Complying with the Internal Revenue Code and all the regulations the Treasury Department passes is hard enough for taxpayers, as they amount to thousands of pages of ambiguous rules and provisions. Making matters worse, the IRS unilaterally publishes guidance documents on its website every year that substantively change some of these rules without any input from Congress or taxpayers.
The IRS then uses this informal guidance against taxpayers during audits—despite the lack of Administrative Procedure Act (APA) and due process compliance in writing them. Thankfully, the Tax Court just made it more difficult for the IRS to enforce such pronouncements against taxpayers in a recent decision.
The case Green Valley Investors, LLC v. Commissioner concerned the applicability of a notice document the IRS issued in a conservation easement case. Conservation easements are transactions that allow taxpayers to limit the use of their land in exchange for charity tax deductions. Internal Revenue Code section 6707A requires taxpayers to disclose certain “reportable transactions” like conservation easements to the IRS or face stiff penalties.
The problem is that neither the statute nor regulations define “reportable transaction.” Instead, the IRS unilaterally publishes notices on its website that list certain transactions that the IRS believes are prone to abuse and require taxpayer disclosure. These notices do not go through APA notice-and-comment that every other federal regulation goes through. If taxpayers cannot find the ad hoc guidance document covering their situation, and fail to disclose the transaction, they are hit with a minimum $10,000 penalty. There are no defenses (such as good faith reliance on a professional advisor) taxpayers can use to avoid this penalty.
Green Valley involves such a 2017 IRS informal guidance document. The IRS published a notice listing the type of conservation easement the taxpayer used in this case as a “reportable transaction.” But the conservation easement in the case was created before the 2017 notice. Nonetheless, the IRS imposed major penalties on the taxpayer, who challenged the assessment as violating the APA because the IRS did not go through the proper steps in making a substantive tax rule.
In a rare opinion made by the full Tax Court, the IRS lost. In the 15-2 decision, the Court found that the IRS notice listing this easement as a reportable transaction was a substantive tax rule subject to full APA notice-and-comment rulemaking. Notice-and-comment rulemaking allows taxpayers to comment on the substance, unfairness, and complexities of the rule and forces the IRS to give an adequate response to legitimate taxpayer concerns before issuing a regulation that has the force of law.
This opinion is one of the most consequential from the Tax Court in recent memory. Its logic could strike down all IRS notices that make substantive changes to the tax code but do not go through notice-and-comment. It would return tax rulemaking to the APA process mandated by Congress and allow taxpayers to give input before an IRS rule is made law. The decision could bring much needed transparency and fairness to tax enforcement. In the upcoming months and years, we will see how consequential this decision will be.
This loss is just one in a string of crucial judicial decisions that have gone against the IRS for blatantly violating procedural requirements. It is long overdue to bring tax rulemaking back to transparency and allow taxpayers to give their input on the rules under which they must comply. It is likely that the government will appeal this decision to the United States Court of Appeals for the Fourth Circuit based in Richmond, Virginia. NTUF’s Taxpayer Defense Center will be monitoring the appeal.