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Sixth Circuit Reverses Lower Court; IRS Violated Administrative Procedure Act in Issuing Notice 2007-83

(Parker Tax Publishing March 2022)

The Sixth Circuit reversed a district court and held that the IRS failed to meet the notice and comment requirements under the Administrative Procedure Act (APA) when it issued guidance in Notice 2007-83 that requires disclosures of certain transactions involving trust arrangements utilizing cash value life insurance policies. The court rejected the IRS's arguments that (1) Notice 2007-83 is an interpretive rule that does not require notice and comment under the APA; and (2) Congress exempted the IRS from the APA's notice and comment requirements. Mann Construction, Inc. v. U.S. 2022 PTC 63 (6th Cir. 2022).


In 2004, Congress added Code Sec. 6707A, a provision which penalizes a taxpayer's failure to provide information concerning "reportable" and "listed" transactions. Regulations under Code Sec. 6011 generally define reportable and listed transactions. A "reportable transaction" is defined as one that has the potential for illegal tax avoidance or evasion. A "listed transaction" is defined as one that is the same as, or substantially similar to, a transaction that the IRS has identified as a tax avoidance transaction. Code Sec. 6707A authorizes monetary penalties and criminal sanctions for noncompliance with these reporting requirements.

In 2007, the IRS issued Notice 2007-83 (the Notice), entitled "Abusive Trust Arrangements Utilizing Cash Value Life Insurance Policies Purportedly to Provide Welfare Benefits." The Notice designates certain employee-benefit plans featuring cash-value life insurance policies as listed transactions. A cash-value life insurance policy combines life insurance coverage with a cash-value investment account. As the IRS saw it, these transactions run the risk of allowing small business owners to receive cash and other property from the business on a tax-favored basis.

Brook Wood and Lee Coughlin own Mann Construction, a Michigan company that provides general contracting, construction management, and similar services. From 2013 to 2017, Mann Construction established an employee-benefit trust that paid the premiums on a cash-value life insurance policy benefitting Wood and Coughlin. The company deducted these expenses, while Wood and Coughlin reported as income part of the insurance policy's value. Neither Wood or Coughlin nor the company reported this arrangement to the IRS as a listed transaction. In 2019, the IRS concluded that this employee-benefit trust fit the description identified in Notice 2007-83 and imposed a $10,000 penalty on the company and an almost $17,000 penalty on its shareholders for failing to disclose their participation in the trust. All three taxpayers paid the penalties for the 2013 tax year and sought administrative refunds, claiming the IRS lacked authority to penalize them. When the administrative process for challenging the penalties left the taxpayers empty-handed, they filed suit against the government in the Eastern District Court in Michigan. The taxpayers challenged the validity of the Notice and penalties on four grounds: (1) the Notice failed to comply with the notice-and-comment requirements of the Administrative Procedure Act (APA); (2) it constituted unauthorized agency action; (3) it was arbitrary and capricious; and (4) even if the Notice was valid, the arrangement at issue did not fall within its scope.

The APA establishes the procedures federal administrative agencies use for "rule making," defined as the process of "formulating, amending, or repealing a rule." The APA provides a three-step procedure for "notice-and-comment rulemaking" whereby agencies are required to (1) issue a general notice of proposed rulemaking, (2) allow interested persons an opportunity to participate, and (3) include in the final rule a concise general statement of its basis and purpose. However, the notice-and-comment requirement does not apply to interpretative rules, general statements of policy, or rules of agency organization, procedure, or practice. The APA also recognizes that Congress may modify these requirements but provides that a subsequent statute may not be held to supersede or modify the APA except to the extent that it does so expressly.

The IRS offered two explanations for not following the notice-and-comment process: (1) Notice 2007-83 is merely an interpretive rule that does not require notice and comment as opposed to a legislative rule (which does require notice and comment); and (2) even if the Notice amounts to a legislative rule, Congress exempted the IRS from the APA's requirements with respect to the disclosure rules in Code Sec. 6707A.

In Mann Construction, Inc. v. U.S., 2021 PTC 134 (E.D. Mich. 2021), the district court agreed with the IRS and held that the IRS's issuance of Notice 2007-83 did not violate the APA. The court concluded that Congress authorized the IRS to issue Notice 2007-83 without a notice and comment period. However, the court emphasized that its holding was a narrow one. The taxpayers appealed to the Sixth Circuit.


The Sixth Circuit agreed with the taxpayers and reversed the district court's holding. The court began by noting that under normal circumstances, an agency issuing a rule must publish a notice about the proposed rule, allow the public to comment on the rule, and, after considering the comments, makes appropriate changes and includes in the final rule a "concise general statement of" its contents. This process, the court stated, serves regulated parties and the agency alike as it gives affected parties fair warning of potential changes in the law and an opportunity to be heard on those changes - and it affords the agency a chance to avoid errors and make a more informed decision.

In determining whether Notice 2007-83 was an interpretive rule as the IRS argued, the court noted that legislative rules have the force and effect of law whereas interpretive rules do not. Legislative rules, the court stated, impose new rights or duties and change the legal status of regulated parties and interpretive rules articulate what an agency thinks a statute means or remind parties of pre-existing duties. According to the court, when rulemaking carries out an express delegation of authority from Congress to an agency, it usually leads to legislative rules whereas interpretive rules merely clarify the requirements that Congress has already put in place. Notice 2007-83, the court said, creates new substantive duties, the violations of which prompt exposure to financial penalties and criminal sanctions. Those are hallmarks of a legislative, not an interpretive, rule. Thus, the court concluded that Notice 2007-83 is a legislative rule subject to the APA's requirements.

The court then looked at whether Congress expressly exempted the IRS from the APA's requirements and concluded that it did not. The court observed that the statutes at issue - Code Sec. 6011 and Code Sec. 6707A - do not say anything, expressly or otherwise, that modifies the baseline procedure for rulemaking established by the APA and the APA requires that Congress "expressly" carve out any exceptions to the APA. Thus, the court found no indication that Congress intended to exempt the IRS from the APA with respect to the disclosure rules in Notice 2007-83.

For a discussion of Notice 2007-83 and the rules relating to tax return disclosures of reportable transactions, see Parker Tax ¶250,140.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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