If the IRS sends a taxpayer a letter saying that it will process their refund claim but then it fails to do so, is the IRS bound by its letter? The court recently addressed this in Hawver v. Commissioner, T.C. Memo. 2017-244.
The Facts & Procedural History
The taxpayer filed his 2005 tax return in 2008. The return reported $90K of tax due. The taxpayer paid $3K of this amount.
The taxpayer filed an amended return for 2005 in 2009. The amended return reported $66K less than the tax due as reported on his originally-filed tax return. The taxpayer did not make any more payments.
The IRS rejected the taxpayer’s amended return as being unprocessable. It concluded that the taxpayer could only file a refund claim for taxes that were paid, not to reduce his tax balance.
The taxpayer filed the same return three more times. The IRS sent him two more rejection letters and then a letter saying that the IRS had adjusted the account as requested. The IRS did not adjust the taxpayer’s account.
The IRS collection division then sent the IRS a notice of intent to levy. On appeal for the levy, the taxpayer raised the underlying tax liability as an issue and the IRS Office of Appeals used its general authority to make some–but not all–of the adjustments in the amended return.
The question for the court was whether the IRS’s last notice was binding on the IRS and, as a result, precluded the IRS from collecting the tax.
Is An IRS Letter or Notice a Closing Agreement?
Section 7121 provides for closing agreements. These are written agreements as to the taxpayer’s liability. They are binding on the IRS and enforceable as a contract.
The IRS has implemented specific procedures for obtaining a closing agreement. They are usually recorded on a on Form 866, Agreement As to Final Determination of Tax Liability or a Form 906, Closing Agreement on Final Determination Covering Specific Matters.
There has been quite a bit of litigation and administrative guidance issued that helps explain what is and is not a closing agreement and when they are binding on the IRS. None of these authorities have gone so far as saying that an IRS letter or notice is a binding closing agreement.
The court noted that it was not able to find any authority saying that an IRS letter or notice like this was a closing agreement. So this opinion may be the first to conclude that such a letter is not a closing agreement. This is as far as the court got in this case. This is not the end of the analysis, however.
Detrimental Reliance or Equitable Estoppel
It does not appear that the taxpayer argued contract law, namely, that he relied on the IRS letter or notice and, given the reliance, a valid and enforceable contract was formed.
Contract law might support this interpretation. There have been a number of courts that have applied detrimental reliance or equitable estoppel in various contexts in relation to closing agreements. These arguments are usually raised by the IRS against the taxpayer, which is opposite of how they might be used here.
It should be noted that detrimental reliance and equitable estoppel, if accepted by the court, could mean that the IRS letter or notice was something less than a closing agreement, but sufficient to finally resolve the tax liability. This could take the issue out of Section 7121 and make it more akin to a judicial rule or practice. It would be the court exercising its power to decide cases and using the IRS’s letter or notice to decide how to resolve the case.
The court did not do this in this case given that the issue wasn’t raised and, it would not have been likely to do so given that it concluded that all four letters issued by the IRS were issued in error.
Administrative Grace May be Saving Grace
This particular case was litigated as a collection due process (“CDP”) hearing case. Taxpayers are generally precluded from challenging the underlying liability in CDP hearing cases if they have been given a prior opportunity to challenge the liability at the administrative level. That is the general rule.
Appeals frequently cites when it doesn’t want to consider a case. Appeals did that here. It concluded that the taxpayer was not able to challenge the underlying liability in the CDP hearing, but, interestingly, Appeals went further and it did in fact consider the liability. It even noted that it was doing so under its general administrative authority to settle cases.
The U.S. Tax Court did the same. It offered the taxpayer an opportunity to challenge the underlying liability (de novo) by proving his expenses, etc. in court. The taxpayer did not present evidence for this during the court process in this case, but the point is that Appeals and the court allowed the taxpayer to do so.
This provides some support for the position that an IRS letter or notice, even if issued in error, can and should open the door for the taxpayer to have the issue considered in Appeals and, if necessary, by the U.S. Tax Court. While less than a full and immediate victory, this second bite at the apple may provide the very remedy taxpayers would need in most cases.