T.C. Memo. 1997-541
UNITED STATES TAX COURT
PATRICIA WILLIAMS, a.k.a. PATRICIA RICHARDSON,
a.k.a. TISH MARTINSON, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 9143-96. Filed December 9, 1997.
Barry L. Guterman, for petitioner.
Edwin A. Herrera and Linas N. Udrys, for respondent.
MEMORANDUM OPINION
JACOBS, Judge: This matter is before the Court on
petitioner's motion for award of litigation and administrative
costs pursuant to section 74301 and Rule 231.
1
References to sec. 7430 are to that section as amended
(continued...)
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Unless otherwise indicated, all section references are to the
Internal Revenue Code in effect for the matter under consideration,
and all Rule references are to the Tax Court Rules of Practice and
Procedure.
Respondent determined the following deficiencies in, and
additions to, petitioner's Federal income taxes:
Additions to Tax
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6651(a)(1) 6653(a)(1)(A) 6653(a)(1)(B) 6653(a)(1) 6654
1
1987 $62,203 $15,551 $3,110 --- $3,359
1988 28,777 7,194 --- --- $1,439 1,843
1989 78,170 19,543 --- --- --- 5,287
1
50 percent of the interest payable under sec. 6601 on the portion of the
underpayment attributable to negligence or disregard of rules or regulations.
The underlying matter herein was resolved pursuant to a
stipulation of settled issues filed with the Court on June 20,
1997. In the settlement, respondent conceded all deficiencies and
1
(...continued)
by sec. 1551 of the Tax Reform Act of 1986, Pub. L. 99-514, 100
Stat. 2752 (applicable to all proceedings commenced after Dec.
31, 1985), and by sec. 6239(a) of the Technical and Miscellaneous
Revenue Act of 1988, Pub. L. 100-647, 102 Stat. 3342, 3743-3747
(effective for all proceedings commenced after Nov. 10, 1988).
Sec. 7430 was again amended by the Taxpayer Bill of Rights 2
(TBOR2), Pub. L. 104-168, sec. 701, 110 Stat. 1452, 1463-1464
(1996), effective for all proceedings commenced after July 30,
1996. The amendments to that section place on the Commissioner
the burden of proving that the position of the United States was
substantially justified. Sec. 7430(c)(4)(B).
A judicial proceeding is commenced by the filing of a
petition. Rule 20(a). Petitioner filed her petition on May 10,
1996. Accordingly, the amendments to sec. 7430 by TBOR2 are
inapplicable here. See Maggie Management Co. v. Commissioner,
108 T.C. 430 (1997).
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additions to tax for 1987 and 1988, and the parties agreed that
petitioner was liable for a 1989 deficiency of $2,831 and an
addition to tax pursuant to section 6651(a)(1) for 1989. The
relevant facts are taken from the parties' submissions and the
existing record.
At the time the petition was filed, petitioner resided in
Rancho Mirage, California.
Background
In January 1989, the Internal Revenue Service (IRS) began an
investigation of petitioner's failure to file Federal income tax
returns for years 1982 through 1987. The investigation was later
expanded to include 1988 and 1989.
Investigation by Revenue Officer Lepkojus
Revenue Officer Ted Lepkojus investigated petitioner from
approximately December 18, 1990, to November 5, 1992. During the
course of his investigation, Revenue Officer Lepkojus had
difficulty locating petitioner due to her failure to file Federal
tax returns and her use of several different names. Letters and
postal tracers were sent to petitioner at her last known address,
but these efforts proved unsuccessful in locating her. Her former
attorney of record, Norman Axe, was also unsure of her whereabouts.
In March 1991, Revenue Officer Lepkojus was contacted by
Michael Kazanjian who indicated that he had paid petitioner
$124,000 in 1987 in exchange for her services as an interior
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decorator. However, in a letter dated June 10, 1991, from Mr.
Kazanjian's accountant, Revenue Officer Lepkojus was informed that
the $124,000 was not for services rendered, but rather for
petitioner's share in a real estate venture which was sold in 1987.
In March 1991, Revenue Officer Lepkojus spoke with Dr. John
Williams, petitioner's former husband, who stated that he had paid
petitioner alimony during the years in issue.
In September 1991, Revenue Officer Lepkojus issued a summons
for petitioner's bank records, and in October 1991 he received the
records which included checks in large amounts.
On December 16, 1991, Revenue Officer Lepkojus obtained
information relating to petitioner's residence in Los Angeles,
California, and subsequently confirmed that address. Petitioner
was not present when he visited the home on January 29, 1992.
Revenue Officer Lepkojus referred petitioner's case to the
U.S. Department of Justice, Criminal Investigation Division (CID).
The case was returned to him in November 1992, and shortly
thereafter he forwarded it to the IRS examination division.
Examination by Revenue Agent Kropp
Revenue Agent David Kropp conducted an examination of
petitioner for her unpaid Federal income taxes for 1987, 1988, and
1989. His investigation took place from approximately May 22,
1995, to October 10, 1995.
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On May 22, 1995, Revenue Agent Kropp mailed a notice to
petitioner scheduling an appointment for June 15, 1995. Neither
petitioner nor a representative on her behalf appeared at the
meeting.
Revenue Agent Kropp mailed a "30-day letter" dated September
5, 1995, to petitioner, along with his examination findings of
unreported income for the years in issue. The 30-day letter stated
that if petitioner disagreed with the findings, she could either:
(1) Mail additional evidence or information; (2) request a
discussion of the findings with the examiner; or (3) discuss her
position with a group or senior manager. The letter further stated
that if petitioner did not want to take any of these courses of
action, she could either call or write the IRS within 30 days from
the date of the letter.
On September 25, 1995, petitioner contacted Revenue Agent
Kropp and informed him that she disagreed with the findings in the
30-day letter and would provide additional information to him.
On October 10, 1995, not having received any information from
petitioner, Revenue Agent Kropp closed petitioner's case as
"unagreed" and forwarded it to the appropriate section of the IRS
for issuance of a notice of deficiency.
On October 26, 1995, petitioner retained Barry L. Guterman to
represent her in the tax matters. On November 6, 1995, Mr.
Guterman informed Revenue Agent Kropp of his retention by
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petitioner and requested copies of the bank records he used as the
basis of his findings. Mr. Guterman also requested additional time
to file a written protest to the findings. On November 7, 1995,
Revenue Agent Kropp advised Mr. Guterman that because petitioner
had not furnished the information she promised, petitioner's case
had been closed as unagreed and that the administrative file had
been sent to the notices section of the Laguna Niguel district of
the IRS. Mr. Guterman requested that the file be retrieved so that
petitioner could provide the necessary information; but on December
15, 1995, Revenue Agent Kropp informed Mr. Guterman that a notice
of deficiency was about to be issued and that petitioner's file
would not be returnable to him (i.e., to Revenue Agent Kropp).
FOIA Request
On December 15, 1995, Mr. Guterman filed a Freedom of
Information Act (FOIA) request with the IRS to determine the basis
of Revenue Agent Kropp's examination adjustments. On or about
April 16, 1996, Mr. Guterman received copies of petitioner's
examination files, including a partially redacted investigation
history, bank printouts, and bank deposit and withdrawal items for
the years in issue. The exam work papers for 1989 stated that "All
income is based on BDA [bank deposits analysis] done by Criminal
Investigation Division from LA District: Deposits being added to
income: $259,952." Similar work papers were prepared for 1987 and
1988.
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Notice of Deficiency
On February 15, 1996, respondent issued a notice of deficiency
to petitioner. The notice stated that upon conducting a bank
deposit analysis of petitioner's City National Bank accounts, the
Commissioner determined that petitioner failed to report taxable
income of $167,693 in 1987, $85,204 in 1988, and $259,957 in 1989.
On May 10, 1996, petitioner filed a petition with this Court,
denying that she had any unreported taxable income during the years
in issue. In the answer filed on June 24, 1996, respondent
asserted that some of the bank deposit sources were verified.
Settlement Negotiations
In late July 1996, Mr. Guterman received a letter from Appeals
Officer Steve Millang requesting a settlement conference for August
12, 1996. The meeting was never scheduled due to the fact that
Mr. Guterman was awaiting the result of a bank deposit analysis
conducted by Steve Slatkin, an expert retained by Mr. Guterman.
Additionally, Mr. Guterman was awaiting the production of
additional bank deposit documents in the IRS's possession. Appeals
Officer Millang forwarded the additional documents to Mr. Guterman.
On or about September 24, 1996, Mr. Guterman wrote District
Counsel Linas Udrys and requested the latter to obtain additional
bank deposit information from the CID. On November 5, 1996,
Appeals Officer Millang wrote Mr. Guterman advising that the CID
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files contained no canceled checks, bank statements, or bank
deposit slips.
A "Branerton letter", dated November 26, 1996, from District
Counsel Udrys was sent to Mr. Guterman informing him that
respondent was preparing for trial. The letter specifically
requested any documentation in Mr. Guterman's possession that would
demonstrate the nontaxable sources of petitioner's bank deposits.
Mr. Guterman requested (and received) additional time to prepare
answers to the Branerton letter questions and complete his own bank
deposits analysis. By letter dated February 24, 1997, District
Counsel Edwin Herrera again asked for Mr. Guterman's responses and
bank deposit analysis. On March 13, 1997, Mr. Guterman forwarded
his Branerton letter responses and bank deposit analysis to
district counsel's office.
On April 30, 1997, following several telephone conferences
between respondent and Mr. Guterman, Appeals Officer Millang
formally offered a settlement proposal which subsequently led to
the stipulation of settled issues.
Petitioner then sought reasonable litigation and
administrative costs from respondent, which respondent rejected.
On June 20, 1997, petitioner filed the instant motion for award of
litigation and administrative costs.
Discussion
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A taxpayer who is a prevailing party in an administrative or
court proceeding may be awarded reasonable litigation and
administrative costs incurred in such proceedings. Sec. 7430(a).
A prevailing party is a taxpayer who establishes: (1) The position
of the United States in the proceeding was not substantially
justified; (2) the taxpayer substantially prevailed with respect to
either the amount in controversy or on the most significant issues;
and (3) the taxpayer's net worth does not exceed $2 million. Sec.
7430(c)(4)(a). Additionally, to recover costs the taxpayer must
have exhausted his/her administrative remedies, sec. 7430(b)(1),2
not have unreasonably protracted the proceedings, sec. 7430(b)(4),
and demonstrated that costs incurred were reasonable, sec.
7430(c)(1) and (2).
Petitioner must establish all of the above requirements before
this Court may award litigation and administrative costs under
section 7430. Minahan v. Commissioner, 88 T.C. 492, 497 (1987).
Petitioner has the burden of proof with respect to each
requirement. Rule 232(e).
The parties primarily dispute whether respondent's position in
both the administrative and judicial proceedings was substantially
justified. Respondent also asserts that petitioner failed to
exhaust her administrative remedies and claims that her costs were
not reasonable.
2
This requirement applies only to litigation costs.
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Petitioner contends that respondent's position in both the
administrative and litigation proceedings was not substantially
justified. Specifically, petitioner claims that prior to the
issuance of the notice of deficiency, respondent knew or had reason
to know that a substantial portion of the bank deposits came from
nontaxable sources, most notably nontaxable child care payments or
property settlement proceeds. Petitioner further claims that the
IRS lost or destroyed much of the evidence supporting these facts,
thus forcing petitioner to prove her case again.
Disagreeing with petitioner, respondent asserts that from the
district counsel's first involvement in this matter, diligent and
reasonable efforts were made to verify petitioner's claims.
Respondent further claims that the IRS's activity prior to district
counsel's involvement is irrelevant in determining whether
petitioner is entitled to reasonable litigation and administrative
costs.
For the reasons set forth below, we shall deny petitioner's
motion for award of litigation and administrative costs.
Respondent generally takes a position in a judicial proceeding
upon the filing of the answer to the petition. Huffman v.
Commissioner, 978 F.2d 1139, 1148 (9th Cir. 1992), affg. in part
and revg. in part on other grounds, and remanding T.C. Memo. 1991-
144. Respondent takes a position in an administrative proceeding
as of the earlier of the date the taxpayer receives an IRS Appeals
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decision or the date of the notice of deficiency. Sec.
7430(c)(7)(B). In Egan v. Commissioner, 91 T.C. 705, 711 (1988),
and Sher v. Commissioner, 89 T.C. 79, 86 (1987), affd. 861 F.2d 131
(5th Cir. 1988), we held that the Court may only consider
respondent's position and actions after the involvement of district
counsel. These cases were legislatively superseded by section
7430(c)(7). Brice v. Commissioner, T.C. Memo. 1990-355, affd.
without published opinion 940 F.2d 667 (9th Cir. 1991).
Respondent's position is substantially justified if that
position could satisfy a reasonable person and if it has a
reasonable basis in both fact and law. Pierce v. Underwood, 487
U.S. 552, 565 (1988); Swanson v. Commissioner, 106 T.C. 76, 86
(1996). We examine the facts known to respondent at the time the
position was taken. Coastal Petroleum Refiners, Inc. v.
Commissioner, 94 T.C. 685, 689 (1990). The fact that respondent
eventually loses or concedes a case is not determinative of whether
petitioner is entitled to reasonable litigation and administrative
costs. Sokol v. Commissioner, 92 T.C. 760, 767 (1989).
We first consider whether respondent's position during the
administrative proceeding was substantially justified.
Respondent's position in the administrative proceeding was first
established with the issuance of the notice of deficiency, dated
February 15, 1996. The notice stated that petitioner's taxable
income was being increased by the amount of bank deposits at City
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National Bank due to "the absence of adequate records". It is not
clear what information respondent possessed at the time the notice
was issued. However, it is evident that such information was
limited to information obtained from third party sources and
witness statements (particularly those of petitioner's former
husband John Williams and Mr. Kazanjian). Moreover, petitioner had
yet to provide any information to respondent to corroborate the
information given by others.
Furthermore, petitioner has not proven that the information
possessed by respondent at the time the notice was issued would
satisfy the hypothetical reasonable person that the bank deposits
came from nontaxable sources. Although, as petitioner contends,
respondent may have known about petitioner's divorce and the
subsequent nontaxable property settlement and child care payments,
there is no evidence that respondent had successfully matched the
bank deposits with those sources. Additionally, there were many
deposits that required explanation, and a determination of the
amount of income (if any) petitioner received from rendering
interior decorating services had to be made.
To be sure, it is not unreasonable for the Commissioner to
require a taxpayer to corroborate his or her claims regarding
dispositive and unresolved facts. Baker v. Commissioner, 83 T.C.
822, 830 (1984), vacated and remanded on another issue 787 F.2d 637
(D.C. Cir. 1986). The Commissioner is not required to concede a
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case until petitioner provides the necessary documentation to prove
petitioner's contentions. See Brice v. Commissioner, supra.
In sum, we find that respondent's position during the
administrative proceeding was substantially justified.
We now turn our attention to whether respondent's position in
the judicial proceeding was substantially justified. Respondent's
position in the judicial proceeding first occurred with the filing
of an answer to petitioner's petition on or about June 24, 1996.
The position taken in respondent's answer was the same as in the
notice of deficiency; i.e., respondent sought verification and
corroboration of petitioner's bank deposit sources.
Because no new information was received between the time the
notice of deficiency was issued (February 15, 1996) and the time
the answer was filed (June 24, 1996), respondent's position in the
answer was reasonable. See Brantley v. Commissioner, T.C. Memo.
1995-564. Moreover, respondent made diligent efforts to resolve
this case, contacting petitioner regarding settlement discussions
within 1 month of filing the answer. One reason why settlement may
not have been reached sooner than it was (in April 1997) was
because of petitioner's request for additional time to complete her
own bank deposit analysis and to gather more information from the
Government.
After the notice of deficiency is issued, respondent may
through district counsel independently verify a taxpayer's claims
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before conceding issues and settling a case. Sliwa v.
Commissioner, 839 F.2d 602, 609 (9th Cir. 1988). Respondent
attempted this through both telephone conversations with Mr.
Guterman and the Branerton letter. Petitioner has not suggested
that respondent's actions after the issuance of the notice of
deficiency were improper or in an effort to delay the proceedings.
In fact, only 1-1/2 months after receiving petitioner's responses
to respondent's Branerton letter and petitioner's own bank deposit
analysis, respondent made a request to settle the case, and shortly
thereafter respondent did in fact concede the majority of it. Cf.
Brantley v. Commissioner, supra, and cases cited therein.
Although petitioner may have believed that the third party
information obtained by the Government was sufficient to resolve
this case, it was not enough to satisfy respondent in the exercise
of reasonable judgment. We find that respondent's position during
the judicial proceeding was substantially justified.
Because we hold that respondent's position was substantially
justified in this case, we do not need to address whether
petitioner exhausted her administrative remedies or whether the
costs sought are reasonable.
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To reflect the foregoing and the stipulation of settled issues
filed June 20, 1997,
An appropriate order and
decision will be entered.