The Service recently issued a Chief Counsel advice (CCA 200802031) that highlights one of the limitations the Service places on the use of closing agreements and serves as a good reminder for practitioners to be aware of those limitations.
In the CCA, the IRS addressed whether a closing agreement that sought to bind the Service and the taxpayer for taxable periods ending after the date of the agreement was valid. The Service concluded that the IRS appeals officer who executed the closing agreement on behalf of the IRS did not have the proper authority to bind the government for taxable periods ending after the date of the agreement. Therefore, the Service determined that the taxpayer could not take advantage of the tax treatment set forth in the closing agreement for those taxable periods subsequent to the date of the closing agreement.
Although the facts in the CCA are heavily redacted, it appears that the owners of a property and the IRS reached an agreement as to the deductibility of certain costs associated with the property. The parties executed a Form 906, Closing Agreement on Determination Covering Specific Matters, that set forth a defined amount of deduction that could be taken by each of the owners over certain tax years. The closing agreement covered tax periods before and after the date of the agreement. It was executed by the owners of the property and the local IRS Appeals Office chief. Subsequently, the owners sold the property to the taxpayer, who sought to take the deductions agreed on in the closing agreement as a successor in interest.
Tax Periods Covered by a Closing Agreement
Sec. 7121 authorizes the Service to enter into a closing agreement with any person relating to tax liabilities of that person for any taxable period. Regulations under Sec. 7121 set forth matters that can be addressed in a closing agreement. For tax periods ending prior to the date of the closing agreement, Regs. Sec. 301.7121-1(b)(2) states:
Closing agreements with respect to taxable periods ended prior to the date of the agreement may relate to the total tax liability of the taxpayer or to one or more separate items affecting the tax liability of the taxpayer, as, for example, the amount of gross income, deduction for losses, depreciation, depletion, the year in which an item of income is to be included in gross income, the year in which an item of loss is to be deducted, or the value of property on a specific date.
For taxable periods ended subsequent to the date of the closing agreement, Regs. Sec. 301.7121-1(b)(3) states:
Closing agreements with respect to taxable periods ending subsequent to the date of the agreement may relate to one or more separate items affecting the tax liability of the taxpayer.
As the above guidance shows, a closing agreement that covers tax years subsequent to the date of the closing agreement is not necessarily invalid.
Separate Items Covered by a Closing Agreement
Administratively, the IRS has placed some limitations on the use of closing agreements. Rev. Proc. 68-16, §3.02, states that with respect to tax periods ending prior to the date of a closing agreement, the closing agreement can determine the taxpayer’s total tax liability for a specific type of tax for such periods, or the closing agreement can determine separate items that make up the tax liability. For tax periods that end after the execution of the closing agreement, the agreement cannot determine the full amount of the tax liability for that period, but it can determine one or more separate items affecting the taxpayer’s tax liability. See also Regs. Secs. 301.7121-1(b)(2) and (b)(3). Included among the “separate items” that can be the subject of a closing agreement are the amount of gross income, deduction for losses, depreciation, depletion, the year in which an item of income is to be included in gross income, the year in which an item of loss is to be deducted, or the value of property on a specific date (Regs. Sec. 301.7121-1(b)(2)).
The following example set forth in Regs. Sec. 301.7121-1(b)(4) illustrates the concept of addressing a separate item in a closing agreement covering future periods:
A owns 500 shares of stock in XYZ Corporation which he purchased before March 1, 1913. A is considering selling 200 shares of such stock but is uncertain as to the basis of the stock for the purpose of computing gain. Either prior or subsequent to the sale, a closing agreement may be entered into determining the market value of such stock as of March 1, 1913, which represents the basis for determining gain if it exceeds the adjusted basis otherwise determined as of such date. Not only may the closing agreement determine the basis for computing gain on the sale of the 200 shares of stock, but such an agreement may also determine the basis (unless or until the law is changed to require the use of some other factor to determine basis) of the remaining 300 shares of stock upon which gain will be computed in a subsequent sale.
The example provides that closing agreements may be used to determine the basis of shares of stock even if a sale is prospective. Thus, this example makes clear that a closing agreement can apply to a future event. It is important to note, however, that the binding determination is made due to the nature of a past transaction, which must be applied to future years, to ensure the accurate determination in the future years. It does not apply to future transactions that have no connection to the past or have not yet occurred.
Delegation of Authority
Because closing agreements are legislatively authorized agreements that bind the government, the person who signs the agreement for the government must have been delegated the authority to do so.
In the CCA, the Service noted that under Delegation Order No. 97, the local Appeals Office chief only has the delegated authority to make an agreement with a taxpayer regarding “a taxable period or periods ended prior to the date of the agreement and related specific items affecting other taxable periods.” Therefore, although a closing agreement may cover tax periods before and after the agreement date, the delegation authority granted under Delegation Order No. 97 does not entirely cover tax periods after the date of agreement. The authority under that order for tax periods after the date of agreement is limited to specific items. As discussed above, those specific items should stem from past transactions whose determination affects the taxpayer’s tax liability in the future.
According to the CCA, the deductions arising from the specific items covered in the closing agreement were not related to past transactions. Instead, the deductions related to activities that were ongoing during the time frame of the agreement. Therefore, because the transactions involved were not in the nature of related specific items and the local Appeals Office chief lacked the authority to expressly bind the Service for future years, the closing agreement did not bind the IRS for taxable periods subsequent to the date of the agreement.
This CCA highlights the need for taxpayers and their representatives to be aware of the limitations on the Service’s use of closing agreements. It is not enough to review the tax periods and the operative provisions of the closing agreement. It is imperative that taxpayers and their advisers ensure that the IRS employee executing the closing agreement has been delegated the authority to execute the agreement and to enter into a closing for the years covered by the agreement. Although the terms of the closing agreement being analyzed in the CCA indicated that the agreement covered tax periods before and after the date of the agreement, the Service determined that the agreement did not bind the IRS for taxable periods subsequent to the date of the agreement because the local Appeals Office chief lacked the appropriate authority to bind the government.
This item does not constitute tax, legal, or other advice from Deloitte Tax LLP, which assumes no responsibility with respectto assessing or advising the reader as to tax, legal, or other consequences arising from the reader’s particular situation.
John L. Miller, CPA, Faculty Instructor, Metropolitan Community College, Omaha, NE
Mr. Miller and Mr. Keenan are members of the AICPA Tax Division’s IRS Practice and Procedures Committee.
For further information about this column, contact Mr. Miller at email@example.com.