comply with the notice-and-comment procedures.

73. Having failed to comply with the notice-and-comment rulemaking requirements, Notice 2017-10 was promulgated unlawfully and South Quail and its members has been adversely affected by Defendant's unlawful conduct, which is reviewable by this Court under the APA. See 5 U.S.C. § 706.

74. The APA empowers this Court to “hold unlawful and set aside agency action, findings, and conclusions found to be . . . without observance of procedure required by law.” See 5 U.S.C. 706(2)(D)

75. Because Notice 2017-10 is an unlawful agency action, South Quail may not be penalized for any understatement of tax attributable to participation in a transaction listed in Notice 2017-10.

76. In the alternative, South Quail cannot be penalized under § 6662A because South Quail correctly reported the charitable contribution deduction in connection with the Easement donation on its Tax Return for the Taxable Year and therefore no underpayments exist.

77. South Quail has correctly valued the Easement and therefore no valuation misstatement exists.

78. South Quail and its members had substantial authority for the position taken on its Tax Return and had reasonable cause and acted in good faith.

79. Under 26 U.S.C. § 6751 no penalty may be assessed by the IRS, unless the initial determination of such assessment is approved in writing by an immediate supervisor of the person making such a determination.

80. The revenue agent failed to obtain written permission from his immediate supervisor.

81. Consequently, South Quail seeks a determination pursuant to 26 U.S.C. § 6226 that no listed-transaction penalties are appropriate under 26 U.S.C. § 6662A(b) in connection with the Easement Donation.

COUNT IV
THE IRS ADJUSTMENTS ARE ERRONOUS BECAUSE THEY ARE PURPORTEDLY BASED ON SOUTH QUAIL'S FAILURE TO COMPLY WITH UNLAWFUL REGULATIONS

82. TS 27 incorporates by reference the preceding allegations contained in this Complaint as if fully set forth herein.

83. The Administrative Procedures Act (“APA”) provides that “[a] person suffering legal wrong because of agency action, or adversely affected or aggrieved by agency action within the meaning of the relevant statute, is entitled to judicial review thereof.” 5 U.S.C. § 702.

84. The APA further empowers this Court to “hold unlawful and set aside agency action, findings, and conclusions found to be . . . without observance of procedure required by law.” 5 U.S.C. § 706(2)(D)

85. Pursuant to the APA, certain “rules” promulgated by an agency must be published in accordance with notice-and-comment procedures. 5 U.S.C. § 553. An agency's failure to comply with notice and comment procedures is grounds for invalidating the rule.

86. The Qualified Conservation Contribution regulations (26 C.F.R. § 1.170A-14 et seq.) are rules subject to the notice and comment procedures under the APA.

87. The IRS is an “agency” within the meaning of the §§ 551(1) and 552(f)(1).

88. The IRS failed to adhere to the APA's requirements in 5 U.S.C. §553(c) when promulgating the Qualified Conservation Contribution regulations, and specifically Treasury regulation § 1.170A-14(g)(6).

89. The IRS did not engage in reasoned decisionmaking in promulgating the portions of the Qualified Conservation Contribution regulations, nor did the IRS provide a reasonable basis for significant portions of the Qualified Conservation Contribution regulations, specifically, Treasury regulation § 1.170A-14(g)(6).

90. As a result of the IRS's arbitrary and capricious actions and failure to engage in reasoned rule-making, its rules and regulations are unlawful. Any subsequent failure to comply for such an unlawful rule is not a basis upon which a deduction may be disallowed

91. South Quail complied with the applicable lawful regulations in claiming a deduction for its donation of a conservation easement.

92. In the alternative, it was error for the IRS to disallows South Quail's deduction for failure to comply with unlawful regulations.

COUNT V
REQUEST FOR DECLARATORY JUDGMENT

93. TS 27 incorporates by reference the preceding allegations contained in this Complaint as if fully set out herein.

94. The Declaratory Judgment Act, 28 U.S.C. § 2201, and Rule 57 of the Federal Rules of Civil Procedure grant this Court authority to declare Plaintiff's legal rights when an actual controversy exists between the parties.

95. South Quail and Defendant have adverse legal interests that are of sufficient immediacy and reality to warrant the issuance of a declaratory judgment in accordance with 28 U.S.C. § 2201.

96. Defendant failed to comply with the APA's notice-and-comment provisions in promulgating Notice 2017-10.

97. Nothing in this lawsuit seeks to restrain the assessment or collection of taxes, only the arbitrary demand for information unrelated to any instances of such assessment or collection.

98. For the above-described reasons, TS 27 respectfully request this Court to declare that Notice 2017-10 violates the notice-and-comment provisions of the APA and to further declare that such Notice is therefore invalid.

PRAYER FOR RELIEF

WHEREFORE, TS 27 prays for the following relief: (1) that this Court determine that South Quail's Tax Return for the Taxable Year was correct as filed; (2) that this Court determine that all of the IRS's adjustments as set forth in the FPAA are erroneous; (3) that this Court determine that the assertion of accuracy-related penalties by the IRS under 26 U.S.C. § 6662 is erroneous; (4) that this Court determine that the assertion of reportable transaction penalties under 26 U.S.C. § 6662A(b) by the IRS is erroneous; (5) that this Court order that the United States return and refund all amount overpaid by South Quail with respect to its members returns together with interest thereon as allowed by law, and pay all other amounts that may be legally due; (6) that this Court issue a judicial declaration that the IRS's actions are arbitrary and capricious; and (7) that this Court award attorney's fees and grant such other further relief that the Court deems just and appropriate.

Respectfully Submitted,

David A. Kendrick
Georgia State Bar No. 414050
415 S. West Street
P.O. Box 1026
Bainbridge, Georgia 39818
KENDRICK LAW FIRM, LLC

Gregory P. Rhodes
Alabama Bar No. ASB-4351-G68R
2311 Highland Avenue South
Birmingham, AL 35205
SIROTE & PERMUTT, P.C.

Attorneys for Plaintiff

FOOTNOTES

1All references to 26 U.S.C. § 6226 contained herein apply to the code prior to the Bipartisan Budget Act amendments of 2015.

END FOOTNOTES

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