Opinion ID: 3171779
Heading Depth: 3
Heading Rank: 1

Heading: Breach of the Closing Agreement

Text: The IRS now admits that it breached Paragraph Q of the Closing Agreement by making the September 2007 assessments without giving Davis a second opportunity to review its calculations. The issue is whether, as the district court concluded, that breach of contract invalidates the subsequent assessments. Closing agreements are contracts, States S.S. Co. v. Comm’r, 683 F.2d 1282, 1284 (9th Cir. 1982), governed by federal common law, United States v. Nat’l Steel Corp., 75 F.3d 1146, 1150 (7th Cir. 1996). “[F]or most purposes closing agreements are just like other contracts.” Id. And, “damages are always the default remedy for breach of contract.” United States v. Winstar Corp., 518 U.S. 839, 885 (1996) (plurality opinion) (citing Restatement (Second) of Contracts § 346, cmt. a (Am. Law. Inst. 1981)). But Davis does not seek damages; instead, he argues that any assessments made in breach of the Closing Agreement are invalid.4 Davis relies primarily on I.R.C. § 7121(b)(2), which provides that closing agreements are “final and conclusive.” He notes that the Tax Court incorporated the Closing Agreement into its decision, making it enforceable as a court order. But, the “final and conclusive” nature of closing agreements simply means that they “settle an existing dispute with finality,” Nat’l Steel, 75 F.3d at 1150, and may not be modified or disregarded “except upon a showing of fraud or malfeasance, or misrepresentation of a material fact,” 4 Davis does not seek rescission of the Closing Agreement. DAVIS V. UNITED STATES 9 I.R.C. § 7121(b); see also In re Hopkins, 146 F.3d 729, 732 (9th Cir. 1998) (“In applying § 7121, courts unanimously have held that closing agreements are meant to determine finally and conclusively a taxpayer’s liability for a particular tax year or years.”). That a contract is “final” does not dictate the remedy for its breach. Cf. Jeff D. v. Andrus, 899 F.2d 753, 759 (9th Cir. 1989) (noting that even after court approval, “[a]n agreement to settle a legal dispute is a contract and its enforceability is governed by familiar principles of contract law”). And, Davis offers no support for the unlikely proposition that, because a settlement with the IRS is “final” and court-approved, the remedy for any breach, however small, is to free the taxpayer from his pre-existing obligation to pay taxes. If this were the case, the IRS justifiably would be reluctant to enter into closing agreements, for fear that a minor error could have major consequences. Davis argues that Philadelphia & Reading Corp. v. United States, 944 F.2d 1063 (3d Cir. 1991), establishes that the remedy for the breach of a closing agreement is invalidation of subsequent assessments. In that case, a settlement waived the statutory requirement that the IRS mail a notice of deficiency prior to making assessments. Id. at 1066–67. The settlement agreement expressly conditioned that waiver on the IRS delaying the assessments until after it had approved a schedule of overpayments, so that the taxpayer, which had overpaid taxes in certain years and underpaid in others, could pay only the net balance owed. Id. at 1067. The IRS, however, assessed taxes before the overpayments had been approved and, more importantly, without sending the statutorily mandated notice of deficiency. Id. at 1068. The Third Circuit held that the assessments were invalid. Id. at 1072. 10 DAVIS V. UNITED STATES However, Philadelphia & Reading is of no aid to Davis. Because the IRS had failed to approve the schedule of overpayments, the Third Circuit found that the taxpayer’s contractual waiver of its statutory right to receive a notice of deficiency never came into effect. Id. The assessments were therefore not authorized by statute. Id. at 1072–73. Here, by contrast, the IRS violated no law in making the assessments. At bottom, the problem with Davis’s argument is that his obligation to pay taxes validly and accurately assessed comes from the Internal Revenue Code, not the Closing Agreement, which only specified the treatment of certain Partnership income as inputs to the calculation of his taxes. The IRS’s failure to perform its contract with the Partnership cannot relieve Davis of his statutory obligation to pay taxes; nothing in the Closing Agreement provided that any taxes assessed on the partners pursuant to statute would be rendered invalid if the government failed to perform. The IRS breached its contract. That entitled Davis to a remedy, but only one in contract.5 Moreover, although the breach denied Davis an opportunity to comment on the amounts of the assessments before they were made, it did not prevent him from challenging the assessed amounts; Davis could have sought to challenge those amounts in an administrative refund claim or a refund action. See I.R.C. § 6230(c)(1)(A). He did not. And, had he done so, Davis 5 Contrary to Davis’s argument, the government preserved this argument in its motion for summary judgment, which argued that “A ‘Breach’ Does Not Entitle Plaintiffs to a Tax Refund.” Because the government does not contest Davis’s ability to raise a contractual claim, we assume for present purposes that although not personally a party to the Closing Agreement, Davis was a third-party beneficiary of that contract. DAVIS V. UNITED STATES 11 might have sought consequential damages resulting from his having to challenge the assessments in a more expensive manner than that provided for by Paragraph Q. Again, he did not. Instead, he threw a Hail Mary and sought a full refund. That pass falls incomplete. We hold that the IRS’s breach of Paragraph Q did not invalidate the assessments.6