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).

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 Fed. Cl. 267 (1998), affd. 215 F.3d 1343 (Fed. Cir. 1999); Rev.

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).

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 deficiency. Id. Accordingly, there would be nothing the taxpayer could challenge. Marathon Oil Co. v. United States, supra at 280.

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 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 616617; 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, 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 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.

ROBERT J. MERLO, PETITIONER v. COMMISSIONER OF
INTERNAL REVENUE, RESPONDENT

Docket No. 21538-03.

Filed April 25, 2006.

P exercised incentive stock options on Dec. 21, 2000, acquiring 46,125 shares of E stock. As a result, under I.R.C. secs. 55(b)(2), 56(b)(3), and 83(a), P was required to include $1,066,064, the spread between the exercise price and the fair market value of the shares of E stock on the date of exercise, in his alternative minimum taxable income in 2000. Instead, P included only $452,025, the spread between the exercise price and the fair market value of the shares of E stock on Apr. 15, 2001. In 2001, E filed for bankruptcy, and P's shares of E stock became worthless. Under I.R.C. sec. 165(g)(1), P realized a capital loss for alternative minimum tax purposes of $1,075,289 in 2001. R determined a deficiency of $169,510 in P's 2000 Federal income tax. P maintains that the capital loss limitations of I.R.C. secs. 1211 and 1212 do not apply for purposes of the alternative minimum tax. As a result, P argues that he may use his capital losses realized in 2001 to reduce his alternative minimum taxable income in 2000. Held, the capital loss limitations of I.R.C. secs. 1211 and 1212 apply for purposes of calculating alternative minimum taxable income. Held, further, P's capital losses realized in 2001 do not create an ATNOL that can be carried back to reduce his alternative minimum taxable income in 2000.

Don Paul Badgley, Brian G. Isaacson, and Duncan C. Turner, for petitioner.

Julie L. Payne and Kirk M. Paxson, for respondent.

OPINION

HAINES, Judge: Respondent determined deficiencies in petitioner's Federal income taxes of $4,833 and $169,510 for the years 1999 and 2000, respectively. After concessions,1 the issues for decision are: (1) Whether the capital loss limitations of sections 1211 and 1212 apply to the calculation of

1 Petitioner concedes respondent's disallowance of a loss of $21,871 claimed on Schedule E, Supplemental Income and Loss, in 1999 and respondent's allowance of additional itemized deductions of $6,797 in 1999.

alternative minimum taxable income (AMTI); and (2) whether petitioner may use capital losses realized in 2001 to reduce his AMTI in 2000.2

Background

The parties submitted this case fully stipulated pursuant to Rule 122. The stipulation of facts and the attached exhibits are incorporated herein by this reference. At the time the petition was filed, petitioner resided in Dallas, Texas.

During 1999 and 2000, petitioner was employed by Service Metrics, Inc. (SMI). On July 2, 1999, petitioner was named vice president of marketing for SMI. On July 14, 1999, petitioner and SMI entered into a stock option agreement (SMI stock option agreement) in which SMI granted petitioner options to purchase 275,000 shares of SMI common stock with an exercise price of 10 cents per share. The stock options granted to petitioner qualified as incentive stock options (ISOS) under section 422.

On November 19, 1999, petitioner entered into an employment agreement with Exodus Exodus Communications, Inc. (Exodus). On November 23, 1999, Exodus acquired SMI. As a result, Exodus converted petitioner's options to purchase shares of SMI common stock to options to purchase shares of Exodus common stock.

On December 21, 2000, petitioner exercised an option to purchase 46,125 shares of Exodus common stock at 20 cents per share, for a total exercise price of $9,225. The price of the optioned stock on the NASDAQ on December 21, 2000, was $23.3125 per share, for a total fair market value of $1,075,289 on the date of exercise. Petitioner was not a dealer in securities but instead was acting as an investor when he exercised the ISOS.

Exodus filed for bankruptcy on September 26, 2001. In a press release dated November 21, 2001, Exodus announced that the company's common stock had no value. Petitioner's shares of Exodus stock were worthless as a result of Exodus's bankruptcy.

2 Unless otherwise indicated, all section references are to the Internal Revenue Code, as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure. Amounts are rounded to the nearest dollar.