T.C. Memo. 1999-30
UNITED STATES TAX COURT
JOHN C. AND KAROL BOWDEN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11152-95. Filed February 1, 1999.
David P. Leeper, for petitioners.
Gerald L. Brantley, for respondent.
MEMORANDUM OPINION
DEAN, Special Trial Judge: This case was assigned to Special
Trial Judge John F. Dean for the purpose of disposing of
petitioners': (1) Motion for an Award of Reasonable Litigation
Costs; and (2) Motion to Determine Prevailing Party Pursuant to
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Rules 230 through 233.1 Respondent filed responses to both
motions. Neither party requested a hearing. Rule 232(a).
Accordingly, we rule on petitioners' motions on the basis of
the parties' submissions and the record in this case. The
underlying issues raised in the petition were settled, and the
Court entered a stipulated decision.
Upon petitioners' subsequent filing of the motions, the
decision was vacated and set aside. The order decreed that the
stipulated decision document was to be filed as a Settlement
Stipulation.
Respondent determined deficiencies in petitioners' Federal
income taxes for the taxable years 1991, 1992, and 1993 in the
amounts of $102,781, $6,262, and $1,323, respectively. John C.
and Karol Bowden resided in El Paso, Texas, at the time their
petition was filed.
Background
John Bowden, Inc. (the corporation), was incorporated by
John Bowden (petitioner) in June 1991 to perform services in the
insurance industry. Prior to its incorporation, petitioner
operated his business as a sole proprietorship, working under
contract as a district manager for a group of insurance
1
All Rule references are to the Tax Court Rules of Practice
and Procedure. All section references, unless otherwise noted,
are to the Internal Revenue Code.
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companies2 in the El Paso, Texas, area. Pursuant to the
contract, petitioner recruited and trained insurance agents to
sell insurance exclusively for the insurance companies with which
he had contracted. After incorporation of his business,
petitioner continued to perform substantially the same services
for the insurance companies that he performed prior to
incorporation, but now he worked as an employee of the
corporation.3
Petitioner served as the sole director of the corporation,
and his wife, Karol Bowden, served as secretary.4 The corporate
minutes reflect that B. Kent Straughan was appointed as corporate
accountant and was instructed to handle the tax preparation and
accounting requirements associated with the incorporation. E. P.
"Bud" Kirk was appointed as corporate attorney.
In a transaction to which section 351 is applicable,
petitioner transferred property to the corporation in 1991
consisting of $10,000 cash, an airplane with a zero basis, a Ford
2
The insurance companies are Farmers Insurance Exchange,
Truck Insurance Exchange, Fire Insurance Exchange, Mid-Century
Insurance Co., Farmers' Texas County Mutual Insurance Co., and
Farmers New World Life Insurance Co.
3
Because petitioner no longer operated the business as a
sole proprietorship, the insurance companies renewed their
service contract with petitioner's corporation, with petitioner
personally performing the services.
4
The corporate minutes reflect that Karol Bowden served as
temporary secretary for purposes of the corporate meetings.
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van with a stated basis of $21,139, a computer system with a
stated basis of $97, office furniture and equipment with a stated
basis of $241, and insurance premium renewals with a stated basis
of $245,000.
In return, the corporation issued petitioner 1,000 shares of
stock. The corporation also assumed a $220,468 liability,
evidenced by a note, that petitioner had incurred to acquire his
ex-wife's community property interest in the sole proprietorship.
Assumption of the debt by the corporation did not relieve
petitioner of his primary liability on the note.
Upon incorporation, an account payable of $60,009 was
created on the books of the corporation to pay cash to petitioner
or pay other personal expenses on his behalf in the amounts of
$15,768, $21,540, and $23,951, for the years 1991, 1992, and
1993, respectively.5
Respondent issued a notice of deficiency to petitioners for
taxable years 1991, 1992, and 1993, determining that they must
recognize net capital gain on incorporation of the business in
the amount of $280,477. The explanation of adjustments in the
notice of deficiency states that in taxable year 1991,
petitioners received boot in the amounts of $60,009 in cash from
5
Although the parties stipulated the yearly amounts paid to
petitioner, the Court notes that the sum of these three payments
exceeds the $60,009 account payable recorded on the books of the
corporation. It is unclear to what source the additional funds
paid to petitioner were attributable.
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the note payable and $220,468 for the note assumed by the
corporation for petitioner's liability to his ex-wife.
Respondent also denied $13,885 in business expenses for 1991
and determined petitioners received constructive dividend income
in the amounts of $28,197 for 1991 and $13,651 for 1992. In
addition, their taxable income was increased in the amounts of
$32,976 and $1,547 for 1991 and 1992, respectively, pursuant to
the passive activity loss limitation provisions of section 469.
For taxable years 1992 and 1993, respondent characterized
petitioners' reported self-employment income as wage income and
disallowed deductions of $10,000 and $9,500, respectively, for
their contribution to a Simplified Employee Pension/Keogh Plan.
Petitioners filed a petition with the Court, alleging error
in each determination contained in the notice of deficiency.
Respondent filed an answer denying each allegation contained in
the petition.
Respondent subsequently filed an amendment to answer
asserting that the insurance premium renewals transferred to the
corporation had a basis of zero, not $245,000 as stated by
petitioners in their 1991 tax return. The amendment to answer
also asserted that there was a deficiency attributable to gain
resulting from the difference between the $220,468 liability
assumed by the corporation and the adjusted basis of all the
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property transferred, including the insurance renewal contract
rights with a zero basis.
The net capital gain to be recognized by petitioners under
these circumstances would be $249,000, consisting of the $60,009
account payable and $188,991 in excess debt assumed over the
total basis of property transferred.
Disputing respondent's contentions, petitioners filed two
motions to shift the burden of proof to respondent on the grounds
that (1) respondent's amended answer contained a new matter for
which respondent should have the burden of proof pursuant to Rule
142(a), and (2) respondent erroneously determined the boot
received in the section 351 transaction. Petitioners also filed
a motion to strike the notice of deficiency, alleging that the
notice of deficiency was arbitrary and erroneous. Petitioners'
motions were denied by order.
This case was eventually settled, and deficiencies were
stipulated in the amounts of $88,292, $4,044, and $1,323 for
taxable years 1991, 1992, and 1993, respectively. Petitioners
then filed a motion for an award of reasonable litigation costs
and a motion to determine prevailing party.
Discussion
Taxpayers may be awarded an amount for reasonable litigation
costs if they meet the requirements of section 7430. In order to
qualify for such an award, a party must: (1) Qualify as a
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prevailing party; (2) have exhausted available administrative
remedies; (3) not have unreasonably protracted the court
proceeding; and (4) show that the costs claimed are reasonable
litigation costs incurred in connection with the court
proceeding. Sec. 7430(c)(4), (b)(1), (b)(4), (a)(2). The
taxpayers have the burden of establishing that all the foregoing
criteria have been satisfied. See Rule 232(e); Maggie Management
Co. v. Commissioner, 108 T.C. 430 (1997).
Both petitioners and respondent agree that all the
administrative remedies available within the Internal Revenue
Service have been exhausted. There is some dispute, however, as
to the other requirements of section 7430.
Prevailing Party
To be a "prevailing party", a taxpayer must establish: (1)
The taxpayer substantially prevailed with respect to either the
amount in controversy or the most significant issue or set of
issues presented; (2) the position of the United States was not
substantially justified; and (3) the taxpayer met the net worth
requirements of 28 U.S.C. section 2412(d)(2)(B) (1994) at the
time the petition was filed. Sec. 7430(c)(4).
Respondent concedes that petitioners meet the net worth
requirements. Therefore, we need examine only the question of
whether petitioners substantially prevailed with respect to the
amount in controversy or the most significant issue or issues
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presented in their case, and whether the Government's litigation
position was substantially justified. See Swanson v.
Commissioner, 106 T.C. 76, 86 (1996).
Substantially Prevail Requirement
In petitioners' motion to determine the prevailing party,
petitioners argue that because respondent ultimately agreed to a
reduced deficiency and settled the case on a different legal
theory from that on which the notice of deficiency was issued,
petitioners are the prevailing party with respect to the most
substantial issue in their case. Respondent, on the other hand,
denies that the case was settled on a new legal theory and
further alleges that the settlement did not substantially reduce
the deficiency. Rather, respondent contends that the settlement
reduced the ultimate deficiency amount only by about $10,000 and
respondent prevailed on 88 percent of the adjustment.
To determine whether the taxpayer has substantially
prevailed within the meaning of section 7430(c)(4)(A), we look to
the final outcome of the case, whether by judgment or settlement.
Cassuto v. Commissioner, 936 F.2d 736, 741 (2d Cir. 1991), affg.
in part and revg. in part 93 T.C. 256 (1989). Section
7430(c)(4)(A)(i) is phrased in terms of issues, not claims. See
Huckaby v. United States, 804 F.2d 297, 299 (5th Cir. 1986).
In this case, the issues presented were: (1) Whether
petitioners must recognize net capital gain on the incorporation
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of their insurance business; (2) whether the self-employment
income reported on petitioners' Schedule C should be reclassified
as wage income; (3) whether petitioners are entitled to deduct
certain expenses on the Schedule C; (4) whether petitioners
received constructive dividends; (5) whether petitioners are
entitled to deduct rental losses; and (6) whether petitioners are
allowed a deduction for contributions to petitioner's retirement
plan.
The record does not reflect, and the parties did not provide
the Court with the details surrounding, the settlement of these
issues. If petitioners prevail on the most significant issue,
however, they have satisfied the requirement of section
7430(c)(4)(A). See Huckaby v. United States, supra.
Based on documents contained in the record, the most
significant issue in this case was whether petitioners must
recognize gain upon the transfer of assets and liabilities to the
corporation. Upon settlement of this case, petitioners conceded
that they must indeed recognize such gain.
Petitioners argue, nevertheless, that because they
recognized gain under section 357(c) instead of section 357(b),
they are the prevailing party on this issue. We disagree. Given
the facts and circumstances of this case, we find it irrelevant
whether gain was recognized under section 357(c) or 357(b).
Simply stated, petitioners must recognize gain due to the
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transfer of assets and liabilities in a section 351 transaction
and therefore did not substantially prevail on the most
significant issue in the case.
We are puzzled by petitioners' unyielding attention to the
section 357(b) and (c) distinction. Petitioners filed a motion
to shift the burden of proof to respondent on the basis that the
Government's amendment to answer asserted gain under section
357(c) and contained a new matter and because the calculation of
gain to be recognized by petitioners was incorrect. This motion
was denied by order of this Court, determining that the section
357(c) gain was not a new issue in the case, and the burden of
proof did not shift to respondent. In light of this Court's
order, we shall not rule in favor of petitioners on a theory that
the section 357(c) issue was not encompassed by the notice of
deficiency. Our earlier ruling concluded that the section 357(c)
issue was indeed contemplated by the notice of deficiency, and we
decline to revisit the issue on petitioners' motion.
With respect to the amount in controversy, the parties
settled on tax deficiency amounts of $88,292, $4,044, and $1,323
for taxable years 1991, 1992, and 1993, respectively. These
settlement figures amount to 86 percent, 65 percent, and 100
percent of the total amounts determined in the notice of
deficiency. Therefore, petitioners have not shown that they are
the prevailing party with respect to either the amount in
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controversy or with respect to the most significant issue
presented. See Bragg v. Commissioner, 102 T.C. 715 (1994).
Because petitioners are not the prevailing party, we need
not decide whether petitioners' litigation costs are reasonable,
or whether petitioners unreasonably protracted the court
proceedings. Accordingly, we hold for respondent and
petitioners' motions for litigation costs and to determine
prevailing party will be denied.
To reflect the foregoing,
An appropriate Order and
Decision will be entered