When is a tax year "closed"?

Tax practitioners routinely use the terms "open tax year" and "closed tax year"; generally, the difference between the two is well understood. In the case of an open tax year, the period of limitations has not expired within which (1) the IRS can assess additional tax and/or (2) the tax payer can file a timely claim for credit or refund of an overpayment in tax. In the case of a closed tax year, the period for assessment and/or refund has expired.

However, the real implications of the expiration of the statute of limitations (SOL) for a particular tax year (i.e., the closing of the year) are often misunderstood. All it really means to say that a year is closed is that generally no tax money can change hands between the Service and the taxpayer. The IRS cannot assess and collect any additional tax; the taxpayer cannot obtain a credit or refund. Beyond that, closure of a tax year imposes few restrictions on either party's ability to review or analyze the tax year and/or to recompute the taxpayer's correct tax liability for that year.

For example, if a net operating loss (NOL) is carried forward, the Service may reexamine the loss year to determine the correct amount of the loss available for carryover purposes, even if the SOL on assessment for the loss year has expired; see ABKCO Industries, 56 TC 1083 (1971), aff'd, 482 F2d 150 (3d Cir. 1973) and State Farming Co., 40 TC 774 (1963). Likewise, a taxpayer may adjust the NOL amount incurred in a closed tax year for purposes of determining the correct NOL amount available for carrying forward into an open tax year (Springfield Street Railway Co., 312 F2d 754 (Ct. C1. 1963) and Rev. Rul. 81-88).

The rationale that applies to carryovers and carrybacks also arguably applies to any other situation in which a determination made with respect to a closed year affects an open year. For example, the running of the SOL does not preclude an examination into events of prior closed years for the purpose of correctly determining a taxpayer's gift tax liability for open tax years (Disston, 325 US 442 (1945)). Likewise, in a case involving the former income-averaging provisions, the Tax Court determined that facts with respect to a prior closed year may be considered to determine correctly the deficiency amount in a later, open year (Robert W. Unser, 59TC 528 (1973)); see also Rev. Rul. 74-61 and Sec. 6214(b)). Accordingly, it is clear that a tax return for a closed year is not immune from reconsideration for all purposes.

At the same time, however, a taxpayer's ability to disregard or disavow a position taken on its return for a closed year is not unlimited. Instead, a "duty of consistency" generally prevents a taxpayer from taking a position in one year and a contrary position in a later year after the SOL has run on the first year. The duty of consistency has been described as a type of equitable (or "quasi") estoppel, which arises when the following elements are present:

* A (mis)representation by the tax payer;

* Detrimental reliance by the IRS on the (mis)representation; and

* An attempt by the taxpayer after the SOL has run to change the previous (mis)representation or recharacterize the situation in such a way as to harm the Service.

When these requirements are met, the IRS may treat the previous (mis)representation as true, even if it is not, and the taxpayer is estopped from asserting the contrary (albeit correct) position; see, e.g., Fabacher, D.C. Miss., 1971, aff'd, 454 F2d 722 (5th Cir. 1972).

Issues regarding the Service's ability to recompute the tax liability for a closed tax year also arise when considering the merits or a claim for refund at a time when the assessment period for the year of the claimed refund has expired. In Lewis v. Reynolds, 284 US 281 (1932), the Supreme Court held that the ultimate question presented in a claim for refund is whether the taxpayer has overpaid his tax. The Service, therefore, may reconsider the taxpayer's entire return for each year that refund or credit of an alleged overpayment is sought, even to the extent of disallowing any deductions that previously had been erroneously allowed (and thereby reducing or eliminating the claimed refund). Such reconsideration, however, is permitted only to determine whether there has been an overpayment, and does not authorize an additional assessment barred by the running of the SOL under Sec. 6501.