When a taxpayer files a tax return reporting their income, the IRS gains insight into their earnings and can compare this information with similarly situated taxpayers. One might expect that this regular reporting would be sufficient for tax administration purposes. The IRS could simply identify and audit returns showing unusual drops in reported tax. This is true even in cases involving large gains offset by tax attributes that would be visible on the tax return.
However, the tax return process has become so cumbersome and complex that just filing a tax return alone is not enough. Taxpayers may have to file numerous different information reports, statements, etc. This includes information returns that are not treated as tax returns, but encompass a significant amount of information. The reportable information can include everything from foreign account balances, to amounts paid to contractors and employees, to bartering transactions.
This is also not enough. The tax reporting rules also require the reporting to highlight specific transactions that the IRS says that it is interested in. There are special rules and forms for this purpose–many of which are so nuanced that taxpayers often fail to file them or file them correctly. These transactions are referred to as “reportable transactions.” The reportable transaction reporting regime has recently faced legal challenges recently.
In the past few years, courts have ruled that the IRS’s process for designating these transactions that require additional information does not comply with administrative law requirements. In response, the IRS has now issued Action on Decision 2024-01, largely accepting these court decisions, even though it has largely rejected the outcome of these court cases for some time now.
Reportable Transactions vs. Listed Transactions
A reportable transaction is a type of tax transaction that the IRS requires taxpayers and their advisors to disclose. The rationale is that the transaction has characteristics that the IRS believes may indicate tax avoidance. Think of it as a transaction that raises certain red flags that the IRS wants to know about.
A listed transaction is a type of reportable transaction. It is more narrow. It is one that the IRS has explicitly identified as a tax avoidance scheme. The IRS has basically labeled these transactions as likely to be abusive and has formally “listed” them published guidance. When the IRS designates something as a listed transaction, it’s essentially saying “we’ve seen this specific scheme before, we consider it problematic, and we want to know if anyone is doing it.”
To give you a concrete example: If a company engages in a complex transaction that generates significant tax losses without corresponding economic losses, that might be a reportable transaction because it has characteristics that suggest potential tax avoidance. If that specific type of transaction matches one that the IRS has previously identified and published as problematic in their guidance, it would be a listed transaction.
Types of Reportable and Listed Transactions
To understand the difference, it is helpful to pause to describe the types of transactions that the IRS has designated as reportable transactions and listed transactions.
Reportable transactions the IRS has not designated as listed transactions are generally defined by their characteristics rather than their structure. They are broader rather than focused on targeted transactions.
Reportable transactions that aren’t listed generally fall into five distinct categories:
- Confidential transactions involve tax advice given under secrecy conditions with restricted disclosure rights.
- Transactions with contractual protection have fees contingent on achieving tax benefits or include refund rights if the tax treatment fails.
- Loss transactions generate significant tax losses above specified thresholds (these amounts vary by taxpayer type, e.g., $10 million for corporations and $2 million for individuals in a single year).
- Transactions of interest occupy a middle ground between regular reportable transactions and listed transactions. These are transactions that the IRS has identified as potentially abusive and is actively investigating, but hasn’t yet made a final determination. Think of it as a watchlist – these transactions might eventually become listed transactions, or the IRS might determine they’re acceptable after further study.
Compare this to the listed transactions that the IRS has designated. These transactions involve particular tax transactions. They are more specific. The transactions that the IRS has identified as listed transactions generally are:
- Are multi-step and highly engineered
- Often involve multiple entity types (corporations, partnerships, trusts)
- Frequently use pass-through entities as key components
- Usually aim to create artificial losses, shift income, or accelerate deductions
- Often involve timing mismatches or basis manipulation
- Frequently cross between corporate and individual taxation
The conservation easement noted in this Action on Decision is an example. A syndicated conservation easement is listed because it takes a legitimate conservation tax benefit and runts it through a partnership structure where investors buy into land at market price, obtain inflated appraisals far above the purchase price, place conservation restrictions on the property, and claim charitable deductions typically worth 4-5x their investment. The capital outlay is much smaller than the tax benefit that is derived. This is accomplished by rapid value inflation, year-end timing, and marketing focused on multiplying tax deductions. One can see why the IRS would be interested in this transaction and want to know who is engaging in these transactions, as the tax benefit is high and the IRS needs to examine them to determine which ones are legitimate and which ones are not.
Material Advisors & Their Obligations
The reporting rules don’t just affect taxpayers. They also apply to so-called “material advisors.” Material advisors are professionals who provide assistance with the reportable transactions.
Material advisors must report all categories of reportable transactions, including listed transactions and transactions of interest. Who qualifies as a material advisor depends on fee thresholds and type of client, but not on transaction type. The threshold is $50,000 in fees for transactions where all advisees are individuals, and $250,000 for transactions involving any other type of advisee (like corporations or partnerships). A tax professional who exceeds these thresholds becomes a material advisor and must comply with the reporting requirements.
Material advisors have to file their own disclosure forms (Form 8918) and maintain lists of advisees who participated in these transactions. These requirements are in addition to any reporting the taxpayer has to do. If the IRS requests these lists, the material advisor must provide them within 20 business days.
This means that both the taxpayer and their advisors must independently report the same transaction. The IRS can then cross-reference these filings to identify unreported transactions. The dual reporting system helps explain why the penalties discussed below are imposed on both taxpayers and material advisors.
Why Does It Matter?
The consequences of failing to disclose reportable transactions can be severe. The IRS has a number of penalties and sanctions that it can apply when it comes to these transactions.
For reportable transactions that are not listed transactions, the penalty is $50,000 per failure to disclose. So-called “material advisors” could also get a $50,000 penalty. This is a per year and per transaction penalty.
For listed transactions, the penalty jumps to $200,000 per failure to disclose. So four times higher than a reportable transaction. Material advisors could also get a penalty equal to $200,000 or 50% of the gross income they received from the transaction advice. This is separate from the IRS’s ability to ask a court to order that the advisor pay over 100% of the fees they earned from the transaction.
Suffice it to say that there is also a greater likelihood of criminal investigation and prosecution in cases involving listed transactions.
There is also a statute of limitations issue. Absent fraud or an unfilled tax return, the rules enacted by Congress generally do not give the IRS unlimited time to evaluate transactions. The IRS only has so long to look for and at issues. With listed transactions, the statute of limitations may be suspended until proper disclosure is made.
How Does the IRS List a Transaction?
The IRS designates a transaction as “listed” through a formal process of issuing published guidance. This typically happens in one of these ways:
- Through a Notice: The IRS issues a formal Notice describing the transaction and declaring it as listed. For example, IRS Notice 2017-10 listed certain syndicated conservation easement transactions.
- Through Revenue Rulings: The IRS can issue a Revenue Ruling that identifies and describes a transaction as listed.
- Through Regulations: The IRS may incorporate listed transactions into Treasury Regulations.
The process typically involves:
- The IRS identifying a pattern of transactions they believe are being used for tax avoidance
- Internal analysis and review of the transaction structure
- Development of detailed technical description of the transaction
- Publication of the formal guidance that:
- Describes the transaction in detail
- Explains why it’s considered abusive
- Specifies which variations of the transaction are covered
- States when the listing is effective
- Outlines disclosure requirements
Once published, all taxpayers and material advisors are on notice that the transaction is listed and must be disclosed if they engage in it or substantially similar transactions.
The IRS even maintains a list of listed transactions on its website.
This brings us to the current Action on Decision and the court cases that the IRS has adamantly contested and now says that it will follow. The question is whether the IRS’s listing process has complied with the Administrative Procedure Act (“APA”).
The APA establishes requirements federal agencies, including the IRS, have to follow to conduct rulemaking. Under the APA, agencies must generally provide notice of proposed rules and give the public an opportunity to comment before rules become final. This “notice-and-comment” process is fundamental to administrative law. It ensures transparency and public participation in agency rulemaking. This is important to our system of justice as administrative agencies are not staffed by individuals elected by the public–they are often career civil servants who may have agendas or views that differ from the law and from what most Americans would expect.
This guidance is in response to Green Rock LLC v. Commissioner, 104 F.4th 220 (11th Cir. 2024), but it addresses several other court cases that preceded Green Rock that held that the IRS’s notice process did not comply with the APA. The first is Mann Construction v. United States, in which the Sixth Circuit considered the IRS’s designation of transactions as “listed” via Notices that did not follow any APA notice-and-comment procedures. The court held that IRS Notices identifying listed transactions are legislative rules subject to the APA’s notice-and-comment requirements and that they are not interpretive rules exempt from these procedures. The court basis was that these Notices create new legal obligations (disclosure requirements) and impose significant penalties for non-compliance, hallmarks of legislative rules. This makes it a legislative rule.
Following Mann and similar decisions in other courts, such as the Green Rock case, the IRS has now acknowledged in this Action on Decision that it will treat its listed transaction designations as subject to APA notice-and-comment requirements. This is a significant shift in how the IRS will designate listed transactions going forward. Rather than immediately implementing listed transaction designations through Notices posted on the IRS.gov website, the IRS will need to first propose the designation, allow for public comment, and then issue a final rule.
For those who failed to report a transaction and were assessed penalties, it may be time to revisit the penalties. This includes cases where the statute of limitations was extended for failing to file the disclosure forms. As noted in the IRS guidance, taxpayers may be able to avoid penalties for these already existing cases.
The Takeaway
The IRS’s acceptance of notice-and-comment requirements for listed transaction designations is a significant shift in tax administration. The notice-and-comment process could benefit both the IRS and taxpayers by fostering dialogue with stakeholders, potentially resulting in more precise and effective guidance that better targets truly abusive transactions. This collaborative approach may help the IRS focus its limited resources on the most concerning transactions while providing clearer boundaries for legitimate tax planning. Those who have been assessed these penalties or who have pending penalties may also benefit by being able to avoid the penalties altogether given this guidance.
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