Closing a case: the form used can expand or limit taxpayers' options.

On reaching an agreement in a tax audit, practitioners face one additional strategy consideration--how to memorialize the agreement. The IRS has three basic types of forms for closing an "agreed" case. All three types have a common element: They permit the Service to assess an income tax deficiency (or abate an overassessment in the case of a refund) without issuing a statutory notice of deficiency. Each type of form, however, has different consequences that must be considered.

Noncommittal Agreements

The first type of form permits the IRS to assess tax, but also allows the taxpayer to file a refund claim after paying the assessed tax. In the income tax context, Form 4549, Income Tax Examination Changes (used by Examination), and Form 870, Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and Acceptance of Overassessment (used by both Examination and Appeals), are generally employed to close "agreed" cases. By signing either form in Examination, the taxpayer loses its right to go to Appeals or to petition the Tax Court.

Form 870 may be used in Appeals if the taxpayer wants to litigate its case in Federal district court or the Court of Federal Claims. Because these are refund forums, the Service must first assess the disputed tax, and the taxpayer must pay the tax and file a refund claim before bringing suit. Form 870 is used in this context simply to expedite the case; otherwise, the IRS would have to issue a deficiency notice and wait 90 days before assessing the tax.

Committal Agreements

The second type of form (Form 870-AD, Offer to Waive Restrictions on Assessments and Collection of Tax Deficiency and to Accept Overassessment, in the income tax context) permits the Service to assess the tax, but generally prohibits refund claims for issues agreed upon by the parties. These forms are used only by Appeals (not by Examination), and are typically used for settlements in which both the IRS and the taxpayer are conceding something in order to settle the case (i.e., mutual concession settlements).

Courts have frequently applied the doctrine of equitable estoppel to prohibit either the Service or the taxpayer from reneging on an agreement embodied in a Form 870-AD (see Whitney, 826 F2d 896 (9th Cir. 1987); General Split Corp., 500 F2d 998 (7th Cir. 1974). However, estoppel typically will not apply if a refund claim issue was not addressed in Form 870-AD, not mentioned during audit and not known by either party at the time the closing agreements were made; see McGraw-Hill, D.C., N.Y, 1990, acq., 1993-1 CB 1.) As a precautionary measure, if there are specific but unrelated refund issues, a taxpayer should insert a provision (a reserve clause) on the Form 870-AD, reserving the right to file a refund claim for these issues before signing the form.

Closing Agreements

The third type of form is a closing agreement. Closing agreements bar the filing of refund claims under contract principles (as opposed to under equitable estoppel) and can be rescinded only on a showing of fraud, malfeasance or misrepresentation of a material fact (Sec. 7121 (b)). There are two types of closing agreements--those that finalize a taxpayer's entire liability for the tax period at issue (Form 866, Agreement as to Final Determination of Tax Liability) and those that finalize the treatment of specific issues (Form 906, Closing Agreement On Final Determination Covering Specific Matters). These two types of agreements may be used in combination for the same case.

As a practical matter, policies make it difficult (but not impossible) to obtain a closing agreement. The Service maintains strict controls over who can sign one. In Examination, most closing agreements must be signed by District Directors or their designees. In Appeals, closing agreements must be signed by the Chief of Appeals; in many instances, District Counsel will have to review a proposed dosing agreement.

If finality is a taxpayer's goal and the case is in Appeals, Form 870-AD accomplishes much die same result as a closing agreement. A closing agreement, however, is the only way to achieve "finality" in an Examination-agreed case. Moreover, a specific matters closing agreement must be used if the taxpayer wants finality for later years that are affected by resolved issues. For example, if the taxpayer and Appeals agree that an asset has a value of $100,000 and is amortizable over a life of 10 years, technically, a Form 870-AD reciting this agreement is not binding on Examination in the subsequent nine years of the asset's life. As a practical matter, Examination almost always applies a prior Appeals settlement, even though, technically, only case managers in coordinated examination program cases are permitted to apply prior Appeals settlements outside of the closing agreement context. In contrast, a specific matters closing agreement that refers to the life and value of an asset will bind the IRS to that agreement throughout the life of the asset.

Strategy Considerations

The type of agreement a taxpayer should ask for depends on his ultimate objective. If finality is the objective, the taxpayer must convince the IRS that a dosing agreement is crucial because, as noted earlier, internal IRS policies make it difficult to obtain one. Typically, finality is not crucial unless the issue affects other tax years. If other years are not affected, a closing agreement is seldom necessary, because although the Service theoretically could reopen a case until the statute of limitations on assessment expires, it rarely does so. Once Examination closes a case, it disappears from the revenue agent's work load. Thus, if a government-favorable court opinion is issued after the parties close the case, it is unlikely the agent will reopen it. Moreover, in Appeals, Form 870-AD will provide the required finality, so a dosing agreement is not necessary.

If an agreed issue affects other tax years, the taxpayer may be more successful in obtaining a closing agreement. For example, the taxpayer could argue that a dosing agreement would eliminate any future controversy on the deductions at issue, thereby saving time and resources.

If flexibility in fling refund claims is important, Form 4549 or Form 870 (or the equivalent form in a non-income tax situation) should be used if the taxpayer wants to file a refund suit. Even if the taxpayer and the IRS reach a settlement and the taxpayer has no current plans to litigate the issues, Form 4549 or Form 870 should be strongly considered. Under Sec. 6511(a), a taxpayer has two years from the date he pays a tax liability to file a refund claim (up to the amount paid within the past two years). The refund claim can (but does not have to) relate to the reason why the payment was initially made. If a taxpayer signs a Form 870 that partially or wholly concedes an issue, and within two years of paying the resulting deficiency a taxpayer-favorable court opinion is issued, the taxpayer may file a refund claim with respect to that issue. If, however, the taxpayer signed a Form 870-AD or a closing agreement, no refund claim could be filed relating to any issue settled by the Form 870-AD or the closing agreement. Unfortunately, appeals officers usually prefer Forms 870-AD, particularly in mutual concession cases, to prevent taxpayers from reneging on their deals. Still, taxpayers should attempt to negotiate with Appeals over whether the parties will sign a Form 870 or a Form 870-AD with an appropriate reserve clause, if flexibility is more important than finality.

Conclusion

Many taxpayers simply sign whatever form the Service presents at the end of an audit controversy. Choosing the appropriate form, however, should be the final strategy consideration in the administrative portion of an audit controversy.