New, improved Form 872.

Without fanfare, the Service revised Form 872, Consent To Extend the Time to Assess Tax, in June 1996. Omitted from the new form is a key provision that had been present for nearly two decades. The change should come as welcome news to tax practitioners. To the IRS's credit, this change helps eliminate a subtle and potentially costly refund trap.

The deleted language, first added in 1979, provided that Form 872 would terminate on the earlier of the agreed expiration date or "the assessment date of an increase in ... tax that reflects the final determination of tax and the final administrative appeals consideration." The trap lay in computing the time for filing a refund claim if the taxpayer had previously agreed to a deficiency assessment for the tax year.

Sec. 6511(a) establishes the general rule that a taxpayer has the longer of three years from the time the return was filed or two years from the payment of the tax within which to file a refund claim. In conjunction with these limitations, Sec. 6511(b)(2) limits the amount of recovery to the tax paid within the three years immediately preceding the filing of the claim or the tax paid within two years preceding the filing of the claim. Sec. 6511(c)(1) provides that if the statute of limitations (SOL) on assessment is extended by agreement, the refund period is automatically extended for the same amount of time, plus six months. The refund lookback period is extended commensurately (Sec. 6511(c)(2)).

Under old Form 872, the Service would argue from time to time that deficiency tax assessed by agreement (e.g., under the authority of Form 870, Waiver of Restrictions on Assessment and Collection and, Acceptance of Overassessment, or Form 870-AD, Offer to Waive Restrictions on Assessment and Collection of Tax and to Accept Overassessment) constituted a final determination of tax and (in the case of Form 870-AD) the final appeals consideration. Thus, the taxpayer had six months from the assessment date, rather than (as many taxpayers automatically assumed) six months from the expiration date spelled out in writing by the parties in Form 872, to file a refund claim eligible for the three-year lookback as extended by reason of Sec. 6511(c)(2).

Example: X, a domestic corporation, timely filed its 1993 Federal income tax return on Mar. 15,1994, reflecting tax due of $5,000,000, which amount was satisfied by estimated tax payments. On Aug. 1, 1996, the IRS began an examination of the return. During the examination, X, at the request of the examining agents, executed Form 872, extending the SOL on assessment from Mar. 15, 1997 to Mar. 15, 1998. On Sept. 30,1997, the Service concludes its examination and determines a $1,000,000 deficiency in X's income tax. X does not agree. X believes it has a $2,000,000 overpayment resulting from unused research and development credits, but does not wish to raise the issue of the credits until after the SOL on assessment has closed. Accordingly, X agrees to assessment of the deficiency, signing Form 870. On Dec. 15, 1997, the IRS assesses the deficiency and sends X notice and demand for payment of the additional tax due. X pays the deficiency on Dec. 31, 1997. X must file a refund claim by June 15, 1998, to recover up to $3,000,000 of tax. If X files a refund claim after that date, recovery will be limited to $1,000,000 of tax, i.e., the amount of tax paid during the two years preceding the filing of the refund claim.

Unquestionably, this position was problematic. Old Form 872 failed to spell out what constituted "the final determination of tax and final administrative appeals consideration". Nor did case law supply an unequivocal answer. To be sure, the old form provided examples of assessments that did not reflect a final determination: assessments of tax under a partial agreement; jeopardy assessments; assessments to correct mathematical or clerical errors; assessments of tax reported on amended returns; and assessments of advance payments. The list, however, did not purport to be exclusive.

In light of the ambiguity (and construing old Form 872 against the government as the drafter), one could argue the plain meaning of "final determination" required something conclusive as to the rights of the parties (e.g., a closing agreement such as Form 86, Agreement as to Final Determination of Tax Liability). It is well-settled that Form 870 does not have the force and effect of a closing agreement. Its execution neither precludes the Service from determining additional deficiencies against the taxpayer for the tax year, nor precludes the taxpayer from seeking a refund of deficiency taxes assessed by agreement and paid.

The foregoing view received support from the Tax Court in Fudim, TC Memo 1994-235. There, in a reversal of roles, the taxpayer argued that the IRS'S assessment of an agreed deficiency had terminated old Form 872, making the later issuance of a deficiency notice for the tax year untimely. The Tax Court disagreed, holding that a final determination of tax necessitates a closing agreement, "the only statutorily authorized method by which the Commissioner and the taxpayer can finalize the taxpayer's tax liability for a particular year."

Whether, as a matter of law, Form 870-AD (in contrast to Form 870) bestows the requisite finality for old Form 872 remains open to question. Courts have uniformly held that Form 870-AD does not qualify as a closing agreement within the meaning of Sec. 7121(a). Nonetheless, from the Service's perspective at least, execution of Form 870-AD normally marks the end of administrative deliberations. Absent fraud, malfeasance and the like, the IRS promises not to assert additional deficiencies for the tax year, and the taxpayer agrees not to file or pursue refund claims.

In Drummond Co., DC Ala., 1992, the Service argued that a taxpayer's execution of Form 870-AD terminated Form 872-A, Special Consent to Extend the Time to Assess Tax. (Like old Form 872, Form 872-A contains "final determination" language.) The district court had no occasion to reach the legal question, however, finding that the taxpayer had expressly reserved a disputed issue under the executed Form 870-AD. At most, then, the form embodied a partial agreement, assessment pursuant to which did not reflect a final determination of tax under the terms of old Form 872 itself.

What of the IRS'S determination and processing of an overassessment on audit, rather than the assessment of additional tax? Would that terminate old Form 872? Although the old form did not specifically refer to overassessments, "Internal Revenue Manual seems to say yes; see IRM 4541.81(6), providing that the "final determination" language of Form 872-A may include the processing of an overassessment. In Masraff, TC Memo 1989-638, however, the Service argued that the terms of a consent to extend the SOL (in that case, Form 872-A) must be literally construed in spite of the provisions of the manual. The Tax Court agreed, holding that the processing of an overassessment in the taxpayer's favor did not cause the assessment period to close before the IRS subsequently sent the taxpayer a deficiency notice for the tax year.

New Form 872 should help eliminate similar disputes over when the extended assessment period ends. But caution is advisable. Tax practitioners must keep in mind that, under the new form, the assessment period will, in fact, remain open to the date specified by the parties. Care must be taken not to overextend that period relative to the anticipated closure of the examination. Otherwise, the Service may have enough time to make an additional deficiency determination, if it chooses. (While it is the IRS's long-standing policy not to reopen an examination, courts have made it clear that the policy cannot be enforced against the Service.)

Even more importantly, the IRS, in revising Form 872, did not similarly change other forms in the 872 series; for example, Form 872-A retains the "final determination" language. Traps for the unwary remain.