The final conclusion of a taxpayer’s entry into one of the Offshore Voluntary Disclosure programs is memorialized in the Form 906, which is the Closing Agreement signed by the taxpayer and the Commissioner of the Internal Revenue Service (IRS). This signifies the completion of the voluntary disclosure. Significantly, the Form 906 has included language making clear that the Closing Agreement does not prevent the IRS from auditing a taxpayer for the relevant years and proposing adjustments that are unrelated to the offshore financial arrangements.  Clearly the Closing Agreement is a very important document when it is involved in any tax dispute, and it is especially critical in the Voluntary Disclosure process.

What is a Closing Agreement? When Will One Be Entered Into by the IRS?

A so-called “closing agreement” (authorized by the US Internal Revenue Code at Section 7121), can be a useful tool to resolve disagreements between the IRS and taxpayers.  The closing agreement is in many ways similar to a contract and general contract law principles apply in interpreting such agreements. It is, generally, a legally binding and final agreement between the IRS and a taxpayer on a specific issue or tax liability.

Both taxpayers and the IRS benefit from a properly executed closing agreement. The taxpayer not only obtains certainty that the issues are finally and permanently concluded, the taxpayer also obtains guidance on how to properly comply with the tax laws going forward.  For its part, the IRS resolves a tax compliance problem that would otherwise have involved significant time and resources to pursue to conclusion.  The IRS also obtains the taxpayer’s commitment to future compliance.

Pursuant to IRS Treasury Regulations, a closing agreement may be entered into in any case in which there appears to be an advantage in having the case permanently and conclusively closed, or if good and sufficient reasons are shown by the taxpayer for desiring a closing agreement and it is determined by the Commissioner that the United States will sustain no disadvantage through consummation of such an agreement. Entering into a closing agreement is completely discretionary with the IRS.

Binding Effect

The closing agreement is comprised of five distinct parts: Part 1 identifies the parties; Part 2 contains the introductory clauses, Part 3 sets out the agreed determination, Part 4 contains the ending clause, and finally, Part 5 provides for the signatures of the parties. 

The IRS can negotiate a written closing agreement with any taxpayer to make a final resolution of any of the taxpayer’s tax liabilities for any period. Once the agreement is signed by the parties, it is final and conclusive.  Unless there is a showing of fraud, malfeasance, or a misrepresentation of a material fact, the agreement cannot be reopened as to the matters agreed on. The agreement cannot later be modified by the IRS; similarly it cannot be disregarded by the government or the courts.  Any items that are not specifically covered by the agreement, however, can still be adjusted by the IRS in later actions.  As such, always bearing in mind that the closing agreement is legally binding and conclusive, it should be meticulously drafted and reviewed before signing to make sure all intended items are covered. There should be no uncertainty as to the determination of tax or other amounts to be paid.

Taxpayers should be very cognizant of the fact that the closing agreement is not binding on the IRS if there has been any misrepresentation of material fact.  Even though inadvertent inaccuracies or omissions are not to be treated as disqualifying misrepresentations, it is always possible that they can be  construed as such.  Therefore the statements contained in the agreement should be accurate reflections of the facts that are relevant to the determinations set out in the agreement.

Pitfalls to Watch Out For

Closing agreements are generally reflected on Form 866, Agreement As to Final Determination of Tax Liability or Form 906, Closing Agreement on Final Determination Covering Specific Matters.  

The use of a closing agreement determining tax liability (Form 866) can prevent the taxpayer from being able to reopen issues that are not contemplated in a settlement. To avoid this possibility, in some instances it may be better to use a closing agreement as to specific matters (Form 906).

Taxpayers must make sure the agreement defines precisely the matters on which the taxpayer wishes to agree. The terms of the agreement must be very carefully described. The possibility of retroactive legislation should be addressed in the agreement. Generally, with regard to retroactive legislation, the agreement can state that no subsequent change or modification of applicable laws will render the agreement ineffective. Also, the taxpayer should be careful not to include any unnecessary statements or matters that could later be viewed as part of the agreement and therefore binding.