When a taxpayer invests in a conservation easement property and claims deductions for the easement, the IRS normally has three years from the date the tax return for that year is filed to assess any taxes or penalties. IRC § 6501(a). Due to Notice 2017-10 (as revised by Notice 2017-29), investors in certain syndicated conservation easements must file Form 8886 with the Office of Tax Shelter Analysis (“OTSA”), and in certain circumstances attach Form 8886 to their tax returns. See our prior blog, “The IRS demands [its] form over substance," explaining the importance of properly filing Form 8886.
Taxpayers who fail to file Form 8886 in the timeframe and manner prescribed by IRC Section 6011 and Treasury Regulation Section 1.6011-4 are subject to—in addition to draconian penalties under IRC Section 6707A—an extended period of assessment under IRC Section 6501(c)(10). Following such a failure, the period in which the IRS can assess for the applicable tax year will remain open until the later of,
- the normal three-year limitations period, or
- one-year after a complete Form 8886 is filed with OTSA.
The extended period of limitations can keep the assessment period open indefinitely. To make matters worse, the IRS guidance and instructions for Form 8886 are ambiguous, if not contradictory. It is foreseeable that IRS Examiners could use that ambiguity to argue that Forms 8886 are incomplete in order to take advantage of an extended period of assessment.
These rules may confuse taxpayers attempting to determine what assessment period applies to a given tax year. Due to the convoluted nature of this area of the law, we thought we would illustrate how these rules work by providing the following examples:
- Example 1: 2013 Syndicated Easement Investment. Taxpayer invested in a syndicated conservation easement transaction during the 2013 taxable year and claimed deductions pursuant to that investment on his 2013 tax return, which was filed on April 15, 2014. Accordingly, the IRS's normal three-year limit on assessment expired on April 15, 2017. Under those facts, Notice 2017-10 (as amended by Notice 2017-29) imposes a duty on the taxpayer to file Form 8886 with OTSA by October 2, 2017. So long as the taxpayer files a complete Form 8886 with OTSA by October 2, 2017, the IRS period of limitations expires April 15, 2017, and the extended period of limitations under IRC Section 6501(c)(10) does not apply.
- Example 2: Failure to File Form 8886. Same facts as Example 1, except the taxpayer fails to file Form 8886 by October 2, 2017. The IRS can assess additional taxes and penalties until the later the normal three-year limit on assessment for the 2013 tax year, which closed as of April 15, 2017, or one-year from the date the taxpayer actually files a complete Form 8886.
- Example 3: Incomplete Form 8886. Same facts as in Example 1, except that in the year 2022, the taxpayer is audited and an IRS Examiner determines the Form 8886 (which the taxpayer timely filed by October 2, 2017) was incomplete or otherwise defective. The IRS can assess additional taxes and penalties for the 2013 tax year until one-year from the date the taxpayer files a Form 8886 that is deemed complete.
- Example 4: What the IRS can Assess. Same facts as in Example 3. In year 2022 what can the IRS assess pursuant to the extended period of limitations under IRC Section 6501(c)(10)? Is the IRS's ability to assess taxes limited to aspects of the tax return related to the “listed” conservation easement, or can the IRS assess taxes related to any aspect of the return subsequently deemed improper? Treasury Regulation Section 301.6501(c)-1(g)(7) indicates that the IRS can assess any tax with respect to the listed transaction, which includes adjustments, additional taxes, interest, penalties related to adjustments (i.e., IRC Sections 6662, 6662A), penalties related to reportable transactions (i.e., IRC Section 6707A), and items affected by the listed transaction even if unrelated to the listed transaction (i.e., the threshold for a medical expense deduction.)
Treasury Regulation Section 301.6501(c)-1(g)(1) indicates that the two assessment periods work together, such that the later of the two assessment periods applies. However, in a recent case—May v. United States—both the District Court of Arizona and the 9th Circuit Court of Appeals implied that IRC Section 6501(c)(10) establishes the assessment period for investments in listed transactions to the exclusion of IRC Section 6501(a).
For investors in micro-captive insurance companies, which were deemed “transactions of interest” in Notice 2016-66 (as revised by Notice 2017-08), the extended period of assessment will not apply because IRC Section 6501(c)(10) only applies to listed transactions, so the assessment period is not indefinitely extended following an untimely or incomplete Form 8886. This begs the question of how the IRS expects to assess the penalty under IRC Section 6707A (for failing to file Form 8886) in circumstances similar to examples above? Consider this example:
Example 5: Micro-Captive Assessment. Taxpayer invested in a micro-captive insurance company during the 2013 taxable year and claimed deductions pursuant to that investment on its 2013 tax return, which was filed on April 15, 2014. Accordingly, the normal three-year period in which the IRS can assess taxes and penalties under IRC Section 6501(a) expired on April 15, 2017. Under such facts, Notice 2016-66 (as amended by Notice 2017-08) imposes a duty on the taxpayer to file a complete Form 8886 with OTSA by May 1, 2017. But, how exactly is the IRS going to assess the IRC Section 6707A penalty for the 2013 tax year when it cannot extend the assessment period because IRC Section 6501(c)(10) does not apply to “transactions of interest?” Under these facts, the IRS (by its own doing) is upstream without a paddle.
We recommend that you talk to your tax advisor to determine which of the assessment periods may apply to your investment in either a syndicated conservation easement transaction or micro-captive insurance company, or if you otherwise need help in complying with disclosure requirements—IRS Form 8886—pursuant to such an investment.
If you have any questions about the dueling assessment periods under IRC Sections 6501(a) and 6501(c)(10), call us.