On Aug. 4, the Department of the Treasury and IRS published a Notice of Proposed Rulemaking to treat certain monetized installment sale transactions as listed transactions. This means the IRS has determined them to be tax avoidance transactions.
Usually, the IRS has announced listed transactions through revenue rulings or notices that aren’t subject to public comment and don’t require advance warning—it has issued 39 revenue rulings and notices to date.
The listing of monetized installment sale transactions is no surprise, as the IRS has been skeptical of such transactions for almost a decade. For example, the IRS included the transactions on its Dirty Dozen lists in 2021, 2022, and 2023—a clear warning the agency intends to audit taxpayers who undertake them. However, the formal manner in which Treasury and the IRS are pursuing the transactions is a break from historic practice.
Once Treasury and the IRS finalize the regulations, participants in the described transactions will be subject to additional disclosure requirements. Specifically, they will be required to file IRS Form 8886. Material advisers—those assisting participants—will be required to file IRS Form 8918 and maintain other records.
Failure to timely disclose can carry significant penalties. A participant can face a penalty of 75% of the amount of the tax (capped at $200,000) that would have been owed but for the participation in the listed transaction. Additionally, a participant can face a higher penalty of 30% of the understatement of tax under Section 6662A of the tax code for failing to disclose a listed or other reportable transaction.
A material adviser also can be subject to a penalty up to 75% of the amount of the adviser’s gross income from the transaction (capped at $200,000), plus a daily penalty of up to $10,000 for failure to provide required records.
Notwithstanding the significant burden and monetary consequences triggered by listing a transaction, Treasury and the IRS in the past had asserted they don’t need to follow formal rulemaking procedures to list a transaction. In the newly proposed REG-109348-22, the government seems to have accepted the weakness of its historic position.
Prior to 2011, Treasury and the IRS argued the Administrative Procedures Act didn’t apply to tax regulations and other generally applicable guidance. In Mayo Foundation for Medical Education and Research v. United States, the US Supreme Court eliminated tax exceptionalism and held that the APA does apply to tax regulations. Among other things, the APA requires that tax regulations be open to notice and comment from the public.
This latest battle centers on whether designating transactions as listed transactions adheres to the APA. In CIC Services, LLC. v. IRS, a material adviser challenged the validity of Notice 2016-66 (micro-captive insurance transactions) before an assessment of penalties. The Supreme Court held the Anti-Injunction Act in Section 7421(a) of the tax code didn’t prevent the material adviser from challenging the validity of the notice prior to an assessment of penalties. The Supreme Court remanded the case for the district court to consider whether the IRS followed the APA.
The tide seems to have turned in favor of requiring formal rulemaking for listed transactions. While CIC Services sought a pre-enforcement solution, the taxpayer in Mann Construction, Inc. v. USA challenged Notice 2007-83 (cash value life insurance) after the IRS imposed penalties for failure to report the transaction. The US Court of Appeals for the Sixth Circuit held that the notice was invalid because the IRS didn’t follow the APA.
In the preamble to REG-109348-22, Treasury and the IRS note their disagreement with recent court decisions and announce their commitment to defend the validity of guidance listing other transactions. “[T]o avoid any confusion and ensure consistent enforcement of the tax laws throughout the nation,” however, the agencies have followed formal rulemaking to designate monetized installment sales as listed transactions.
Affected stakeholders can comment on the scope of the identified transactions until the Oct. 3 due date. Treasury and the IRS recently published proposed regulations regarding micro-captive insurance. Fifteen stakeholders filed comments, mostly on the breadth of the definition of the transactions covered by the listing, and five of the stakeholders testified at the hearing.
Treasury and the IRS are required to consider and process the comments. The formal rulemaking process will result in more targeted guidance to address the transactions of concern. This will provide savings for taxpayers, material advisers, and IRS resources.
Although the Sixth Circuit has spoken on the application of the APA, other circuits may take a different view, requiring the Supreme Court to resolve a circuit split. Therefore, following APA procedures—as the IRS has done with monetized installment sale transactions—inoculates designations of transactions and provides certainty for uniform application.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Joshua D. Odintz is a partner in Holland & Knight’s Washington office. He focuses on tax policy, tax controversy, and tax planning.
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