Cole v. Commissioner

T.C. Memo. 1996-375

UNITED STATES TAX COURT

DEBORAH A. COLE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 20685-94. Filed August 13, 1996.

Keith H. Cole, Jr., for petitioner.

Stephanie R. Jensen, for respondent.

MEMORANDUM OPINION

FOLEY, Judge: This matter is before the Court on

petitioner’s Motion for Award of Reasonable Administrative and

Litigation Costs and Fees under section 7430 and Rule 231.

Unless otherwise indicated, all section references are to

the Internal Revenue Code as in effect for the period relevant
here, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

Background

Petitioner resided in Irving, Texas, at the time the

petition in this case was filed.

On or about April 15, 1992, petitioner filed her 1991

Federal income tax return. The return reported two items of

income: (1) $7,700 of wages and (2) $2,427.25 of other income

(with a handwritten note “MISC INCOME”). For petitioner's 1991

tax year, respondent received two Forms 1099. A Form 1099-MISC

from Dr. Mark Imhoff, an individual for whom petitioner had

rendered services, indicated that petitioner had been paid

$4,147.50. The Form 1099-MISC reported the income as nonemployee

compensation. In addition, a Form 1099-INT indicated that

petitioner had been paid $12 of interest income.

On January 18, 1994, respondent mailed a 30-day letter to

petitioner. The letter indicated that respondent proposed to

increase petitioner’s taxable income by $3,866.50 ($12 interest

plus $4,147.50 nonemployee income less a $293 self-employment tax

deduction). The proposed increase produced an additional tax

liability of $1,163 and accrued interest of $162. The letter

stated that if petitioner did not respond within 30 days,

respondent would issue a notice of deficiency. The letter

further stated that if petitioner did not agree with respondent's
 - 3 -

proposed changes, petitioner should submit a signed letter of

explanation and supporting documentation.

On February 15, 1994, petitioner informed respondent that

she disagreed with respondent's proposed changes. On

February 18, 1994, petitioner mailed respondent a letter further

delineating her position. In the letter, petitioner conceded

that her return should have included the interest income but

disputed that her return omitted $4,147.50 of other income.

Petitioner asserted that for the 1991 tax year she: (1) Did not

receive a Form 1099-MISC from Dr. Imhoff; (2) estimated her

income from Dr. Imhoff and reported it as $2,427.25 of

miscellaneous income on her return; (3) was an employee (not an

independent contractor) of Dr. Imhoff and thus received employee

wages rather than self-employment income; and (4) did not owe any

additional Federal Insurance Contributions Act (FICA) tax.

On April 4, 1994, respondent replied to petitioner's letter

but did not address petitioner's contentions as set forth in the

February 18, 1994, letter. On April 26, 1994, petitioner again

wrote to respondent and requested that respondent address the

positions taken by petitioner in her letter. On May 18, 1994,

respondent requested information from Dr. Imhoff. Dr. Imhoff

responded on June 16, 1994, by asserting, as he did on the Form

1099-MISC filed with the Internal Revenue Service (IRS), that the

$4,147.50 constituted nonemployee income.
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On August 9, 1994, respondent mailed petitioner a statutory

notice of deficiency determining an increase of $1,163 in

petitioner's 1991 tax liability. On November 10, 1994,

petitioner filed her petition with this Court, and on January 17,

1995, respondent filed her answer.

From January through early June of 1995, respondent's

Appeals Office and petitioner conducted settlement discussions.

On June 11, 1995, petitioner mailed respondent's Appeals Office a

letter with attached copies of billing records showing that

petitioner had received $2,462 from Dr. Imhoff. The letter noted

that the $2,462 amount was only $35 higher than the amount

reported as miscellaneous income on the return. Petitioner

proposed that respondent concede the $35 understatement. Also

around this time, respondent obtained from Dr. Imhoff copies of

checks paid to petitioner and ledgers maintained by Dr. Imhoff's

office. After June 11 but prior to July 27, 1995, respondent

concluded that: (1) The Form 1099-MISC prepared by Dr. Imhoff,

which reported that petitioner had been paid $4,147.50,

overstated amounts paid by $631.75; (2) the correct amount of

wages from Dr. Imhoff was $3,515.75; (3) petitioner had

understated income by $1,088.50 ($3,515.75-$2,427.25 of

miscellaneous income reported on petitioner's return); (4) the

$1,088.50 understatement resulted from petitioner's failure to

report checks from Dr. Imhoff of $703.50, $350, and $35; and (5)

petitioner qualified as an employee and would not be liable for
 - 5 -

self-employment tax, but would be liable for additional FICA

tax.1 Respondent did not immediately communicate these

conclusions to petitioner.

On July 10, 1995, respondent mailed petitioner a letter

encouraging petitioner to settle at the Appeals level and to

provide documentation supporting her position. On July 27, 1995,

respondent mailed petitioner a letter offering a settlement and

enclosed a proposed stipulation of facts for petitioner's

signature or comment. Respondent offered to concede that $631.75

of income was overreported by Dr. Imhoff and that petitioner was

an employee liable for only the employee portion of FICA tax.

The tax treatment of the three checks totaling $1,088.50 was not

mentioned in the letter. Respondent also did not address

petitioner's contention that a portion of the alleged

understatement was attributable to the $2,427.25 that petitioner

had reported as miscellaneous income.

On September 27, 1995, petitioner provided respondent with

wage statements for 1990. Petitioner also explained that the

$703.50 check, dated January 2, 1991, was earned in 1990. The

$703.50 was reported on petitioner's 1990 income tax return but

was erroneously included on both the 1990 Form 1099-MISC and the

1
This information is derived from the Appeals officer's
handwritten notes. Although the notes are undated, we find that
they were written after June 11, 1995 (i.e., the date petitioner
mailed information incorporated in the notes) and before July 27,
1995 (i.e., the date respondent proposed a settlement offer that
incorporated calculations from the notes).
 - 6 -

1991 Form 1099-MISC prepared by Dr. Imhoff. Petitioner offered

to pay the additional income tax associated with the $350 and $35

checks as well as the employee portion of the FICA tax. The

determination of the year in which the $703.50 check should be

includable, however, remained in dispute.

On October 6, 1995, respondent acknowledged that petitioner

had reported the $703.50 amount on her 1990 income tax return.

Although respondent noted that petitioner, a cash basis taxpayer,

was required to report income in the year of receipt (i.e.,

1991), respondent agreed to reduce the asserted unreported income

for 1991 by $703.50. Respondent did not concede that petitioner

had reported $2,427.25 of the alleged understatement as

miscellaneous income. On October 11, 1995, respondent changed

her position and offered to concede that $2,427.25 of the alleged

understatement had in fact been reported as miscellaneous income.

After taking these proposed concessions into account, there

remained unreported income of $385, producing an income tax

deficiency of $59 and FICA tax liability of $199, plus interest.

On October 16, 1995, the parties filed with this Court a

decision document and a stipulation of settled issues. The

decision document stated that petitioner is liable for a

deficiency of $59 in her 1991 income tax. The stipulation of

settled issues stated that: (1) Petitioner agrees to pay FICA

tax of $199 for 1991; (2) petitioner agrees that she is liable
 - 7 -

for a deficiency of $59 in her 1991 income tax; (3) petitioner

agrees that respondent was substantially justified in her

position that petitioner received $703.50 of income in January

1991; and (4) respondent agrees that petitioner may file a claim

for litigation and administrative costs.

The Court entered the agreed decision on October 30, 1995.

On December 6, 1995, petitioner filed her Motion for Award of

Reasonable Administrative and Litigation Costs and Fees, and the

Court ordered for cause that the October 30, 1995, decision be

vacated.

Discussion

Section 7430(a) provides that a party that has prevailed in

a Tax Court proceeding may recover reasonable administrative and

litigation costs and fees. The Court will award administrative

and litigation costs only if petitioner establishes that:

(1) She has exhausted her administrative remedies (applicable to

litigation costs only); (2) she has "substantially prevailed" in

the controversy; (3) she satisfies certain net worth

requirements; (4) the position of the United States was not

substantially justified; (5) she has not unreasonably protracted

the administrative or Court proceedings; and (6) the amount of

costs sought is reasonable. Sec. 7430. Petitioner bears the

burden of proving that she meets each of these requirements.

Rule 232(e); Estate of Johnson v. Commissioner, 985 F.2d 1315,

1318 (5th Cir. 1993). Her failure to establish any one of the
 - 8 -

requirements will preclude an award of costs. Minahan v.

Commissioner, 88 T.C. 492, 497 (1987). For the reasons discussed

below, we conclude that petitioner is entitled to recover

administrative and litigation costs.

Respondent has conceded that petitioner has substantially

prevailed and that she meets the net worth requirement. We

address the remaining requirements of section 7430 in turn.

I. Substantial Justification

Respondent's position is substantially justified if the

position was justified to a degree that would satisfy a

reasonable person. Pierce v. Underwood, 487 U.S. 552, 565

(1988); Lenox v. Commissioner, 998 F.2d 244, 248 (5th Cir. 1993),

revg. in part T.C. Memo. 1992-382. To meet this standard,

respondent's position must have a basis in fact and law. Pierce

v. Underwood, supra; Lenox v. Commissioner, supra.

To recover administrative and litigation costs, petitioner

must prove that respondent's positions in both the administrative

proceeding and the proceeding in this Court were not

substantially justified. Sec. 7430(c)(4)(A)(i), (7)(A) and (B);

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; Stieha v. Commissioner, 89 T.C.

784, 790 n.5 (1987). This "not substantially justified" standard

under section 7430 is applied as of the separate dates respondent

took positions in the administrative proceeding and the
 - 9 -

proceeding in this Court. Sec. 7430(c)(7)(A) and (B); Huffman v.

Commissioner, supra at 1143-1147; see also Caparaso v.

Commissioner, T.C. Memo. 1993-255. For purposes of the

administrative proceeding, respondent took a position on August

9, 1994, the date of the notice of deficiency. Sec.

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

respondent took a position on January 17, 1995, the date she

filed her answer. Huffman v. Commissioner, supra at 1148.

Petitioner contends that respondent's position was not

justified when taken. Respondent counters that her position was

substantially justified. We agree with petitioner.

Under Golsen v. Commissioner, 54 T.C. 742, 756-757 (1970),

affd. 445 F.2d 985 (10th Cir. 1971), we are obligated to follow

the law as stated by the Court of Appeals in the circuit to which

this case is appealable. We thus consider whether respondent was

substantially justified pursuant to precedent established by the

U.S. Court of Appeals for the Fifth Circuit.

In Portillo v. Commissioner, 932 F.2d 1128 (5th Cir. 1991)

(Portillo I), affg. in part and revg. in part T.C. Memo. 1990-68,

the taxpayer, a self-employed painting subcontractor, had filed a

Federal income tax return reporting that $10,800 of income had

been received from a contractor. The contractor later submitted

to the IRS a Form 1099 that reported a $35,305 payment from the

contractor to the taxpayer. The Commissioner then issued a
 - 10 -

notice of deficiency claiming that the taxpayer had underreported

his income by $24,505 (i.e., the difference between the $35,305

the contractor reported to the IRS and the $10,800 reported on

the taxpayer's return).

The U.S. Court of Appeals for the Fifth Circuit held for the

taxpayer and stated that the notice of deficiency issued on the

basis of the Form 1099 was "arbitrary and erroneous". Id. at

1134. Thus, the Commissioner was not entitled to the presumption

of correctness ordinarily applicable to her determinations. Id.

The rationale for the Court of Appeals' holding is to prevent

taxpayers from having to bear the unreasonable burden of proving

the nonreceipt of income. Id. at 1133.

In Portillo v. Commissioner, 988 F.2d 27 (5th Cir. 1993)

(Portillo II), revg. T.C. Memo. 1992-99, the taxpayer appealed

our denial of administrative and litigation costs. The U.S.

Court of Appeals for the Fifth Circuit held that the

Commissioner's position was not substantially justified. The

court noted that "one person's word, i.e. 'a naked assertion,' is

not sufficient support for a notice of deficiency" and that the

notice of deficiency was arbitrary and erroneous. Id. at 29. As

a result, the court concluded that the Commissioner's position

was not substantially justified. Id.

In the present case, respondent took a position in her

notice of deficiency and answer based on a Form 1099-MISC from
 - 11 -

Dr. Imhoff, indicating that petitioner received $4,147.50 of

income in 1991, and on an unsubstantiated assertion by Dr. Imhoff

that the $4,147.50 constituted nonemployee income. Respondent

did not obtain the necessary documentation from Dr. Imhoff and

petitioner until after the notice of deficiency was issued and

the answer was filed. Once respondent obtained the necessary

information, she had little difficulty confirming most of

petitioner's assertions. This process should have preceded the

issuance of the notice of deficiency.

Respondent argues that the parties have stipulated that "the

Commissioner was substantially justified in its [sic] position

that petitioner received income from a check of $703.50 in

January, 1991." Our determination, however, of whether

respondent was "substantially justified" within the meaning of

section 7430(c)(4)(A)(i) is based on the position respondent took

on August 9, 1994 (i.e., the date the notice of deficiency was

issued), and January 17, 1995 (i.e., the date respondent filed

her answer). See sec. 7430(c)(7)(A) and (B); Huffman v.

Commissioner, supra at 1143-1147. On both of these dates,

respondent's position was not substantially justified, because

she had an insufficient basis in fact to determine that

petitioner had received $4,147.50 of nonemployee income.

Portillo II, supra. Respondent did not take a position relating

to the $703.50 check until June or July of 1995, when she

received a copy of the check. The fact that respondent then took
 - 12 -

a valid position relating to the year in which the check was

includable has no bearing on our conclusion that respondent's

position was not substantially justified on the earlier dates

identified above.

II. Exhaustion of Administrative Remedies

Section 7430(b)(1) generally requires that a party seeking

litigation costs exhaust all administrative remedies. Minahan v.

Commissioner, 88 T.C. 492 (1987). Section 301.7430-1(b)(1),

Proced. & Admin. Regs., provides that, where "an Appeals office

conference is available", administrative remedies are exhausted

only if a taxpayer (1) participated in such conference prior to

filing a petition, or (2) requested an Appeals conference and

such request was denied. Respondent contends that petitioner did

not participate in an Appeals conference. Petitioner concedes

this point, but contends that prior to the filing of the petition

no Appeals conference was "available" within the meaning of

section 301.7430-1(b), Proced. & Admin. Regs.

Several factors lead us to conclude that petitioner

exhausted her administrative remedies. First, respondent's 30-

day letter made no mention of the Appeals function at all.2 The

30-day letter stated that "THE ENCLOSED PUBLICATION 1383 CONTAINS

2
By contrast, the Department of the Treasury's Statement of
Procedural Rules recognizes the importance of apprising taxpayers
of their Appeals rights and states that a 30-day letter includes
a description of such rights. Sec. 601.105, Statement of
Procedural Rules.
 - 13 -

MORE INFORMATION ABOUT HOW TO RESPOND TO THIS NOTICE." The

reference to Publication 1383, however, did not mention

petitioner's right to Appeals consideration. In addition,

Publication 1383 was not attached to the copy of the 30-day

letter provided by respondent. It therefore is unclear whether

Publication 1383 was even mailed to petitioner.

Second, petitioner did exactly what the 30-day letter

encouraged--she attempted to resolve the matter by written

correspondence. The letter stated:

IF YOU DO NOT AGREE WITH THE PROPOSED CHANGE(S), WE
ENCOURAGE YOU TO WORK WITH US TO RESOLVE THE MATTER BY
MAIL. WE HAVE FOUND THAT THE ITEM(S) IN QUESTION ON
YOUR RETURN CAN BE RESOLVED BY WRITTEN CORRESPONDENCE.
PLEASE RETURN A SIGNED STATEMENT OF EXPLANATION AND
SUPPORTING DOCUMENTATION ALONG WITH A COPY OF THIS
NOTICE IN THE ENCLOSED ENVELOPE.

On February 15, 1994, petitioner informed respondent that she

disagreed with respondent's proposed changes. On February 18,

1994, petitioner mailed respondent a letter detailing her

position. Respondent wrote back on April 4, 1994, but did not

respond to the issues raised by petitioner. Petitioner wrote

again on April 26, 1994, and requested that respondent address

petitioner's positions. Respondent issued the notice of

deficiency before she replied to petitioner's April 26, 1994,

letter. This is not a case where the taxpayer chose silence as

her litigation strategy. See DeVenney v. Commissioner, 85 T.C.

927, 933 (1985); Rogers v. Commissioner, T.C. Memo. 1987-374.
 - 14 -

While petitioner attempted to resolve the matter through

correspondence, it was respondent who failed to cooperate.

Third, when respondent issued the notice of deficiency, the

parties were in the middle of the negotiations process.

Respondent had yet to reply to petitioner's letter of April 26,

1994, and petitioner had no reason to believe that the

negotiations had reached an impasse. Yet on August 9, 1994, 9

months before the period of limitations was to expire, respondent

precipitously issued a notice of deficiency.

For the above reasons, we conclude that petitioner did all

that was necessary in these circumstances to exhaust her

administrative remedies.

III. Unreasonable Protraction of Proceedings

Section 7430(b)(4) provides that a taxpayer may recover

administrative and litigation costs and fees only if she

demonstrates that she did not unreasonably protract the

administrative and Court proceedings. Respondent argues that

petitioner did not provide information regarding the $703.50

check in a timely manner. Consequently, respondent argues that

petitioner unreasonably protracted the litigation. We disagree.

The issue relating to the $703.50 check was not the last

issue settled by the parties. On October 6, 1995, respondent

conceded this issue. Yet the issue relating to the $2,427.45

reported by petitioner as miscellaneous income was not settled

until October 11, 1995. Thus, any delay attributable to the
 - 15 -

dispute over the $703.50 check did not unreasonably protract the

administrative and Court proceedings.

IV. Reasonableness of Fees Claimed

Section 7430(c) defines reasonable litigation and

administrative costs as including: (1) Reasonable court costs;

(2) administrative fees charged by the IRS; (3) certain costs

related to expert witnesses and production of reports; and (4)

reasonable fees for the services of an attorney. Recoverable

attorney's fees are limited to a maximum of $75 per hour adjusted

for cost of living increases and special factors. Sec.

7430(c)(1) and (2).

Petitioner seeks reimbursement for $3,075 of her attorney's

fees. Respondent contends that a majority of these fees related

to the dispute over the year in which the $703.50 check was

includable. While petitioner does not refute this contention,

the record reveals that respondent did not take a position

relating to the $703.50 check until June or July of 1995.

Therefore, all attorney's fees incurred prior to this period are

recoverable. The stipulation, however, does affect the total

amount of recoverable fees. Accordingly, we award petitioner

$2,125 for her attorney's services.

In addition, petitioner claims reimbursement for expenses of

$132.95, relating to photocopies ($25), phone calls ($13),

postage ($16.54), fax charges ($5.41), Federal Express charges

($13), and her Tax Court filing fee ($60). With the exception of
 - 16 -

the Federal Express charges, see Cassuto v. Commissioner, 93 T.C.

256, 275 (1989), affd. in part and revd. in part 936 F.2d 736 (2d

Cir. 1991), all of the above expenses are reasonable.

Consequently, petitioner is entitled to reimbursement of her

reasonable administrative and litigation fees and costs of

$2,244.95 ($2,125.00 + 119.95).

We have considered all other arguments made by petitioner

and respondent and found them to be either irrelevant or without

merit. Accordingly, we shall grant petitioner's Motion for Award

of Reasonable Administrative and Litigation Costs and Fees.

To reflect the foregoing,

An appropriate order and

decision will be entered.