Page 3 - Is It Really Over? Closing Agreements with the IRS

that this ruling results in a windfall to Plaintiffs of taxes that they do not dispute would be owed but for the delay by the IRS. However, the weight of authority supports this result. As the Third Circuit observed: ‘taxation is a game which must be played strictly in accordance with the rules.’”31 The government appealed, and in January 2016, the U.S. Court of Appeals for the Ninth Circuit reversed the decision.
Throughout the proceedings, the IRS conceded that it had breached the Closing Agreement by assessing the tax without giving Davis the opportunity to review the assessments, as the parties had agreed.32 The Ninth Circuit, however, found in favor of the government and reversed the district court’s decision. The Ninth Circuit noted that IRS closing agreements are contracts,33 and that the usual remedy for breach of contract is damages.34 Davis did not seek damages but instead sought to have the entire assessment invalidated. In both the district court and the Court of Appeals, Davis relied on Philadelphia & Reading Corp.,35 in which the court held that the remedy for the IRS’s breach of a closing agreement was the invalidation of the assessment. In that case, the taxpayer waived its right to a notice of deficiency in exchange for the IRS delaying the assessments until after the IRS had approved a schedule of overpayments, so that the taxpayer, who had overpaid in certain years and underpaid in others, could pay the net balance owed.36 The IRS assessed taxes before the overpayments were approved and without sending a notice of deficiency.37 The Ninth Circuit distinguished Philadelphia & Reading from the Davis matter on the ground that the taxpayer’s waiver of its statutory right to receive a notice of deficiency before assessment did not come into effect because of the IRS’s failure to approve the overpayment schedule, and that the assessments were thus not authorized by statute because the IRS was required to issue a notice of deficiency, and that in Davis’s case, the IRS had not violated the law by making the assessment.38
As explained by the Ninth Circuit: “At bottom, the problem with Davis’s argument is that his obligation to pay taxes validly and accurately assessed comes from the Internal Revenue Code, not the Closing Agreement ....”39 The Ninth Circuit explained that Davis’s only remedy now is for breach of contract, and that in his administrative refund claim and refund action, he could have challenged the computational adjustments,40 i.e., he could have raised any of the objec- tions contemplated by Paragraph Q. Davis did not do so
but based his refund claim entirely on breach of the Closing Agreement.41 The Ninth Circuit noted this failure to seek consequential damages or to raise other challenges in a re- fund claim: “Instead, he threw a Hail Mary and sought a full refund. That pass falls incomplete. We hold that the IRS’s breach of Paragraph Q did not invalidate the assessments.”42
The Ninth Circuit’s decision was not the end of the mat- ter, however. On remand, Davis submitted various argu- ments, including whether the IRS’s breach of the Closing Agreement, and other IRS actions, which he alleges were taken in bad faith, deprived him of the opportunity to make claims in his refund action related to the computational adjustments, whether equitable adjustments to partnership items are invalid due to the expiration of the statute of limitations, and other issues.43 Although the final outcome of the Davis case remains to be seen, it appears that the IRS will suffer no consequence from having directly violated a closing agreement that it negotiated and signed.
Considerations for Tax Practitioners
Given the difficulty of getting out of a final closing agree- ment, at least for taxpayers, and in trying to enforce a closing agreement against the IRS, practitioners should consider the lessons from Davis and other cases. First, a practitioner should make sure that the client understands what is covered in the closing agreement, and what is not, i.e., are specific tax matters resolved for past and future years or only the tax liability, which tax years does the closing agreement cover, and are the assessment of penalties and interest resolved by the agreement? The practitioner should make sure that everything that is understood by the parties is contained in the agreement, and that the client is not relying on any kind of oral side agreement or understand- ing with the IRS. Moreover, along with considering what issues are ostensibly resolved by the closing agreement, the practitioner should think about what the taxpayer’s remedy would be if the IRS breaches a particular provision of a closing agreement, and if there is any language that could be included to avoid further dispute if a breach does indeed occur. It is not always easy to convince the IRS to include nonstandard language and terms in a closing agreement, but practitioners should make an effort to think through the closing agreement and its various consequences before recommending that their clients finalize an agreement.
endnotes
1 See megan l. Brackney, A Limit on the IRS’s Prerogative to Change its Mind: Reliance on a Prior No Change Letter as a Defense to Penalties, J. Passthrough entities, may–June 2016, at 41.
2 A. Davis, CA-9, 2016-1 ustc ¶50,157, 811 F3d 335.
3 T.C. Rink, 100 tC 319, 324, dec. 48,969 (1993) (citing Code sec. 7121(b); J.J. Magarian Est., 97
tC 1, 4–5, dec. 47,436 (1991); S. Zaentz, 90 tC
753, 760, dec. 44,714 (1988)).
4 In re M. Hopkins, CA-9, 98-2 ustc ¶50,492, 146
F3d 729, 732 (internal citations omitted).
September–october 2016
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