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 that definitively resolves a tax liability. Authorized by Internal Revenue Code section 7121, this legally binding document provides finality, preventing the same issue from being revisited by either the taxpayer or the IRS in the future.

This agreement is not a routine part of filing taxes but is reserved for specific circumstances. It serves as a formal settlement, often used to close out complex cases, such as those before the IRS Office of Appeals or in tax litigation. By entering into the agreement, the taxpayer gains assurance that the matter is settled.

Situations Warranting a Closing Agreement

Closing agreements are suitable when a taxpayer or the IRS seeks to permanently settle a tax issue. These situations generally fall into two categories, each addressed by a specific form for different circumstances. The decision to pursue an agreement arises when there is an advantage to having a case conclusively closed.

One use is to determine the tax treatment of specific items, often before a tax return is filed, using Form 906, Closing Agreement On Final Determination Covering Specific Matters. Such agreements can clarify the tax basis of an asset after a corporate reorganization, establish the amount of a net operating loss, or define the tax consequences of a business transaction.

Another application is to settle a taxpayer’s entire tax liability for a completed tax period, which is common at the conclusion of an audit. This is formalized using Form 866, Agreement As To Final Determination of Tax Liability. For example, a closing agreement can finalize the total tax, penalties, and interest due for that year, which is useful for estates distributing assets or for businesses undergoing liquidation.

Information and Documentation for the Request

To initiate a closing agreement, a taxpayer must prepare a request package with specific information. The request must include the taxpayer’s full name, current address, and Taxpayer Identification Number (TIN). It is also necessary to identify the specific tax years or periods the proposed agreement will cover.

The submission requires a detailed statement of the relevant facts pertaining to the tax issue. This must be accompanied by an explanation of the controlling tax law, regulations, or published rulings that apply. The taxpayer must also present proposed terms for resolution, including any specific figures for tax, penalties, or credits.

This information is compiled to complete either Form 866 or Form 906. All relevant supporting documents must be attached to substantiate the facts presented. This evidence may include contracts, transaction records, independent appraisals, or financial statements.

The Closing Agreement Process

The process begins when the taxpayer submits the completed Form 866 or Form 906 with all supporting documentation. The package is sent to the IRS office with jurisdiction over the matter, such as the District Director or the IRS Appeals office if the case is under review.

An IRS agent or officer then reviews the submission, which may involve communication with the taxpayer. If the initial terms are not acceptable, a period of negotiation may follow to reach a resolution. IRS attorneys may be asked to review or draft the agreement, particularly in complex cases.

After negotiations are complete and both parties agree on the terms, the IRS drafts the final closing agreement. The process concludes when the agreement is signed by both the taxpayer and an authorized IRS official, making it a legally binding contract.

Finality and Effect of the Agreement

A fully executed closing agreement is legally binding on both the taxpayer and the IRS for the matters it addresses. As outlined in Treasury Regulation Section 301.7121-1, the agreement is final and cannot be modified, disregarded, or reopened by either party. This means the IRS cannot seek additional tax on the covered issues, and the taxpayer cannot file a claim for a refund.

The agreement is subject to very limited exceptions and can only be set aside upon a showing of fraud, malfeasance, or a misrepresentation of a material fact. These circumstances are rare and require substantial evidence to invalidate the agreement. Absent such proof, the resolution remains permanent, even if subsequent changes in tax law would have otherwise affected the outcome.

Following the signing, the taxpayer must fulfill the agreement’s terms. This most commonly involves paying any tax deficiency determined by the agreement by the specified deadline. The agreement provides certainty, allowing the taxpayer to move forward with knowledge of their exact tax obligations.