hen an IRS audit identifies deficiencies in a tax return, the taxpayer may be asked to sign a closing agreement. There are two types of closing agreements. The first—contained on Form 866, Agreement as to Final Determination of Tax Liability —establishes the final tax liability. The other, contained on Form 906, Closing Agreement on Final Determination Covering Specific Matters, makes a determination on only those items specifically listed on the form. Other items still can be adjusted by the IRS in subsequent actions. These agreements are binding on both sides absent fraud, malfeasance or misrepresentation of material fact.
In a form 866 closing agreement, a deficiency notice is not necessary. Both sides agree to a final liability and, therefore, there is no need to provide an opportunity for the taxpayer to request a court review. 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. Therefore, the IRS must issue a deficiency notice before attempting to collect.
Bernhard Manko was a 99% partner in Comco. The IRS audited the partnership returns for 1987 to 1991 and reached an agreement with Manko and the other partners on necessary adjustments. Since the adjustments affected Manko’s individual return, he agreed to an indefinite extension of the time for assessment of additional tax. After agreeing to the partnership adjustments, Manko signed a form 906 closing agreement. Although the partnership items were settled, the IRS used this form because it wanted to retain the right to make other adjustments to Manko’s individual return. The IRS then examined the individual return and issued an Income Tax Examination Changes form reflecting both partnership and individual adjustments. It assessed the extra tax shown on the change form without issuing a deficiency notice. According to the IRS, Manko owed $10.763 million for 1988 and $2.644 million for 1989. From 1996 through 2000 the IRS sent five additional change forms adjusting the amounts due for 1988 and 1989. In 2003 Manko terminated his consent to extend the assessment deadline. The IRS issued a final notice of intent to levy. At a hearing, the taxpayer argued that the levy should not proceed since he had not received a deficiency notice. In 2004 the IRS ruled that the levy could be implemented. The taxpayer petitioned the court for a determination.
Result . For the taxpayer. Usually a deficiency notice must be issued before the IRS can assess a deficiency, but Manko had signed a form 906 closing agreement and the IRS argued that the closing agreement waived the necessity of issuing such a notice. The Tax Court disagreed.
A deficiency notice allows the taxpayer the right to petition the Tax Court to review the assessment. (The notice is not necessary if the assessment is based solely on a mathematical or clerical error or if the taxpayer waives the restrictions on assessment.)
As this case demonstrates, taxpayers need to know which form is being used and which items are still in dispute to preserve their right to contest these items. The Tax Court acknowledged that when form 906 is used, the IRS must issue a deficiency notice. However, according to the regulations, taxpayers don’t have the right to challenge any item listed on the form. Items subject to challenge are settled and not open to review. Any other item is covered by the normal rules for tax disputes.
Bernhard F. Manko v. Commissioner, 126 TC no. 9.
Prepared by Edward J. Schnee, CPA, PhD, Hugh Culverhouse Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.