The following is a comment letter submitted through Tax Notes on December 20, 2023 ​​​by Adam R. Young.

On November 20, 2023, the U.S. Department of the Treasury (“Treasury”) issued proposed regulations purporting to implement the statutory disallowance rule enacted as part of the SECURE 2.0 Act of 2022 (the “Proposed Regulations”). Rather than providing simplified guidance for taxpayers and tax practitioners, the Proposed Regulations are a complex labyrinth in which one misstep leads to the disallowance of the charitable deduction and imposition of the gross overvaluation penalty under I.R.C. § 6662(h) [1]. While the complexity of the Proposed Regulations makes it nearly impossible for the average taxpayer to determine whether they have complied with the rules, it also places a significant burden on IRS Exam and IRS Appeals to determine not only compliance at the contributing partnership level but also at the level of an indeterminable number of upper-tier partnerships.

Beyond complexity, there is one major issue the Proposed Regulations addresses in a way that is unsupported by prior IRS guidance, and one major issue that is not addressed at all.

1. Complexity

According to the Proposed Regulations, the estimated burden for taxpayers filing Form 8283 is “nineteen minutes for recordkeeping, twenty-nine minutes for learning about the law or the form, one hour and four minutes for preparing the form, and thirty-four minutes for copying, assembling, and sending the form to the IRS.” These estimates drastically underestimate the time needed to read, understand, and apply the Proposed Regulations and do not promote sound tax administration.

Instead of proposing rules that are easily understandable, it appears that the Proposed Regulations were drafted for an audience of a select few tax practitioners as opposed to the average taxpayer. Specifically, the Proposed Regulations provide an unclear legal standard with respect to the application of the disallowance rule to tiered partnership structures and thus do not promote simplification and taxpayer burden reduction [2].

The maze of examples and computations contained within the Proposed Regulations likely will lead to inaccurate reporting, potential lack of compliance, and continued litigation with respect to conservation easement donations. With a reported inventory of more than 750 cases and anecdotal suggestions that the Tax Court is trying about 30 cases a year, it could take 25 years to clear the Tax Court docket of the current conservation easement cases. Treasury is required to draft regulations to minimize litigation, but the Proposed Regulations likely will increase litigation as the regulations are overly complex and burdensome for the average taxpayer [3]. I suggest that the IRS should simplify the Proposed Regulations, including the examples and calculations, to promote sound tax administration, minimize litigation, and reduce the burden on average taxpayers to read, understand, and comply with I.R.C. § 170(h)(7).

2. Family Pass-Through Entities

The SECURE Act 2.0 excepted from I.R.C. § 170(h)(7) certain family pass-through entities if substantially all of the interests in such entity are held, directly or indirectly, by an individual and members of the family of such individual [4]. Treasury’s interpretation as to the meaning of “substantially all” is not supported by the citations included in the Proposed Regulations and does not promote compliance with I.R.C. § 170(h)(7).

First, the citations in the Proposed Regulations with respect to the 90-percent rule do not relate to ownership in a legal entity. Treas. Reg. §§ 1.103-8(a)(1)(i) and 1.103-16(c) define “substantially all” by looking to the percentage of proceeds (i.e., cash) of a tax-exempt bond issuance. Treas. Reg. § 1.731-2(c)(3)(i) defines “substantially all” by looking to the percentage of an entity’s assets that consist of marketable securities. Treas. Reg. § 1.1400Z2(d)-2(d)(3) defines substantially all by looking to the percentage of time that an entity holds qualified opportunity zone business property. As such, the citations provided by Treasury in the Proposed Regulations relate to the percentage of cash, percentage of assets, or percentage of time, but do not relate to the percentage of ownership in a legal entity.

In prior published guidance, Treasury has defined “substantially all” with respect to entity ownership percentages, to mean 85% of the ownership interests. See Rev. Rul. 73-248, 1973-1 CB 295. With respect to the Proposed Regulations, Treasury arbitrarily decided that “substantially all” means 90% of the interests of an entity. As the IRS and Treasury have indicated that conservation easement transactions will continue to be heavily scrutinized, it is unclear why Treasury chose the highest possible threshold for meeting the “substantially all” test in I.R.C. § Section 170(h)(7)(D). I propose that Treasury reduce the substantially all threshold to 85% to better reflect Treasury’s own guidance regarding the meaning of substantially all with respect to entity ownership interests and to be closer to the average of the four percentages cited by Treasury in the Proposed Regulations [5].

3. Section 704

The Proposed Regulations do not define the term “distributive share” with any reference to I.R.C. § 704. As a result, it is unclear whether I.R.C. § 704(c) may apply to determine each partner’s distributive share. To promote transparency, Treasury should define the term “distributive share” and further discuss what impact, if any, I.R.C. § 704(c) may have with respect to conservation easement transactions in the context of I.R.C. § 170(h) generally and I.R.C. § 170(h)(7) specifically.

The Proposed Regulations provide detailed rules for determining whether a qualified conservation contribution runs afoul of I.R.C. § 170(h)(7) but fail to provide capital accounting guidance under I.R.C. § 704(b) to the extent that a contribution is disallowed. Although Congress intended to combat syndicated conservation easement transactions, it is reasonable to assume that the IRS will continue to scrutinize all qualified conservation contributions including contributions made by both operating entities and newly formed entities. In the event that a contributing entity continues to do business post-contribution, the lack of I.R.C. § 704(b) guidance will create confusion among tax practitioners, increase the reporting burden on taxpayers, and require further guidance from Treasury. I recommend that Treasury include book capital account guidance under I.R.C. § 704(b) with respect to I.R.C. § 170(h)(7).

4. Conclusion

The IRS and tax practitioners continue to litigate conservation easement cases in Tax Court and such litigation shows no signs of stopping. Simplifying the Proposed Regulations by providing straightforward examples and calculations likely will minimize future litigation with respect to I.R.C. § 170(h)(7) and reduce the compliance burden on taxpayers and tax practitioners. Providing guidance with respect to the potential applicability of I.R.C. §§ 704(b)-(c) would provide all tax practitioners with the tools needed to correctly apply the Proposed Regulations and prepare accurate tax returns. Treasury should follow the mandates provided in Executive Order 12866 by revising the Proposed Regulations to be simple and easy to understand and tailoring the Proposed Regulations to impose the least burden on taxpayers.

[1] See I.R.C. § 6662(h)(2)(D). Doc 2024-251
[2] See IRM 32.1.4.1.1(1)(b) (08-11-2004).
[3] Exec. Order No. 12866, 58 Fed. Reg. 190 (Oct. 4, 1993); See IRM 32.1.4.1.1(1)(a) (08-11-2004). Doc 2024-251
[4] I.R.C. § 170(h)(7)(D). Doc 2024-251
[5] The average of the four percentages cited in the Proposed Regulations is 83.75% (i.e., (70 + 80 + 90 + 95) / 4 = 83.75). Doc 2024-251