T.C. Memo. 1997-44
UNITED STATES TAX COURT
BEAVER BOLT, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 22087-93. Filed January 27, 1997.
Merritt S. Yoelin, for petitioners.
Cheryl B. Harris, for respondent.
MEMORANDUM OPINION
COLVIN, Judge: This matter is before the Court on
petitioner’s motion for litigation costs under section 74301 and
Rule 231. Respondent concedes that petitioner substantially
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Section references are to the Internal Revenue Code. Rule
references are to the Tax Court Rules of Practice and Procedure.
2
prevailed, exhausted its administrative remedies, and meets the
net worth requirements. Sec. 7430(b)(1), (c)(4)(A)(ii)(I),
(iii). The remaining issues for decision are:
1. Whether respondent’s position in the underlying
proceeding was substantially justified. We hold that it was not;
and
2. whether petitioner's counsel is entitled to be
reimbursed at the rate of $75 per hour plus a cost of living
adjustment, as respondent contends; or at a rate of $125, $150,
and $180 per hour, as petitioner contends. We hold that the
appropriate hourly rate is $103.95 for 1994 and $107.10 for 1995.
The parties submitted memoranda and affidavits supporting
their positions. We decide the motion based on the memoranda and
affidavits provided by the parties. Neither party requested a
hearing. There are no significant factual disputes. We conclude
that a hearing is not necessary to decide this motion. Rule
232(a)(3).
Background
1. Petitioner
Petitioner is a corporation, the principal place of business
of which was in Portland, Oregon, during the years in issue and
when it filed its petition.
2. Underlying Tax Case
The primary issue in the underlying case, Beaver Bolt, Inc.
v. Commissioner, T.C. Memo. 1995-549, filed November 20, 1995,
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was whether payments petitioner made to Jane Grecco (Grecco) were
for a covenant not to compete, as petitioner contended, or were
for her stock in petitioner. Petitioner had a stock purchase
agreement with its officers, including Grecco, which gave
petitioner the option to repurchase its stock owned by a
terminated employee. The agreement included a formula setting
the purchase price for the stock. Grecco negotiated a financial
settlement with petitioner under which petitioner paid Grecco
$513,400 when she ceased working for petitioner. Petitioner
treated $130,000 of this amount as payment for Grecco's stock in
petitioner and $383,400 as payment for the covenant not to
compete. Petitioner amortized $383,400 for the covenant not to
compete over 3 years.
Respondent prepared an Engineering and Valuation report,
dated July 31, 1992, which concluded that Grecco's stock in
petitioner was worth $739,000 on June 30, 1988, and the covenant
not to compete was worth $0. Respondent disallowed petitioner's
amortization deductions in full in the notice of deficiency sent
on July 15, 1993.
On April 18, 1994, petitioner's expert concluded that
Grecco's stock was worth $190,000. Petitioner's expert prepared
a stock valuation report, a copy of which respondent received on
June 24, 1994. On August 22, 1994, respondent's expert concluded
that Grecco's stock was worth $188,600 and that the covenant not
to compete was worth $52,669. On September 27, 1994, the parties
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agreed that the fair market value of Grecco's stock in petitioner
was $189,300. At trial, respondent contended that the value of
the covenant was $52,669.
Respondent did not contend that petitioner paid the $513,400
to Grecco for anything other than the covenant not to compete and
Grecco's stock in petitioner. Petitioner argued, and we held,
that the covenant not to compete was worth $324,100, the
difference between the total amount petitioner paid Grecco
($513,400) and the agreed value of Grecco's stock redeemed by
petitioner ($189,300).
Discussion
A. Motion for Litigation Costs: Introduction
Generally, a taxpayer who has substantially prevailed in a
Tax Court proceeding may be awarded reasonable litigation costs.
Sec. 7430(a)(2). 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) Show that the position of the United States in the
action was not substantially justified. Sec. 7430(c)(4)(A)(i).
Respondent contends that petitioner does not meet this
requirement.
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(d) Be an individual whose net worth did not exceed $2
million, or an owner of an unincorporated business, or any
partnership, corporation, etc., the net worth of which did
not exceed $7 million, when the petition was filed. Sec.
7430(c)(4)(A)(iii); 28 U.S.C. sec. 2412(d)(2)(B). Respondent
concedes that petitioner meets this requirement.
(e) Establish that the amount of costs and attorney's
fees claimed is reasonable. Sec. 7430(a), (c)(1). Recoverable
attorney's fees are limited to $75 per hour adjusted for cost of
living increases and special factors. Sec. 7430(c)(1)(B)(iii).
Respondent contends that petitioner does not meet this
requirement.
A taxpayer has the burden of proving that it meets each
requirement before the Court may order an award of 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); Minahan v. Commissioner, 88 T.C. 492, 497 (1987).2
2
In 1996, legislation was enacted which shifted to the
Commissioner the burden of proving whether the position of the
United States was substantially justified, sec. 7430(c)(4)(B), as
amended by the Taxpayer Bill of Rights 2 (TBR2), Pub. L. 104-168,
sec. 701, 110 Stat. 1452, 1463 (1996), and raised the hourly rate
for attorney's fees to $110, sec. 7430(c)(1)(B)(iii), as amended
by TBR2 sec. 702(a), 110 Stat. 1464. These changes do not apply
here because they are effective for proceedings commenced after
July 30, 1996. TBR2 secs. 701(d), 702(b), 110 Stat. 1464; see
National Industrial Investors, Inc. v. Commissioner, T.C. Memo.
1996-423.
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B. Whether Respondent's Position Was Substantially Justified
1. Background
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 litigation costs. Sec.
7430(c)(4)(A)(i); Rule 232(e); Bragg v. Commissioner, 102 T.C.
715, 717 (1994). The position of the United States is the
position taken by the Commissioner: (a) In the court 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).
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. Nicholson v.
Commissioner, 60 F.3d 1020, 1026 (3d Cir. 1995), revg. T.C. Memo.
1994-280; 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, 470 (1993), affd. on this
issue and revd. in part and remanded on other issues 43 F.3d
172 (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.
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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). However, it is a factor to be considered. 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); Powers v.
Commissioner, supra at 471. The taxpayer need not show that the
Commissioner demonstrated 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.
2. Whether Respondent's Position That the Covenant Not To
Compete Had No or Minimal Value Had a Reasonable Basis
in Fact and Law
Respondent's position in Beaver Bolt, Inc. v. Commissioner,
T.C. Memo. 1995-549, was that Grecco's stock was worth $189,300
and that the covenant not to compete was worth $52,669.
Petitioner contends that the position of the United States was
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not substantially justified once respondent received the August
22, 1994, valuation report of its expert, which estimated that
Grecco's stock in petitioner was worth $188,600 as of June 30,
1988. Petitioner argues that it is entitled to recover costs
from that time.3
Respondent argues that petitioner intended that the purchase
price ($513,400) provided in petitioner's stock purchase
agreement was payment solely for Grecco's stock. Respondent
points out that petitioner was obligated to pay Grecco that
amount even if Grecco had not agreed not to compete and even if
the fair market value of the stock was less than that amount.
Respondent maintains that the fact that petitioner and respondent
agreed to the fair market value for the stock did not alter the
fact that the allocation of any value to the covenant not to
compete lacked economic reality. Respondent argues that the
amount allocated to the covenant not to compete did not result
from arm's-length negotiations. Respondent points out that
Grecco and petitioner did not have adverse tax interests with
respect to the allocation of $383,400 to the covenant.
3
Generally, the position of the United States in the
judicial proceeding is the position taken in the Commissioner's
answer to the petition. Sec. 7430(c)(7)(A); Huffman v.
Commissioner, 978 F.2d 1139, 1148 (9th Cir. 1992), affg. in part,
revg. in part on other grounds and remanding T.C. Memo. 1991-144.
Respondent filed the answer on Dec. 6, 1993. Petitioner does not
contend that it is entitled to an award for litigation costs
incurred before Aug. 22, 1994.
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Respondent argues that Grecco was not concerned with the
allocation of the purchase price between her stock in petitioner
and the covenant not to compete, and that she was only concerned
with the total amount she would receive when she left petitioner.
None of these points establish that respondent had a basis
in fact for continuing to contend, after August 22, 1994, that
the covenant not to compete was worth $52,669. Respondent had
petitioner's expert's report on June 24, 1994 (3 months before
trial), and had respondent's expert's report on August 22, 1994
(one month before trial). Respondent did not concede that the
covenant was worth $324,100 (or any amount more than $52,669)
despite the fact that (a) petitioner's expert said that Grecco's
stock in petitioner was worth $190,000, respondent's expert said
it was worth $188,600, and the parties agreed that the stock was
worth $189,300, and (b) respondent presented no fact or theory to
support the conclusion that petitioner paid the remaining
$324,100 ($513,400 - 189,300 = $324,100) to Grecco for anything
other than the covenant not to compete. Respondent did not offer
a reasonable theory for why the covenant not to compete was worth
less than $324,100. Respondent's failure to reevaluate that
position after August 22, 1994, was unreasonable. Frisch v.
Commissioner, 87 T.C. 838, 841 (1986) (the Commissioner's
valuation position was unreasonable where the Commissioner had
the taxpayer's appraisal for 7 months before trial and did not
investigate further or reevaluate the Commissioner's own position
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as new facts came to light); Williford v. Commissioner, T.C.
Memo. 1994-135 (the Commissioner's valuation position was
unreasonable where the Commissioner was slow to seek an
appraisal, did not contact the taxpayer's valuation expert, and
did not modify her position after receiving the Commissioner's
expert's report 42 days before trial). Respondent's position in
the instant case is weaker than the Commissioner's position in
Frisch v. Commissioner, supra, because here respondent's expert
substantially agreed with petitioner's expert regarding the value
of Grecco's stock. We conclude that respondent's position did
not have a reasonable basis in fact or law.
3. Amount of Reasonable Attorney's Fees and Litigation
Costs
Petitioner seeks an award of litigation costs of $44,737.25,
comprising $42,254.75 for attorney's fees and $2,482.50 for out-
of-pocket expenses.
a. Hourly Rate
Respondent argues that the maximum hourly rate for
attorney's fees is $75, adjusted for increases in the cost of
living, sec. 7430(c)(1)(B)(iii), and that a higher limit should
not apply absent a showing that a special factor justifies a
higher rate, sec. 7430(c)(1)(B)(iii); Stieha v. Commissioner, 89
T.C. 784, 792 (1987).
Petitioner does not argue that special factors are present
that warrant payment of attorney's fees at a rate higher than
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$75. Accordingly, we apply the $75 hourly rate, adjusted for
increases in the cost of living. Sec. 7430(c)(1)(B)(iii).
b. Adjustment of $75 Limit for Increases in the Cost
of Living From 1986
We use the Consumer Price Index (CPI) for all urban
consumers to adjust the $75 hourly limit for increases in the
cost of living. Powers v. Commissioner, 100 T.C. at 491; Cassuto
v. Commissioner, 93 T.C. 256, 273 (1989), affd. in part and revd.
in part 936 F.2d 736 (2d Cir. 1991).
We have held that 1981 is the appropriate base year for
calculating cost of living increases under section
7430(c)(1)(B)(iii). Bayer v. Commissioner, 98 T.C. 19, 23
(1992); Cassuto v. Commissioner, supra at 269. However, the U.S.
Court of Appeals for the Ninth Circuit, to which this case is
appealable, has held that the appropriate base year for
calculating cost of living increases is 1986. Huffman v.
Commissioner, 978 F.2d 1139, 1151 (9th Cir. 1992), affg. in part
and revg. in part T.C. Memo. 1991-144. We follow that holding
here. Golsen v. Commissioner, 54 T.C. 742, 756-758 (1970), affd.
445 F.2d 985 (10th Cir. 1971).
In addition to attorney's fees, petitioner incurred
litigation costs of $2,482.50. Respondent does not argue that
the amount of litigation costs claimed by petitioner is
unreasonable except for the hourly rate issue just decided. We
treat this as respondent's concession that the number of hours
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billed by petitioner's attorneys and other litigation costs were
reasonable. The hours billed by petitioner's attorneys for which
petitioner is entitled to be reimbursed are for work performed
from August 1994 to March 1995. We award petitioner attorney's
fees at an hourly rate not to exceed $103.95 for 1994 and $107.10
for 1995, and litigation costs in the amount of $2,482.50.
An appropriate order and
decision will be entered.