T.C. Memo. 1996-91
UNITED STATES TAX COURT
MARY LEE SHARER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 22562-92, 13219-93. Filed February 29, 1996.
Roderick L. MacKenzie, for petitioner.
Kathryn K. Vetter, for respondent.
MEMORANDUM OPINION
PARR, Judge: These cases were assigned to Special Trial
Judge D. Irvin Couvillion pursuant to section 7443A(b)(4)1 and
Rules 180, 181, and 183. The Court agrees with, and adopts, the
Opinion of the Special Trial Judge, which is set forth below.
1
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years at issue. Rule
references are to the Tax Court Rules of Practice and Procedure.
- 2 -
OPINION OF THE SPECIAL TRIAL JUDGE
COUVILLION, Special Trial Judge: These cases are before the
Court on petitioner's motions for award of litigation and
administrative costs pursuant to section 7430 and Rule 231.
Neither party requested a hearing, and the Court concludes that a
hearing is not necessary for the proper disposition of these
motions. Rule 232(a)(3). These cases were consolidated for
purposes of trial, briefing, and opinion. Rule 141(a).
Background
The motions for administrative and litigation costs involve
petitioner's 1988 and 1989 tax years.2 In the notice of
deficiency for 1988, respondent determined a deficiency in income
tax of $26,691 and additions to tax under sections 6651(a)(1),
6653(a)(1), and 6661 in the amounts of $6,665, $1,353, and
$6,673, respectively. In the notice of deficiency for 1989,
respondent determined a deficiency in income tax of $12,399 and
an accuracy-related penalty of $2,480 under section 6662(a).
2
Petitioner also has before the Court a motion for litigation
and administrative costs in docket No. 25899-91 involving her
1986 and 1987 tax years. That case was tried, and the opinion of
the Court is reported as T.C. Memo. 1994-453. Several of the
issues litigated in petitioner's 1986 and 1987 tax case are the
same as or similar to the issues involving petitioner's 1988 tax
year. Where necessary, therefore, the Court here relies on the
findings of the Court in T.C. Memo. 1994-453 (involving tax years
1986 and 1987) as such findings relate to the merits of
petitioner's motion for 1988.
- 3 -
Petitioner filed separate petitions for each of the notices
of deficiency. At the time the petitions were filed, and during
the years at issue, petitioner's legal residence was Sacramento,
California.
The subject cases did not proceed to trial. The parties
filed separate stipulations of settlement for each docketed case.
For tax year 1988, the parties stipulated that petitioner had a
deficiency in tax of $544 and an addition to tax under section
6653(a)(1) of $27, and no additions to tax under sections
6651(a)(1) and 6661. For tax year 1989, the parties stipulated
that petitioner had a deficiency in tax of $150 and a penalty of
$30 under section 6662(a). No decisions have been entered as a
result of petitioner's motions for administrative and litigation
costs. Rules 231(a)(2)(C), 232(f).
Petitioner is an accountant. In 1975, she married Michael
Sharer (Mr. Sharer), and one child, Derek, was born of the
marriage in 1986. Petitioner's marriage to Mr. Sharer was a
stormy one; however, neither she nor Mr. Sharer filed for divorce
or legal separation. The Court in Sharer v. Commissioner, T.C.
Memo. 1994-453 (involving petitioner's 1986 and 1987 tax years),
found that petitioner and Mr. Sharer were not living together but
were maintaining separate households beginning in early 1986.
The same factual situation existed during 1988 until Mr. Sharer's
death on June 8, 1988.
- 4 -
Mr. Sharer was a certified public accountant who, beginning
in 1980, operated an accounting practice, Sharer Accountancy
(business), as a sole proprietorship. In 1986, petitioner began
helping her husband with his business. Petitioner had authority
to write checks on the accounts of the business. During 1986,
1987, and 1988, petitioner and Mr. Sharer wrote checks to
petitioner on the business accounts which were annotated as
"spousal wages".
During 1986, 1987, and 1988, petitioner and Mr. Sharer also
shared a joint personal checking account, into which petitioner
deposited her "spousal wages", and Mr. Sharer deposited his draw
from the business. Petitioner also shared a joint checking
account with her mother, Mary McDonald.
After Mr. Sharer's death, petitioner worked as an
independent contractor for the Maynard & McDonald partnership
(M & M) and Gold Country Financial, Inc. (Gold Country). M & M
and Gold Country were in the business of preparing tax returns,
providing assistance to clients in tax-related matters, and
providing accounting services. Petitioner's father, Bill
McDonald, was a partner in M & M. Respondent's Information
Returns Master File Transcript did not show that either M & M or
Gold Country filed Forms 1099 or W-2 with the Internal Revenue
Service indicating wages or other compensation paid to
petitioner. However, petitioner reported Schedule C gross
- 5 -
receipts of $7,160 on her 1989 return.3 In addition, Gold
Country paid petitioner an automobile allowance during each of
the years at issue (1988 and 1989). This automobile allowance
was determined by respondent to constitute income for the 2 years
in question.
By letter dated November 16, 1990, the Internal Revenue
Service (IRS) informed petitioner that her 1986, 1987, and 1988
income tax returns had been selected for examination. In the
letter, an audit appointment was scheduled for December 12, 1990,
and attached to the letter was an Information Document Request
(IDR), requesting that petitioner provide certain information,
which included bank records and information on nontaxable sources
of income. Petitioner did not provide the requested information
to the IRS.
On January 17, 1991, the IRS sent another letter and a
second IDR, this time to petitioner's attorney. Petitioner again
did not provide the requested records. As a result, the IRS
summonsed petitioner's bank for information. The IRS was unable
to get copies of all of petitioner's bank records, such as copies
of all checks deposited and all checks written.
A notice of deficiency for 1988 was issued on August 11,
1992. In that notice, respondent determined net income
3
Petitioner listed the name of her Schedule C business as
"Mary Lee Sharer".
- 6 -
adjustments totaling $83,845. Consistent with the determinations
in the notice of deficiency for 1986 and 1987, respondent
determined that, for 1988, petitioner was required, under
California's community property law, to include in her income
one-half of the net income, or $40,415, of Sharer Accountancy,
her late husband's accounting proprietorship. Other adjustments
totaled $25,205, which included automobile allowances paid to
petitioner by Gold Country, unaccounted and unexplained deposits
to petitioner's bank accounts, and personal expenses of
petitioner paid by a third party. Respondent also determined
that $20,000 petitioner received from a law firm during 1988, as
well as a State income tax refund of $1,312, constituted gross
income. All of these adjustments, except for the $40,415 from
Sharer Accountancy, were based upon bank records and information
provided to respondent by payors.
Petitioner filed her petition on October 9, 1992, contesting
the deficiency notice for 1988. On December 10, 1992, respondent
filed an answer. On September 27, 1993, an Appeals Officer of
respondent mailed a letter to petitioner's attorney setting out
the issues and inviting the attorney to submit evidence in
support of petitioner's case, noting that the case was calendared
for trial on January 24, 1994. Respondent also suggested that
petitioner sign a Stipulation to be Bound by the finding of the
Court for tax years 1986 and 1987 with respect to the issue of
- 7 -
the community income from Sharer Accountancy and all other issues
related thereto. Neither petitioner nor her attorney responded
to this letter, nor were any additional documents submitted to
respondent. However, because of the pending case involving
petitioner's 1986 and 1987 tax years, the parties agreed to
continue generally the trial of this case.
On September 8, 1994, the opinion in petitioner's 1986 and
1987 case was rendered. See Sharer v. Commissioner, T.C. Memo.
1994-453. This Court found that petitioner and Mr. Sharer were
living separate and apart during 1986 and 1987, and that the net
income from Sharer Accountancy was Mr. Sharer's separate income
and was not community income. The Court also found that
petitioner had to include in income a portion of the amounts paid
to her as "spousal wages". The Court found that the remainder of
the payments represented repayment of loans made by petitioner to
Mr. Sharer, and such payments were not income.
On October 20, 1994,4 the same Appeals Officer contacted
petitioner's attorney again to see if the 1988 tax year could be
settled in light of the Court's opinion for the 1986 and 1987 tax
years. By letter dated November 2, 1994, petitioner's attorney
4
From this point on, it appears from the record of both cases
that all correspondence and communications between the parties
dealt with both years 1988 and 1989. The issues considered by
the parties in subsequent correspondence related to either year
or both years. As discussed later in this opinion, the petition
challenging respondent's determinations for the 1989 tax year was
filed on June 24, 1993.
- 8 -
provided some documentation to respondent. The record does not
indicate what information was enclosed with this letter. By
letter dated January 10, 1995, petitioner's attorney provided
further documentation to respondent. Again, the record does not
indicate what information was provided in this letter. This
letter, however, indicated petitioner's inability to locate
documentation justifying the "auto expense", one of the
adjustments in the notice of deficiency that respondent
determined was taxable income.
On March 3, 1995, respondent sent a letter to petitioner's
attorney summarizing the issues in the 1988 and 1989 cases. In
the letter, respondent conceded the 1988 $40,415 community
property income adjustment as a result of the opinion in Sharer
v. Commissioner, supra. Respondent also conceded part of the
1988 $25,205 adjustment for additional earned income but
requested additional documentation as to the other parts of this
adjustment and the $20,000 adjustment for a payment received by
petitioner from a law firm during 1988. Petitioner claimed that
the $20,000 payment was a personal injury settlement, which was
not taxable under section 104(a)(2). Respondent requested
further information on this item because some of respondent's
documentation indicated that petitioner's claim included taxable
as well as nontaxable elements. Finally, respondent conceded the
adjustment for the State income refund, and also allowed
- 9 -
petitioner itemized deductions in excess of those allowed in the
notice of deficiency.
On March 19, 1995, petitioner's attorney provided more
information to respondent in response to the March 3, 1995,
letter. Based on this documentation, respondent, in a letter
dated March 22, 1995, conceded additional income adjustments and
the substantial understatement penalty under section 6661. In
the same letter, respondent sent copies of a proposed stipulation
settlement.
By letter dated March 29, 1995, respondent's Appeals Officer
confirmed by letter to petitioner's attorney a basis for
settlement of the case for 1988 and included an audit statement
reflecting the settlement and a decision to be filed with the
Court. The decision was signed by the parties and filed with the
Court as a Stipulation of Settlement in view of petitioner's
simultaneous filing of the motion for litigation costs. Rule
231(c).
With respect to the 1989 tax year, petitioner was first
informed by letter dated December 8, 1992, that her 1989 return
would be examined. Attached to that letter was an IDR requesting
petitioner to provide certain information that included bank
records and information on nontaxable income. On December 18,
1992, the IRS agent assigned to the case met with petitioner's
attorney to discuss some of the issues in the case. However,
- 10 -
none of the requested documents was provided to the agent. The
agent then summonsed petitioner's bank records on January 7,
1993. On February 3, 1993, petitioner's attorney sent a letter
to the agent indicating that a response from petitioner was
enclosed with the letter. The record, however, does not include
petitioner's response.
On April 7, 1993, respondent issued a notice of deficiency
for petitioner's 1989 tax year. Based on information derived
from bank records and information obtained from audits of related
taxpayers, respondent determined net income adjustments totaling
$35,403. By far, the largest adjustment was additional income
totaling $42,831, which consisted essentially of the same kind of
items as generated the $25,205 adjustment for petitioner's 1988
tax year.5 Other adjustments included $150 taxable Social
5
Specifically, the items consisted of:
$ 3,000 Automobile allowance paid to petitioner by
Gold Country
9,580 Checks from petitioner's mother deposited
in petitioner's checking account
800 A deposit of currency in petitioner's
checking account
25,258 Deposited into petitioner's M & B Investment
Club account
3,904 Adjustment for personal living expenses
7,449 Amount received for sale of the Sharer
Accountancy client list
$49,991 TOTAL
Since petitioner had reported $7,160 of the above items as
Schedule C trade or business income, the $42,831 adjustment
represented net unreported income.
- 11 -
Security income, computational adjustments for self-employment
tax and the earned income credit, an allowance for additional
itemized deductions, and imposition of the accuracy-related
penalty under section 6662(a).
Petitioner filed her petition on June 24, 1993. Respondent
filed an answer on August 17, 1993.
On September 10, 1993, the same IRS Appeals Officer
considering petitioner's 1988 tax year mailed a letter to
petitioner's attorney suggesting a conference for settlement of
the case for 1989, without trial, or to submit additional
evidence to support petitioner's case. Petitioner did not
respond to this letter, nor was any additional documentation
provided.
On October 20, 1994, the Appeals Officer mailed another
letter to petitioner renewing the offer to discuss the issues for
both the 1988 and 1989 cases. The letter noted this Court's
opinion in Sharer v. Commissioner, T.C. Memo. 1994-453 (with
respect to petitioner's 1986 and 1987 tax years). Petitioner's
attorney responded to this letter on November 2, 1994, and
provided some information regarding the 1989 year. The record is
unclear, however, as to what information was actually sent to
respondent. On November 22, 1994, the Appeals Officer responded
to the November 2, 1994, letter from petitioner's attorney
acknowledging receipt of the information.
- 12 -
By letter dated January 10, 1995, petitioner's attorney
provided to respondent additional information and statements from
petitioner.
On March 3, 1995, the Appeals Officer sent a letter to
petitioner conceding some adjustments, contesting others, and
requesting additional information about bank deposits. More
specifically, the letter stated, in pertinent part, that
respondent would concede $7,444 of the $7,449 adjustment for
payments from Hoffelt, et al., for the Sharer accountancy client
list, that respondent would concede the adjustment of $3,904
personal living expenses paid in cash, and that petitioner would
concede that the auto allowance of $3,000 from Gold Country was
includable in income. Furthermore, the Appeals Officer requested
additional information about $9,580 in checks written to
petitioner by Mary McDonald and $25,258 in funds deposited into
petitioner's investment account.
By letter dated March 19, 1995, petitioner's attorney
provided an affidavit from Mary McDonald with respect to the
$9,580 in checks written by her to petitioner and the $25,258
deposited into petitioner's investment account.
By letter dated March 22, 1995, the Appeals Officer conceded
all of the income items except the $3,000 auto allowance that
petitioner conceded was income. Respondent also conceded the
$150 Social Security adjustment. Petitioner conceded the
- 13 -
accuracy-related penalty under section 6662(a) and the
computational adjustments. All issues for 1989, therefore, had
been settled.
In the same letter, the Appeals Officer enclosed decision
documents and audit statements that would close the case for
1989. These documents were signed by petitioner and forwarded to
respondent in a letter dated March 31, 1995. The stipulated
decision was then filed by this Court as a Stipulation of
Settlement in view of petitioner's simultaneous filing of the
motion for litigation costs. Rule 231(c).
A taxpayer who substantially prevails in an administrative
or court proceeding may be awarded a judgment for reasonable
costs incurred in such proceedings. Sec. 7430(a)(1) and (2). A
judgment may be awarded under section 7430 if a taxpayer (1) was
the "prevailing party"; (2) exhausted the administrative remedies
available to the taxpayer within the Internal Revenue Service;
and (3) did not unreasonably protract the proceedings. Sec.
7430(a), (b)(1), (b)(4). A taxpayer must satisfy each of these
three requirements to be entitled to a judgment under section
7430. Respondent concedes that petitioner exhausted the
administrative remedies available. The Court is left to decide
(1) whether petitioner was the prevailing party, and (2) whether
petitioner did not unreasonably protract the proceedings.
- 14 -
To qualify as the "prevailing party", the taxpayer must
establish that (1) the position of the United States in the
proceeding was not substantially justified; (2) the taxpayer
substantially prevailed with respect to the amount in controversy
or with respect to the most significant issue or set of issues
presented; and (3) the taxpayer satisfies the applicable net
worth requirements. Sec. 7430(c)(4)(A). Respondent concedes
that petitioner meets the second and third criteria listed above.
Respondent argues, however, that the position taken in both
proceedings was substantially justified. Rule 232(e); Dixson
Corp. v. Commissioner, 94 T.C. 708, 714-715 (1990); Gantner v.
Commissioner, 92 T.C. 192, 197 (1989), affd. 905 F.2d 241 (8th
Cir. 1990). Accordingly, the Court must decide, with respect to
both cases, whether "the position of the United States in the
proceeding was not substantially justified." Gantner v.
Commissioner, 905 F.2d at 245.
In deciding this issue, the Court must first identify the
point in time at which the United States is considered to have
taken a position and then decide whether the position taken from
that point forward was not substantially justified. The "not
substantially justified" standard is applied as of the separate
dates that respondent took a position in the administrative
proceeding as distinguished from the proceeding in this Court.
Sec. 7430(c)(7)(A) and (B); Han v. Commissioner, T.C. Memo. 1993-
- 15 -
386. For purposes of the administrative proceedings, respondent
took a position on August 11, 1992, and April 7, 1993, the dates
the notices of deficiency for tax years 1988 and 1989,
respectively, were issued. Sec. 7430(c)(7)(B). For purposes of
the proceeding in this Court, respondent took positions for the
1988 and 1989 tax years on December 11, 1992, and August 18,
1993, respectively, the dates respondent filed the answer in each
of the cases. See Huffman v. Commissioner, 978 F.2d 1139, 1143-
1147 (9th Cir. 1992), affg. in part, revg. in part on other
grounds, and remanding T.C. Memo. 1991-144.
Whether respondent's position was not substantially
justified turns on a finding of reasonableness, based upon all
the facts and circumstances, as well as the legal precedents
relating to the case. Pierce v. Underwood, 487 U.S. 552 (1988);
Sher v. Commissioner, 89 T.C. 79, 84 (1987), affd. 861 F.2d 131
(5th Cir. 1988). A position is substantially justified if the
position is "justified to a degree that could satisfy a
reasonable person." Pierce v. Underwood, supra at 565; Powers v.
Commissioner, 100 T.C. 457, 470-471 (1993). A position that
merely possesses enough merit to avoid sanctions for
frivolousness will not satisfy this standard; rather, it must
have a "reasonable basis both in law and fact". Pierce v.
Underwood, supra at 564-565.
- 16 -
The Court must "consider the basis for respondent's legal
position and the manner in which the position was maintained".
Wasie v. Commissioner, 86 T.C. 962, 969 (1986). The fact that
respondent eventually loses or concedes the case does not
establish an unreasonable position. Sokol v. Commissioner, 92
T.C. 760, 767 (1989); Baker v. Commissioner, 83 T.C. 822, 828
(1984), vacated on other issues 787 F.2d 637 (D.C. Cir. 1986).
The reasonableness of respondent's position and conduct
necessarily requires considering what respondent knew at the
time. Cf. Rutana v. Commissioner, 88 T.C. 1329, 1334 (1987);
DeVenney v. Commissioner, 85 T.C. 927, 930 (1985). The taxpayer
has the burden of establishing that respondent's position was
unreasonable. Rule 232(e).
At all relevant times, respondent's position in both of
petitioner's cases was that, using the bank deposits method,
respondent properly calculated, in the notices of deficiency,
petitioner's income tax for 1988 and 1989. Petitioner argues
that respondent's position was not reasonable as a matter of law
or fact. As a matter of law, petitioner argues that respondent's
use of the bank deposits method, an indirect method in
determining petitioner's taxable income, was not reasonable.
This Court has long held that the bank deposits method of
determining taxable income is reasonable when, as in the present
case, taxpayers fail to maintain, or submit for examination by
- 17 -
the Commissioner, complete and adequate books and accounts for
their income-producing activities. DiLeo v. Commissioner, 96
T.C. 858, 867 (1991), affd. 959 F.2d 16 (2d Cir. 1992).
Prior to respondent's issuance of the notices of
deficiencies for 1988 and 1989, respondent sent letters to
petitioner requesting she provide information described in the
IDR's accompanying the letters. Petitioner did not present any
of these records for either year at issue. As a result, it was
necessary, and reasonable, for respondent to use the bank
deposits method in determining petitioner's income for 1988 and
1989. The Court notes that respondent's determinations were not
based upon information petitioner voluntarily submitted, but
rather upon information obtained from summonses on banks and
information from payors reported to the IRS. Accordingly, we
reject petitioner's argument that respondent's use of the bank
deposits method was unreasonable as a matter of law.
In deciding whether petitioner is entitled to administrative
costs, the Court takes into account the information available to
respondent from the date the notices of deficiency were mailed.
The notice of deficiency for 1988 was mailed on August 11, 1992.
The notice of deficiency for 1989 was mailed on April 7, 1993.
With respect to both years, between the time that the notices of
deficiency were mailed and the time respondent's answers were
filed, petitioner provided no records or pertinent documentation
- 18 -
to respondent. Accordingly, respondent was substantially
justified, in fact and in law, in taking and maintaining the
positions determined in the notices of deficiency. Petitioner's
motions with respect to administrative costs are, therefore,
denied for both years at issue.
With respect to litigation costs, the Court must look to the
information available to respondent at the time the answers were
filed and from that point forward.
Respondent's answer in the 1988 case was filed on
December 10, 1992. On September 27, 1993, respondent mailed a
letter to petitioner requesting that she submit evidence in
support of her position. Petitioner did not respond to this
letter. After the decision was rendered in Sharer v.
Commissioner, T.C. Memo. 1994-453, on September 8, 1994,
respondent contacted petitioner again to see if the 1988 case
could be settled and, as to those issues common to the 1986,
1987, and 1988 tax years, respondent agreed to abide by the
Court's opinion that dealt with petitioner's 1986 and 1987 years.
Petitioner sent respondent some documentation with a letter dated
November 2, 1994, and further documentation with a letter dated
January 10, 1995. Although the information provided in these
letters is not shown in the record, it is evident from the
language in the several letters between the parties that
petitioner was moving in the direction toward providing
- 19 -
information that respondent had long sought. By letter dated
March 3, 1995, respondent conceded several of the adjustments in
the notice of deficiency. In the same letter, respondent asked
for additional documentation with respect to the adjustment for
earned income. After receiving the additional information from
petitioner on March 19, 1995, respondent conceded, 3 days later,
more of the income adjustments and the substantial understatement
penalty. As a result, a settlement was reached by the parties.
The record of the case clearly shows that respondent's
litigation position was reasonable. It is apparent from the
record that petitioner provided very little in the way of
documentation until such time as the case progressed toward an
ultimate trial date. The correspondence in the record does not
indicate or show any unreasonableness on the part of respondent's
Appeals Officer, nor does the correspondence from petitioner's
attorney to the Appeals Officer indicate or express any
frustration or complaints about respondent's positions or
requests for additional information. Based on this record,
therefore, this Court holds that petitioner is not entitled to
litigation costs for the 1988 case.
With respect to petitioner's 1989 tax case, the
correspondence described above with respect to the 1988 tax case
also dealt with the 1989 tax year. For the same reasons
- 20 -
described above, the Court holds that petitioner is not entitled
to litigation costs for the 1989 case.
As the Court has decided that respondent's position was
substantially justified in both the administrative and Court
proceedings for both years, it is not necessary for the Court to
decide whether petitioner unreasonably protracted the proceedings
and the amount of petitioner's administrative and litigation
costs. Petitioner's motions, therefore, will be denied.
Appropriate orders and
decisions will be entered.