T.C. Memo. 1996-317
UNITED STATES TAX COURT
SIMPSON FINANCIAL SERVICES, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
RICHARD H. AND CHRISTINE R. SIMPSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 4255-95, 4354-95. Filed July 15, 1996.
Robert D. Winston, Jr., for petitioners.
Emile L. Hebert III, for respondent.
MEMORANDUM OPINION
LARO, Judge: Petitioners moved the Court on March 13, 1996,
to recover $19,126 of administrative and litigation costs under
section 7430 and Rule 231. Petitioners petitioned the Court to
redetermine respondent's determination for their 1988 taxable
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year. On December 20, 1994, respondent had issued petitioners
separate notices of deficiency reflecting her determination that
they were liable for the following deficiencies in Federal income
tax and additions thereto:
Simpson Financial Services, Inc., docket No. 4255-95
Additions to Tax
Sec. Sec. Sec.
Year Deficiency 6651(a)(1) 6653(a)(1) 6661
1988 $28,225 $7,056 $1,411 $7,056
Richard H. and Christine R. Simpson, docket No. 4354-95
Additions to Tax
Sec. Sec. Sec.
Year Deficiency 6651(a)(1) 6653(a)(1) 6661
1988 $13,083 $3,271 $778 $3,271
Prior to trial, the parties settled all issues raised in
respondent's notices of deficiency. In their settlement
agreement, the parties agreed that there remained a deficiency
for Simpson Financial Services, Inc., for its 1988 taxable year
in the amount of $1,579, and a $395 addition thereto under
section 6651(a)(1). Respondent conceded all adjustments with
respect to Richard H. and Christine R. Simpson.
Following this agreement and concession, we must decide
whether respondent's position was substantially justified in fact
and law for purposes of section 7430(c)(4)(A)(i).1 We conclude
1
Respondent filed her answers on Apr. 20, 1995, generally
denying all material allegations of error contained in the
petitions. Respondent's position taken in her answers was the
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that it was.2 All section references are to the Internal Revenue
Code in effect for the year in issue, and all Rule references are
to the Tax Court Rules of Practice and Procedure. Dollar amounts
are rounded to the nearest dollar. Simpson Financial Services,
Inc., Richard H. Simpson, and Christine R. Simpson are separately
referred to as Simpson Financial, Mr. Simpson, and Mrs. Simpson,
respectively. Mr. Simpson and Mrs. Simpson are collectively
referred to as the Simpsons.
Background
We decide petitioners' motion for an award of administrative
and litigation costs on the record of the case, including
respondent's objection and the parties' affidavits and exhibits,
which are incorporated herein by this reference. Neither party
requested a hearing, and we conclude that one is not necessary.
Rule 232(a)(3). Simpson Financial's principal place of business
was Kenner, Louisiana, when it filed its petition. The Simpsons
are husband and wife. When they filed their petition, they
resided in Kenner, Louisiana.
On February 24, 1993, respondent issued 30-day letters to
petitioners, proposing deficiencies in their income taxes.
same as that taken in her notices of deficiency.
2
Based on our holding, we do not decide the other issue in
dispute; namely, whether the litigation and administrative costs
claimed in petitioners' motion filed Mar. 13, 1996, are
reasonable.
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Included with these letters were copies of the revenue agent's
examination reports (RAR) and waiver forms.
With respect to Simpson Financial, the RAR contained
essentially four types of adjustments to its income tax return
for 1988. First, the RAR increased Simpson Financial's gross
receipts and decreased its cost of goods sold. These adjustments
stemmed from what the revenue agent perceived as a misapplication
by Simpson Financial of its method of accounting. Second, the
RAR decreased, for lack of substantiation, Simpson Financial's
claimed expenses for its office, public relations, travel and
entertainment, insurance, and depreciation. Third, the RAR
disallowed Simpson Financial's claimed net operating loss (NOL)
carryforward from its 1987 taxable year. The revenue agent
disallowed this loss, due to the revenue agent's determination
that there were apparent discrepancies between Simpson
Financial's 1987 Federal income tax return and its books and
records for 1987. Fourth, the RAR determined that Simpson
Financial paid constructive dividends to the Simpsons during the
subject year. The RAR issued to the Simpsons reflected the
revenue agent's adjustment to their taxable income to reflect the
constructive dividends. The RAR's also reflected additions to
tax for delinquent filing of returns, negligence, and substantial
understatement of tax.
Petitioners did not protest the RAR with respondent's
Appeals Division (Appeals). Petitioners requested review of the
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RAR relating to Simpson Financial with respondent's examination
division. A revised RAR for Simpson Financial was issued to
petitioners on June 28, 1993. The revised RAR conceded portions
of the revenue agent's adjustments to Simpson Financial's gross
receipts and cost of goods sold. The revised RAR stated that
Simpson Financial's proposed deficiency was $28,682, rather than
$55,844 as reflected on the previous RAR, and the additions to
Simpson Financial's tax were proportionately lowered.
Respondent mailed notices of deficiency to petitioners on
December 20, 1994, taking into account the adjustments in the
revised RAR. On March 20, 1995, petitioners filed their
respective petitions in this Court. After respondent answered
these petitions on April 20, 1995, she transferred the cases to
Appeals for settlement consideration.
On April 24, 1995, an Appeals officer mailed a letter to
petitioners' counsel suggesting that they discuss the cases on
May 17, 1995. By letter dated May 2, 1995, petitioners' counsel
requested a later date. The parties held a conference on
July 25, 1995, and petitioners provided documentation to the
Appeals officer, which was in addition to other documentation
provided earlier to the revenue agent during her examination.
Based upon this new documentation, the Appeals officer wrote
petitioners' counsel on July 27, 1995, to settle various issues.
While the cases were still within Appeals, Appeals asked the
examination division to audit the NOL reported for Simpson
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Financial's 1987 taxable year. Appeals made this request due to
the disallowed loss carryforward from 1987 to 1988.
Settlement negotiations between the parties continued
through September 11, 1995, when it became apparent to the
parties that they would be unable to reach a mutually agreeable
settlement. Petitioners' counsel sent the Appeals officer a
letter requesting the case be transferred back to District
Counsel, citing his objection to the Appeals officer's continued
demands for additional documentation. On September 15, 1995,
Appeals referred the cases back to District Counsel for trial
preparation.
Shortly thereafter, District Counsel was notified by the
examination division that Simpson Financial's 1987 Federal income
tax return would not be audited. Petitioners and District
Counsel held a conference on December 14, 1995, to discuss the
cases in preparation for trial. At that conference, the parties
reviewed various documentation that petitioners provided in
response to District Counsel's informal discovery request. While
some of this documentation had been provided earlier by
petitioners to respondent either at the audit level or later at
the Appeals level, petitioners furnished additional documentation
that had not previously been provided to respondent. The parties
settled all issues raised by the notice of deficiency issued to
Simpson Financial, including the NOL carryforward, which
respondent conceded. Respondent conceded the NOL issue after the
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examination division decided not to audit Simpson Financial's
1987 taxable year.
With respect to the Simpsons' individual return, respondent
fully conceded the constructive dividend issue. Petitioners
established to the satisfaction of respondent's counsel that the
sums in question were repayments of the Simpsons' loans to
Simpson Financial, rather than constructive dividends.
Petitioners had not established this fact at the audit, nor at
the Appeals level.
1. Motion for Litigation and Administrative Costs: Overview
In order to recover reasonable administrative and litigation
costs under section 7430, petitioners must prove, inter alia,
that they were the "prevailing party" within the meaning of
section 7430(c)(4), which requires petitioners to establish:
(1) That respondent's position was not substantially justified in
fact or law, sec. 7430(c)(4)(A)(i); Pierce v. Underwood, 487 U.S.
552, 564-565 (1988); Wilkerson v. United States, 67 F.3d 112, 119
(5th Cir. 1995); Bouterie v. Commissioner, 36 F.3d 1361, 1373
(5th Cir. 1994), revg. T.C. Memo. 1993-510; Han v. Commissioner,
T.C. Memo. 1993-386; (2) that they substantially prevailed in the
proceeding with respect to the amount in controversy or the most
significant issues presented, sec. 7430(c)(4)(A)(ii); and
(3) that at the commencement of the proceeding, they met the net
worth requirement under section 7430(c)(4)(A)(iii) and 28 U.S.C.
sec. 2412(d)(2)(B) (1994). In addition, petitioners must prove
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that they exhausted their administrative remedies within the
meaning of section 7430(b)(1);3 that they did not unreasonably
protract the proceedings within the meaning of section
7430(b)(4); and that their claimed costs are reasonable, sec.
7430(c)(1) and (2). These requirements are in the conjunctive.
Minahan v. Commissioner, 88 T.C. 492, 497 (1987). Petitioners
must prove each and every requirement. Rule 232(e); Welch v.
Helvering, 290 U.S. 111, 115 (1933); Nalle v. Commissioner, 55
F.3d 189, 191 (5th Cir. 1995), affg. T.C. Memo. 1994-182; Lennox
v. Commissioner, 998 F.2d 244, 248 (5th Cir. 1993), revg. in part
T.C. Memo. 1992-382; Gantner v. Commissioner, 92 T.C. 192, 197
(1989), affd. 905 F.2d 241 (8th Cir. 1990).
Respondent agrees that petitioners have met all of the above
requirements except two. Respondent disputes petitioners'
contention that her position was not substantially justified, and
respondent argues that some of petitioners' claimed costs are not
reasonable.
2. Whether Respondent's Position was Substantially Justified
Whether respondent's position was substantially justified
turns on a finding of reasonableness, based on all the facts and
circumstances of the case, as well as any legal precedents which
may relate thereto. Wilkerson v. United States, supra at 119;
Nalle v. Commissioner, supra at 191; Coastal Petroleum Refiners,
3
This requirement only applies to an award of reasonable
litigation costs. Sec. 7430(b)(1).
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Inc. v. Commissioner, 94 T.C. 685, 688-696 (1990). We ask
ourselves, "whether * * * [respondent] knew or should have known
that her position was indefensible at the onset". See Nalle v.
Commissioner, supra at 191. Respondent first took a position in
these cases when she issued the subject notices of deficiency.4
Sec. 7430(c)(7)(B)(ii); see, e.g., Han v. Commissioner, T.C.
Memo. 1993-386.
Petitioners allege that respondent's positions were
unreasonable as evidenced by the fact that she conceded a large
percentage of the deficiencies reflected in the subject notice of
deficiencies. We disagree. The Government's position can be
justified even if ultimately rejected by the Court. Wilfong v.
Commissioner, 991 F.2d 359, 364 (7th Cir. 1993). The fact that
respondent eventually loses or has made substantial concessions
is not dispositive in establishing that the positions taken by
respondent were unreasonable, Nalle v. Commissioner, supra at
191; Bouterie v. Commissioner, supra at 1367, but is merely one
factor to consider; Heasley v. Commissioner, 967 F.2d 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); Sher v. Commissioner, 89 T.C. 79, 84 (1987),
4
A 30-day letter is not the equivalent of a notice of the
decision from the IRS Office of Appeals or a notice of
deficiency. Consequently, a 30-day letter does not constitute a
position of the United States, for purposes of claiming an award
of administrative costs under sec. 7430. See Estate of Gillespie
v. Commissioner, 103 T.C. 395 (1994).
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affd. 861 F.2d 131 (5th Cir. 1988). For petitioners to prevail,
respondent's position, as a matter of both fact and law, must not
have been "justified to a degree that could satisfy a reasonable
person." Pierce v. Underwood, supra at 565; Wilkerson v. United
States, supra at 119. Whether respondent's position has a
reasonable basis in fact and law turns in part on whether there
is "substantial evidence" to support it. Pierce v. Underwood,
supra at 564-565; Powers v. Commissioner, 100 T.C. 457, 473
(1993). Respondent must have at least some relevant evidence
sufficient to support her position.
Respondent developed her position in the instant case based
on her examination and investigation of petitioners' returns.
Cf. Powers v. Commissioner, supra. In the notices of
deficiency, respondent premised the adjustments primarily on
petitioners' failure to substantiate items on their returns.
Deductions are a matter of legislative grace, and petitioners
bore the burden of establishing their entitlement thereto.
New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). In
addition, section 6001 imposed on petitioners an affirmative duty
to maintain books and records sufficient to establish items
reported on their returns. It was reasonable for respondent not
to concede the adjustments until she had received and verified
adequate substantiation for the items in question. Harrison v.
Commissioner, 854 F.2d 263, 265 (7th Cir. 1988), affg. T.C. Memo.
1987-52; Sokol v. Commissioner, 92 T.C. 760, 765 (1989).
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Shortly after respondent answered petitioners' petitions,
she transferred the cases to Appeals. The Appeals officer met
with petitioners' counsel in an effort to settle these cases.
The Appeals officer reviewed petitioners' documentation for their
claimed deductions and other items and requested additional
substantiation from petitioners in order to determine their
correct tax liability. Respondent, through her Appeals officer,
made changes to her positions and offered settlements regarding
those changes based on the documentation petitioners furnished at
the Appeals conference; however, the parties could not then reach
a mutually acceptable settlement. After these cases were
transferred back to District Counsel, respondent's counsel
requested additional documentation through informal discovery.
Upon review of this additional documentation and a conference
between the parties, respondent was able to settle these cases
shortly over 1 year after issuing her notices of deficiency and
within 11 months of answering petitioners' petition.
Petitioners argue that respondent did not have a reasonable
basis in either fact or law primarily because her revenue agent
"employed poor audit procedures, made substantial erroneous
conclusions of fact and law, made arbitrary adjustments and
concocted corruptions of fact and law." Petitioners also argue
that respondent's agents did not contact petitioners at various
times during the review of their audit or during the interval
between the issuance of the revised RAR on June 28, 1993, and the
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issuance of the notices of deficiency approximately 1-1/2 years
later. Petitioners state that respondent unjustly denied them
the opportunity to seek an administrative appeal by not issuing a
second 30-day letter after issuing the revised examination
report. Petitioners charge that there existed a pattern of
harassment against petitioners by respondent's agents, which
unreasonably increased the asserted deficiencies and made
petitioners' substantiation efforts unduly difficult.
We are not persuaded by petitioners' arguments. Based on
our review of the record before us, we find nothing to support
petitioners' claims of overreaching and abusive tactics by
respondent's agents. To the contrary, our review of the record
indicates that respondent expeditiously conceded several issues
when petitioners provided convincing evidence concerning the
matters in dispute. Although petitioners attempt in their motion
to articulate the abuse and overreaching of respondent's agents,
such statements are not proof. Rule 143(b); See Niedringhaus v.
Commissioner, 99 T.C. 202, 214 n.7 (1992); Viehweg v.
Commissioner, 90 T.C. 1248, 1255 (1988); Evans v. Commissioner,
48 T.C. 704, 709 (1967), affd. 413 F.2d 1047 (9th Cir. 1969).
We hold that respondent's positions had a reasonable basis
in law and fact. Accordingly, petitioners are not entitled to
administrative and litigation costs under section 7430.
To reflect the foregoing,
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An appropriate order will
be issued denying
petitioners' motion for an
award of administrative and
litigation costs, and
decisions will be entered.