Opinion
3177-20
01-02-2024
LUIS M. HERRERA & ARLENE M. VASQUEZ, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER
KATHLEEN KERRIGAN, CHIEF JUDGE
This case is before the Court on respondent's Motion for Partial Summary Judgment (motion), filed May 18, 2023, which seeks a ruling that a closing agreement entered into by the parties covering tax years 2016-18 is valid. Petitioners filed a Response to Motion for Partial Summary Judgment, and respondent filed a Reply to Response to Motion for Partial Summary Judgment.
Petitioners claimed an exclusion of $101,300 of petitioner husband's income pursuant to section 911. Respondent contends that petitioners waived their right to exclude such income when petitioner husband entered a closing agreement with the Internal Revenue Service (IRS). Petitioners assert that the closing agreement should be disregarded for any of several reasons. Several similarly situated petitioners have filed motions for partial summary judgment in cases with similar facts. We recently issued a division opinion in one of such cases, see Smith v. Commissioner, 159 T.C. 33 (2022), as well as a memorandum opinion and an order denying the taxpayer's motion for summary judgment in two others. See Henaire v. Commissioner, T.C. Memo. 2023-131; Order, Mattson v. Commissioner, No. 6501-20 (T.C. Nov. 20, 2023).
Unless otherwise indicated, statutory references are to the Internal Revenue Code, Title 26 U.S.C, in effect at all relevant times, regulation references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and Rule references are to the Tax Court Rules of Practice and Procedure. We round all monetary amounts to the nearest dollar.
See Hall, Docket No. 4747-21; Nunez, Docket No. 6500-20; Hill & Fuhrman, Docket No. 4854-20; & Bebout, Docket No. 2506-21.
Background
The parties do not dispute the following facts. The facts are drawn from the parties' motion papers, stipulations of fact, and the exhibits attached thereto. Petitioners resided in Australia when the petition was timely filed.
On December 9, 2019, respondent issued a statutory notice of deficiency for tax year 2016 to Luis Herrera and Arlene Vazquez. The notice of deficiency, in part relevant to respondent's Motion, disallowed petitioners' exclusion of foreign earned income pursuant to section 911 relating to petitioner husband's employment at the Joint Defense Facility at Pine Gap (Pine Gap) in Australia.
Petitioner husband began working for Raytheon at Pine Gap in 2012. Pine Gap is a defense surveillance facility in remote Australia, jointly operated by the United States and Australia. After petitioners arrived in Australia, Raytheon presented petitioner husband with a closing agreement with the IRS.
On May 31, 2016, petitioner husband signed the closing agreement at issue (2016-18 Closing Agreement). Deborah Palacheck, Director, Treaty Administration, signed on behalf of the Secretary on May 12, 2017. Raytheon was not a party to the agreement. In the agreement petitioner husband agreed to not make any election under section 911(a) with respect to income earned from working at Pine Gap.
Petitioners initially filed their 2016 tax return in accordance with the 2016-18 Closing Agreement by not claiming a section 911 income exclusion. Petitioners later filed Form 1040X, Amended U.S. Individual Income Tax Return, which respondent received on November 7, 2018. On their amended return petitioners claimed to exclude $101,300 of petitioner husband's foreign earned income. Petitioners received a refund of $22,301 on account of the amended return.
The Commissioner determined a deficiency as a result of the disallowance of petitioners' exclusion of petitioner husband's Pine Gap earnings. The Commissioner also determined an accuracy-related penalty. The notice of deficiency was issued to petitioners on December 9, 2019.
Discussion
I. Summary Judgment
The purpose of summary judgment is to expedite litigation and avoid costly, time-consuming, and unnecessary trials. Fla. Peach Corp. v. Commissioner, 90 T.C. 678, 681 (1988). The Court may grant summary judgment when there is no genuine dispute as to any material fact and a decision may be rendered as a matter of law. Rule 121(a)(2); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994).
In deciding whether to grant summary judgment, we construe factual materials and inferences drawn from them in the light most favorable to the adverse party. Sundstrand Corp., 98 T.C. at 520. The nonmoving party may not rest upon mere allegations or denials in his pleadings, but instead must set forth specific facts showing that there is a genuine dispute for trial. Rule 121(d); see also Sundstrand Corp., 98 T.C. at 520.
II. Taxation of U.S. Citizens Working at the Pine Gap Facility
As is common with U.S. citizens living and working abroad, a U.S. citizen working at Pine Gap faces issues regarding which jurisdiction will tax the income.
A. General Principles of International Taxation
The United States taxes its citizens on their worldwide income. Cook v. Tait, 265 U.S. 47, 56 (1924); Huff v. Commissioner, 135 T.C. 222, 230 (2010). This rule creates the potential for double taxation. AptarGroup Inc. v. Commissioner, 158 T.C. 110, 112 (2022).
The Internal Revenue Code provides relief for U.S. citizens working abroad. Relevant to petitioners here, section 911 permits certain qualified individuals to elect to exclude foreign earned income from their gross income and to treat that income as exempt from U.S. federal income taxation. § 911(a).
In addition to the Internal Revenue Code, tax treaties often address issues of which jurisdiction can tax a citizen working abroad. Australia and the United States entered into a treaty governing the general avoidance of double taxation in 1953. See Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, Austl.-U.S., May 14, 1953, 4 U.S.T. 2274 (1953 Treaty).
B. Pine Gap Agreements
In 1966 and 1969, the United States and Australia entered into a pair of executive agreements governing the establishment and operation of Pine Gap. See Agreement Relating to the Establishment of a Joint Defense Space Research Facility, Austl.-U.S., Dec. 9, 1966, 17 U.S.T. 2235; Agreement Relating to the Establishment of a Joint Defense Space Communications Station in Australia, Austl.-U.S., Nov. 10, 1969, 20 U.S.T. 3097 (collectively, Pine Gap Agreements). Both agreements generally provide that income earned by U.S. citizens working at Pine Gap is deemed not to have been earned in Australia as long as it is not "exempt from tax" and is "brought to tax" by the United States. 17 U.S.T. at Art. 9(1); 20 U.S.T. at Art. X(1). Australia has codified the effect of the agreements in its domestic law. See Income Tax Assessment Act 1936 (Cth) s 23AA(5) (Austl.).
These agreements were made pursuant to Article II of the Security Treaty Between Australia, New Zealand, and the United States of America, Sept. 1, 1951, 3 U.S.T. 3420, but are not treaties themselves. Instead, they are executive agreements made pursuant to a treaty. See generally Restatement (Second) Foreign Rel. § 119 (stating that, in general, executive agreements made pursuant to a treaty of the United States "may be coextensive with the treaty with regard to [their] scope and subject-matter" and have "the same effect and validity as the treaty").
C. 1982 Tax Treaty and the Competent Authority Process
In 1982 the United States and Australia entered into a tax treaty that superseded the 1953 Treaty. Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, Austl.-U.S., Aug. 6, 1982, 35 U.S.T. 1999 (1982 Treaty).
Article 15(1) of the 1982 Treaty generally states that U.S. citizens working in Australia would be subject to tax by both the United States and Australia. Id. at 2037 ("salaries, wages and other similar remuneration derived by an individual who is a resident of one of the Contracting States in respect of an employment . . . shall be taxable only in that State unless the employment is exercised or the services performed in the other Contracting State.").
Article 1(2)(b) of the 1982 Treaty, however, preserved the effect of the Pine Gap Agreements for U.S. workers at Pine Gap. It provides that "[the 1982 Treaty] shall not restrict in any manner any exclusion, exemption, deduction, rebate, credit, or other allowance accorded from time to time . . . by any other agreement between the Contracting States." Id. at 2002. Insofar as the Pine Gap Agreements confer favorable tax treatment in the form of an "exclusion, exemption, deduction, rebate, credit, or other allowance[,]" a taxpayer may rely on them to prevent the double taxation otherwise prescribed by the 1982 Treaty.
With the 1982 Treaty in effect, the United States and Australia needed to coordinate taxing U.S. citizens working at Pine Gap. Specifically they needed to ensure that income earned by U.S. citizens at Pine Gap would be "brought to tax" and "not exempt" in the United States and that the term "exempt" was applied consistently by both countries. A letter submitted by petitioners from an IRS official to an official at the U.S. Department of Defense described the efforts of the two countries to resolve the issue as follows:
During 1983 and 1984, the United States and Australian competent authorities worked together to develop a procedure to apply the provisions of the Pine Gap Agreement to U.S. citizens working in [Pine Gap]. As a result of those joint consultations, the Australian Tax Office agreed that if an employee executes a closing agreement with the [IRS] stating that he or she will not claim the income exclusion available under section 911(a) of the [Code], then he or she will not be liable to tax in Australia.
The procedure ensures that income does not inappropriately escape taxation or become subject to double taxation. It further provides clarity, choice, and assurance for the employee as to where they want to be taxed - either (1) solely in the United States with a waiver of the IRC section 911(a) income exclusion, or (2) in both Australia and the United States, with double taxation being
relieved by the United States through the IRC section 911(a) income exclusion or a foreign tax credit.See Smith, 159 T.C. at 41 (citing Letter from Nicole L. Welch, Program Manager, Treaty Assistance and Interpretation Team, IRS, U.S. Dep't of the Treasury, to John Turnicky, Hous. Program Manager, U.S. Dep't of Def. (Jan. 26, 2018)).
III. Closing Agreements, Generally
The Secretary is authorized to enter into closing agreements with taxpayers relating to the taxpayer's liability "in respect of any internal revenue tax for any taxable period." § 7121(a). As we have said: "[c]losing agreements are meant to insure the finality of liability for both the taxpayer and the IRS. This is why courts have strictly enforced closing agreements, finding them binding and conclusive on the parties . . ." Hopkins v. Commissioner, 120 T.C. 451, 457 (2003) (quoting Hopkins v. United States (In re Hopkins), 146 F.3d 729, 733 (9th Cir. 1998)).
Upon approval of the Secretary, closing agreements "shall be final and conclusive," and shall not be reopened or invalidated "except upon a showing of fraud or malfeasance, or misrepresentation of material fact . . ." § 7121(b). The signature of a taxpayer is considered an offer to agree and execution on behalf of the Commissioner constitutes acceptance of the offer. Smith v. Commissioner, T.C. Memo 1991-412. A closing agreement is, therefore, approved by the Secretary when it is signed by the taxpayer and executed on behalf of the Secretary. The 2016-18 Closing Agreement was approved by the Secretary when Deborah Palacheck signed it on behalf of the Secretary on May 12, 2017.
Issues concerning the enforceability of a closing agreement are governed by section 7121. Urbano v. Commissioner, 122 T.C. 384, 393 (2004) ("section 7121 sets forth the exclusive means by which an agreement between the Commissioner and a taxpayer concerning the latter's tax liability may be accorded finality.") (citing Hudock v. Commissioner, 65 T.C. 351, 362 (1975)). General contract principles are relevant to the interpretation of a closing agreement, but to the extent the federal common law of contracts conflicts with the Code, the Code prevails. Marathon Oil Co. v. United States, 42 Fed.Cl. 267, 274 (1998), aff'd, 215 F.3d 1343 (Fed. Cir. 1999).
IV. Enforceability of the 2016-18 Closing Agreement
Petitioners advance several arguments attacking the validity of the 2016-18 Closing Agreement. Among these are that the agreement is invalid because (1) it was not made on a form prescribed by the treasury regulations, (2) it lacks Ms. Vasquez's signature, (3) respondent procured the agreement by malfeasance in the forms of a violation of section 6103 and/or by placing petitioner husband under duress, and (4) that respondent made material misrepresentations that induced petitioner husband to sign it.
A. Improper Form
Applicable regulations specify that all closing agreements shall be executed on forms prescribed by the IRS. Statement of Procedural Rules, 26 C.F.R. § 601.202(b); Treas. Reg. § 301.7121-1(d)(1). Form 866, Agreement As to Final Determination of Tax Liability, and Form 906 Closing Agreement As to Final Determination of Covering Specific Matters, are identified as appropriate forms. Statement of Procedural Rules, 26 C.F.R. § 601.202(b); Rev. Proc. 68-16, §§ 6.01 and 6.02, 1968-1 C.B. 770, 780. Form 906 is used, as it was in this case, "where there is an agreement as to a specific matter affecting tax liability," and "may be used with regard to specific items in past or future years." Zaentz v. Commissioner, 90 T.C. 753, 760-61 (1988). We have held that "only the prescribed forms . . . qualify as closing agreements." Estate of Sower v. Commissioner, 149 T.C. 279, 286 (2017) (citing Statement of Procedural Rules § 601.202(b), Treas. Reg § 301.7121-1(d)(1)). Use of a document bearing the specific words "Form 906" is not mandated, however.
The 2016-18 Closing Agreement was typed on plain paper. Petitioner, without supporting authorities, equates this to the idea that the agreement was not drafted on a Form 906. The 2016-18 Closing Agreement, however, contains all of the necessary elements contemplated by section 7121 and regulations thereunder. Drawing inferences from the text of that section, a closing agreement may be made (1) with any taxpayer, (2) relating to the liability of such taxpayer, (3) with respect to any internal revenue tax, and (4) with respect to any taxable period. The 2016-18 Closing Agreement specifies all of these items with respect to the treatment of petitioner husband's foreign earned income. The mere fact that the words "Form 906" are omitted from the document's label does not render it void.
B. Wife's Signature
Petitioners argue that because the 2016-18 Closing Agreement does not contain Mrs. Vasquez's signature, the entire agreement should be disregarded. Neither section 7121 nor the regulations thereunder suggest that absence of a joint filer's signature is a condition upon which a closing agreement may be invalidated in its entirety. Revenue Procedure guidance, rather, provides that "where an agreement as to specific matters pertains only to the tax affairs of one spouse, it may not be necessary that the agreement be signed by both spouses." Rev. Proc. 68-16, § 6.13.
The United States Court of Federal Claims recently fielded a similar argument and held that the lack of the taxpayer's spouse's signature did not justify invalidation of the closing agreement. Baney v. United States, No. 20-1037T, 2023 WL 6564028, at *5 (Fed. Cl. Oct. 10, 2023). The Baney court reasoned that the taxpayer's spouse had signed at least six such closing agreements and thereby effectively ratified her assent to the closing agreement at issue. Id.
Mrs. Vasquez does not tout a history of signing closing agreements like the spouse in Baney, but the lack of her signature cannot invalidate the entire agreement. Petitioners' case is precisely what Rev. Proc. 68-16 envisioned. The tax liability at issue only concerns the tax affairs of the spouse who signed the agreement. The Internal Revenue Manual further implies that the lack of a spouse's signature does not invalidate a closing agreement, but merely questions its enforceability against the non-signor. § 8.13.1.3.17.2 ("An agreement signed by one spouse . . . will not bind the non-signing spouse.").
If Mrs. Vasquez wishes to not be bound by the terms of the 2016-18 Closing Agreement, she could have filed separately for the relevant years or she could seek innocent spouse relief pursuant to section 6015, wherein we could properly assess her interaction with the closing agreement at issue. Because the absence of a joint filer's signature is not one of the statutorily enumerated grounds on which we can invalidate a closing agreement, we decline to do so with respect to the 2016-18 Closing Agreement.
C. Malfeasance
Petitioners' malfeasance arguments track those presented in Smith. See Smith, 159 T.C. at 60. Petitioners suggest the 2016-18 Closing Agreement should be set aside because the IRS committed malfeasance when they (1) initially informed Raytheon of the request for a closing agreement, (2) received the executed closing agreement directly from Raytheon, (3) sent the completed agreement and a transmittal letter concerning the agreement to Raytheon, and (4) procured the agreement by duress attributable to IRS by virtue of an agency relationship with Raytheon.
The predecessor to our Court declined to set aside a closing agreement absent malfeasance "in the making of the agreement." Ingram v. Commissioner, 32 B.T.A. 1063, 1065 (1935), aff'd per curiam, 87 F.2d 915 (3d Cir. 1937). Opinions of this Court have acknowledged the same rule. See, e.g., Halpern v. Commissioner, T.C. Memo. 2000-151, slip op. at 7. The taxpayer must "establish[ ] that the parties were induced to sign the agreement . . ." Bennett v. Commissioner, T.C. Memo. 1988-557.
The Code and accompanying regulations do not define malfeasance. According to Black's Law Dictionary, it is a "wrongful, unlawful, or dishonest act; esp., wrongdoing or misconduct by a public official." Malfeasance, Black's Law Dictionary 1145 (11th ed. 2019).
a. Section 6103
Officers and employees of the United States are prohibited from "disclos[ing] any return or return information obtained by him in any manner in connection with his service as such an officer or an employee or otherwise. . ." § 6103(a). A "disclosure" is the "making known to any person in any manner whatever a return or return information." § 6103(b)(8). Among other things "return information" means "any agreement under section 7121, and any similar agreement, and any background information related to such an agreement or request for such an agreement . . ." § 6103(b)(2)(d). Return information "does not include data in a form [that] cannot be associated with, or otherwise identify, directly or indirectly, a particular taxpayer." § 6103(b)(2) (flush text).
In Smith, we concluded under similar circumstances that no violation of section 6103 could have occurred that would have provided grounds for setting the agreement aside. We "assume[d] without deciding that willful disclosure of confidential return information in violation of section 6103 is an act of malfeasance for purposes of section 7121(b)." Smith, 159 T.C. at 63. Even so, we found "no malfeasance 'in the making of" Mr. Smith's closing agreement. Id.
The Smith Court "easily dispense[d] with" the argument that the IRS violated section 6103 when it sent Mr. Smith's employer a blank closing agreement. Id. There we found the form agreement was not "return information." "[A]n unsigned, blank agreement," we reasoned, "is not an 'agreement under section 7121 because it has not been adopted by any party." Id.
Petitioners here have, similarly, failed to produce evidence that respondent requested a closing agreement from petitioner husband, disclosed that request to Raytheon, and, in so doing, disclosed to Raytheon information protected by section 6103(a). Petitioner's response contains merely a declaration that petitioner husband received a blank closing agreement from his employer. There is no evidence that respondent requested from, or disclosed to, Raytheon any information or data that could be associated with petitioner husband. Any disclosure of such identifiable information was initiated by petitioner husband.
As for the post-execution claims, any malfeasance that might have occurred when the IRS sent the fully executed agreement back to Raytheon would not have been grounds to set the agreement aside. Id. at 68. It is logically impossible that petitioner husband could have been induced into signing the agreement by an action taken after he signed the agreement on May 31, 2016. Even if the alleged actions were considered malfeasance, they could not have induced petitioner husband into executing the agreement and cannot provide a valid basis on which to invalidate the agreement. Id.
b. Duress
Duress includes "actions by one party [that] deprive another of his or her freedom of will to do or not to do a specific act." Zapara v. Commissioner, 124 T.C. 223, 229 (2005) (citing Diescher v. Commissioner, 18 B.T.A. 353, 358 (1929)), aff'd, 652 F.3d 1042 (9th Cir. 2011). We have described this subjective standard as an inquiry "not [into] the nature of the threats; but rather the state of mind induced thereby in the victim[.]" Robertson v. Commissioner, T.C. Memo 1973-205, 32 T.C.M. (CCH) 961.
Petitioners rely on Robertson to support their position that acts constituting duress need not be "unlawful" in the technical sense of the term. A survey of our modern decisions provides, however, that "[b]y contrast, legally authorized actions that limit another to choosing between undesirable options do not constitute duress." Smith, 159 T.C. at 74; Cf. Systems Technology Assoc., Inc. v. United States, 699 F.2d 1383, 1387-88 (Fed. Cir. 1983) (explaining that legally authorized actions may support a claim of duress only when they leave the counterparty no reasonable alternative).
Petitioners claim that the timing of when petitioner husband was presented with the initial closing agreement in 2012 placed him under duress justifying invalidation of the 2016-18 Closing Agreement. In their response to respondent's Motion, petitioners state that "Mr. Herrera was not placed into a position to consider signing the [initial] [c]losing [a]greement, Raytheon told him it is a requirement of employment after he arrived in Alice Springs." The parties stipulated, to the contrary, that the Raytheon Australian Operations Overseas Handbook informed Pine Gap employees that signing such an agreement was optional. Even when construing these facts in the light most favorable to petitioners, the circumstances fail to rise to the level of duress.
When presented with similar circumstances in Smith, we said that the taxpayer signed the agreement "having had much time to reflect on whether he should sign another one." Smith, 159 T.C. at 73; See also Hall v. Commissioner, T.C. Memo. 2013-93, at *12 (a taxpayer's "ample time for deliberation" weighs against finding duress). Petitioners have failed to distinguish their claims of duress from those we found unpersuasive in Smith.
As was true in Smith, we "find it hard to see how the Commissioner might have placed [petitioner husband] under duress" when petitioner husband admittedly had no interaction with the IRS. Smith, 159 T.C. at 74. We need not consider the parties' agency arguments. If we were to accept that Raytheon, in requiring petitioner husband to sign the 2016-18 Closing Agreement, acted as respondent's agent, we would reach the same conclusion because petitioner husband's decision to enter the agreement would merely have been between two undesirable options. Petitioners have failed to carry their burden of demonstrating conduct by respondent that sufficiently prevented petitioner husband from exercising free will when entering into the 2016-18 Closing Agreement.
D. Material Misrepresentation
Section 7121 provides that a closing agreement may be set aside upon a showing of fraud or a misrepresentation of material fact. § 7121(b). Petitioners have not alleged fraud.
The plain language of section 7121(b) provides that we may set aside a closing agreement "only in the event of a misrepresentation of material fact." Smith, 159 T.C. at 71. In Smith we found that "a misrepresentation is an assertion that is not in accord with the facts," and is "material if it would be likely to induce a reasonable person to manifest his assent, or if the maker knows that it would be likely to induce the recipient to do so." Id. at 70 (citing Restatement (Second) of Conts. §§ 159, 162 (Am. L. Inst. 1981). Neither mistake nor misrepresentation of law provides a viable path to parties seeking to set aside a closing agreement. See Zaentz, 90 T.C. at 761- 62.
Petitioners argue that the 2016-18 Closing Agreement should be set aside because respondent made material misrepresentations in the recitals of the agreement. Petitioners object to the same recitals that the taxpayer in Smith assigned error to, which state, in relevant part, as follows:
WHEREAS any wages, allowances, benefits and other emoluments, paid or provided to said taxpayer as consideration for services performed for the employer in Australia, hereinafter referred to as income, are subject to taxation by the Government of the Commonwealth of Australia; and
WHEREAS, Article 9 and Article X of the [Pine Gap Agreements], provide that such income shall be deemed not to have been derived in Australia, provided it is not exempt, and is brought to tax, under the taxation laws of the United States.
In their response to respondent's Motion, petitioners argue that these recitals are material misstatements because Australian law provides an independent exemption for income earned by Americans at Pine Gap, and that the Pine Gap Agreements are "not enforceable law in Australia." Petr's Resp. to Mot. For Summ. J. 85. Petitioners support this argument by further alleging that Raytheon told petitioner husband that he must sign the agreement to avoid paying Australian taxes. For purposes of analyzing the Commissioner's Motion, we assume without deciding that the first recital expresses an erroneous legal conclusion, as petitioners contend.
In both Smith and Henaire, we classified these recitals as statements of law rather than fact. See Smith, 159 T.C. at 69-72; Henaire, T.C. Memo. 2023-131, at *13-15. These recitals, as statements of law, cannot provide a basis to set aside the 2016-18 Closing Agreement. Even if the statements were factually incorrect, they would not justify rescission. Mere error is not enough; "misrepresentation denotes something more deliberate or more conscious than mere error or mistake." Smith, 159 T.C. at 70 n.49 (citing Ingram, 32 B.T.A. at 1066). On that basis we find that no material misrepresentation of material fact was made to support disregarding the 2016-18 Closing Agreement in petitioners' case.
V. Conclusion
Respondent has established that he is entitled to summary judgment on the issue of whether the 2016-18 Closing Agreement is valid. We grant respondent's Motion. We have considered all of petitioners' arguments, and to the extent not discussed above, we find them to be irrelevant, moot, or without merit.
Accordingly, it is hereby
ORDERED that respondent's Motion for Partial Summary Judgment filed May 18, 2023, is granted. It is further
ORDERED that a joint status report is due on or before January 31, 2024.