The Senate Finance Committee today released a report examining the conservation easement tax deduction. The report, released by Chairman Chuck Grassley (R-Iowa) and Ranking Member Ron Wyden (D-Ore.), explores potential taxpayer abuse related to the deduction.
While it is Congress’s prerogative to investigate waste, fraud, and abuse in the tax code, lawmakers should reject efforts to retroactively raise taxes on taxpayers claiming the conservation easement deduction.
If Congress determines that the deduction (or any statutory provision) is being used by taxpayers in a way that is inconsistent with its original intent, Congress should disallow or modify the provision on a prospective basis.
The appropriate way to hold taxpayers accountable that are alleged to be using the deduction improperly is through the courts, not Congress. While the IRS is currently doing that, it is also important that this process affords taxpayers fairness and due process.
Efforts to Investigate the Conservation Easement Deduction Must be Fair
The conservation easement deduction was first enacted in 1976 with the goal of incentivizing property owners to conserve land and historic sites through a charitable deduction. In order to claim the deduction, the taxpayer must agree to restrict their right to develop or alter the property. Organizations known as land trusts agree to monitor the restrictions placed on the property.
In exchange for foregoing the opportunity to develop the land, the taxpayer is allowed to deduct the “fair market value” of the property, limited to 50 percent of adjusted gross income (AGI) in any given year with the ability to carry forward any unused deductions for up to 15 years.
The Senate Finance Committee report focuses its investigation on so-called “syndicated conservation easement transactions,” which is when the deduction is claimed by taxpayers through a partnership.
Critics of the deduction have claimed that some taxpayers are abusing the tax benefits by overvaluing property and increasing their tax deduction.
While there may be bad actors taking advantage of the provision, the possibility of tax avoidance occurring is not unique to the conservation easement deduction.
If taxpayers are abusing the provision, it is incumbent on the IRS to take these taxpayers to court and challenge them based on the letter of the law.
In many cases, the IRS has done that. However, the agency has repeatedly lost these cases. According to an analysis of lawsuits by Tax Notes, of the $92.7 million in conservation easement deductions claimed by taxpayers, over 80 percent – or $74.7 million of those deductions were upheld by the courts.
Increasingly, the IRS is putting pressure on taxpayers through heavy enforcement actions and burdensome compliance requirements. For instance, taxpayers wishing to claim an easement deduction covered by the Notice must now fill out Form 8886, a “Reportable Transaction Disclosure Statement.” This form takes approximately 20 hours to complete and has a top penalty of $100,000 for failing to properly complete it.
In addition, the IRS is routinely alleging that conservation easement donations have little or no value and that taxpayer easement appraisals are inflated. While it can be expected that there are disputes over valuation, it is difficult to believe that donations have no value.
Ultimately, in cases where a taxpayer may have abused the conservation easement deduction, it is incumbent on the IRS to resolve the case through the legal process in a fair and balanced way.
Congress Should Reject Retroactive Tax Increases
The increased scrutiny of the conservation easement deduction has not been limited to the IRS. Some in Congress have proposed S. 170, the “Charitable Conservation Easement Program Integrity Act of 2019,” legislation that would make changes to the conservation easement deduction effective to “contributions made in taxable years ending after December 23, 2016.”
This legislation should be rejected.
S. 170 would restrict or disallow deductions from donations made as far back as January 2016 – imposing tax increases on taxpayers retroactively for tax years 2016, 2017, 2018, and 2019 and imposing tax increases prospectively.
Not only would this significantly increase taxes, it would undermine the legal agreement that taxpayers enter into with a land trust to forgo developing the land. Under S.170, the taxpayer would still be bound by this agreement, even though their ability to claim the tax deduction would be reduced or eliminated.
The December 23, 2016 date coincides with the release of IRS Notice 2017-10, a notice released without prior stakeholder input that subjected taxpayers to burdensome new filing requirements and onerous compliance costs. While this notice signaled the intent of the IRS to scrutinize transactions, there is no basis for it to be used as justification to narrow the deduction.
There is significant legislative history affirming the intent of Congress to preserve and expand the deduction:
- In 2006, the deduction was temporarily enhanced with strong bipartisan, bicameral support to allow taxpayers to deduct up to 50 percent of their adjusted gross income and carry forward any unused deductions for up to 15 years. This enhancement was made permanent in 2015, a year before Notice 2017-10.
- Since the 2016 notice, Congress has passed several substantive pieces of tax legislation including the Tax Cuts and Jobs Act and tax extenders legislation. In each case, Congress declined to impose limitations on the deduction.
The tax code must be applied with consistency, certainty, and fairness. Taxpayers routinely make decisions based on a reasonable interpretation of the law with the expectation that future changes to the law will not be applied looking backwards.
Retroactively changing the tax code undermines these principles by changing the rules after the fact. This can have significant financial consequences for taxpayers in the form of thousands or millions of dollars in additional tax liability from past years’ individuals or businesses.
It can also increase costs prospectively given that financial decisions would have been made based on the prior interpretation of the law.
This undermines confidence in the tax system and discourage taxpayers from taking advantage of explicit tax incentives (e.g., for charitable contributions, business investments, and energy efficiency) if they fear Congress might retroactively eliminate these incentives in the future.
Moving forward, lawmakers should reject any effort to impose retroactive tax increases on taxpayers claiming the conservation easement deduction. The proper way to hold taxpayers accountable is through the courts, a process that must be conducted fairly and with the guarantee of due process. If lawmakers decide they wish to modify the deduction, they should do so prospectively.