Owens v. CIR

United States Court of Appeals
Fifth Circuit
F I L E D
IN THE UNITED STATES COURT OF APPEALS May 15, 2003

FOR THE FIFTH CIRCUIT Charles R. Fulbruge III
_____________________ Clerk

No. 02-61057
Summary Calendar
_____________________

CHARLES B. OWENS; SALLY L. OWENS,

Petitioners-Appellants,

versus

COMMISSIONER OF INTERNAL REVENUE,

Respondent-Appellee.

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Appeal from the United States Tax Court
(672-01)
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BEFORE DAVIS, WIENER, and EMILIO M. GARZA, Circuit Judges.

PER CURIAM:*

Petitioners-Appellants Charles B. Owens (“Owens”) and Sally L.

Owens, husband and wife, (collectively, “Petitioners”) filed a

motion in the United States Tax Court under § 7430 of the Internal

Revenue Code (“IRC”) of 19861 to recover from Respondent-Appellee

Commissioner of Internal Revenue (“Commissioner”) the

administrative and litigations costs that they had incurred.

Petitioners had successfully sued the Commissioner in that court

*
Pursuant to 5TH CIR. R. 47.5, the court has determined that
this opinion should not be published and is not precedent except
under the limited circumstances set forth in 5TH CIR. R. 47.5.4.
1
References to “Section” or “§” shall be to the IRC.
for a redetermination of an income tax deficiency asserted by the

Internal Revenue Service (“IRS”) in connection with 1994 income

taxes. Petitioners now appeal the Tax Court’s judgment to the

extent it denied recovery of a portion of their claim under § 7430.

We affirm the uncontested portion of the Tax Court’s judgment

awarding Petitioners $1,449.58 on the issue of penalties

improvidently sought by the Commissioner, but we reverse the Tax

Court’s judgment to the extent that it rejected the balance of

Petitioners’ total claim, viz., the portion that the Tax Court

attributed to the issue of discharge-of-indebtedness income. We

therefore remand the case to the Tax Court with instructions to

modify its judgment to include the amount of $8,697.49 as

calculated but rejected by the court, plus additional sums,

pursuant to § 7430, for recoverable costs incurred by Petitioners

in this appeal and those that they will incur in proceedings in the

Tax Court on remand.

I. Facts and Proceedings

The Tax Court noted, and none dispute on appeal, that there is

no disagreement on the operative facts underlying this case. Thus,

the following facts come either from stipulations or uncontested

evidence.

Owens obtained a loan (“the Owens loan”) from a bank that

subsequently failed. The Owens loan was one of a number that the

FDIC acquired from that failed bank, which loan was one that was

managed for the FDIC by AMRESCO. In 1994, the FDIC issued Owens a

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Form 1099-C, Cancellation of Debt 1994. This form specified

October 6, 1994 as the date of cancellation of the Owens loan and

listed the total amount for which the loan was canceled, including

interest. Certain that the 1099-C had been issued in error,

Petitioners dutifully reported the amount set forth on that form as

debt cancellation income on their tax return for 1994 but “zeroed-

out” that figure with an offsetting entry labeled “ERRONEOUS 1099-C

—— DEBT NOT DISCHARGED” (Petitioners eventually reported income

from their discharge of this indebtedness for the later year in

which the statute of limitations for collection expired).

In the course of its examination of Petitioners’ 1994 income

tax return, the IRS issued a summons to the FDIC for documentation

relating to the Owens loan. The data received by the IRS in

response included a copy of a “Dormant Account Status Approval

Form” regarding that loan, effective October 6, 1994, bearing the

statement, “This memorandum is a request for Authorization to write

off the remaining balance” of the Owens loan (emphasis added).

This form also bears the statement “Not Economic to Pursue and

Unsaleable,” together with a narrative of the loan’s history,

collection efforts, and unavailability of assets, as well as the

conclusion that “[i]t does not appear to be cost effective to

pursue a collection lawsuit against the obligor.” This dormant

account form had apparently been prepared by an agent of AMRESCO

and is stamped “REQUEST APPROVED BY OVERSIGHT COMMITTEE SPECIAL

ASSET BANK” on October 20, 1994. The documentation furnished to

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the IRS by the FDIC also included copies of two letters exchanged

between Owens and the principal of AMRESCO, one dated November 1,

1994 and the other dated November 7, 1994. Neither these letters

nor any other instrument obtained by the IRS expressly states that

the Owens loan was canceled; and there is no evidence that the FDIC

or AMRESCO contacted Petitioners after November 7, 1994.

Significantly, the record is also devoid of evidence that the Owens

loan was ever actually canceled by or on behalf of the FDIC.

Even more to the point of this § 7430 case is the absence of

any testimony or documentary evidence whatsoever that the IRS ever

attempted to contact representatives of AMRESCO or the FDIC, either

to confirm or refute the contention, continually advanced by

Petitioners to the IRS, that the FDIC had issued the subject Form

1099-C in error, and that, in fact, the Owens loan had never been

canceled. Without making any effort to run that key question to

ground, and instead apparently relying solely on the contested Form

1099-C and on erroneous inferences that it drew from one or more of

the instruments obtained from the FDIC, the IRS stuck to its

conclusional position that the Owens loan had been canceled in

1994, producing discharge-of-indebtedness income to Petitioners in

that year, and resulting in a deficiency in the amount of income

taxes reported on their return for 1994.

After extensive administrative practice failed to resolve this

controversy, the IRS issued a deficiency letter in November, 2000,

asserting that Petitioners owed additional income tax plus a 20%

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accuracy-related penalty under § 6662 for negligence or disregard

of rules or regulations. In January, 2001, Petitioners filed a

petition in Tax Court seeking redetermination of the deficiency

asserted by the IRS. The Commissioner answered in March of that

year, denying error. The Tax Court scheduled the trial of the

matter for early December, 2001, but shortly before the trial date

the Commissioner completely changed his position and advised

Petitioners that he would concede the entire case, stipulating to

that effect in the Tax Court. With Petitioners reserving their

right to file for relief under § 7430, the Tax Court dismissed

their suit on the basis of the Commissioner’s concession.

On motion of Petitioners for relief under § 7430, the Tax

Court awarded them $1,449.58, which it attributed to costs they

incurred in connection with penalties improvidently sought by the

Commissioner under § 6662. After adjusting the $9,529.16 balance

of Petitioners’ claim to $8,697.49, however, the Tax Court rejected

this entire balance of Petitioners’ claim in connection with the

discharge-of-indebtedness issue, reasoning that, despite having

prevailed in their deficiency redetermination litigation and having

correctly asserted that the Commissioner’s position with respect to

the penalty issue was not “substantially justified” within the

meaning of § 7430(c)(4)(B)(i), the Commissioner was nevertheless

substantially justified with respect to the discharge-of-

indebtedness issue.

5
 Petitioners appealed the denial of the portion of their § 7430

claim that is based on the discharge-of-indebtedness issue. As the

Commissioner did not cross-appeal the Tax Court’s award to

Petitioners in connection with the penalty issue, however, that

part of the court’s judgment stands.

II. Analysis

A. Standard of Review

When a taxpayer’s entitlement to recover costs under § 7430

turns on a trial court’s determination that the position of the

Commissioner in the underlying litigation was or was not

“substantially justified” for purposes of § 7430(c)(4)(B)(i), we

review such determination for abuse of discretion.2 One way that

a trial court can abuse its discretion is to ground its exercise

thereof either in errors of law or clearly erroneous facts.3 More

specifically, the Commissioner bears the burden of proving by a

preponderance of the evidence that a deficiency notice is grounded

in fact and law; if such a notice is not thus grounded, it is

“clearly erroneous” as a matter of law, making reliance on such a

notice unjustified, substantially or otherwise, and in turn making

2
Hanson v. Commissioner, 975 F.2d 1150, 1152-53 (5th Cir.
1992).
3
See, e.g., United States v. Marolf, 277 F.3d 1156, 1160 (9th
Cir. 2002)(citation omitted).

6
a court’s refusal to grant an award of § 7430 costs an abuse of

discretion.4

B. The Position of the Commissioner Was Not Substantially
Justified.

To recover reasonable administrative and litigation costs

under § 7430, a taxpayer must be the “prevailing party.”5 In

addition to showing that he has exhausted his administrative

remedies —— not an issue in the instant case —— a taxpayer must

show that he substantially prevailed either on the “amount in

controversy” or “the most significant issue or set of issues

presented.”6 A taxpayer is not a “prevailing party”if the United

States establishes that the Commissioner’s position was

“substantially justified.”7 Here, given the Commissioner’s total

capitulation shortly before trial, there can be no question that

Petitioners substantially prevailed on both the amount in

controversy and the most significant set of issues presented, i.e.,

that the FDIC did not cancel the Owens loan in 1994 (or any other

year for that matter) and that the assertion of a negligence

penalty against Petitioners was baseless. Thus, the only question

remaining is whether the Commissioner was nevertheless

4
See Portillo v. Commissioner (“Portillo II”), 988 F.2d 27,
28-29 (5th Cir. 1993).
5
26 U.S.C.§ 7430(c)(4)(A)(i).
6
26 U.S.C. § 7430(c)(4)(A)(i)(I)-(II).
7
Id. § 7430(c)(4)(B); see also Sherbo v. Commissioner, 255
F.3d 650, 653 (8th Cir. 2001).

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substantially justified in the position taken relative to

discharge-of-indebtedness income in 1994.

For purposes of determining whether the Commissioner’s

position was substantially justified, the fact that he lost the

case —— here, conceded it —— is not alone sufficient.8 It is,

however, a factor for consideration. As instructed by the Supreme

Court in Pierce v. Underwood, the position of the Commissioner is

substantially justified if it has a reasonable basis both in fact

and in law.9 As this standard is conjunctive, a position is not

substantially justified if it lacks a reasonable basis in either

fact or law.

In concluding that the Commissioner was substantially

justified in maintaining that Petitioners had discharge-of-

indebtedness income in 1994, the Tax Court observed that the issue

is “extremely fact specific, often turning on the subjective intent

of the creditor as manifested by an objectively identifiable

event,” citing Friedman v. Commissioner,10 and Cozzi v.

Commissioner.11 The Tax Court pointed to the FDIC’s issuance and

filing of the 1099-C with respect to the Owens loan as an

identifiable (albeit non-dispositive) event, because, to the court,

8
Maggie Mgmt. Co. v. Commissioner, 108 T.C. 430, 443 (1997).
9
487 U.S. 552, 565, 108 S.Ct. 2541, 2550 (1988).
10
75 T.C.M. (CCH) 2383 (1998), aff’d, 216 F.3d 257 (6th Cir.
2000).
11
88 T.C. 435, 445-448 (1987).

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it evidenced “an intention to cancel the loan” —— not, we must

point out, actual cancellation of the loan. Indeed, the Tax Court

recognized inconsistent evidence of cancellation in the November 7,

1994 letter from the principal of AMRESCO to Owens, observing in a

footnote, that “[w]hile the term ‘dormant’ does not necessarily

signify an intent on the part of the FDIC to cancel the loan, the

language of the FDIC’s ‘Dormant Account Status Approval Form’ for

the [Owens] loan in some respects evidences such an intent (e.g.,

‘This memorandum is a request for Authorization to write off the

remaining balance’)” (emphasis added). In light of all the

operative facts, especially those just mentioned, we conclude that

the Tax Court clearly erred in finding the 1099-C and related

documentation from the FDIC to be an “identifiable event”

sufficient to credit the Commissioner’s position with a reasonable

basis in both law and fact.

First, the Tax Court equates the intention to act in the

future with the actual performance of the act: AMRESCO’s

recommendation to cancel the Owens loan and even the FDIC’s intent

to cancel it are not synonymous with the FDIC’s actually canceling

that debt. Second, and more significant, the record confirms that

no agent of the IRS bothered to follow up on the intention —— the

evidence of which postdated the 1099-C —— to verify actual

cancellation. Whether this failure resulted from overwork,

deliberate indifference, inability to distinguish intention to do

something in the future from doing something in the present, or any

9
other reason, cause, or excuse, the fact remains that the IRS

dropped the ball. Given the consistent insistence of Petitioners

that the Owens loan had never been canceled, the failure of the IRS

to take the last logical step and verify cancellation vel non is

antithetical to the conclusion that the Commissioner had a

reasonable basis in fact to issue the deficiency notice and

tenaciously cling to it throughout the administrative process and

the responsive pleadings phase of the lawsuit, recanting only

shortly before trial by conceding the case.

The parties in their briefs and the Tax Court in its opinion

discuss at length the pair of cases from this court that are

directly on point and controlling: Portillo I,12 and Portillo II.13

Briefly, Portillo I involved a deficiency assessed against a

taxpayer who, as a painting subcontractor, had received a Form 1099

from a general contractor for whom the taxpayer performed painting

services. The taxpayer insisted that the 1099 erroneously stated

an inflated quantum of payments from the contractor during the tax

year in question. Agents of the IRS contacted the contractor who

had issued the 1099 and were told by him that the larger figure was

correct, claiming that, in addition to paying the taxpayer with

checks (the total amount of which equaled exactly the lesser amount

of income claimed by the taxpayer on his tax return), he had made

12
Portillo v. Commissioner, 932 F.2d 1128 (5th Cir. 1991).
13
Portillo v. Commissioner, 988 F.2d 27 (5th Cir. 1993).

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cash payments as well. Instead of proceeding to verify which

version of the relevant facts was correct, the IRS agent took it

upon himself to make a credibility call, electing to believe the

contractor rather than the taxpayer.

In the ensuing litigation over the deficiency assessed to the

subcontractor as taxpayer, we reversed judgment for the

Commissioner and held that the subject 1099, unverified except by

the agent’s impermissible credibility call, was insufficient.

Subsequently, when the taxpayer sought to recover costs from the

Commissioner under § 7430, the Tax Court determined that, despite

having lost the case, the Commissioner had nevertheless taken a

substantially justified position in reliance on the contested 1099

and the testimony of its issuer. In Portillo II, we again

reversed, holding that the Tax Court had abused its discretion in

denying § 7450 litigation costs to the Taxpayer on the facts of the

case. Noting that the panel in Portillo I had characterized the

deficiency notice based on the unsubstantiated and unreliable 1099

as “clearly erroneous,” we stated in Portillo II that “[t]here can

be no clearer indication from this Court that the government’s

position in relying on such an unsupported notice of deficiency was

not justified.”14 We went on to conclude that “[t]he

unsubstantiated and unreliable 1099 Form submitted to the IRS by

[the contractor] was insufficient to form a rational foundation for

14
Portillo II, 988 F.2d at 29.

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the tax assessment against the Portillos” making the assessment

arbitrary and erroneous.15

In the instant case, the Tax Court viewed Portillo II as

distinguishable, relying on the difference between the

investigation and ensuing credibility call by the IRS agent in

Portillo, on the one hand, and the IRS agent’s reliance on the

documentation obtained from the FDIC in this case, on the other

hand. Given the facts that (1) Petitioners here repeatedly

insisted from the outset that the 1099-C was issued in error by the

FDIC because the loan was never canceled, (2) the documentation

obtained from the FDIC supports no conclusion other than an

intention to cancel the loan rather than its actual cancellation,

and (3) the utter failure of the IRS to contact the FDIC and obtain

a simple, factual determination whether the loan had in fact been

canceled in 1994, there is no distinguishable difference in fact or

in law from the situation in the Portillo cases: issuance of a

taxpayer-contested 1099 followed by a deficiency assessment

grounded in nothing more than the agent’s credibility call in a

swearing match between the issuer and the recipient of that

document. Indeed, the Commissioner might have been on even

slightly more solid ground in Portillo because there the agent at

least contacted the issuer of the 1099 and obtained a statement;

here, the agent failed to contact the FDIC at all. This is not the

15
Id.

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stuff of which a reasonable basis both in law and in fact is made,

absent which, as a matter of law, the position of the Commissioner

cannot be “substantially justified.”

III. Conclusion

The Commissioner’s reliance on the contested 1099-C and

documentation from the issuer reflecting nothing more than an

intention to cancel the Owens loan at some future time fails to

provide a reasonable basis in either fact or law. Absent that, the

deficiency assessment, and the litigating position of the

Commissioner, was not substantially justified. Consequently,

Petitioners were prevailing parties in the underlying litigation

and are entitled to recover their administrative and litigation

costs from the Commissioner on both the penalty issue and the

cancellation-of-indebtedness issue, pursuant to the provisions of

§ 7430. The ruling of the Tax Court to the contrary constitutes

abuse of discretion and must, therefore, be reversed.16

Although we affirm the judgment of the Tax Court to the extent

it awarded Petitioners $1,449.58 in connection with the penalty

issue, we reverse the court’s denial of eligible costs of

$8,697.49. We therefore remand this case with instructions to the

Tax Court to modify its judgment by increasing the amount of the

16
See United States v. Logan, 861 F.2d 859, 866 n.5 (5th Cir.
1988)(“Of course, ‘abuse of discretion’ is a phrase which ‘sounds
worse than it really is’; it is simply a legal term of art which
carries no pejorative connotations of a professional or personal
nature.”)(citation omitted).

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award to Petitioners by $8,697.49, plus reasonable amounts,

consistent with the provisions of § 7430, for additional litigation

costs incurred in this appeal and in the Tax Court on remand.

AFFIRMED in part, REVERSED in part, and REMANDED WITH INSTRUCTIONS.

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