Last week’s blog post, here, discussed the details of the Internal Revenue Service “Voluntary Disclosure Practice” (VDP). VDP is the one and only method for voluntary disclosures that apply to criminal tax activity, regardless if the activity involves offshore issues or strictly domestic ones. The final conclusion of a taxpayer’s entry into the Voluntary Disclosure program is memorialized in the Form 906, Closing Agreement on Final Determination Covering Specific Matters. This is the Closing Agreement signed by the taxpayer and the IRS Commissioner and signifies the completion of the voluntary disclosure. It is a very important document. Today’s post provides the details.
The closing agreement is authorized by the US Internal Revenue Code at Section 7121. It is a useful tool to resolve IRS-taxpayer disagreements and is in many ways similar to a contract although not governed strictly by contract law. General contract law principles apply in interpreting such agreements. It is, generally, a legally binding and final agreement between the IRS and a taxpayer on a specific issue or tax liability.
Both taxpayers and the IRS benefit from a properly executed closing agreement. The taxpayer not only obtains certainty that the issues are finally and permanently concluded, the taxpayer also obtains guidance on how to properly comply with the tax laws going forward. For its part, the IRS resolves a tax compliance problem that would otherwise have involved significant time and resources to pursue to conclusion. The IRS also obtains the taxpayer’s commitment to future compliance.
Pursuant to IRS Treasury Regulations, a closing agreement may be entered into in any case in which there appears to be an advantage in having the case permanently and conclusively closed, or if good and sufficient reasons are shown by the taxpayer for desiring a closing agreement and it is determined by the Commissioner that the United States will sustain no disadvantage through consummation of such an agreement. Entering into a closing agreement is completely discretionary with the IRS.
The closing agreement is comprised of five distinct parts:
Part 1 identifies the parties; Part 2 contains the introductory clauses, Part 3 sets out the agreed determination, Part 4 contains the ending clause, and finally, Part 5 provides for the signatures of the parties.
Once the agreement is signed by the parties, it is final and conclusive. Unless there is a showing of fraud, malfeasance, or a misrepresentation of a material fact, the agreement cannot be reopened as to the matters agreed on. The agreement will be set aside by a court if there is good reason, and that includes IRS impropriety. The burden of proof in establishing the disqualifying factors is on the party seeking to set aside the closing agreement.
The agreement cannot later be modified by the IRS; similarly it cannot be disregarded by the years covered, the determination of tax or other amounts to be paid. The Form 906 includes language making clear that the Closing Agreement does not prevent the IRS from auditing a taxpayer for unrelated issues and tax years.
Remember, the closing agreement is not binding on the IRS if there has been any misrepresentation by the taxpayer of material fact. Even though inadvertent inaccuracies or omissions are not to be treated as disqualifying misrepresentations, it is always possible that they can be construed as such. Therefore, the statements contained in the agreement should be accurate reflections of the facts that are relevant to the determinations set out in the agreement.
Watch Potential Pitfalls
Closing agreements are generally reflected on IRS Form 866, Agreement As to Final Determination of Tax Liability or IRS Form 906, Closing Agreement on Final Determination Covering Specific Matters. Taxpayers need to know which form is being used and understand the difference between them. If the situation concerns the final determination of a tax liability, then Form 866 is executed. However, when the determination involves specific matters, or particular items, rather than complete liability, Form 906 is used.
With a Form 866 closing agreement, because the taxpayer and IRS agree to a final tax liability, an IRS so-called “deficiency notice” is not required. Generally, the notice of deficiency provides an opportunity for the taxpayer to request a court review. Since the tax liability is agreed between the parties with Form 866, there is nothing left to dispute and so there is no need for the notice of deficiency. With form 906, all unstated items are left open for future review. If the IRS adjusts any of these items, the taxpayer has the right to request court review and therefore, the IRS must issue a deficiency notice before attempting to collect.
In a nutshell, the use of a closing agreement determining tax liability (Form 866) can prevent the taxpayer from being able to reopen issues that are not contemplated in a settlement. To avoid this possibility, in some instances it may be better to use a closing agreement as to specific matters (Form 906).
Taxpayers must make sure the agreement defines precisely the matters on which the taxpayer wishes to agree. The terms of the agreement must be very carefully described; the taxpayer should be careful not to include any unnecessary statements or matters that could later be viewed as part of the agreement and therefore binding.
Posted November 10, 2022
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