Sharer v. Commissioner

T.C. Memo. 1996-90

UNITED STATES TAX COURT

MARY LEE SHARER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 25855-91. Filed February 29, 1996.

Roderick L. MacKenzie and Debra S. Friedman Shoop, for

petitioner.

Kathryn K. Vetter, for respondent.

MEMORANDUM OPINION

PARR, Judge: This matter is before the Court on

petitioner's motion for an award of administrative and litigation

costs under section 74301 and Rule 231. Neither party requested

1
All section references are to the Internal Revenue Code
as in effect for the years in issue, and all Rule references are
to the Tax Court Rules of Practice and Procedure, unless
a hearing, and we conclude that a hearing is not necessary to

properly dispose of this motion. Rule 232(a)(3).

In our opinion issued on September 8, 1994, Sharer v.

Commissioner, T.C. Memo. 1994-453, we held, among other things,

that petitioner (1) was entitled to claim head of household

filing status on her returns for 1986 and 1987; (2) was entitled

to child care credits for 1986 and 1987; (3) did not have to

include in her income one-half of the income generated from an

accounting business operated by her husband during 1986 and 1987,

because this income was not community income of hers under the

community property laws of California; (4) had to include in her

income, for 1986 and 1987, payments she received from her

husband's accounting business denominated as "spousal wages",

except for a portion of the 1987 payments we determined were

repayments of loans petitioner had made to her husband; (5) was

entitled to deduct a partnership loss for 1986, because she had

substantiated her husband's basis in his partnership interest as

of the end of 1986, but was not entitled to deduct a partnership

loss for 1987, because she had not substantiated her husband's

basis in his partnership interest as of the end of 1987; (6) was

entitled to deduct all of the itemized deductions claimed on her

1986 and 1987 returns, because she had paid those deductible

expenses entirely out of her separate funds; and (7) would be

liable for various additions to tax for failure to file,

otherwise indicated.
 - 3 -

negligence, and substantial understatement, for 1986 and 1987, if

certain mathematical requirements were met under a Rule 155

computation. Sharer v. Commissioner, T.C. Memo. 1994-453. We

directed that a decision in the case would be entered pursuant to

Rule 155.

Respondent subsequently agreed that petitioner (1) was not

liable for an addition to tax for failure to file under section

6651(a) for 1986, because her withholding tax credits exceeded

the amount of tax required to be shown on her return for 1986,

(2) was not liable for an addition to tax for substantial

understatement for 1986, because there was no substantial

understatement of her income tax for that year, and (3) was

liable, in recomputed amounts, for additions to tax for

negligence under section 6653(a), for 1986 and 1987, and for an

addition to tax for substantial understatement under section 6661

for 1987.

Background

Petitioner is an accountant. In 1975, she married Michael

Sharer (Mr. Sharer). During their marriage, she and Mr. Sharer

had one child, Derek, who was born in 1986.

Their marriage was a stormy one. From early 1986 until Mr.

Sharer's death in 1988, petitioner and Mr. Sharer did not live

together but maintained separate households. However, they never

filed for legal separation or divorce.
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Mr. Sharer was a certified public accountant. Beginning in

1980, he operated as a sole proprietorship an accounting business

known as Sharer Accountancy. During 1987, petitioner helped her

husband with his accounting business.

Sharer Accountancy maintained one bank account throughout

1986 and 1987, and another bank account from November 1986

through the end of 1987. Petitioner had authority to write

checks on both these accounts.

Throughout 1986 and 1987, petitioner and Mr. Sharer also

maintained a joint personal checking account. This account was

in the name of "Michael E. Sharer or Mary Lee Sharer".

Petitioner deposited her wages into the account, and Mr. Sharer

deposited his draw from his accounting business into the account.

Although petitioner and Mr. Sharer were not living together,

from early 1986 until about the time of Mr. Sharer's death in

1988, they represented to Mr. Sharer's accounting clients and

others, including Mr. Sharer's secretary, Sandra Matsko, that

they were still living together.

Petitioner received from Sharer Accountancy amounts marked

"spousal wages", of $1,500 for 1986 and $25,950 for 1987.

Petitioner was paid substantially all of these funds by checks

that were drawn on the Sharer Accountancy accounts; each of the

checks was annotated "spousal wages". She or Mr. Sharer made

this notation on the checks. A $9,555 portion of the funds
 - 5 -

petitioner received in 1987 was in repayment of loans she had

made to Mr. Sharer during that year.

Petitioner failed to file timely her income tax return for

1986. Her 1986 return was filed on October 18, 1988.

By letter dated November 16, 1990, the Internal Revenue

Service (IRS) informed petitioner that her 1986 and 1987 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, documentation on her income from taxable and nontaxable

sources, and returns and other tax statements concerning

petitioner's investment in the partnership from which she claimed

partnership loss deductions for 1986 and 1987. 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. The second IDR

requested essentially the same information and documentation that

had been sought by the first IDR. The second IDR also asked for

promissory notes and records on loans that petitioner made from

1986 through 1988. Petitioner again did not provide the

requested records. As a result, the IRS summonsed bank records,

obtained a copy of the partnership agreement of the partnership

in which petitioner claimed loss deductions for 1986 and 1987

from the Sacramento Recorder's Office, and obtained a copy of
 - 6 -

that partnership's partnership return for 1986 from the IRS

Service Center.

On August 15, 1991, respondent issued the notice of

deficiency with respect to petitioner's tax liabilities for 1986

and 1987.

On November 12, 1991, petitioner filed her petition,

contesting the notice of deficiency issued to her for 1986 and

1987. On January 9, 1992, respondent filed an answer.

In a letter dated November 15, 1992, to her attorney,

petitioner stated as follows:

Mr. Sharer and I carried on a pretense of marriage in
order to protect his business and to promote an image
of stability. Even his secretary [Sandra Matsko]
didn't know the truth. Mr. Sharer was always telling
her various stories, as he did to other clients and
associates. Mr. Sharer told other people what he
thought they wanted to hear. One minute I was okay,
the next minute I was a witch and responsible for all
his problems. I think he wanted people to feel sorry
for him or to be "on his side" as his secretary was.
To this day I still (along with other clients) don't
understand that relationship. He was always going to
fire her but could never quite do it. If Mr. Sharer
and I were meeting clients, we always met at the
restaurant or office. No one ever came to my house
except for birthdays and holidays, at which people
would expect to see Derek's father and he would appear
for those occasions.

A copy of this letter was furnished to the IRS on November 30,

1992.

Shortly before trial, petitioner provided respondent with

copies of partnership returns for 1980 through 1985 to support
 - 7 -

her claim that she was entitled to partnership loss deductions

for 1986 and 1987.
 - 8 -

Discussion

A taxpayer who substantially prevails in an administrative

or court proceeding may be awarded a judgment for reasonable

administrative or litigation costs incurred in such proceedings.

Sec. 7430(a)(1) and (2). A judgment of administrative or

litigation costs 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 IRS, 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 to her within the IRS. We are left to decide (1)

whether petitioner was the "prevailing party", (2) whether

petitioner did not unreasonably protract the proceedings, and (3)

whether the amounts petitioner claims as administrative and

litigation costs are reasonable.

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 substantially prevailed with respect to the
 - 9 -

amount in controversy and meets the applicable net worth

requirements. Respondent argues, however, that the position

taken in both the administrative and court 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 whether the

position of the United States in the administrative and court

proceedings was not substantially justified.

In deciding this issue, we 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 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-

386. For purposes of the administrative proceeding, respondent

took a position on August 15, 1991, the date upon which the

notice of deficiency for 1986 and 1987 was issued to petitioner.

Sec. 7430(c)(7)(B). For purposes of the proceeding in this

Court, respondent took a position on January 9, 1992, the date

upon which respondent filed the answer in this case. See Huffman

v. Commissioner, 978 F.2d 1139, 1143-1147 (9th Cir. 1992), affg.
 - 10 -

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 the 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, the

position must have a "reasonable basis both in law and fact".

Pierce v. Underwood, supra at 564-565.

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).

An evaluation of the reasonableness of respondent's position and

conduct necessarily requires considering what respondent knew at
 - 11 -

the time. Cf. Rutana v. Commissioner, 88 T.C. 1329, 1334 (1987);

DeVenney v. Commissioner, 85 T.C. 927, 930 (1985).

Generally, when respondent presents evidence which, if

credited by the Court, is sufficient to support a decision in

respondent's favor, there will be a reasonable basis for

respondent's position. See Wilfong v. United States, 991 F.2d

359, 369 (7th Cir. 1993).

The taxpayer has the burden of establishing that

respondent's position was unreasonable. Rule 232(e).

A. Head of Household Filing Status, Child Care Credits, and
Inclusion in Petitioner's Income of One-Half of Sharer
Accountancy's Income

Petitioner's entitlement to claim head of household filing

status and child care credits turned on whether she and her

husband, in fact, maintained separate households during 1986 and

1987. Similarly, whether petitioner had to include one-half of

the income from Sharer Accountancy in her income for 1986 and

1987, turned on whether she and her husband were living "separate

and apart". Under the community property laws of California,

income earned by Mr. Sharer during 1986 and 1987, while he and

petitioner were married, generally would be community income of

Mr. Sharer and petitioner. However, if Mr. Sharer and petitioner

were living separate and apart, with no intention of resuming

marital relations, Mr. Sharer's earnings would be his separate

property, rather than community income. See discussion in Sharer

v. Commissioner, T.C. Memo. 1994-453.
 - 12 -

Although we determined that petitioner and Mr. Sharer

maintained separate households and were living separate and

apart, respondent's position at all relevant times, including the

date the notice of deficiency was issued and the date the answer

was filed, was substantially justified. Respondent's position

was reasonable and supported by substantial evidence. During

1986 and 1987, petitioner and Mr. Sharer continued to maintain a

joint checking account into which petitioner deposited her wages

and Mr. Sharer his draw from Sharer Accountancy. At trial,

respondent offered testimony from Mr. Sharer's secretary, Sandra

Matsko, that indicated petitioner and Mr. Sharer were still

living together. Our holding in petitioner's favor,

notwithstanding this evidence to the contrary, resulted in large

part from our crediting petitioner's testimony concerning her and

Mr. Sharer's marital relationship. As the Court of Appeals for

the Seventh Circuit explained, "when resolution of a case hinges

to such an extent on determinations of witness credibility, it is

an abuse of discretion to find that the government's position was

not substantially justified." Wilfong v. United States, supra at

368.

B. Funds Petitioner Received as Loan Repayments

We determined that $9,555 of the $25,950 petitioner received

from Sharer Accountancy in 1987 was not taxable income of

petitioner's because the $9,555 was in repayment of loans

petitioner had previously made to Mr. Sharer. At trial,
 - 13 -

petitioner did not offer any documentary evidence supporting her

contention that this $9,555 she received from Sharer Accountancy

in 1987 was in repayment of loans. Our holding in her favor

resulted from our crediting her testimony that this money

represented loan repayments.

However, respondent's position on this issue was

substantially justified. During 1987, petitioner, who was an

accountant, helped Mr. Sharer with Sharer Accountancy's

accounting business. Substantially all of the funds that we

ultimately held to be loan repayments were paid to petitioner by

checks drawn on Sharer Accountancy's accounts that were annotated

"spousal wages". As of the time the notice of deficiency was

issued, as of the time respondent's answer was filed, and at all

other pertinent times, a reasonable basis existed for

respondent's position. See Wilfong v. United States, supra at

368-369.

C. Partnership Loss Deduction for 1986

We determined that petitioner had substantiated her

husband's adjusted basis in his partnership interest as of the

end of 1986 so as to be entitled to deduct a partnership loss for

1986. However, we think that respondent's position was

substantially justified. Petitioner provided respondent with

copies of the partnership's returns for 1980 through 1985,

helping to substantiate the adjusted basis of the partnership

interest as of the end of 1986, only shortly before trial. As of
 - 14 -

the time the notice of deficiency was issued and respondent's

answer was filed, and thereafter, a reasonable basis existed for

respondent's position that Mr. Sharer's basis in the partnership

had not been adequately substantiated. See Balken v.

Commissioner, T.C. Memo. 1994-499, affd. 72 F.3d 133 (8th Cir.

1995).

D. Itemized Deductions Claimed on 1986 and 1987 Returns

We determined that petitioner was entitled to deduct all of

the itemized deductions claimed on her 1986 and 1987 returns,

because the expenses had been paid out of her separate property,

and not out of community funds. Our holding in petitioner's

favor turned on whether she and Mr. Sharer were living "separate

and apart". As indicated above and in our opinion in Sharer v.

Commissioner, T.C. Memo. 1994-453, under the community property

laws of California, income earned by a spouse during marriage is

community income. However, earnings and accumulations of a

spouse, while living separate and apart from the other spouse,

are the separate property of that spouse.

Respondent's position on this issue was substantially

justified. As discussed above, there was substantial evidence

supporting respondent's position. Our finding that petitioner

and Mr. Sharer were living separate and apart was based in large

part on our crediting petitioner's testimony about their marital

relationship.

E. Additions to Tax
 - 15 -

Pursuant to our direction that a decision in this case would

be entered pursuant to Rule 155, respondent subsequently agreed

that petitioner (1) was not liable for an addition to tax for

failure to file under section 6651(a) for 1986, because her

withholding tax credits exceeded the tax required to be shown on

her return, (2) was not liable for an addition to tax for

substantial understatement under section 6661 for 1987, because

there was no substantial understatement of her tax for that year,

and (3) was liable, in recomputed amounts, for additions to tax

for negligence under section 6653(a), for 1986 and 1987.

Petitioner failed to timely file her 1986 return. As a

result, in our opinion in Sharer v. Commissioner, supra, we

originally determined that she would be liable for an addition to

tax under section 6651(a) for 1986. We further originally

determined that petitioner would be liable for additions to tax

for (1) negligence under section 6653(a), for 1986 and 1987, and

(2) substantial understatement under section 6661, for 1986 and

1987, if the Rule 155 computation reflected that she had

substantially understated her tax for those years.

Respondent's position on these issues was substantially

justified. As discussed above, respondent's position on a number

of other issues which we decided in petitioner's favor was

reasonable and substantially justified. If these other issues

had been decided in respondent's favor, then the withholding

credits would not have exceeded the tax required to be shown on
 - 16 -

her return and she would have been liable for an addition to tax

for failure to file under section 6651(a) for 1986. Similarly,

if these issues had been decided in respondent's favor,

petitioner then would have substantially understated her tax and

would have been liable for an addition to tax under section 6661

for 1986. Finally, if these issues had been decided in

respondent's favor, then petitioner's liability for additions to

tax for negligence under section 6653(a) for 1986 and 1987, and

for substantial understatement under section 6661 for 1987, would

have been increased.

F. Conclusion

As we have decided that respondent's position in both the

administrative and Court proceedings for the years in issue was

substantially justified, we need not decide (1) whether

petitioner unreasonably protracted the proceedings, and (2)

whether the administrative and litigation costs petitioner claims

are reasonable. Petitioner's motion, therefore, will be denied.

An appropriate order and

decision will be entered.