What Is An IRS Promise?

Tax Controversy

A Taxpayer Learns an IRS Promise May Not Be a Promise: the Case of Hinkle v. Commissioner 2018 TC 176

In a recently decided case a taxpayer learned the Internal Revenue Service (“IRS”) is not likely bound by its promises unless they are written on certain forms.

The facts giving rise to this lesson learned began in April 2009. The taxpayers, R. Bryan Hinkle, Matilda Garcia, and William D. Hinkle (sometimes hereinafter the “Hinkles”), were notified by IRS agent Russell Gadway, that their tax return had been selected for examination. On June 14, 2010 the taxpayers received a letter from the examiner. It stated:

“This correspondence is to see if I can convince you to agree to the enclosed examination change report. This report is different from previous ones in that the penalties have been waved (sic) if you agree at my level when you relied on your preparer for taking the deduction”

Agent Gadway’s correspondence was accompanied by an IRS Form 4549 titled “Income Tax Examination Changes.” Included on the form was a IRC Sec. 6662 accuracy-related penalty. In July of 2010 the taxpayers received a second Form 4549 with the Sec 6662 penalty removed and no other penalties listed. The taxpayers promptly signed and returned the second Form 4549, believing in the process they were binding the IRS to a promise not to impose any penalties against them.

On July 19, 2010, the taxpayers learned that they were sorely mistaken. On that day, the IRS notified the Hinkles that the Service was considering assessing penalties under 26 U.S.C. Sec. 6707A for failure to disclose a tax avoidance listed transaction.

The taxpayers sued in District Court. The questions presented before the Court were: (1) Did the Form 4549 the taxpayers signed in July 2010 bar the IRS from imposing penalties that had been removed from the document? (2) Did the taxpayers have a commitment from the Service not to impose penalties under any other provisions of the Internal Revenue Code?

The Hinkles argued the IRS’s second Form 4549 constituted an offer to them for a penalty free assessment, which they accepted. Alternatively, the Hinkles argued the IRS should be barred from imposing penalties on a theory of promissory estoppel.

The IRS made two counterarguments: First, they argued, the IRS had only agreed to abate the penalties removed from the first Form 4549, the Section 6662 accuracy-related penalties. Second, the IRS contended representations made on Form 4549 could not bind the IRS under any circumstances.

The District Court ruled in favor of the IRS, citing IRC Section 7121 governing IRS closing agreements. That court said the closing agreement is the means by which the IRS can be bound by its promises.

According to the court, closing agreements are generally reflected on Form 866, Agreement As to Final Determination of Tax Liability or Form 906, Closing Agreement on Final Determination Covering Specific Matters.

The takeaway from the Hinkle case is simple – You run the risk if you bank on an IRS promise unless it appears on Form 866 or 906. If you have any questions about how to bind the IRS, please contact your local Withum advisor.

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