Originally published on Forbes.com.
There is a sign that the IRS is raising the stakes in its attack on syndicated conservation easements (SCE). Jennifer Black, (Senior Counsel Procedure and Administration) authored two chief counsel advices CCA 202044009 and CCA 202044010 in response to National Fraud Counsel Carolyn A. Schenck.
Ms. Schenck was asking about how the IRS goes about determining the applicability of the civil fraud penalty in examinations of different sorts of partnerships that have participated in SCEs.
Civil Fraud
If you engage in tax shenanigans you will most likely get away with it. But what is the worst thing that can happen if you get caught? The worst thing that can happen is that you can forfeit your liberty. Kent Hovind was in prison for over eight years. Irwin Schiff died in prison. Those are just examples, there are more. Actually going to prison for tax shenanigans is pretty improbable. Financial penalties are another matter.
The IRS will routinely assert the 20% accuracy penalty (Code Section 6662) if your underpayment is “substantial” (greaterr than greater of 10% of the correct tax or $5,000). The Tax Court usually goes along with them.
If the underpayment is the result of a “gross valuation misstatement”, the penalty is 40%. A valuation misstatement is gross if it is than 200% or more of the correct amount. Since as noted in the Senate Finance Committee report on SCEs the “engine of every syndicated conservation-easement transaction” is an inflated appraisal, the 40% penalty will be coming up a lot.
Worse than the 40% and actually as bad as it can get for basic shenanigans is the fraud penalty (Code Section 6663). The fraud penalty is 75%. (There are worse financial penalties, but they tend to be for particular forms of noncompliance such as not reporting foreign accounts). The problem with the fraud penalty from the IRS viewpoint is that the burden is on the IRS to establish fraud.
The Two Types Of Partnership
Ms. Schenck’s inquiries were about TEFRA partnerships and BBA partnerships. TEFRA refers to the Tax Equity and Fiscal Responsiblity Act of 1982 and BBA refers to the Bipartisan Budget Act of 2015. Keeping it realy simple, audits of tax years 2017 and before will be goverened by TEFRA and tax years 2018 and after by BBA. Under both TEFRA and BBA determinations are made at the partnership level.
The big difference is that under BBA, the default is that the IRS collects an imputed underpayment from the partnership in the “adjusement year” (i.e. when the case is finally settled). Under TEFRA and by election under BBA the adjustment is pushed out to the partners in the “affected year” i.e. the year that is being audited.
If an SCE partnership that is under BBA does not elect to push out the adjustment, it seems likely that the IRS will have a challenging time collecting. SCEs, by design, produce tax benefits that are greater than any assets that they ever have.
The issue Ms. Schenk sought guidance on was how to determine the applicability of the civil fraud penalty in the case of SCEs for each of the partnership types (TEFRA and BBA).
How The Deals Are Described
Contrasting SCEs with donations of conservation easements generaly Ms. Black wrote:
However, in some cases, promoters of SCE transactions purport to give partners the opportunity to claim charitable contribution deductions in amounts that significantly exceed the amount invested in the partnership. In such a SCE transaction, a promoter offers
prospective partners the possibility of a charitable contribution deduction for the donation of a conservation easement. The promoters then syndicate ownership interests in the partnership that owns the real property, or in one or more of the tiers of pass-through entities, using promotional materials suggesting to prospective partners that a partner may be entitled to a share of a charitable contribution deduction that equals or exceeds an amount that is two and one-half times the amount of the partner’s investment. The promoters obtain an appraisal that purports to be a qualified appraisal as defined in §170(f)(11)(E)(i), but that greatly inflates the value of the conservation easement based on unreasonable conclusions about the development potential of the real property. After the partners obtain their interests in the partnership, the partnership that owns the real property donates a conservation easement encumbering the property to a tax-exempt entity. Once the donation is made the inflated charitable contribution deduction flows through to the partners.
(Emphasis added)
When you read Tax Court decisions and see the word “purport”, you know things are not going to go well for the taxpayer. I generally read it as “liar, liar pants on fire”, but that might just be me.
And The Answer
The answer is the same for both types of partnerships. The fraud penalty is determined at the partnership level. In order to assert the fraud penalty the IRS must prove “by clear and convincing evidence, the elements of the fraud penalty based on the partnership-level conduct and intent of the manager(s) of the partnership”. What the investor partnersh though is really not relevant.
Ms. Black makes it clear that there is nothing different about SCEs in this regard compared to other partnerships.
What Is The Point?
I’m thinking that these CCAs are in the nature of a warning to participants in these deals, that they might want to take the offer IRS recently made. I asked one of my knowledgable sources if the inquiry is an indication that IRS is gearing up for civil fraud penalties. Here is a bowdlerized response:
I think so.
Most gross overvaluations are fraudulent, known to the appraiser and the promoter. Most investors of even average intelligence know it is too good to be true. The 6662 overvaluation penalties are just more objective than the IRS proving fraud by clear and convincing evidence. But, the IRS should mount a campaign targeting the civil fraud penalties for gross overvaluations.
Overvaluations have been Achilles heel of bull***t tax shelters of many varieties far beyond conservation easements
I think that the 40% gross valuation misstatement penalty in 6662(h) is to provide a stiff penalty based on overvaluation alone without the IRS having to prove fraud, a substantial burden under the clear and convincing standard. Using the 40% penalty in most cases preserves IRS and court resources that would be required by the fraud penalty. But the IRS should use the civil fraud penalty in some cases (increasing the penalty cost by 35%) just to let the community of promoters and taxpayer “investors” that the addition 35% cost (with interest from the due date of the return) may apply.
David Deary who is spearheading class action lawsuits against the promoters and their professional enablers responded:
It appears that way to me; but that is just an opinion based on the text. Might be using this as additional pressure to get the syndicate members to accept the global settlement.
Other Coverage
Paul Streckfus ran a copy of CCA 202044010 in EO Tax Journal 2020-222. (Behind a paywall)
Bloomberg Tax has IRS CCA: Procedures for Determining Civil Fraud Penalties for BBA Partnerships (IRC §6663) behind its paywall.
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