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Crandall v. Commissioner (T.C. Memo. 2021-39)

On March 29, 2021, the Tax Court issued a Memorandum Opinion in the case of Crandall v. Commissioner (T.C. Memo. 2021-39). The primary issue presented in Crandall was whether the parties’ closing agreement precluded the determined deficiency and penalty.

Background to Determination

During taxable years 2003 through 2011 the petitioners received foreign-source pension income, interest income, and ordinary dividends. For each of those years they paid Italian income tax.  For none of those years they reported said income to the U.S. government.  The petitioners entered into the IRS’s Offshore Voluntary Disclosure Program (OVDP) in 2012. The petitioners included with their written submission a Form 1040X (Amended U.S. Individual Income Tax Return) for each of those years. The petitioners also submitted nine separate check payments covering additional tax and interest for each amended return year.  The IRS reviewed the OVDP filings, but it did not accept the petitioner’s Forms 1040X as filed. The petitioners negotiated with the IRS, ultimately agreeing on a $111,000 payment in 2015.

The Closing Agreement

In July 2015 the IRS sent an original and two copies of a Form 906 (Closing Agreement on Final Determination Covering Specific Matters). Petitioners immediately signed the closing agreement and mailed it to IRS. The closing agreement states that it “contains the complete agreement between the parties” and “is final and conclusive” except in the event of fraud, malfeasance, or misrepresentation of material fact.  The closing agreement, however, does not specify the amount of foreign tax credit the petitioners were entitled to in 2011.

The Assessment

In November 2015 the IRS assessed additional income tax of $11,043 and an accuracy-related penalty of $2,209 for 2011. The assessment of additional income tax equaled the prior year minimum tax credit the revenue agent had accidentally allowed petitioners.  The petitioner’s cried foul and filed a Form 911 (Request for Taxpayer Advocate Service Assistance). Ultimately, the IRS issued the petitioners a Notice CP21C for 2011 showing a balance due of zero after partial abatements in the amount of $7,000 (income tax) and $1,000 (penalties).

After the partial abatement of tax, the IRS either opened an examination of petitioners’ 2011 return or reopened the review of petitioners’ OVDP submission (the Tax Court was not clear on the exact circumstances).  In February 2017, the IRS issued the petitioners a notice of deficiency which determined a deficiency of, you might have guessed, $7,000 (income tax) and $1,000 (penalties).  The petitioners paid the deficiency and filed a petitioner seeking a redetermination of the deficiency.

Tax Court Jurisdiction to Redetermine a Deficiency

The Tax Court has jurisdiction to redetermine a deficiency if a valid notice of deficiency is issued by the IRS and if a timely petition is filed by the taxpayer. Rochelle v. Commissioner, 116 T.C. 356, 358 (2001), aff’d per curiam, 293 F.3d 740 (5th Cir. 2002); GAF Corp. & Subs. v. Commissioner, 114 T.C. at 521. The Tax Court also has jurisdiction to determine the amount of any overpayment a taxpayer made for a year that is properly before the Tax Court on a petition to redetermine a deficiency. IRC § 6512(b)(1). If the Tax Court determines that there is an overpayment and further determines the amount of the overpayment that is refundable in accordance with IRC § 6512(b)(3), the overpayment amount thus determined “shall, when the decision of the Tax Court has become final, be credited or refunded to the taxpayer.” IRC § 6512(b)(1).

The Petitioners’ Argument

Petitioners argued that the closing agreement includes the parties’ agreement not to adjust the FTC claimed on petitioners’ 2011 return. According to petitioners, that agreement precludes the IRS’s adjustment to the FTC in the deficiency notice.

The IRS’s Argument

The IRS recognized that the closing agreement does not adjust petitioners’ 2011 FTC. It argued, however, that the absence of such an adjustment indicates that there was no agreement about the correct amount of FTC for 2011. According to IRS, the closing agreement does not prohibit a “subsequent” adjustment to that item.

Closing Agreements, Generally

The IRS is authorized to fully settle tax liabilities through a closing agreement with any person regarding his or her liability for any taxable period. IRC § 7121(a); Urbano v. Commissioner, 122 T.C. 384, 393 (2004). IRC § 7121 sets forth the exclusive means by which a closing agreement between the IRS and a taxpayer may be accorded finality. Urbano, 122 T.C. at 393. Closing agreements are final, conclusive, and binding on the parties as to matters agreed upon, Analog Devices, Inc. v. Commissioner, 147 T.C. 429, 445 (2016), and may not be annulled, modified, set aside, or disregarded in any suit or proceeding unless there is a “showing of fraud or malfeasance, or misrepresentation of a material fact,” see IRC § 7121(b).

The scope of a closing agreement is strictly construed to encompass only the issues enumerated in the agreement itself. Analog Devices, Inc., 147 T.C. at 445-446. Any recitals in a closing agreement are not binding on the parties. See id. at 446. However, recitals are explanatory and can give insight into the intent of the parties. See Estate of Magarian v. Commissioner, 97 T.C. 1, 5 (1991); see also Rev. Proc. 68-16, § 6.05(3).

Applying Contract Law

Closing agreements are contracts, and they are subject to the rules of Federal common law contract interpretation. Analog Devices, Inc., 147 T.C. at 446. Contracts are construed according to the intent of the parties as of the time of entering into the agreement. Long v. Commissioner, 93 T.C. 5, 10 (1989), aff’d without published opinion, 916 F.2d 721 (11th Cir. 1990). The starting point for ascertaining the parties’ intent is the contract itself. See Baldwin v. Univ. of Pittsburgh Med. Ctr., 636 F.3d 69, 76 (3d Cir. 2011). The contract must be read as a whole, and the contract must be interpreted in context. See Senior Exec. Benefit Plan Participants v. New Valley Corp. (In re New Valley Corp.), 89 F.3d 143, 149 (3d Cir. 1996). That is because the meaning of words commonly depends on their context. When the parties have adopted a writing as a final expression of their agreement, interpretation is directed to the meaning of that writing in the light of the circumstances. Analog Devices, Inc., 147 T.C. at 446.

Intent is inferred from the four corners of the agreement where the contract is unambiguous; extrinsic evidence may be used to discern intent where the contract has ambiguities. Rink v. Commissioner, 100 T.C. 319, 325 (1993), aff’d, 47 F.3d 168 (6th Cir. 1995). A court cannot simply determine whether, from its point of view, the language is clear in deciding whether a contract term is ambiguous. New Valley Corp., 89 F.3d at 150. Instead, a court must consider the contract language, the meanings suggested by counsel, and the extrinsic evidence offered in support of each interpretation. Id.

Whether a contractual term is ambiguous is a question of law. See id. at 149. If the Tax Court determines that a contractual term is ambiguous, then the interpretation of that term is a question of fact for the trier of fact to resolve in light of the extrinsic evidence offered by the parties in support of their respective interpretations. Sanford Inv. Co. v. Ahlstrom Mach. Holdings, Inc., 198 F.3d 415, 421 (3d Cir. 1999). Extrinsic evidence “may include the structure of the contract, the bargaining history, and the conduct of the parties that reflects their understanding of the contract’s meaning.” New Valley Corp., 89 F.3d at 150; see also Sanford Inv. Co., 198 F.3d at 421.

And Back to the Closing Agreement

The provisions of the closing agreement “reflect an intention to accord finality to the tax consequences stemming from petitioners’ income items that they disclosed” except those unrelated to offshore financial arrangements or related to offshore financial arrangements not included in the petitioners’ voluntary disclosure. Thus, the Tax Court observed, unless the petitioners’ 2011 FTC falls in either of those excepted categories, the closing agreement precludes the determined deficiency.

The IRS “summarily suggests” that the 2011 FTC was “unrelated to offshore financial arrangements”. The Tax Court summarily disagreed. It found that the petitioners’ 2011 FTC was clearly “related to offshore financial arrangements,” given that petitioners’ claim for the credit arose from their payment of foreign income tax on foreign-source income.

The IRS next argued that the 2011 FTC was “not included” in petitioners’ voluntary disclosure. It also argued that, even if the 2011 FTC was “included” in petitioners’ voluntary disclosure, a subsequent adjustment to that item is nevertheless permissible.  The Tax Court was unimpressed.

The Holding

The recitals of the closing agreement express an intention “to resolve for 2003 through 2011 the proper amount of federal income taxes” flowing from petitioners’ voluntary disclosure of unreported offshore income and assets. Given this intention, the Tax Court concluded that the 2011 FTC related to petitioners’ offshore financial arrangements that they voluntarily disclosed to the IRS in that the FTC pertained to the petitioners’ foreign-source income, was addressed in the closing agreement, and affected the calculation of their additional tax liabilities.  Further, the Tax Court held that the petitioners’ disclosure of their foreign income was the very “heart” of the closing agreement.  Therefore, the closing agreement precludes the determined deficiency, which was based on an adjustment to a credit that the agreement had allowed in full.

Game, set, match – petitioners.

(T.C. Memo. 2021-39) Crandall v. Commissioner

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