Bernhard F. and Cynthia G. Manko v. Commissioner ( 2006 )

126 T.C. No. 9UNITED STATES TAX COURT
BERNHARD F. AND CYNTHIA G. MANKO, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 24124-04L. Filed April 20, 2006.
Ps and R executed a closing agreement covering specific
matters relating to the treatment of certain partnership
items on Ps’ returns. R assessed Ps’ taxes without issuing
Ps a deficiency notice. R then commenced collection action
against Ps. Ps argue that R may not proceed with the
proposed collection action because R failed to issue a
statutory deficiency notice before R assessed Ps’ taxes.
Held: R may not proceed with collection because R
failed to issue a deficiency notice before assessing
Ps’ taxes. The requirement to issue a deficiency
notice before assessment is not altered by the closing
agreement covering the treatment of certain items on
Ps’ returns for the years at issue. Accordingly, R may
not proceed with collection of Ps’ liabilities.
- 2 -
Irwin S. Meyer, for petitioner Bernhard F. Manko.
Hugh Janow, for petitioner Cynthia G. Manko.
Gerard Mackey, for respondent.
OPINION
KROUPA, Judge: Petitioners seek review under section
6330(d)1 of respondent’s determination to proceed with a proposed
levy to collect petitioners’ Federal income tax liabilities for
1988 and 1989 (the years at issue). We are asked to decide
whether respondent may proceed with collection of these
liabilities, which respondent assessed without first issuing
petitioners a notice of deficiency (deficiency notice). We hold
that respondent may not proceed with collection.
This case was submitted fully stipulated pursuant to Rule
122, and the facts are so found. The stipulation of facts and
the accompanying exhibits are incorporated by this reference.
Petitioners resided in Lighthouse Point, Florida, at the time
they filed the petition.
Background
Petitioner Bernhard F. Manko (Mr. Manko) was a 99-percent
partner in Comco, a partnership not subject to TEFRA proceedings.
1
All section references are to the Internal Revenue Code in
effect at all relevant times, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
- 3 -
See sec. 6221. Respondent examined certain items relating to
Comco for the taxable years 1987 through 1991 and reached
agreement with Mr. Manko and Comco’s other partner on these
items.
The changes to the Comco items required changes to
petitioners’ joint Federal income tax returns for the years at
issue. To facilitate this process, petitioners agreed to extend
the time indefinitely for respondent to assess income taxes for
the years at issue. Petitioners and respondent agreed on the
treatment of the Comco items on petitioners’ returns for the
years at issue and memorialized their agreement on Form 906,
Closing Agreement on Final Determination Covering Specific
Matters (the closing agreement).
The preamble to the closing agreement explains that the
parties wish to determine with finality petitioners’ distributive
share of income, gains, losses, deductions, and credits with
respect to Comco for the years at issue. The final paragraph of
the closing agreement provides that the agreement does not affect
or preclude later adjustments of any item (other than those
relating to Comco) for the years at issue.
When the parties executed the closing agreement, respondent
was also examining petitioners’ returns for the years at issue
for issues unrelated to Comco (the non-Comco items). After the
parties executed the closing agreement, respondent prepared an
- 4 -
Income Tax Examination Changes, marked it “Copy—Information Only”
and sent it to petitioners. This document, prepared 2 years
after the closing agreement and almost 7 years after the end of
the last year at issue, reflected respondent’s computation of
petitioners’ tax liabilities after the agreed treatment of the
Comco items was taken into account.
Respondent then assessed the deficiencies shown in
respondent’s Income Tax Examination Changes against petitioners
for the years at issue without issuing petitioners a deficiency
notice. Specifically, respondent assessed a $10,763,212
deficiency for 1988 and a $2,644,240 deficiency for 1989. These
assessments did not meet the statutory exceptions to the
requirement that a deficiency notice must first be issued before
assessment. See sec. 6213(b). Specifically, the assessments did
not arise out of mathematical or clerical errors, were not the
result of a determination that a tentative carryback or refund
adjustment was excessive, and were not based on the receipt of
any payment of tax.
After these assessments, respondent continued to alter the
amounts petitioners owed for the years at issue. Respondent sent
petitioners five subsequent Income Tax Examination Changes from
1996 through 2001. Respondent sent the latest report to
petitioners in October 2001, 12 years after the end of the last
year at issue and 7 years after the parties executed the closing
- 5 -
agreement. In January 2003, petitioners terminated their special
consent to extend the time for respondent to assess tax for the
years at issue. Respondent has never issued petitioners a
deficiency notice for the years at issue, and petitioners never
executed a formal waiver of the restrictions on assessment.
Respondent sent petitioners a Final Notice of Intent to Levy
and Your Right to a Hearing with respect to the years at issue,
and petitioners timely requested a hearing. Petitioners asserted
in their request for a hearing that the proposed levy should not
proceed for a variety of reasons. These reasons included that
petitioners had never received a deficiency notice, that
petitioners had made payments toward the liabilities for the
years at issue, and that petitioners had an increased net
operating loss for a prior year that would decrease their
liability for the years at issue. The parties then held a
hearing. Respondent issued petitioners a notice of determination
on December 1, 2004 (the determination notice), which sustained
the proposed levy for the years at issue. The determination
notice stated that petitioners had not raised challenges to the
existence or amount of the underlying tax liability. The
determination notice concluded that the assessments for the years
at issue should not be abated, briefly citing legal opinions in
the case file.
Petitioners timely filed a petition with this Court.
- 6 -
Discussion
We are asked to decide for the first time whether the
Commissioner is required to issue a deficiency notice before
assessing taxes for years subject to a closing agreement that
covers the treatment of only certain items. Petitioners argue
that respondent may not proceed with collection because
respondent did not issue them a deficiency notice before
respondent assessed their taxes. This failure, petitioners
argue, precluded them from challenging their income tax
liabilities before the assessment and before this levy
proceeding. Respondent, on the other hand, argues that a
deficiency notice is not required before assessment in all
situations. Rather, respondent argues no deficiency notice is
required if the changes to a taxpayer’s return arise solely from
computational adjustments made by applying a closing agreement
covering specific matters to the taxpayer’s return. We find for
petitioners.
We first address our jurisdiction in this case as well as
the standard of review.
I. Jurisdiction and Standard of Review
We have jurisdiction to review a hearing officer’s
determination in a collection action where the underlying tax
liability is of a type over which this Court normally has
jurisdiction. Sec. 6330(d)(1)(B); Katz v. Commissioner, 115 T.C.
- 7 -
329, 338-339 (2000). Respondent has assessed and proposes to
collect Federal income taxes for 1988 and 1989 attributable to
adjusting the Comco items reported on petitioners’ returns. We
generally have jurisdiction to redetermine deficiencies in income
taxes and related additions to tax. See secs. 6211, 6213(a),
6214(a); see also Goza v. Commissioner, 114 T.C. 176, 182 (2000).
We therefore have jurisdiction to review the determination notice
in this case. See Katz v. Commissioner, supra at 339.
Where the underlying tax liability is at issue in a
collection action, we review the determination de novo. Sego v.
Commissioner, 114 T.C. 604, 610 (2000). Where the underlying
liability is not at issue, we review the determination for an
abuse of discretion. Goza v. Commissioner, supra at 181-183.
The key facts are fully stipulated and described in the
determination notice. Where, as here, we are faced with a
question of law (e.g., whether the Commissioner must issue a
deficiency notice before assessing taxes when a closing agreement
covers the treatment of certain items on a return for that year),
our holding does not depend on the standard of review we apply.
We must reject erroneous views of the law. See Kendricks v.
Commissioner, 124 T.C. 69, 75 (2005) (and the cases cited
therein); McCorkle v. Commissioner, 124 T.C. 56, 63 (2005).
- 8 -
II. Deficiency and Assessment Procedures
Petitioners contend that respondent may not proceed with
collection of their tax liabilities because respondent failed to
issue a deficiency notice before assessing their taxes.
A. A Deficiency Notice Is Generally Required Before
the Commissioner May Assess a Deficiency
An assessment is an administrative recording of a taxpayer’s
liability and sets the collection process in motion.
Philadelphia & Reading Corp. v. United States, 944 F.2d 1063,
1064 n.1 (3d Cir. 1991). An assessment is made by recording the
liability of the taxpayer in the office of the Secretary. Sec.
6203. The purpose of requiring the assessment to be so recorded
is to insure both that the Secretary is maintaining proper
records and that taxpayers receive a summary of records of their
tax liability. Gentry v. United States, 962 F.2d 555, 556 (6th
Cir. 1992).
The Secretary generally may not assess a deficiency in tax
unless the Secretary has first mailed a deficiency notice to the
taxpayer and allowed the taxpayer to petition the Tax Court for a
redetermination.2 Sec. 6213(a). There are certain exceptions to
the requirement that a deficiency notice must be issued, however.
For example, a deficiency notice is generally not required where
2
A deficiency notice is not required to assess taxes where
there is no deficiency. For example, the Secretary may assess
without a deficiency notice the amount of tax shown due on a
return. Sec. 6201(a)(1).
- 9 -
the assessment arises from mathematical or clerical errors,
arises from tentative carryback or refund adjustments, or is
based on the receipt of a payment of tax. See sec. 6213(b). The
Commissioner may also assess a deficiency without issuing a
deficiency notice if a taxpayer waives the restrictions on
assessment. Sec. 6213(d).
A deficiency notice provides taxpayers certain procedural
safeguards. See Commissioner v. Shapiro, 424 U.S. 614, 616-617
(1976). A deficiency notice entitles a taxpayer to litigate his
or her tax liability without first paying the tax the
Commissioner has determined is owing. Bourekis v. Commissioner,
110 T.C. 20, 27 (1998); McKay v. Commissioner, 89 T.C. 1063, 1067
(1987), affd. 886 F.2d 1237 (9th Cir. 1989); Mulvania v.
Commissioner, 81 T.C. 65, 67 (1983). Deficiency notices have
been characterized as “tickets to the Tax Court” affording
taxpayers the opportunity to litigate in this forum. Bourekis v.
Commissioner, supra; McKay v. Commissioner, supra; Mulvania v.
Commissioner, supra. A deficiency notice also allows a taxpayer
to litigate his or her tax liability before the Commissioner
makes an assessment and collection proceedings begin.3
Commissioner v. Shapiro, supra.3
A taxpayer may generally dispute his or her liability in
collection proceedings only if the taxpayer has not previously
had the opportunity to dispute it. Sec. 6330(c)(2)(B); Sego v.
Commissioner, 114 T.C. 604, 609 (2000); Goza v. Commissioner, 114
T.C. 176, 180-181 (2000).
- 10 -
The parties agree that respondent did not issue petitioners
a deficiency notice, that no statutory exception to the
restrictions on assessment applies, and that petitioners have not
waived the restrictions on assessment. Accordingly, respondent
may not proceed with collection unless, as respondent argues, the
closing agreement obviates the need for a deficiency notice.
B. The Closing Agreement Covering Specific Matters Does
Not Render Deficiency Notice Unnecessary
1. Types of Closing Agreements
We now address closing agreements. The Commissioner may
enter into an agreement with any person regarding his or her
liability for any taxable period. Sec. 7121(a). These
agreements are final and conclusive and bind the parties as to
matters agreed upon. Sec. 7121(b); Urbano v. Commissioner, 122
T.C. 384, 394 (2004). They may be reopened only in exceptional
circumstances such as fraud, malfeasance, or misrepresentation of
a material fact. Urbano v. Commissioner, supra. All closing
agreements shall be executed on forms prescribed by the Internal
Revenue Service. Id.; sec. 301.7121-1(d), Proced. & Admin. Regs.
The Commissioner has prescribed two forms of closing
agreements, each used in different circumstances. One type of
closing agreement is a final determination of a taxpayer’s
liability for a past taxable year or years. Zaentz v.
Commissioner, 90 T.C. 753, 760-761 (1988); Rev. Proc. 68-16,
1968-1 C.B. 770. This type of closing agreement is completed on
- 11 -
Form 866, Agreement as to Final Determination of Tax Liability.
Urbano v. Commissioner, supra; Zaentz v. Commissioner, supra. A
second type of closing agreement finally determines one or more
separate items affecting the taxpayer’s liability and is executed
on Form 906. Urbano v. Commissioner, supra; Zaentz v.
Commissioner, supra; see sec. 601.202, Statement of Procedural
Rules.
A closing agreement on Form 906, covering specific matters,
binds the parties as to the matters agreed upon. Zaentz v.
Commissioner, supra. This type of closing agreement does not,
however, conclusively determine the taxpayer’s tax liability for
that year. For example, this type of closing agreement does not
bar the Commissioner from subsequently determining that a
taxpayer is liable for additions to tax.4 Estate of Magarian v.
Commissioner, 97 T.C. 1 (1991).
4
A requesting spouse is not entitled to innocent spouse
relief when the requesting spouse has entered into a closing
agreement that disposes of the same liability. See sec. 1.6015-
1(c)(1), Income Tax Regs. A closing agreement entered into
before the effective date of sec. 6015, however, does not cut off
a claim for innocent spouse relief under that section. Hopkins
v. Commissioner, 120 T.C. 451 (2003). Under the former innocent
spouse relief statute, sec. 6013(e), a closing agreement, even
one that determined liability only with regard to specific
issues, precluded a taxpayer’s later claim for innocent spouse
relief where the defense was not preserved in the text of the
closing agreement. See Hopkins v. United States, 146 F.3d 729(9th Cir. 1998).
- 12 -
Petitioners and respondent executed a closing agreement
covering specific matters on Form 906. The specific matters
included the treatment of Comco items on petitioners’ returns for
the years at issue. The agreement did not cover all items
affecting petitioners’ tax liability. In their closing
agreement, the parties did not agree to the amount petitioners
owed for the years at issue, and, in fact, the closing agreement
specifically states that it does not affect or preclude later
adjustments of non-Comco items for the years at issue.5
2. Effect of Closing Agreement on Deficiency
Notice Requirement
We agree that a deficiency notice is not required before
assessment if a taxpayer and the Secretary execute a closing
agreement on Form 866, finally determining the taxpayer’s
liability for the year.6 Marathon Oil Co. v. United States, 42
5
Respondent was examining petitioners’ returns when the
parties executed the closing agreement and, over several years,
adjusted the amounts petitioners owed several times. Subsequent
adjustments were not only contemplated in the parties’ closing
agreement. They actually occurred.
6
In cases where the parties agree to the amount of the
taxpayer’s liability, such as those involving Form 866, the
taxpayer has already agreed to the deficiency amount and that the
deficiency is proper. Thus, a deficiency notice would provide no
additional safeguards and is not required. Marathon Oil Co. v.
United States, 42 Fed. Cl. 267, 280 (1998), affd. 215 F.3d 1343(Fed. Cir. 1999). Moreover, a closing agreement may not be
reconsidered in the absence of fraud, malfeasance, or
misrepresentation of a material fact. Sec. 7121(b). Absent
these exceptional circumstances, the closing agreement remains
binding and could not be reopened in an action to redetermine a
(continued...)
- 13 -
Fed. Cl. 267 (1998), affd. 215 F.3d 1343 (Fed. Cir. 1999); Rev.
Proc. 68-16, 1968-1 C.B. 770. Unlike a Form 866, however, the
parties here executed a closing agreement on Form 906. The Form
906 executed here covered only specific matters (i.e., the
treatment of the Comco items). The parties did not agree to the
total amount of petitioners’ liabilities for the years at issue.
Respondent argues that he merely computed the effect of the
Comco items agreed in the closing agreement on the amounts
petitioners reported on their returns. Respondent maintains that
in this circumstance, he is not required to issue a deficiency
notice before assessing the resulting liability. We disagree.
Respondent may not dispense with a deficiency notice in this
situation where petitioners were never allowed to challenge
respondent’s computations. See Commissioner v. Shapiro, 424 U.S.
at 616-617. By failing to issue petitioners a deficiency notice,
respondent deprived petitioners of the opportunity of filing a
deficiency suit to dispute these computations and to argue that
other adjustments should be made to their liabilities for the
years at issue. See sec. 6213(a); Commissioner v. Shapiro, supra
at 616-617. Respondent unilaterally implemented the closing
agreement by applying the terms of the agreement to the amounts
6
(...continued)
deficiency. Id. Accordingly, there would be nothing the
taxpayer could challenge. Marathon Oil Co. v. United States,
supra at 280.
- 14 -
reported on petitioners’ returns and then assessed the resulting
liabilities. Because respondent did not issue a deficiency
notice, petitioners were never afforded the opportunity to
litigate the amount of their tax liabilities before the
collection process began. See Commissioner v. Shapiro, supra at
616-617; cf. Marathon Oil Co. v. United States, supra at 280.
3. Our Holding Would Not Permit Petitioners To
Challenge the Terms of the Closing Agreement
Respondent also argues that he was not required to issue a
deficiency notice to petitioners because petitioners are not
allowed to challenge the terms of the closing agreement.
Respondent reasons that issuing petitioners a deficiency notice
and allowing them to file a petition with this Court would
frustrate the purpose of the closing agreement as a binding,
conclusive agreement that may be reopened only in exceptional
circumstances. We disagree.
The closing agreement remains binding on both parties.
There has been no fraud, malfeasance, or misrepresentation of a
material fact. See sec. 7121(b). A deficiency notice would have
allowed petitioners to challenge respondent’s determination of
petitioners’ tax liabilities for the years at issue, but it would
not have allowed petitioners to reopen or contest the treatment
of the Comco items. The parties agreed to the treatment of the
Comco items in the closing agreement. The parties did not agree,
- 15 -
however, to settle all issues related to petitioners’ tax
liabilities for the years at issue.
We conclude that the closing agreement here, which covers
specific matters only, does not absolve respondent from issuing a
deficiency notice before assessing petitioners’ liabilities.
Accordingly, we hold that respondent may not proceed with
collection. See sec. 6213(a).
C. Our Holding Does Not Violate Section 7121(b)(2)
Respondent argues that section 7121(b) requires us to give
full effect to the closing agreement in this proceeding. Section
7121(b) provides that a closing agreement (or any assessment in
accordance with a closing agreement) shall not be annulled,
modified, set aside, or disregarded in any subsequent suit,
action or proceeding.
We hold that collection may not proceed because respondent
failed to follow the law regarding assessments, not because we
are disregarding the parties’ closing agreement. See secs. 6212
and 6213. We are not constrained to hold that respondent may
proceed with collection simply because the collection proceeding
is for a year in which there was a closing agreement between the
parties.
III. Conclusion
Respondent assessed petitioners’ tax liabilities without
first issuing petitioners the statutorily required deficiency
- 16 -
notice. The existence of a closing agreement covering specific
matters for the years at issue does not abrogate respondent’s
duty to issue petitioners a deficiency notice before assessment.
Accordingly, we hold that respondent may not proceed with
collection of petitioners’ liabilities.
To reflect the foregoing,
Decision will be entered
for petitioners.