Is It Really Over? Closing Agreements with the IRS

megan L. BracKney is a Partner at Kostelanetz & Fink, llP in New York, New York.
Tax Controversy Corner
is it really over? Closing Agreements with the irs
By Megan L. Brackney
In my last column, I discussed the IRS’s prerogative to change its mind—to approve of a tax reporting position in one year, and then assess penalties on the ground that the taxpayer was negligent or did not have substantial authority for having taken that position in a later year.1 In this column, we will look at whether the IRS’s prerogative to change its mind extends to breaching a closing agreement with a taxpayer. In the recent decision in A. Davis,2 although the IRS conceded it had breached its own closing agreement, the Court allowed the assessment of tax to stand. This column summarizes the rules for IRS closing agreements and then discusses the Davis case.
The Basics on Closing Agreements with the IRS
Code Sec. 7121(a) states that the IRS may enter into closing agreements “in writing with any person relating to the liability of such person (or of the person or estate for whom he acts) in respect of any internal revenue tax for any tax- able period.” Any such agreement is final and binding as to the matters agreed upon and “may not be annulled, modified, set aside, or disregarded in any suit or proceeding unless there is a showing of fraud, malfeasance, or misrepresenta- tion of a material fact.”3 Closing agreements “are meant to determine finally and conclusively a taxpayer’s liability for a particular tax year or years.”4
The most common forms of IRS closing agreements are the Form 866 and the Form 906. The Form 866, which was the form involved in the Davis case, is used to determine the total tax liability for a past tax year or years and is binding upon the parties only as to the tax periods covered by the agreement and neither party is barred from challenging the same issue addressed in the Form 866 in a differ- ent year.5 A Form 906 closing agreement is used to memorialize an agreement as to a specific matter and may apply to specific items in later years.6 In addition, the parties can come to an agreement that covers both the total tax liability for a past year or years and specific matters in later years.7
Numerous courts have held that ordinary principles of contract law govern the interpretation of closing agreements.8 These principles include that if the agree- ment is clear and unambiguous, courts will look only within the “four corners” of the closing agreement,9 and extrinsic evidence may be considered only if the
September–october 2016
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