T.C. Memo. 1995-534
UNITED STATES TAX COURT
BOCA CONSTRUCTION, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18570-92. Filed November 13, 1995.
Richard S. Lynch and John Kennedy Lynch, for petitioners.
Mario J. Fazio and J. Scott Broome, for respondent.
MEMORANDUM OPINION
COLVIN, Judge: This matter is before the Court on
petitioner's motion for award of administrative and litigation
costs under section 7430 and Rule 231.
To prevail, petitioner must show that respondent's position
in the underlying administrative and judicial proceeding was not
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substantially justified. We conclude that petitioner has not
made this showing. Thus, petitioner's motion will be denied.
The parties have submitted affidavits and memoranda
supporting their positions. We decide the motion based on the
memoranda, affidavits, and exhibits attached to the affidavits.1
The parties do not dispute the facts in the affidavits or the
authenticity of the exhibits attached to the affidavits. There
are no significant conflicts of fact presented by the affidavits.
Neither party requested a hearing. We conclude that a hearing is
not necessary to decide this motion. Rule 232(a)(3).
Section references are to the Internal Revenue Code in
effect for the years in issue. Rule references are to the Tax
Court Rules of Practice and Procedure.
Background
1. Petitioner and the Underlying Tax Case
1
By motion, petitioner asked us not to consider affidavits
and exhibits attached to respondent's memorandum. The affidavits
and exhibits generally addressed whether respondent's position
had the requisite basis in fact. We denied petitioner's motion
because our Rules allow parties to submit affidavits in
connection with a motion for an award of administrative and
litigation costs. Rules 231, 232; see Rule 34(b) (taxpayer may
not claim litigation costs in petition); Rule 70(a)(2) (no
discovery relevant to litigation costs without leave of Court
before hearing set on motion for litigation costs). However, as
we stated in denying petitioner's motion, neither party requested
a hearing or suggested that there is any factual dispute relating
to the affidavits or exhibits submitted by the parties. We also
stated that we would consider the affidavits and exhibits only to
decide petitioner's motion for administrative and litigation
costs.
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Petitioner is a closely held corporation, the principal
place of business of which was in Ohio when it filed its
petition.
The primary issue in the underlying case, Boca Constr., Inc.
v. Commissioner, T.C. Memo. 1995-5, filed January 9, 1995, was
whether petitioner may deduct as reasonable compensation amounts
it paid to its officers in the years in issue. Petitioner
deducted as compensation for its officers $689,600 for 1989 and
$817,500 for 1990. Respondent's revenue agent examined
petitioner's return and investigated this case. Respondent
determined that the amount of compensation petitioner paid to
its officers in the years in issue was unreasonable. Respondent
relied on facts obtained by the revenue agent and reports from
Robert Morris Associates (RMA) and the Occupational Outlook
Handbook to determine reasonable compensation.
In the notice of deficiency, the answer, at trial, and on
brief, respondent's position was that reasonable compensation for
petitioner's officers was $274,000 in 1989 and $282,000 in 1990.
Respondent did not call any witnesses at trial. We held that the
compensation petitioner paid to its officers was reasonable.
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Discussion
1. Motion for Administrative and Litigation Costs:
Introduction
Generally, a taxpayer who has substantially prevailed in
a Tax Court proceeding may be awarded reasonable administrative
and litigation costs. Sec. 7430(a), (c). To be entitled to an
award, the taxpayer must:
a. Exhaust administrative remedies. Sec. 7430(b)(1).
Respondent concedes that petitioner meets this requirement.
b. Substantially prevail with respect to the amount in
controversy. Sec. 7430(c)(4)(A)(ii)(I). Respondent concedes
that petitioner meets this requirement.
c. Be an individual whose net worth did not exceed
$2,000,000, or an owner of an unincorporated business, or any
partnership, corporation, etc., the net worth of which did not
exceed $7,000,000, when the petition was filed. Sec.
7430(c)(4)(A)(iii); 28 U.S.C. sec. 2412(d)(2)(B) (1988).
Respondent concedes that petitioner meets this requirement.
d. Show that the position of the United States in the
action was not substantially justified. Sec. 7430(c)(4)(A)(i).
Respondent contends and we hold that petitioner does not meet
this requirement.
e. Establish that the amount of costs and attorney's fees
claimed by petitioner is reasonable. Sec. 7430(a), (c)(1) and
(2). Respondent contends that petitioner does not meet this
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requirement. We need not decide this issue because we conclude
that respondent's position was substantially justified.
A taxpayer has the burden of proving that it meets each
requirement before the Court may order an award of administrative
and litigation costs under section 7430. Rule 232(e); Estate of
Johnson v. Commissioner, 985 F.2d 1315, 1318 (5th Cir. 1993);
Gantner v. Commissioner, 92 T.C. 192, 197 (1989), affd. 905 F.2d
241 (8th Cir. 1990).
A taxpayer must establish that the position of the United
States in the litigation was not substantially justified to be
entitled to an award for administrative or litigation costs.
Sec. 7430(c)(4)(A)(i). The position of the United States is the
position taken by respondent: (a) In the judicial proceeding,
and (b) in the administrative proceeding as of the earlier of,
(i) the date the taxpayer receives the notice of the decision
of the Internal Revenue Service Office of Appeals, or (ii) the
date of the notice of deficiency. Sec. 7430(c)(7). Here,
respondent's position in the notice of deficiency, the answer,
throughout trial, and posttrial briefs, was that petitioner paid
unreasonable compensation to its officers. Thus, respondent's
position in both the judicial and the administrative proceeding
was that taken in the notice of deficiency.
2. Whether Respondent's Position That Petitioner Paid
Unreasonable Compensation to its Officers Was Substantially
Justified
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a. Background
The Equal Access to Justice Act's substantially justified
standard requires that the Government's position be justified
to a degree that would satisfy a reasonable person. Pierce v.
Underwood, 487 U.S. 552, 565 (1988). That standard applies to
motions for litigation costs under section 7430. Comer Family
Equity Pure Trust v. Commissioner, 958 F.2d 136, 139-140 (6th
Cir. 1992), affg. T.C. Memo. 1990-316; Powers v. Commissioner,
100 T.C. 457, 471 (1993), affd. on this issue and revd. in part
and remanded on other issues 43 F.3d 172 (5th Cir. 1995),
remanded 51 F.3d 34 (5th Cir. 1995). To be substantially
justified, the Commissioner's position must have a reasonable
basis in both law and fact. Pierce v. Underwood, supra; Hanover
Bldg. Matls., Inc. v. Guiffrida, 748 F.2d 1011, 1015 (5th Cir.
1984); Powers v. Commissioner, supra at 473. For a position to
be substantially justified, there must be "substantial evidence"
to support it. Pierce v. Underwood, supra at 564-565; Powers v.
Commissioner, supra at 473.
The fact that the Commissioner eventually loses or concedes
the case does not in itself establish that a position is
unreasonable. Wilfong v. United States, 991 F.2d 359, 364 (7th
Cir. 1993); Hanson v. Commissioner, 975 F.2d 1150, 1153 (5th Cir.
1992), revg. an unpublished Order of this Court. However, it is
a factor to be considered. Heasley v. Commissioner, 967 F.2d
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116, 120 (5th Cir. 1992), affg. in part and revg. in part T.C.
Memo. 1991-189; Estate of Perry v. Commissioner, 931 F.2d 1044,
1046 (5th Cir. 1991); Powers v. Commissioner, supra at 471.
The taxpayer need not show bad faith to establish that the
Commissioner's position was not substantially justified for
purposes of a motion for litigation costs under section 7430.
Estate of Perry v. Commissioner, supra; Powers v. Commissioner,
supra.
b. Respondent's Basis in Fact
Respondent's position in Boca Constr., Inc. v. Commissioner,
supra, was that the compensation petitioner paid to its officers
of $689,600 for 1989 and $817,500 for 1990 was unreasonable and
that compensation of not more than $274,000 for 1989 and $282,000
for 1990 would have been reasonable. Whether compensation is
reasonable is a question of fact. Botany Worsted Mills v. United
States, 278 U.S. 282, 289-290 (1929); Trinity Quarries, Inc. v.
United States, 679 F.2d 205, 210 (11th Cir. 1982); Estate of
Wallace v. Commissioner, 95 T.C. 525, 553 (1990), affd. 965 F.2d
1038 (11th Cir. 1992).
Petitioner points out that in Boca Constr., Inc. v.
Commissioner, T.C. Memo. 1995-5, we considered 12 factors in
deciding whether compensation was reasonable. We concluded that
eight favored petitioner and four were neutral. However, we
believe that respondent's position had a basis in fact because
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respondent knew that Michael Bockrath (Bockrath) and Joseph
Caizzo (Caizzo) were petitioner's sole shareholders who, as
employees, did not deal at arm's length with petitioner to set
their compensation; petitioner paid compensation to the
shareholders in proportion to their stockholding; and petitioner
did not have records adopting the compensation formula upon which
petitioner relied. Respondent knew that Bockrath and Caizzo
spent time helping another company called CABO, Inc.; that
petitioner had fewer than 30 employees; and that petitioner's
business was limited to resurfacing roads. Respondent also knew
that petitioner paid Bockrath and Caizzo $689,600 in 1989 and
$817,500 in 1990, and that petitioner did not claim that it made
catchup payments for service in prior years. Respondent also
considered data from RMA that was admitted into evidence.
Although we found petitioner's evidence in the underlying
case to be more convincing than respondent's, we believe that
respondent's position had a reasonable basis in fact.
In the notice of deficiency, respondent determined that the
amounts petitioner deducted as compensation for its officers in
the years in issue were unreasonable. Petitioner points out
that respondent did not explain at trial how respondent
calculated the amount of reasonable compensation stated in the
notice of deficiency. Petitioner's argument misses the mark.
The point is not whether respondent gave the basis for the
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determination in the notice of deficiency; it is whether
respondent had a basis in fact for that position. We may
consider evidence not offered at trial in deciding a motion
for litigation costs. Rules 231, 232; see Rule 34(b) (taxpayer
may not claim litigation costs in petition); Rule 70(a)(2) (no
discovery relevant to litigation costs without leave of Court
before hearing set on motion for litigation costs).
Respondent relied on RMA and Occupational Outlook Handbook
data to determine petitioner's reasonable compensation for
officers. This case is different from Powers v. Commissioner,
supra at 472, in which the Commissioner determined a deficiency
without considering any information about the case.
Respondent did not call any expert witnesses. However,
even without an expert at trial, we believe respondent's position
had a basis in fact.
c. Respondent's Basis in Law
The parties generally agreed about the factors courts have
used to decide whether compensation is reasonable, but disagreed
on how the factors applied to this case. Petitioner does not
contend that respondent did not have a reasonable basis in law.
We conclude respondent had a reasonable basis in law.
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3. Conclusion
We conclude that respondent's position in the underlying
administrative and judicial proceedings had a reasonable basis
in both law and fact. We hold that respondent's position was
substantially justified and that petitioner is not entitled to
an award for administrative or litigation costs under section
7430. In light of this conclusion, we need not decide whether
the amount of costs petitioner claims is reasonable.
Petitioner's motion for litigation costs will be denied. To
reflect the foregoing,
An appropriate order
will be issued denying
petitioner's motion for
an award of administrative
and litigation costs.