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Tax Court Hands IRS Major Defeat In Its Battle Against Conservation Easement Transactions

Posted on Nov. 10, 2022

Yesterday in Green Valley Investors v Commissioner, a reviewed opinion, the Tax Court held the IRS violated the APA when it issued Notice 2017-10 without complying with the notice and comment provisions of the APA or otherwise establishing that it was not required to subject the rule to the APA’s notice and comment procedures. The opinion is a major defeat for the IRS and is an important decision applying administrative law principles to IRS guidance.

The opinion follows up on recent cases like Mann Construction (blogged here) where other federal courts have held that the IRS’s issuance of a Notice ran afoul of the APA. Tax Notes’ Kristen Parillo does a bang-up job summarizing [$] and placing the opinions and dissents in that context. The opinion deserves a major write up, and I may return to do so in PT but in the interest of getting something to our readers here are a few initial observations and thoughts.

In addition to the APA issue, the taxpayer also argued that penalties the IRS imposed under section 6662A were improper because they were assessed retroactively after the issuance of Notice 2017-10. The retroactivity issue is a tough one for taxpayers, but the Tax Court was able to sidestep the issue by holding that the IRS violated the APA with respect to the Notice’s issuance.

While there are two concurring opinions and a dissenting opinion, no opinion agreed with the IRS view that the rule in question was interpretive and thus not generally required to be issued under notice and comment. As such, Green Valley is another firm rebuke of the IRS’s take on how its subregulatory guidance fits in with broader administrative law and APA norms and requirements. The majority opinion defines a legislative rule as one that “impose[s] new rights or duties and change the legal status of regulated parties.” That low bar easily put the Notice at issue in that camp.

Elaborating on its holding that the Notice is a legislative rule, the majority states that “the 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.” To reinforce its conclusion, the opinion details the effect of the IRS’s classification in the Notice on taxpayers and material advisors.

That majority’s framing suggests that many more pieces of subregulatory guidance are subject to procedural APA attacks.

The statutory framework at issue in this and other challenges highlights a separate legal question, namely whether Congress intended to displace the APA’s notice and comment regime. Section 6707A(c)(1) permits the Secretary to define reportable transactions “under regulations,” and respondent pointed out that Congress remained silent after Treasury issued regulations allowing the agency to define that crucial term through essentially any type of guidance, including IRB guidance at issue in this and other similar cases.

Displacing the APA is the prerogative of Congress, not the IRS. It is here that the Tax Court (and other courts) divided. For an agency to issue a legislative rule without notice and comment (and without good cause for skipping it) there needs to be an express statutory displacement of the APA. The different opinions in this case explore how or whether this principle should apply here. There is more nuance to unpack, and in a future post I may revisit the topic, but for now, the takeaway is that the majority opinion sets that hurdle pretty high.

Finding a violation of the APA leads to the hot issue of remedy, and whether a court could set aside the tainted IRS Notice for all, or only for those taxpayers who brought the challenge. The majority did not wade deeply into that issue but in footnote 22 essentially told the IRS that its opinion has the similar effect as vacating broadly, stating that “[a]lthough 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.”

This is a major development. But it is not the last development, for sure, either in the ongoing battle between IRS and those engaging or participating in easement transactions or in the broader issue of IRS compliance with the APA’s procedural requirements associated with rulemaking.

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