In a highly-anticipated decision, the Eleventh Circuit in Hewitt v. Commissioner, No. 20-13700 (11th Cir. 2021), reversed the Tax Court’s disallowance of the Hewitts’ charitable deduction and held that the Commissioner’s interpretation of Treasury Regulation §1.170A-14(g)(6)(ii), which was the basis for the Tax Court’s decision below, “is arbitrary and capricious and violates the APA’s procedural requirements.” This is the second significant Eleventh Circuit decision where taxpayers have succeeded in reversing the Tax Court’s decision to disallow the taxpayers’ entire charitable deductions based on “technical issues.”
Since 2016, the IRS has argued that a provision commonly found in conservation easement deeds, which are usually drafted by land trusts and other charitable organizations, violated Treasury Regulation § 1.170A-14(g)(6)(ii) (the “Proceeds Regulation”). The widely-adopted provision, often referred to as an “improvements clause,” provides that if the easement is extinguished, any subsequent proceeds are split between the land trust and the landowner based on their relative interest in the property, but any proceeds attributable to post-donation improvements built by the landowner will go the landowner. The IRS argued that an improvements clause in an easement deed violates the Proceeds Regulation, which requires the proceeds be distributed to the land trust and landowner based on the “proportionate value” of their interest, as established at the time of donation. As a result of the IRS’s new position, hundreds – if not thousands – of taxpayers were in jeopardy of losing their entire charitable contribution deduction based solely on this widely-accepted clause.
In the Tax Court, the Hewitts argued that the Department of Treasury failed to explain the purpose of the Proceeds Regulation in the regulation’s preamble and failed to respond to significant comments. In particular, Treasury failed to respond to concerns raised by commenters that, as drafted, the regulation would provide the land trust with a disproportionate share of proceeds attributable to post-donation improvements and imposing this requirement would discourage conservation.
The Eleventh Circuit agreed with the Hewitts and held that Treasury did not follow the required steps in issuing the regulation. Specifically, Treasury should have addressed the New York Landmarks Conservancy’s significant comment that directly addressed the post-donation improvements issue. This comment warranted a response because it (1) directly addressed major policy decisions reflected in Congress’s committee reports and (2) showed how the proposed regulation would undermine those major policy decisions. By failing to respond to this comment, and others, taxpayers and courts could not “see objections and why the agency reacted to them as it did,” rendering the Proceeds Regulation procedurally invalid.
The DOJ has stated in pleadings in other pending cases impacted by the Hewitt decision that it is considering whether to seek a rehearing by the entire Eleventh Circuit or certiorari at the Supreme Court.
This Hewitt decision follows closely behind the Eleventh Circuit’s decision in Pine Mountain Preserve, LLLP v. Commissioner, 978 F.3d 1200 (11th Cir. 2020) in which the Eleventh Circuit rejected the Tax Court’s conclusion that an entire charitable deduction could be disallowed because the easement deed allowed future homesites to move their location on the eased property. Like the technical issue in Hewitt, the IRS disallowed numerous charitable deductions based on the moving homesite technical issue before the Eleventh Circuit’s decision.