Due to recent taxpayer-favorable court decisions requiring the Department of the Treasury to use formal notice-and-comment procedures under the Administrative Procedure Act (APA), the process by which the IRS publicly identifies listed transactions has undergone significant changes. It remains unclear whether these changes will ultimately have taxpayer-favorable effects, and CPAs are well advised to closely monitor developments.

Background

Since the enactment of the American Jobs Creations Act of 2004 (AJCA), careful tax professionals have kept a watchful eye on the latest IRS guidance. Pursuant to IRC section 6707A(a) and (c), taxpayers are required to disclose on Form 8886, Reportable Transaction Disclosure Statement, any transaction “which is the same, or substantially similar to, a transaction specifically identified by the Secretary [of the Treasury] as a tax avoidance transaction for purposes of section 6011.” Taxpayers must attach Form 8886 to their tax returns for each tax year in which they participate in a listed transaction [Treasury Regulations section 1.6011-4(e)(1)]. When taxpayers first file Form 8886 with respect to a particular transaction, they must also send a copy of Form 8886 to the IRS Office of Tax Shelter Analysis (OTSA) [Treasury Regulations section 1.6011-4(e)(1)].

If taxpayers fail to disclose a listed transaction, they may be subject to a maximum penalty of $200,000 (for entities) or $100,000 (for natural persons) under IRC section 6707A and an enhanced penalty of up to 30% of any reportable transaction understatement. Undisclosed participation in a listed transaction tolls the period of limitations for the IRS to assess tax and penalties with respect to the transaction until one year after a disclosure is eventually made by either the taxpayer or their material advisor [IRC section 6501(c)(10); Treasury Regulations section 301.6501(c)-1(g)(1) and (7)].

The IRS has long taken the position that it can identify a listed transaction (thus triggering the accompanying disclosure obligations, penalties, and statute of limitations tolling consequences), in a notice published in the Internal Revenue Bulletin and on IRS. gov, without any opportunity for public notice-and-comment. To support this proposition, the IRS has relied upon a pre-AJCA regulatory provision, Treasury Regulations section 1.6011-4(b) (2), which provides that a listed transaction may be “identified by notice, regulation, or other form of published guidance.” The IRS has made ample use of this authority, identifying over 30 listed transactions (“Recognized Abusive and Listed Transactions,” https://www.irs.gov/businesses/corporations/listed-transactions). In turn, courts have typically sustained the assessments of penalties for nondisclosure of transactions identified as listed [e.g., Interior Glass Sys., Inc. v. United States, 927 F.3d 1081, 1083 (9th Cir. 2019); Vee’s Mktg., Inc. v. United States, 816 F.3d 499, 501 (7th Cir. 2016); Prosser v. Comm’r, 777 F.3d 582, 594 (2d Cir. 2015); Yari v. Comm’r, 153 T.C. 157, 169 (2014), aff’d, 669 F. App’x 489 (9th Cir. 2016)].

This status quo changed in 2022. In Mann Construction, Inc. v. United States [27 F.4th 1138 (6th Cir. 2022)], the Sixth Circuit vacated (or “set aside,” in the parlance of the APA) IRS Notice 2007-83, which had identified certain cash-value life insurance policies held by trusts as a listed transaction. The Sixth Circuit reasoned that Notice 2007-83 was a legislative rule that had the force and effect of law and thus should have been issued via notice-and-comment rulemaking under the APA. Not long after, in a reviewed opinion with two authored dissents, the Tax Court similarly vacated Notice 2017-10, which had identified syndicated conservation easements as a listed transaction [Green Valley Invs., LLC v. Commissioner, 159 T.C. 80 (2022)].

In the aftermath of these decisions, the IRS and Treasury have proceeded cautiously and begun using the notice-and-comment rulemaking process to identify listed transactions. That includes the recent issuance of proposed regulations identifying certain monetized installment sales [Notice of Proposed Rulemaking, 88 Fed. Reg. 149 (Aug. 4, 2023)], Malta pension plan schemes [Notice of Proposed Rulemaking, 88 Fed. Reg. 37186 (June 7, 2023)], micro-captive insurance structures [Notice of Proposed Rulemaking, 88 Fed. Reg. 21547 (Apr. 11, 2023)], and syndicated conservation easements [Notice of Proposed Rulemaking, 87 Fed. Reg. 75185 (Dec. 8, 2022)], as listed transactions. The IRS recently released a priority guidance plan that also indicates that proposed regulations identifying as listed certain 1) “basket transactions”; 2) “notional principal contract transactions”; 3) and “uses of charitable remainder annuity trusts” are forthcoming [Department of Treasury, “2023-2024 Priority Guidance Plan,” Sep. 29, 2023, https://www.irs.gov/pub/irs-utl/2023-2024-priority-guidance-plan-initial-version.pdf.]

The Implications

What does all this mean for tax advisors? With respect to transactions identified in IRS notices that have since been “set aside” by the courts or otherwise not yet identified by a final rule, one might argue that a basis exists for not disclosing such transactions on a current-year Form 8886. Although this strategy may well be technically correct on the law, it likely remains ill-advised as a practical matter. As demonstrated by the recent flurry of proposed regulations identifying listed transactions, the IRS is highly likely to continue transforming its previously issued notices into final rules. The recent proposed regulations provide that the listed transaction identifications are only “effective as of the date of publication in the Federal Register” of the final rule; a final rule, however, may still apply to tax years before the effective date. Taxpayers may be well advised to protectively disclose “soon-to-be-identified-as-listed” transactions, even if not yet identified in a final rule, for several reasons [see Treasury Regulations section 1.6011-4(f)(2), providing for protective disclosure on Forms 8886].

First, failing to file Form 8886 may still retroactively expose an inattentive taxpayer to penalties for nondisclosure (Green Valley, 159 T.C. at 86: “We have previously upheld the retroactive application of penalties, even though the taxpayers became subject to the penalties after they had entered into the transactions or after their tax returns had been filed.”). If the IRS identifies a listed transaction and the taxpayer fails to file Form 8886 with the OTSA within 90 days, section 6707A and enhanced section 6662A penalties are applicable. [See Kenna Trading, LLC v. Commissioner, 143 T.C. 322, 372 (2014), aff’d sub nom. Sugarloaf Fund, LLC v. Commissioner, 911 F.3d 854 (7th Cir. 2018); see also IRC sections 6662A(c); 6664(d)(3)(A); Treasury Regulations section 1.6011-4(e)(2)(i); Treasury Regulations section 301.6707A-1(c)(2), example 6.] Along with that increased penalty exposure, a taxpayer might be precluded from invoking a reasonable cause defense under IRC section 6664(d) (1) for the section IRC 6662A penalty, as one of that defense’s preconditions is that “the relevant facts affecting the tax treatment of the item are adequately disclosed in accordance with the regulations prescribed under section 6011”—i.e., on Form 8886 filed with the return or within 90 days of the identification. [See IRC section 6664(d)(3)(A); Treasury Regulations section 1.6011-4(e)(1) and (2)(i).]

Second, the statute of limitations for assessment will be tolled. IRC section 6501(c)(10) provides that, if a taxpayer fails to disclose a listed transaction, the period of limitations for the IRS to assess “any tax imposed by [the Code] with respect to such transaction” shall not expire until one year after the earlier of 1) the date that the IRS is furnished with Form 8886 or 2) the date that a material advisor furnishes to the IRS a list of persons advised by the advisor with respect to the transaction, as required by section 6112(a). In other words, the limitations period to assess tax, penalties, and interest with respect to the transaction would be tolled until after the identifying disclosure is made—even if in the tax year that the taxpayer engaged in the transaction and filed a return, the transaction was not yet listed. [See Blak Invs. v. Comm’r, 133 T.C. 431, 451 (2009): “Under section 6501(c)(10), it is of no consequence that the transaction in question became a reportable transaction after the transaction had already occurred.”] Accordingly, for taxpayers who participated in a transaction that is not currently a listed transaction, but is near certain to become one in the imminent future, filing Form 8886 as a protective disclosure with a current-year tax return has benefits in limiting exposure to the tolled period of limitations [Treasury Regulations section 1.6011-4(f)(2)].

Third, filing Form 8886 may avoid another open legal question: whether disclosing a listed transaction on Form 8275, Disclosure Statement (the typical method for items not otherwise adequately disclosed on the return) is sufficient to avoid the penalty and tolling of the statute of limitations. Two decisions (though of limited precedential value) have suggested that the disclosure requirement is not met for purposes of section 6707A and section 6501(c)(10) if not made on Form 8886. For example, in May v. United States [691 F. App’x 334, 336 (9th Cir. 2017)] the Ninth Circuit concluded that disclosure must be made on a Form 8886 for purposes of section 6501(c)(10) (A)], and in Mann Construction, Inc. v. United States [495 F. Supp. 3d 556, 580–81 (E.D. Mich. 2020)] a district court held that taxpayer’s prior-year filing of Form 8275 disclosing a listed transaction was insufficient to start running of limitations period under section 6501(c)(10)(A) [rev’d on other issue, 27 F.4th 1138 (6th Cir. 2022)].

Not the Last Word

One final consideration: Mann Construction and Green Valley may not be the last word on how the IRS may identify listed transactions. The IRS continues to publicly maintain that it disagrees with both decisions and intends to defend already-issued listing notices (IRS Announcement 2023-11, https://www.irs.gov/pub/irs-drop/a-23-11.pdf). The government is currently pursuing an appeal in the Eleventh Circuit of a separate district court decision that adopted Green Valley’s reasoning and set aside Notice 2017-10 [Green Rock, LLC v. IRS, No. 21-cv-01320, 2023 WL 1478444 (N.D. Ala. Feb. 2, 2023), appeal filed (11th Cir. March 31, 2023)]. More appeals are likely to follow; other courts may view the issue differently than the Sixth Circuit panel in Mann Construction, whereas the Tax Court may have occasion to revisit the issue in future. Should a court reach a contrary conclusion in a future case, the IRS will press its position that a listed transaction identified by a notice still gives effect to the various consequences provided for by the IRC.

All in all, the continued uncertainty surrounding the listed transaction framework may not lead to much significant change in practice. Whether done quickly by notice, or slowly through the notice-and-comment process, listed transactions give rise to serious consequences for affected taxpayers.

Michael Waalkes, JD, LLM (Tax), is an associate at Kostelanetz LLP, Washington, D.C.