IRS Conservation Easement Settlement Offer

One of the IRS’s major campaigns of the past decade may be entering its wind-down phase. That campaign is against syndicated conservation easements, which I call the nonsense-based industry. Judge Lauber laid out what happened in the recent Excelsior Aggregates decision I covered. The developers acquired land for $9.5 million, raised $36 million from investors, and then awarded $187 million in charitable deductions to the investors, with the land donated in two batches to the National Wild Turkey Federation. Excelsior Aggregates was not an anomaly. The tax court docket is full of such cases. After a few victories like Excelsior, the IRS announced that it would send settlement offer letters to “certain taxpayers” in July. And it appears to be a pretty generous offer. One of my sources sent me a redacted copy of an offer to one of these taxpayers.

Caution

I am unable to confirm the authenticity of the document further than I have. The ultimate source is a linked article by William Stone, a tax litigation attorney at Morris, Manning & Martin in Atlanta. The most compelling evidence for the legitimacy of the document is that it was allegedly a plan for someone to have invented it. And for what purpose? So I believe it was an offer made by the IRS. Other offers may have been made to taxpayers in different situations, but nothing like this has come to my attention. For what it is worth, IR-2014-174, the announcement says that “The settlement offer r“requires a substantial concession of tax benefits and the application of penalties” (emphasis added). This seems to imply that there is only one proposed settlement.

What is the problem?

This offer is made to a partnership on a return that does not have an associated registered tax record. The offer is an election made by the partnership and will be signed by the “authorized signatory” on the return. Who is responsible for it depends on whether or not the return was subject to TEFRA in the Bipartisan Budget Act of 2015. Non-TEFRA partnerships or those for which there was an election outside of the BBA will require the signatures of all partners to close the deal. If the statute of limitations is less than one year, an extension of at least one year will be required.

The terms of the agreement provide that the partnership is not entitled to any charitable deduction, but that a deduction will be allowed to the extent that the partners contributed cash. That sounds good to me, but then it goes from good to great. The IRS will calculate the tax owed at the partnership level at a rate of 21% with a 5% penalty added. We’ll get to why that’s great later. The partnership must foot the entire bill. If a partner made a deposit, they can claim a refund under Revenue Procedure 2005-18. In the case of TEFRA partnerships, all partners must “participate in the resolution.”

Practical questions

SCE arrangements tend to be single transaction partnerships, so most of them probably don’t have assets available to pay the tax bill. So where do they get the money? Logically, it would seem that they have to get it from the partners. But what if some partners don’t want to participate? And as has been noted in some cases, all partners must cooperate in the settlement. And this is done over a very short period of time. The election must be filed within thirty days.

Is this a good deal?

Although there were more aggressive deals, a four-for-one deduction was fairly common. Let’s say you’re a surgeon in Rome, Georgia. You paid $100,000 and got a $400,000 deduction. In the top bracket, that saved you $158,400 in federal taxes. In the Escambia Aggregate decision, it appears that investors are entitled to about 7% of the deduction. To simplify the math, let’s do one better and get 10%. That gives you a deficit of $142,560. The 40% penalty makes the tab $200,000.

Under the agreement, you are entitled to your out-of-pocket expense, which means the non-deductible amount is $300,000. And that amount is taxed at 21%, which makes a deficit of $63,000 for a total of $66,000 with the penalty added. Of course, there will be interest on top of that. However, if at the time of entering into the agreement you made a wise investment with your $58,4000 in savings plus the investment, you will have actually made money for investing in a truly ridiculous deal.

Many people who invest in shelters do not save their savings and therefore feel like they are not getting such a good deal.

Back to practical aspects

Settling the case with a single check from the partnership significantly eases the administrative burden on the IRS, which may explain what I consider a generous offer. The tax shelters of the late 1990s and early 2000s, which were to be assessed and collected on a partner-by-partner basis, still generate litigation. The last case I covered involved Action Blizzard CEO Bobby Kotick in 2023, but I haven’t been watching them much lately. That was a 2001 deal. The IRS can have a hard time imposing partnership adjustments on individual partners and collecting large sums.

On the other hand, it may be insurmountable for some sponsors to convince partners to contribute to deficit financing. It would be wonderful if the IRS could come up with an offer that could be implemented by individual partners.

Other points of view

William Stone, the lawyer who published the redacted offer, has some hesitations about the offer. He writes:

“This settlement offer is a step in the right direction. However, it cannot be the only step taken. As we have discussed in detail in previous posts, many SCETs are properly valued, meaning the partnership received the appropriate deduction. This settlement, while better than previous offers, would still be a bad deal for partnerships that properly valued their donation. As such, the IRS must also review each case on its merits and reach specific settlements for partnerships that do not accept this offer, as I imagine there will be many.”

Stone wrote an article in Tax Notes arguing that the IRS has overstated the valuation problem. He relies on valuations allegedly made relative to what the tax court has allowed in many cases. These cases do not appear to involve transactions after 2010, however, and are not all or even primarily syndicated transactions. I would be surprised if it turns out that there are “many” more recent SCET transactions that are correctly valued.

Lew Taishoff, who blogs extensively about the Tax Court, was not as impressed as I was by the generosity of the offer. He wrote to me:

“Mr. Reilly, may I summarize?

“Throw all weapons, firearms and handguns, including knives and baseball bats, out the window where we can see them. Remove and discard all headgear, vests, backpacks, boots, fanny packs and belts where we can see them. Slowly walk out the front door one at a time with your hands behind your bare heads. Maintain a distance of six feet between each other. Officers will come up behind you and secure your wrists. Do not resist or speak. We will use force if any of you resist or refuse to comply.”

This makes the OVDI look like a school picnic.

I asked him to clarify and he wrote:

“Mr. Reilly, interest on tax evasion charges. The tax rate is 21%, but the shortfall is the full amount claimed by the taxpayer. The agreement states: “6. Shortfall interest will be calculated as required by law.” Interest payable at the increased rate for taxpayer-motivated tax evasion on agreements that are ten years old will be greater than the tax due.

Of course, if the taxpayer sues and loses, the big players will lose their Section 170 deductions and get benefits. Their transaction costs, administrative costs and legal fees will be wiped out anyway. And the mitigation could open up blackout years to hit them for the gains they tried to shelter. But that’s for later, and this deal is done today.

I don’t think Mr. Taishoff and I have the same interpretation of the offer, but I have to take his point of view seriously. He went on to say that the number of people who accept the offer will be the proof of the success of the operation, but I don’t know if we will ever know.

Too generous?

My understanding of the deal is that investors get almost all of their investment in net tax savings. And in most deals, the partnership still owns an interest in the encumbered property, which is presumably worth something. Of course, if they spend their tax savings instead of investing them, they end up upside down because of the interest on the deficit. Yet based on my admittedly rough calculations, they get away with about a third of what a bad outcome in tax court would yield.