It seems like every other day the IRS issues some type of guidance on syndicated conservation easement (“SCE”) transactions. Without doubt, these transactions are on the IRS’ radar. Recently, on October 9, 2020, IRS Chief Counsel released a memorandum to provide guidance to IRS employees on imposing civil fraud penalties on such transactions. This Insight discusses that memorandum.
Background
The Internal Revenue Code permits a deduction for qualified conservation easement deductions. Generally, these are deductions for the contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes. See I.R.C. § 170(h)(1)-(5). As with many provisions in the Code, there are several hurdles the taxpayer must jump through, but there is nothing, in itself, nefarious about taking a qualified conservation easement deduction.
But, because such contributions constitute less than all of a taxpayer’s interest in the property, the transactions can be subject to abuse by taxpayers. Today, many of these types of abusive transactions have been labeled by the IRS as “syndicated conservation easement contributions.” In these transactions, promoters of partnerships seek to give partners an opportunity to claim deductions in amounts that far exceed the amount invested in the partnership itself. Of course, these types of transactions are subject to a litany of potential attacks by the IRS, including economic substance. Thus, it is no surprise the IRS has scrutinized these transactions and challenged them (often times, successfully) both administratively and in federal court proceedings.
IRS Memorandum
Perhaps because so many of these transactions are working their way through the IRS administrative level, IRS chief counsel recently released a memorandum to IRS employees regarding guidance on how to properly assert the 75% fraud penalty against TEFRA partnerships. Although TEFRA has been replaced by the BBA partnership audit rules, tax professionals can still expect to see some TEFRA related audits, particularly where the fraud penalty is asserted (which extends the statute of limitations for assessment).
In these cases, the IRS memorandum advises IRS employees that if fraud is established at the partnership level (e.g., through actions of partnership managers), then all partners may be liable for the fraud penalty on any underpayments of tax resulting from adjustments to partnership items that are attributable to fraud.
The IRS memorandum reminds IRS employees that after any penalties are determined to be applicable at the partnership level and directly assessed at the partnership level, the IRS must issue a computational adjustment notice to the partners. Generally, the partners have 6 months from the date of the notice to file a claim and argue that the IRS erroneously imposed the penalty. This may include raising any partner-level defenses to the penalties.
Conclusion
The recent IRS memorandum is a good reminder to taxpayers who participated in syndicated conservation easement transactions that the IRS continues to review SCE transactions for the potential of fraud. In these cases, it is extremely likely the IRS will assert the heightened 75% fraud penalty on any tax underpayments. Taxpayers who have participated in SCE transactions should consult with tax professionals to determine whether the fraud penalty may apply and, if so, to what extent the taxpayer can mitigate such risk of a fraud penalty being imposed.
In recent years, the IRS has prioritized tax enforcement efforts against syndicated conservation easements that it believes to be abusive. Freeman Law’s tax controversy practice regularly represents clients in conservation easement tax disputes. Schedule a consultation or call (214) 984-3000 to discuss your conservation easement concerns or questions.
