T.C. Memo. 2002-175
UNITED STATES TAX COURT
FREDERICK M. AND CHERYL A. PROUTY, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 6020-01. Filed July 24, 2002.
Frederick M. and Cheryl A. Prouty, pro sese.
William W. Kiessling, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
DEAN, Special Trial Judge: This case is before the Court on
petitioners' Motion for Administrative Costs filed pursuant to
section 7430 and Rule 231. All references to section 7430 are to
such section as in effect at the time the petition was filed.
Unless otherwise specified, all other section references are to
the Internal Revenue Code in effect for the year in issue, and
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all Rule references are to the Tax Court Rules of Practice and
Procedure.
Respondent filed a response to petitioners' motion.
Respondent agrees that petitioners: (a) Have substantially
prevailed with respect to the most significant issue presented;
and (b) have exhausted their administrative remedies.
Respondent does not agree, however, that petitioners: (1)
Have shown that they meet the net worth requirements as provided
by law; (2) have not unreasonably protracted the administrative
proceedings; (3) have claimed a reasonable amount of costs; or
(4) that respondent's positions in the administrative proceedings
were not substantially justified.
We conclude that a hearing is not necessary to decide this
motion. See Rule 232(a)(2). Accordingly, we rule on
petitioners' motion for administrative costs on the basis of the
parties' submissions and the record in this case.
FINDINGS OF FACT
Petitioners resided in Old Hickory, Tennessee, at the time
they filed their petition.
Petitioners timely filed their Form 1040, U.S. Individual
Income Tax Return, for 1998. One of the attachments to the
return was a Form W-2, Wage and Tax Statement, in the name of
Fred M. Prouty, Jr., reporting wages of $23,925.30. The total
wages reported on line 7 of the tax return were $23,925. There
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was another attached Form W-2 for Mr. Prouty from "Theatrical &
TV Motion Picture Special Payment Fund" (TMPSPF) in the amount of
$10.40.
Attached to the return were two Forms W-2 in the name of
Cheryl Prouty (petitioner). One was from "Sinclair Television of
Nashville, Inc." indicating wages, tips and other compensation of
$28,429.47, and the other was from "Lambert Broadcasting of
Nashville" (Lambert) indicating $26,259.82. On neither form was
box 15 checked to indicate that petitioner was a "statutory
employee".
Petitioners filed with their return two Schedules C, Profit
or Loss From Business. No Schedule C was filed for Mr. Prouty,
both were for petitioner. One was for her multilevel sales
representative business, and one was for the business of "TV
Sales Executive" under the business name, "WZTV & WNAB". The
latter Schedule C reported business income of $61,001, expenses
of $7,904, and net profit of $53,097.
The Internal Revenue Service Center (Service Center) in
Ogden, Utah, sent petitioners a form notice CP-2000 dated October
31, 2000, proposing changes to their 1998 income tax return.
Among other items, the Internal Revenue Service (IRS) proposed an
increase in taxable wages of $7,914, an amount that comports with
the sum of the disallowance of petitioner's TV Sales Executive
Schedule C deduction of $7,904 and the Form W-2 in the name of
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Mr. Prouty reporting $10.40 of income from TMPSPF. One paragraph
of the notice states: "Since your employer did not indicate on
Form W-2 that you were a statutory employee, we disallowed the
expenses you claimed against that income on Schedule C", and the
notice requests verification that "you are a statutory employee."
A copy of the notice CP-2000 that was sent to petitioners
was returned to the Ogden Service Center and dated as received on
November 17, 2000. The returned copy of the notice exhibits
various handwritten notations and included an attachment. The
attachment is a copy of a letter from an official of the Lambert
Broadcasting Company describing petitioner as an outside sales
representative compensated 100 percent by commissions. On the
face of the letter, beneath the signature of the official, the
following is typed:
Note: The other TV station I worked for was the
same type employment. (Sullivan Broadcasting of
Nashville) I am not on good terms with them so I had
rather not get a letter from them. I received no
travel allowance from them. I hope this letter will be
satisfactory.
Thank you, Cheryl Prouty
As part of the returned copy of the notice, there was a statement
signed by petitioner authorizing William DeMontbreun, CPA, to
contact the IRS about the notice.
A statutory notice of deficiency dated February 6, 2001, was
issued to Frederick M. and Cheryl A. Prouty for the tax year
1998. The notice determines adjustments for increased taxable
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wages of $7,914, an increase in nonemployee compensation of
$1,160, a disallowance of the claimed $766 credit for excess
Social Security and RRTA tax withheld, and computational
adjustments.
On February 13, 2001, the Ogden Service Center received a
faxed copy of a letter "To Whom It May Concern", stating that
petitioner "was a 100% commissioned Account Executive for
Sullivan Broadcasting"1 from November 1989 to June 1998.
On March 9, 2001, the Ogden Service Center received a
"Transfer To Appeals Request" signed by petitioners, requesting
that their case be transferred to the Appeals Office in
Nashville, Tennessee. The Ogden Service Center sent to
petitioners a revised notice of tax changes dated March 20, 2001,
proposing the allowance of the claimed $7,904 of deductions on
petitioner's Schedule C. Petitioners met with their accountant
on March 23, 2001, to discuss the proposed tax changes sent to
them on March 20, 2001.
The petition in this case was filed on May 8, 2001, and
respondent filed the answer on June 29, 2001. On July 2, 2001,
the case was assigned to an Appeals officer for consideration.
The Appeals officer, on August 23, 2001, met with petitioner and
her accountant who stated that although Mr. Prouty had failed to
1
There is no explanation in the record as to whether
"Sullivan" broadcasting is the same company as "Sinclair
Television of Nashville" as listed on the W-2.
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report business income of $1,160, he also had failed to claim
certain business expenses. They requested that the Appeals
officer allow additional time for them to gather substantiation
for the unclaimed expenses. On September 21, 2001, petitioners
faxed to the Appeals officer a copy of a Schedule C for Mr.
Prouty that reported the previously unreported nonemployee
compensation of $1,160 and also unclaimed expenses of $720.
Respondent having conceded petitioner's TV executive
expenses of $7,904 as of March 20, 2001, petitioners conceded the
other adjustments in the notice of deficiency, and respondent
additionally agreed to the Schedule C expenses for Mr. Prouty of
$720. A Stipulation of Settlement was filed by Order of the
Court dated February 13, 2002.
OPINION
Requirements Under Section 74302
Under section 7430(a), a judgment for costs incurred in an
administrative proceeding in connection with the determination of
any tax may be awarded only if a taxpayer: (1) Is the
"prevailing party"; and (2) did not unreasonably protract the
administrative proceeding. See sec. 7430(a) and (b)(3).
A taxpayer must satisfy each of the respective requirements
in order to be entitled to an award of administrative costs under
2
We apply sec. 7430 as amended by Congress in the IRS
Restructuring and Reform Act of 1998, Pub. L. 105-206, sec. 3101,
112 Stat. 727-730.
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section 7430. See Rule 232(e). Upon satisfaction of these
requirements, a taxpayer may be entitled to reasonable costs
incurred in connection with the administrative proceeding. See
sec. 7430(a)(1) and (2), (c)(1) and (2).
To be a prevailing party, the taxpayer must substantially
prevail with respect to either the amount in controversy or the
most significant issue or set of issues presented and satisfy the
applicable net worth requirement. See sec. 7430(c)(4)(A).
Respondent argues that petitioners have not shown that they
satisfy the net worth requirements of section 7430(c)(4)(A)(ii).
Because petitioners, even if they meet the net worth
requirements, will nevertheless not be treated as prevailing
parties if respondent can establish that his position in the
administrative proceedings was substantially justified, we
examine this factor first. See sec. 7430(c)(4)(B).
Substantial Justification
The Commissioner's position is substantially justified if,
based on all of the facts and circumstances and the legal
precedent relating to the case, the Commissioner acted
reasonably. See Pierce v. Underwood, 487 U.S. 552 (1988); Sher
v. Commissioner, 89 T.C. 79, 84 (1987), affd. 861 F.2d 131 (5th
Cir. 1988). In other words, to be substantially justified, the
Commissioner's position must have a reasonable basis in both law
and fact. See Pierce v. Underwood, supra; Rickel v.
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Commissioner, 900 F.2d 655, 665 (3d Cir. 1990), affg. in part and
revg. in part on other grounds 92 T.C. 510 (1989). 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). Thus, the Commissioner's position may be incorrect
but nevertheless be substantially justified "'if a reasonable
person could think it correct'". Maggie Mgmt. Co. v.
Commissioner, 108 T.C. 430, 443 (1997) (quoting Pierce v.
Underwood, supra at 566 n.2).
The relevant inquiry is "whether * * * [the Commissioner]
knew or should have known that * * * [his] position was invalid
at the onset". Nalle v. Commissioner, 55 F.3d 189, 191 (5th Cir.
1995), affg. T.C. Memo. 1994-182. We look to whether the
Commissioner's position was reasonable given the available facts
and circumstances at the time that the Commissioner took his
position. See Maggie Mgmt. Co. v. Commissioner, supra at 443;
DeVenney v. Commissioner, 85 T.C. 927, 930 (1985).
The fact that the Commissioner eventually concedes, or even
loses, a case does not establish that his position was
unreasonable. Sokol v. Commissioner, 92 T.C. 760, 767 (1989);
see also Estate of Perry v. Commissioner, 931 F.2d 1044, 1046
(5th Cir. 1991). The Commissioner's concession, however,
remains a factor to be considered. See Powers v. Commissioner,
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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, the position of the United States that
must be examined in light of the substantial justification
standard with respect to the recovery of administrative costs is
the position taken by the Commissioner as of the date of the
notice of deficiency. See sec. 7430(c)(7)(B).
In order to decide whether the Commissioner's position was
substantially justified we must review the substantive merits of
the case.
Reasonable Basis In Fact
In Rev. Rul. 90-93, 1990-2 C.B. 33, respondent announced the
position that a person described in section 3121(d)(3), commonly
referred to as a "statutory employee", is "not an employee for
purposes of sections 62 and 67." Such persons may properly
reflect business income and expenses in full on Schedule C in
calculating adjusted gross income under section 62(a)(1).
Persons who are employees for purposes of sections 62 and 67 have
their miscellaneous deductions limited as provided by section
67(a).
Petitioners do not appear to suggest that respondent applied
the wrong legal standard in taking a position denying their
deduction on Schedule C of expenses for the business of "TV Sales
Executive" under the business name, "WZTV & WNAB". A reading of
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their transfer to Appeals request indicates that petitioners feel
that respondent's position on the adjustment was not reasonable
in fact based upon their statements to respondent.
As to that argument, respondent asserts that it was
incumbent upon petitioners to substantiate their entitlement to
the items claimed. It is reasonable, according to respondent,
not to concede an adjustment until he has received and verified
adequate substantiation for the items in question. He therefore
concludes that as to the stated adjustment, his position was
reasonable when taken and appropriately conceded when
substantiation was provided to Appeals.
Taxpayers are required to maintain books and records in
accordance with rules and regulations prescribed by the Secretary
of the Treasury. See sec. 6001. Generally, taxpayers must keep
records sufficient to establish gross income, deductions, or
other matters required to be shown on the return. See sec.
1.6001-1(a), Income Tax Regs.
Petitioners' request for transfer to Appeals argues that the
Code does not require an employer to indicate that an employee is
a statutory employee and that petitioners sent the Commissioner a
letter describing petitioner's duties. Regardless of what
responsibility petitioner's employers may have had, it was
petitioner's responsibility to verify her entitlement to report
income and deductions on Schedule C. The Forms W-2 attached to
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the return indicate petitioner's status as an employee. The
amounts reported on the forms were not included as wages, and
without further explanation it is not apparent what income items
are reported on the Schedule C. A taxpayer's self-serving
declaration is no ironclad substitute for the records that the
law requires. See Weiss v. Commissioner, T.C. Memo. 1999-17; see
also Seaboard Commercial Corp. v. Commissioner, 28 T.C. 1034,
1051 (1957) (a taxpayer's income tax return is a self-serving
declaration that may not be accepted as proof for the deduction
or exclusion claimed by the taxpayer); Halle v. Commissioner, 7
T.C. 245, 247 (1946) (a taxpayer's return is not self-proving as
to the truth of its contents), affd. 175 F.2d 500 (2d Cir. 1949).
Petitioner submitted on November 17, 2000, a letter that
substantiated her status as a person described in section
3121(d)(3) as to the amount on one of her Forms W-2. It was not
until February 13, 2001, that evidence of her status, a person
described in section 3121(d)(3), with respect to the Sullivan
Broadcasting3 was supplied to the Commissioner. Respondent must
then have concluded that the amounts reported on petitioner's
Schedule C include the amounts reported on the Forms W-2. The
notice conceding the business expense issue related to her
employment status was sent to petitioners less than a month
later.
3
See supra note 1.
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From the record before us we conclude that the case remained
unsettled due to petitioners' request for additional time to
substantiate unreported expenses to offset what they conceded was
income not reported by Mr. Prouty.
It is reasonable for respondent to make adjustments for
items and to refuse to concede the adjustments until he has
received and verified substantiation for the amounts adjusted.
See Beecroft v. Commissioner, T.C. Memo. 1997-23; Simpson Fin.
Servs., Inc. v. Commissioner, T.C. Memo. 1996-317; McDaniel v.
Commissioner, T.C. Memo. 1993-148.
We are persuaded that respondent's position on the above
issue was reasonable. Respondent's position was based on
petitioners' failure to substantiate fully or account for the
item. Further, the issue was settled within a reasonable period
of time after petitioners gave sufficient information to
respondent. See Harrison v. Commissioner, 854 F.2d 263, 265 (7th
Cir. 1988), affg. T.C. Memo. 1987-52; Wickert v. Commissioner,
842 F.2d 1005 (8th Cir. 1988), affg. T.C. Memo. 1986-277; Ashburn
v. United States, 740 F.2d 843 (11th Cir. 1984); McDaniel v.
Commissioner, supra.
Because respondent's position in the administrative
proceedings was substantially justified, we need not decide
whether petitioners meet the net worth requirements, unreasonably
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protracted the proceedings, or whether the administrative costs
claimed by petitioners are reasonable.
Conclusion
We find that respondent's position on the disputed issue was
a reasonable position sufficiently supported by the facts and
circumstances in petitioners' case and the existing legal
precedent. See Pierce v. Underwood, 487 U.S. 552 (1988).
Because we find respondent's position to have been reasonable, we
cannot find petitioners to be "prevailing" parties, and their
motion will therefore be denied.
To reflect the foregoing,
Decision will be entered
in accordance with the
agreement of the parties.