T.C. Memo. 2001-74
UNITED STATES TAX COURT
JOHN S. GIBSON, f.k.a. JOHN S. MACTAVISH, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7628-98. Filed March 23, 2001.
Peter L. Milinkovich, for petitioner.
John C. Schmittdiel, for respondent.
MEMORANDUM OPINION
PANUTHOS, Chief Special Trial Judge: This case is before
the Court on petitioner’s Motion for Litigation and
Administrative Costs filed pursuant to section 7430 and Rule 231.
All references to section 7430 are to that section as in effect
at the time the petition was filed. Unless otherwise indicated,
all other section references are to the Internal Revenue Code in
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effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
We must decide whether petitioner is entitled to
administrative and litigation costs. After concessions,1 the
issue for decision is whether respondent’s position in the
underlying proceeding was substantially justified. We hold that
respondent’s position was substantially justified, and,
therefore, petitioner is not entitled to an award of
administrative and litigation costs.
Petitioner seeks fees and costs totaling $5,655.40. The
parties submitted memoranda and affidavits supporting their
positions. We decide the motion on the basis of those memoranda,
affidavits, and the record in this case. Neither party requested
a hearing, and we conclude that a hearing is not necessary to
decide this motion. See Rule 232(a)(2).
Petitioner resided in Ramsey, Minnesota, at the time he
filed his petition.
Background
Respondent began an examination of petitioner’s Federal
income tax returns for tax years 1991 through 1993 sometime in
1995. Petitioner did not file a Federal income tax return for
1
Respondent concedes that petitioner (1) substantially
prevailed with respect to the amount in controversy, (2) met the
net worth requirement as provided by sec. 7430, and (3) exhausted
his administrative remedies.
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tax year 1994, and this tax year was also included as part of the
examination.
During the examination, respondent obtained petitioner’s
accounts receivable book (redbook). Respondent computed gross
receipts and proposed adjustments to income relying on the
redbook. Petitioner sent respondent a letter on at least one
occasion to dispute the method by which respondent interpreted
the redbook in proposing adjustments to gross receipts.2 Each
time petitioner or his representative identified errors,
respondent considered the information and modified the
adjustments to income.
Respondent issued a notice of deficiency to petitioner on
January 30, 1998. Respondent determined deficiencies in
petitioner’s Federal income taxes, penalties, and additions to
tax as follows:
Additions to Tax Penalties
Year Deficiency Sec. 6651(a)(1) Sec. 6654 Sec. 6662(a)
1991 $3,272 $790 --- $654
1992 3,455 --- --- 691
1993 58,640 2,932 --- 11,728
1994 150,431 37,608 $7,750 ---
2
Petitioner did not attach to his motion for costs a
copy of the correspondence, but the notice of deficiency makes
reference to unspecified allegations of error by petitioner.
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Respondent computed gross receipts for 1992 through 1994 by
relying on petitioner’s redbook. Respondent reconstructed income
for the 1991 tax year using the bank deposits method.
Petitioner timely filed a petition with this Court.
Petitioner disagreed with respondent’s method of calculating
gross receipts. Petitioner alleged in the petition as follows:
The Petitioner disagrees with each and every adjustment
set forth in Respondent’s notice of deficiency. The
respondent has recomputed Petitioner’s income based on
a method that is so flawed and full of errors that it
lacks all basis in reality. Furthermore, since the
income computation is incorrect, the penalties which
are applied against the income are not appropriate and
are therefore disputed.
Petitioner did not specifically identify the alleged errors made
by respondent in the notice of deficiency.
In his answer, respondent generally denied the allegations
of error. At some point in 1999, respondent, with petitioner’s
assistance, calculated income for 1992 and 1993 via the bank
deposits method. Petitioner provided information to respondent’s
Appeals officer to establish that certain deposits for 1991,
1992, and 1993 were not taxable. The parties agreed to the
amount of unreported gross receipts for tax years 1991 through
1993 shortly thereafter.
Between May 1999 and May 2000, the parties reconstructed
petitioner’s income and expenses for tax year 1994. The parties
also reached agreement regarding the adjustment to business gross
receipts for 1994. The gross receipts per the notice of
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deficiency and the gross receipts per the agreement are set forth
below:
Year Notice of Deficiency Agreed Amount
1991 $11,363 $5,000
1992 15,031 6,107
1993 200,457 13,992
1994 574,759 571,259
Total 801,610 596,358
A stipulation of settlement based on the agreement of the
parties was filed on September 11, 2000. The deficiencies,
additions, and penalty agreed to are as follows:
Additions to Tax Penalty
Year Deficiency Sec. 6651(a)(1) Sec. 6654 Sec. 6662(a)
1991 $1,489 $331 --- None
1992 955 --- --- $191
1993 None None --- None
1994 7,753 1,938 None ---
Petitioner argues that respondent was not substantially
justified because respondent used a flawed method of determining
income by treating the redbook as a cash receipts journal instead
of including as income the amounts petitioner actually received.3
Petitioner contends that respondent’s determination resulted in
an overstatement of income. Petitioner further argues that
respondent should have used a bank deposits or net worth method
3
We note that while neither party presented evidence as
to whether petitioner reported income and expenses by the cash or
accrual method, we assume that the method of accounting and
reporting is not in issue in this case.
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to verify income. Finally, petitioner asserts that the “need to
independently verify the calculation [gross receipts] arose from
the IRS’ distrust of the taxpayer, not the inadequacy of the
records.”
Respondent contends that he was substantially justified
because he relied on petitioner’s books and records in
determining income pursuant to section 446(a), and, when it
became apparent that petitioner’s books and records were
inaccurate, respondent, in concert with petitioner’s counsel,
employed the bank deposits method. Further, respondent claims
that he was substantially justified as to tax year 1994 because
petitioner did not file a tax return, and, therefore, respondent
was required to compute income. It was by use of the bank
deposits method that the parties were able to resolve the amounts
in dispute.
Discussion
A. Section 7430
Section 7430(a) provides that the prevailing party in any
administrative or court proceeding may be awarded a judgment for
(1) reasonable administrative costs incurred in connection with
such administrative proceedings within the Internal Revenue
Service (IRS), and (2) reasonable litigation costs incurred in
connection with such court proceedings. See sec. 7430(a), (c).
The prevailing party must exhaust his administrative remedies,
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and the prevailing party must not protract either the
administrative or court proceedings. See sec. 7430(b)(1), (3).
The parties agree that petitioner exhausted his administrative
remedies.4
A prevailing party is defined as a taxpayer who
substantially prevails as to the amount in controversy or with
respect to the most significant issue or set of issues. See sec.
7430(c)(4)(A)(i); sec. 301.7430-5(a)(2), Proced. & Admin. Regs.
Respondent concedes that petitioner substantially prevailed as to
the amount in controversy or with respect to the most significant
set of issues. Petitioner will nevertheless fail to qualify as
the prevailing party if respondent can establish that
respondent’s position in the administrative and court proceedings
was substantially justified. See sec. 7430(c)(4)(B).
B. Substantial Justification
The Commissioner will be substantially justified where his
position has a reasonable basis in both law and fact. See Pierce
v. Underwood, 487 U.S. 552 (1988); Rickel v. Commissioner, 900
F.2d 655, 665 (3d Cir. 1990), affg. in part and revg. in part on
other grounds 92 T.C. 510 (1989); Hanover Bldg. Materials, Inc.
v. Guiffrida, 748 F.2d 1011, 1015 (5th Cir. 1984).
4
As a result of our conclusion herein, we need not
decide whether petitioner protracted the proceeding.
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A position is substantially justified if the position is
“justified to a degree that could satisfy a reasonable person.”
Pierce v. Underwood, supra at 565 (construing similar language in
the Equal Access to Justice Act). The Commissioner’s position
may be incorrect but nevertheless be substantially justified “‘if
a reasonable person could think it correct.’” Maggie Management
Co. v. Commissioner, 108 T.C. 430, 443 (1997) (quoting Pierce v.
Underwood, supra at 566 n.2).
The fact that the Commissioner eventually loses or concedes
a case does not establish that his position was unreasonable.
See Wilfong v. United States, 991 F.2d 359, 364 (7th Cir. 1993);
Hanson v. Commissioner, 975 F.2d 1150, 1153 (5th Cir. 1992);
Estate of Perry v. Commissioner, 931 F.2d 1044, 1046 (5th Cir.
1991); Sokol v. Commissioner, 92 T.C. 760, 767 (1989). However,
it does remain a factor to be considered. See Estate of Perry v.
Commissioner, supra; Powers v. Commissioner, 100 T.C. 457, 471
(1993), affd. in part, revd. in part and remanded on another
issue 43 F.3d 172 (5th Cir. 1995).
As relevant herein, we review the Commissioner’s position as
of the date of the notice of deficiency to determine whether he
was substantially justified with respect to the recovery of
administrative costs. See sec. 7430(c)(7)(B). We examine the
Commissioner’s position in his answer to the petition to
determine whether he was substantially justified with respect to
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the recovery of litigation costs. See Bertolino v. Commissioner,
930 F.2d 759, 761 (9th Cir. 1991); Sher v. Commissioner, 861 F.2d
131, 134-135 (5th Cir. 1988), affg. 89 T.C. 79 (1987).
Ordinarily, we consider the reasonableness of each of these
positions separately. See Huffman v. Commissioner, 978 F.2d
1139, 1144-1147 (9th Cir. 1992), affg. in part, revg. in part and
remanding on other issues T.C. Memo. 1991-144. In the present
case, however, we jointly consider the positions because there is
no indication that respondent’s position changed between the
issuance of the notice of deficiency (on January 30, 1998) and
the filing of the answer to the petition (on May 22, 1998). See
Swanson v. Commissioner, 106 T.C. 76, 87 (1996).
C. Reasonable Basis in Law and Fact
Taxpayers are required to maintain books and records in
accordance with rules and regulations prescribed by the
Secretary. See sec. 6001. Generally, taxpayers must “keep such
permanent books of account or records” sufficient to establish
gross income, deductions, or other matters required to be shown
on the return. Sec. 1.6001-1(a), Income Tax Regs. Accounting
records include the taxpayer’s regular books and other records
and data necessary to support entries on books and tax returns.
See sec. 1.446-1(a)(4), Income Tax Regs.
Taxable income is generally computed under the method of
accounting on the basis of which the taxpayer regularly computes
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his income in keeping his books. See sec. 446(a). However, if
the method of accounting or the books do not clearly reflect
income, the Commissioner may compute income through any method
that clearly reflects income. See sec. 446(b); Holland v. United
States, 348 U.S. 121, 132 (1954); Mallette Bros. Constr. Co.,
Inc. v. United States, 695 F.2d 145, 148 (5th Cir. 1983);
Meneguzzo v. Commissioner, 43 T.C. 824 (1965); Zamzam v.
Commissioner, T.C. Memo. 2000-371.
The Commissioner’s reconstruction of income need only be
reasonable; it need not be exact. See Holland v. United States,
supra; Giddio v. Commissioner, 54 T.C. 1530, 1533 (1970);
Schroeder v. Commissioner, 40 T.C. 30, 33 (1963); Diesel Country
Truck Stop, Inc. v. Commissioner, T.C. Memo. 2000-317. The
Commissioner need not concede an adjustment until he has
“received and verified adequate substantiation for the items in
question.” Simpson Fin. Services v. Commissioner, T.C. Memo.
1996-317 (citing Harrison v. Commissioner, 854 F.2d 263, 265 (7th
Cir. 1988), affg. T.C. Memo. 1987-52); see Sokol v. Commissioner,
supra at 765.
Respondent relied on petitioner’s books and records in
computing gross receipts for 1992 through 1994. Respondent
determined in the notice of deficiency for tax years 1992, 1993,
and 1994 that petitioner omitted gross receipts totaling
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$790,247.5 Although respondent’s method of computing gross
receipts was not error free, respondent was 75 percent accurate
in the determination in the notice of deficiency using
petitioner’s books and records.6 After respondent filed his
answer, petitioner and third parties provided documents to
respondent that led respondent to adjust the computation of
income. Respondent had a reasonable basis in law and fact in
relying on petitioner’s records in determining the deficiencies.
Petitioner argues that respondent was not substantially
justified because respondent should have used the bank deposit
method in his determination rather than relying on the redbook.
Petitioner further asserts that respondent’s agent misconstrued
the redbook. According to petitioner, the only reason respondent
sought to substantiate the gross receipts reported, and in the
case of 1994, not reported, was respondent’s vendetta against
petitioner. In essence, petitioner refutes the accuracy of his
own books and records. Petitioner repeatedly emphasizes that
respondent was not substantially justified because respondent did
not verify gross receipts through another method. We reject
5
We do not address 1991 since respondent employed the
method (bank deposits) which petitioner argues respondent should
have used.
6
The notice of deficiency determined gross receipts for
1992 through 1994 of $790,247. The parties agreed that, under
the bank deposits method, petitioner failed to report gross
receipts of $591,358 for those years.
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petitioner’s nonsensical arguments. Even assuming the agent
misconstrued petitioner’s books and records, it is apparent that
the records did not accurately reflect income. Further, each
time petitioner provided additional information to respondent,
recomputations were made to the proposed adjustment to income.7
D. Conclusion
We hold that petitioner is not entitled to an award of
administrative and litigation costs because respondent’s position
was substantially justified. In so holding, we have carefully
considered the remaining arguments made by the parties, and to
the extent not discussed above, we consider those arguments to be
without merit.
In order to reflect the foregoing,
An appropriate order and
decision will be entered.
7
As indicated, petitioner did not file a return for tax
year 1994. In 1999, a year after respondent filed his answer to
the petition, the parties began a yearlong process of calculating
petitioner’s gross receipts. Respondent was not unreasonable in
his initial determination or the consideration of documentation
to verify gross receipts for 1994.