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Thursday, April 27, 2006


When the IRS asserts that an insufficient amount of tax has been reported by a taxpayer, it generally must follow certain procedural steps before it can collect the additional tax.

First, it must issue a Notice of Deficiency. This Notice of Deficiency allows the taxpayer to petition the Tax Court for a redetermination of the asserted deficiency, without having to pay the tax first. If it does not issue the Notice of Deficiency, the IRS cannot proceed to the next step of "assessing" the tax - an assessment is made by recording the liability on the books of the IRS, nor the further steps of collecting the tax, including through levy against taxpayer assets.

There are exceptions to the need for a Notice of Deficiency. For example, one is not needed when the assessment arises from methematical or clerical errors, it arises from a tentative carryback or refund adjustment, or is based on the receipt of a payment of tax. Further, a taxpayer can waive the need for a Notice of Deficiency.

In Manko v. Comm., 126 T.C. No. 9 (4/20/06), the IRS and the taxpayer entered into a Form 906, Closing Agreement on Final Determination Covering Specific Matters - a closing agreement that bound the IRS and the taxpayer to the treatment of certain tax issues. The IRS never issued a Notice of Deficiency. The IRS proceeded to levy on the assets of the taxpayer for the agreed upon tax. The taxpayer objected. In its decision, the Tax Court sided with the taxpayer and held that notwithstanding the Closing Agreement, the IRS must follow the statutory procedures and issue a Notice of Deficiency before it can levy to collect the tax.

The IRS argued that issuing a Notice of Deficiency would have allowed the taxpayer to then go to Tax Court and reopen the issues of the Closing Agreement, thus obviating the benefits of using Closing Agreements to avoid litigation. The Tax Court was not impressed with this argument, noting that while the taxpayer could go to Tax Court, the Closing Agreement was still binding on the taxpayer so the agreements in the Closing Agreement could not be overturned by the Tax Court.

Interestingly, the Tax Court did recognize that there is a type of Closing Agreement that does not require a Notice of Deficiency to enforce. This is a Form 866, Agreement as to Final Determination of Tax Liability. The principal difference between the Form 866 from a Form 906 is that a Form 906 covers only the specific taxes addressed in the Agreement, while the Form 866 effects all tax issues for the subject tax year. Since the taxpayer under a Form 866 has agreed to the total amount of the taxpayer's liability for the tax year, a Notice of Deficiency provides no further procedural safeguards to the taxpayer since there is nothing left to the taxpayer to challenge in Tax Court, and thus it is not needed before the IRS can levy.

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