Onerous penalties are a primary concern for conservation easement syndication transactions recently made “listed transactions” under Notice 2017-10. Investors in syndicated conservation easement transactions and substantially similar transactions are potentially subject to a pair of penalties specific to listed transactions. Section 6707A imposes a penalty on investors, who fail to timely file a complete disclosure statement (Form 8886). This penalty is 75% of the decrease in tax due to the deduction taken pursuant to such investment. The maximum penalty is $100,000 for natural persons or $200,000 for all other taxpayers, and the minimum penalty is $5,000 for natural persons or $10,000 for all other taxpayers. Ouch!
Additionally, Section 6662A imposes a penalty on underpayments of tax if related to a Listed Transaction, regardless of disclosure or substantial authority for the deduction. The penalty is 20% of the underpayment if a timely, complete Form 8886 is filed, or 30% of the underpayment if not adequately disclosed.
While these penalties are clearly onerous, the Tax Court recently addressed whether such penalties violate the Eighth Amendment's excessive fine clause. This is academically interesting since tax lawyers rarely get to consider constitutional issues. Academic fun!
The Court addressed the constitutionality of Section 6662A in Thompson v. Commissioner, 148 T.C No. 3 (Judge Wherry, Doc. No. 6613-13, 2/2/17). The facts were fairly simple: the taxpayers participated in a “distressed asset debt” tax shelter in 2005. The IRS denied the deductions taken and assessed significant taxes, which the taxpayers conceded were due. The IRS also added more than $100,000 in penalties. The transaction was a listed transaction under Notice 2008-34, but the taxpayers failed to properly disclose the listed transaction, leading to a 30% penalty under Section 6662A. The taxpayers argued that the penalty violated the Eighth Amendment as an excessive fine.
The Tax Court found that the 6662A penalty was “proportional to the harm caused” to the government. Judge Wherry noted that “(t)ax shelters are notoriously difficult to detect and hard to prosecute. Some promoters and taxpayers, aware of low tax return audit rates, consciously engage in attempts to game the tax system and get away with questionable transactions."
Although the Thompson case involved a “distressed asset debt” tax shelter, it underscores the potential harsh consequences of conservation easement syndication transactions becoming listed transactions in Notice 2017-10. Keep in mind that “listed transaction” status under Notice 2017-10 does not, in itself, affect the validity of charitable deductions taken pursuant to an investment that is subject to the Notice. However, the Notice requires a participant in a listed transaction to make certain disclosures— on IRS Form 8886—and to satisfy a record keeping requirement, which will require the investor to gather and retain certain documents. Listed transaction status triggers penalties (the 75% penalty under Section 6707A and the 30% penalty under Section 6662A) if these requirements are not met. Even if the proper disclosures are made, Section 6662A imposes a 20% penalty on tax underpayments attributable to a listed transaction.