What Is an IRS Closing Agreement and How Does It Work?

An IRS Closing Agreement is a formal, written contract between a taxpayer and the Internal Revenue Service (IRS) that resolves a specific tax matter. Authorized by Internal Revenue Code Section 7121, its purpose is to provide finality for both the taxpayer and the government. The agreement is legally binding, meaning the IRS cannot seek further taxes or penalties on the covered items, and the taxpayer cannot claim a refund. This tool ensures certainty when the tax treatment of an item is ambiguous or could have ongoing consequences.

Circumstances for a Closing Agreement

A closing agreement is appropriate in any situation where a taxpayer or the IRS sees an advantage in having a case permanently closed. The IRS will agree to this if it determines the government will not face a disadvantage from the arrangement. These agreements are often used to resolve complex situations where finality is needed before certain actions can be taken.

One common scenario involves the administration of estates and trusts. An executor or trustee may seek a closing agreement to finalize the estate’s tax liability before distributing assets to beneficiaries, which protects the fiduciary from future IRS claims. Similarly, a business undergoing liquidation or a sale can use a closing agreement to settle its tax obligations and provide certainty to the parties in the transaction.

Closing agreements are also used to determine the tax treatment of a specific issue that may affect multiple tax years, such as establishing the tax basis of an asset to ensure consistent depreciation. Other uses include resolving the U.S. tax status for taxpayers becoming non-resident aliens or fulfilling a court order that requires a final determination of tax liability.

Information and Forms Required

Requesting a closing agreement involves specific IRS forms and supporting documentation. The two primary forms are Form 866, Agreement As to Final Determination of Tax Liability, and Form 906, Closing Agreement on Final Determination Covering Specific Matters. The choice of form depends on the scope of the issue being resolved.

Form 866 is used to finalize a taxpayer’s total tax liability for a past, completed tax period. To complete it, you must specify the tax period, the type of tax involved (such as income, estate, or gift), and the final, agreed-upon total tax amount. This form provides a complete settlement for that specific period.

Conversely, Form 906 is used to resolve one or more specific items instead of the entire tax liability. This form requires a detailed description of the matter, the agreed-upon tax treatment, and all applicable tax periods the agreement will cover. For instance, it could be used to finalize the deductibility of a business expense with multi-year implications.

Beyond the forms, a complete request package must include substantial supporting information. A detailed narrative explaining the relevant facts of the case provides context for the IRS. All pertinent documents, such as contracts, appraisals, or financial statements, must be attached. The request should also cite any legal authorities, like statutes or court cases, that support the taxpayer’s proposed treatment.

The Closing Agreement Request and Finalization Process

Once the form and documentation are prepared, the request is submitted. The completed package is sent to the IRS office currently handling the taxpayer’s case. If no case is actively open, the request should be submitted to the district director of internal revenue where the relevant tax return was filed.

Upon receipt, the IRS assigns the request to an agent or attorney for review. This official examines the facts, analyzes the applicable law, and evaluates the proposed terms. This stage often begins a negotiation, as the IRS may accept the proposal, reject it, or present a counteroffer. This can lead to back-and-forth communication, including meetings to reach mutually acceptable terms, often within the IRS Office of Appeals.

After all terms are agreed upon, the IRS prepares the final agreement for execution. The taxpayer or their authorized representative signs the agreement first. It then proceeds through an internal IRS review before receiving a final signature from an authorized IRS official, like the Commissioner of Internal Revenue. The taxpayer then receives a fully executed copy for their records.

Binding Nature of a Finalized Agreement

A finalized closing agreement is legally conclusive. The agreement is intended to withstand subsequent changes in the interpretation of the law by the courts. However, an agreement covering a future tax period is subject to any changes in the law enacted after the agreement date that are applicable to that period.

There are very few exceptions to this finality. A closing agreement can only be set aside upon a showing of fraud, malfeasance, or misrepresentation of a material fact. Simple errors in the application of tax law or mistakes in factual understanding are not sufficient grounds to overturn the agreement. This high threshold underscores the durable and certain resolution the agreement provides.