An Intelligence Site, A Tax Treaty, and a Closing Agreement

I am looking at a case involving IRS closing agreements and the U.S. Pine Gap facility in Australia.

It gives us a chance to talk about closing agreements, an uncommon topic.

It also gives a chance to talk about Pine Gap, which is a U.S. Intelligence-gathering facility in the Northern Territory of Australia. It started decades ago as a monitoring station for Soviet ballistic testing, and with the years it has acquired several new roles. Think of drone attacks in Pakistan, and you have an idea of what happens at Pine Gap.

FIRST ACT: we have a spooky intelligence site.

Let’s move on to a treaty.

Under general tax rules, Australia would be able to tax American workers at Pine Gap. They are - after all – working in Australia. This was not the desired result, so a treaty in the 1960s exempted American workers at Pine Gap from Australian tax. There was a requisite, though: to be exempt, the wages had to be taxed by the U.S.

Got it. There was a one-bite-at-the-apple rule. Australia would back off if the U.S. got the first bite.

But U.S. tax law also includes a foreign earned income exclusion, whereby an American worker overseas could exempt some (or all) of his/her wages from tax, if certain requirements were met.  

How could Australia be sure that the wages were being taxed by the U.S.? Mind you, the alternative was for Australia to apply the default rule, meaning that both Australia and the U.S. would tax the wages. Sure, the worker could claim a foreign tax credit on his/her U.S. tax return, but the tax consequences of working at Pine Gap would have escalated unappealingly.  

The treaty was revised in the 1980s to allow American workers at Pine Gap to relinquish their foreign earned income exclusion by entering into a closing agreement with the IRS.

SECOND ACT: we have an income tax treaty.

Cory was a U.S. Air Force veteran and engineer. In 2009 he received a job offer from Raytheon to work at Pine Gap. He was informed that Australia would not tax him, but to get there he would have to sign a closing agreement with the IRS. The agreement was straightforward: he would not claim the foreign earned income exclusion.

Mind you, he did not have to sign a closing agreement. Australia would then tax him, and his U.S. return would get a little more complicated.

Cory signed the agreement.

The point behind a closing agreement is finality. Both sides agree, settle, and move on. Excepting fraud or malfeasance, there are no “do-overs.” That is - as you would expect - the reason that one requests one. An example is the wrap-up of a taxable estate. The tax practitioner does not want that estate resurrecting later, causing headaches when all parties considered the matter closed.

Cory wanted out of his closing agreement.

Problem.

Closing agreements arise under a Code section. This means that the Court would be reviewing statutory law (that is, the Code as statute on the matter) and not just the general principles of contract law (offer, acceptance, and all that).

That Code section doesn’t let one off the hook without showing malfeasance or misrepresentation of a material fact.

Cory argued that he met that standard. Somebody somewhere at the IRS did not have appropriate signature authority; the IRS committed malfeasance by sharing information with his employer, Raytheon; he was induced to sign by false representations.

I think Cory was grasping at straws.

The Court apparently thought the same way. The Court decided Cory was stuck with the agreement. He signed it; he owned it.

THIRD ACT: we have a closing agreement.

This is a specialized case pulling-in several different areas of the Code.

I get Cory’s point. He wanted exemption both from Australian tax AND some/all U.S. tax.

Me too, Cory. Me too.

Our case this time was Cory H Smith v Commissioner, 159 T.C. No. 3 (Aug 25,2022).

A CPA’s Signature And The Informal Claim Doctrine

 

I am looking at case where the CPA signed a return on behalf of a client.

Been there and done that.

There is a hard-and-fast rule when you do this.

Let’s go through it.

The Mattsons were working in Australia for the Raytheon Corporation.

In April, 2017 they timely filed their 2016 individual tax return, paying $21,190 in federal taxes.

COMMENT: This immediately strikes me as odd. I would have anticipated a foreign income exclusion. Maybe they were over the exclusion limit, meaning that some of their income was exposed to U.S. tax. Even so, I would then have expected a foreign tax credit, offsetting U.S. tax by taxes paid to Australia.

Turns out they had signed a closing agreement when they went to Australia. The agreement was with the IRS, and they waived their right to claim the foreign income exclusion.

Ahh, that answers my first question.

Why would they do this?

In return for agreeing not to claim the 911 exclusion, the government of Australia has entered into an agreement with the United States Government not to subject the income earned by the taxpayer to Australian taxes."

Yep, there are advantages to working with the big company. It also answers my second question.

Seems to me that we are done here. Taxpayers paid taxes on their Australian wages solely to the United States. In exchange they forwent the foreign income exclusion. Makes sense.

The Mattsons changed CPA firms. The new firm prepared an amended 2016 return for – you guessed it – the foreign income exclusion.

COMMENT: I presume the new firm did not know about the closing agreement.

A CPA at the firm signed the amended return on behalf of the Mattsons.

No problem, but she did not attach a power of attorney authorizing the CPA to sign the return.

Not good, but there is time to fix this.

The IRS held the amended return and sent a letter wanting to know why the Mattsons had taken a position contrary to the closing agreement.

Me too.

In May, 2019 the CPA firm requested an Appeals hearing.

OK.

In July, 2019 the IRS sent a letter that they were disallowing the refund.

The taxpayers filed suit in Court.

To me, the controversy was done with discovery of the closing agreement. There is a Don Quixote quality to this story once that fact came to light.

There is a requirement in the tax Code and a list of cases as long as my arm that taxpayers have to sign a return, especially a claim (that is, a return requesting a refund). A CPA can sign the return on behalf of a client, but the CPA is charged with attaching a copy of a power of attorney to the return.

Hold on, argued the CPA. We sent a power of attorney to the IRS in November, 2018.

This is new information.

And it introduces the “informal claim” doctrine to our discussion.

The idea is that the taxpayer can correct the defect in a claim. That is what “informal” means in this context – think of the first claim as a placeholder until it is perfected. The CPA firm had failed to initially attach a power of attorney, but it subsequently corrected this error in November, 2018.

Issue: the claim has to be perfected BEFORE the start of a lawsuit.

Fact One: the lawsuit was filed in July, 2019.

Fact Two: the power was sent to the IRS in November, 2018.

Reasoning: the dates work.

Question: did the taxpayer correct their claim in time?

I sign powers of attorney all the time. I doubt I go a week without filing at least one with the IRS. I like to explain to clients (unless they have been through the process before) what the limitations are to a standard tax power of attorney. I can call the IRS, request and/or agree to adjustments or stays, and so forth.

However, what our standard power does not do is allow me to sign the return. A client can give me that authority, true, but is has to be separately stated on the power. Our routine powers here at Galactic Command, for example, do not include the authority to sign a return on behalf of a client. In truth, unless there are exceptional circumstances, I do not want that authority. I don’t want to receive a client’s refund check, either.

I can almost visualize what happened.

The CPA signed the return. She knew that she needed a power, so she – or a staff accountant – generated one from their software. It was a default power, the one they – like we – use in almost all cases. No one paused to consider that the default power was not appropriate in this instance.

There was still time to fix this. The firm could revise the power to allow the CPA authority to sign, collect the appropriate signatures and record the power with the IRS.

But they had to do this before bringing suit.

Which they did not.

The informal claim doctrine did not apply, because the placeholder claim was not perfected before filing suit.

Our case this time was Mattson v U.S., 2021 PTC 110 (Fed Cl 2021).