*262 Respondent's position with respect to discharge of indebtedness issue was substantially justified and respondent's position with respect to imposition of accuracy- related penalty was not substantially justified. Petitioner entitled to recover costs as determined by court.
R determined a deficiency in tax, and an accompanying
accuracy-related penalty, attributable to Ps' failure to account
for discharge of indebtedness income in 1994. Ps filed a
petition for redetermination, and R subsequently conceded the
entire case. Ps seek recovery of administrative and litigation
costs in the amount of $ 10,978.74 pursuant to
1. Held: R's position with respect to the discharge
of indebtedness issue was substantially justified within the
meaning of
2. Held, further, R's position with respect to the
penalty issue was not substantially justified within the meaning
of
3. Held, further, Ps are entitled to recover costs
in the amount of $ 1,449.58.
*263 MEMORANDUM OPINION
HALPERN, Judge: This case is before the Court on petitioners' motion for an award of administrative and litigation costs pursuant to
Petitioners seek to recover costs in the amount of $ 10,978.74 incurred in connection with respondent's determination of a deficiency in tax with respect to their taxable (calendar) year 1996. Neither party requested an evidentiary hearing, and we conclude that such a hearing is not necessary for the proper disposition of the motion. See Rule 232(a)(2). The primary issue for decision is whether respondent's positions in the administrative and judicial proceedings involved here were substantially justified within the meaning of
Factual and Procedural Background
The Loan
In 1986 petitioner Charles B. Owens (petitioner) borrowed $ 596,078 from First RepublicBank (the loan). The loan matured in 1989. Upon the failure of First RepublicBank, the loan became the property of the Federal Deposit Insurance Corporation (FDIC). Petitioner never made any payments on the loan, and*265 the FDIC issued him an Internal Revenue Service Form 1099-C, Cancellation of Debt 1994 (the Form 1099-C) with respect thereto. The Form 1099-C specifies the date of cancellation of the loan (October 6, 1994), the total amount canceled ($ 1,338,924.32), and the portion of the total amount canceled consisting of interest ($ 742,846.32).
Petitioners' Returns
Petitioners made a joint return of Federal income tax for 1994 by filing a Form 1040, U.S. Individual Income Tax Return (the 1994 return). On line 21 of the 1994 return ("Other income"), petitioners reported a negative amount, $ 354,495. In a statement supporting that entry, petitioners, among other things, (1) reported $ 1,338,924 as an item of income, labeled "FDIC-SOUTHWEST SERVICE CENTER-Form 1099-C", (2) subtracted an equal amount, labeled "ERRONEOUS 1099-C -- DEBT NOT DISCHARGED", and (3) subtracted $ 390,173 as a net operating loss (NOL) deduction. That NOL deduction consisted of NOL carryovers from 1986, 1990, and 1993.
Petitioners made a joint return of Federal income tax for 1996 by filing a Form 1040, U.S. Individual Income Tax Return (the 1996 return). On line 21 of the 1996 return ("Other income"), petitioners reported*266 a negative amount, $ 118,961. In a statement supporting that entry, petitioners, among other things, subtracted $ 137,033 as an NOL deduction. That NOL deduction consisted of NOL carryovers from 1990 and 1993.
Respondent's Examination
Respondent undertook an examination of the 1994 return. During the course of that examination, respondent summoned the FDIC to produce all documentation relating to the loan. The ensuing FDIC correspondence to respondent (the FDIC correspondence) includes a copy of a "Dormant Account Status Approval Form" with respect to the loan, which shows an effective date of October 6, 1994. The form contains the following statement: "This memorandum is a request for Authorization to write off the remaining balance of $ 1,338,924.32". 2 Under the heading "1099 Will be Generated", the preparer marked the space adjacent to the entry "Not Economic to Pursue and Unsalable". The form also contains a brief narrative describing the loan and the status of collection efforts with respect thereto. The narrative references a July 1994 asset search that revealed no assets available for repayment of the loan. The narrative concludes: "It does not appear to be cost effective*267 to pursue a collection lawsuit against the obligor." The form bears the stamp "REQUEST APPROVED BY OVERSIGHT COMMITTEE SPECIAL ASSET BANK" with a handwritten date of October 20, 1994.
The FDIC correspondence also includes two pieces of correspondence between petitioner and Wayne D. Eckstine, a principal of AMRESCO. 3 In a letter to Mr. Eckstine dated November 1, 1994 (the November 1 letter), petitioner reiterates his reluctance to provide current financial information in light of the adverse effect such information may have on certain other settlements he had reached with creditors. The November 1 letter concludes with the following language:
Further, as I explained at our meeting, the*268 real point is that I
have a huge negative net worth under either scenario. So my
ability to pay any amount is questionable because of the
mountain of debt hanging over me from the past, and the fact
that I have no permanent source of present income, nor assets
that have any equity that isn't already pledged to the hilt.
Basically, I am now and have always been ready to resolve this
matter by meeting with the appropriate officers and agreeing on
a resolution. I'll be glad to answer any questions openly as I
did at our meeting. So please let me hear from you to discuss
how we can fully and finally resolve this situation.
Mr. Eckstine responded to the November 1 letter by letter dated November 7, 1994 (the November 7 letter). The body of the November 7 letter is as follows:
This letter is in response to your inquiry of November 1, 1994
with respect to our previous request to provide current
financial information and a current Affidavit of Financial
Condition. I appreciate your concern about explaining the
complexities of other settlements that you may have ongoing*269 with
other lenders. I would suggest that you attach any and all
pertinent data to any current financial statements to supplement
the information needed to clarify your presentation.
All requests to settle for less than the full amount owing on
any debt must be made in writing and accompanied by the
information previously discussed. Until this information is
received, we are unable to answer specific questions or make any
decisions regarding a payoff of your indebtedness. Should there
be a change in our policies and procedures and our ability to
negotiate a settlement otherwise, you will be contacted.
Petitioners do not allege, and there is no evidence to suggest, that the FDIC contacted them regarding the loan after November 7, 1994.
Respondent issued a "30-day letter" to petitioners for taxable years 1994 and 1996. In that letter, respondent proposed certain adjustments based on his conclusion that petitioners had realized income from the discharge of indebtedness in 1994 equal to the principal amount of the loan ($ 596,078). 4 Specifically, because petitioners were insolvent when the alleged discharge*270 occurred, respondent proposed to reduce to zero petitioners' unused 1994 NOL deduction (the unused 1994 NOL deduction) of $ 137,033 pursuant to section 108(b)(2)(A). Since petitioners' 1996 NOL deduction derived entirely from the unused 1994 NOL deduction, the proposed elimination of the unused 1994 NOL deduction had the effect of reducing petitioners' 1996 NOL deduction to zero. That elimination of petitioners' 1996 NOL deduction had the effect of increasing petitioners' 1996 tax by $ 36,042 (after an adjustment for a reduction in itemized deductions pursuant to section 68). Respondent also proposed to impose an accuracy-related penalty for 1996 of $ 7,208.40.
Petitioners submitted a written protest in response to respondent's 30-day letter. Thereafter, petitioners and respondent were unable to resolve the issues set forth*271 in respondent's 30-day letter. By letter dated November 2, 2000, respondent determined a deficiency in petitioners' 1996 income tax liability of $ 36,048 and an accuracy-related penalty under
On January 16, 2001, petitioners filed their petition assigning error to respondent's determinations. 6 On March 19, 2001, respondent filed his answer denying that he had erred. The case was set for trial at the Court's trial session commencing on December 3, 2001, in Houston, Texas. Prior to that date, respondent communicated to petitioners his intent to concede the case. When the case was called from the trial calendar, the parties filed a Stipulation of Settled Issues, pursuant to which (1) respondent conceded the proposed income tax deficiency*272 and penalty, and (2) petitioners reserved their right to file a motion for costs under
Discussion
I. Overview of1. Issue-by-Issue Analysis
The underlying controversy between the parties presented two distinct issues: *273 (1) Whether petitioners were liable for the income tax deficiency of $ 36,048, and (2) whether petitioners were liable for the
2. Administrative and Litigating Positions
In the context of a claim for administrative costs in a deficiency proceeding, the "position of the United States" with respect to any issue is generally that set forth in the Commissioner's notice of deficiency. See
An administrative or litigating position of the United States is substantially justified if it has a reasonable basis in both law and fact. E.g.,
The determination of whether a discharge of indebtedness has occurred for tax purposes is extremely fact specific, often turning on the subjective intent of the creditor as manifested by an objectively identifiable event. 7 In the instant case, the FDIC's issuance and filing of the Form 1099-C with respect to the loan, while not dispositive, is certainly an identifiable event that is evidence of an intention to cancel the loan, as is the FDIC's reclassification of the loan as a "dormant account" pursuant to established internal procedures. 8 The only evidence that is perhaps inconsistent with an intention on the part of the FDIC to cancel the loan in 1994 is the November 7, 1994, letter from Mr. Eckstine to petitioner. Given the prevailing "identifiable event" standard and the state of the evidence, we conclude that respondent's position with respect to the discharge of indebtedness issue had a reasonable*276 basis in both law and fact and therefore was substantially justified within the meaning of
*277 Petitioners cite
*278 Petitioners also suggest that, because respondent conceded the case without (as petitioners allege and respondent, in his objection to the motion, appears to confirm) having uncovered any new factual information that would cause respondent to reconsider his position, such concession is indicative of the unreasonableness of respondent's position in his notice of deficiency and answer. We acknowledge that there may be circumstances in which the absence of new information would weigh against the Commissioner in the context of a concession. See, e.g.,
This Court has observed: "The fact that respondent's counsel ultimately [decides] to concede the case may reflect a consideration of a variety of factors -- including litigation risks -- which earlier were not considered or which were not weighed as heavily by respondent."
As noted above, respondent asserted that petitioners were liable for the
Bearing in mind that we are evaluating the reasonableness of respondent's assertion of the penalty, 10 rather than the applicability of the penalty itself, we nonetheless conclude that respondent's position on the penalty issue was not reasonable. As discussed above, the determination of whether a discharge of indebtedness has occurred for tax purposes is extremely fact specific. When respondent issued his notice of deficiency (and again when he filed his answer in the judicial proceeding), he was aware of the conflicting evidence with respect to the discharge of indebtedness issue. While we have found that such conflicting evidence did not render unreasonable respondent's decision to continue to pursue that issue, we conclude otherwise with regard to respondent's decision to pursue the negligence penalty. Cf.
Petitioners seek costs in the amount of $ 10,978.74. However, petitioners' submission of costs includes 18.25 hours of services performed by C.P.A. Nancy J. Critz prior to January 19, 1999. The cost of those services is not recoverable under
Petitioners have not allocated their costs between the discharge of indebtedness issue and the penalty issue, nor would we expect them to, given the interrelatedness of the two issues. We therefore allocate petitioners' remaining eligible costs between the two issues based on the relative dollar amounts involved. See, e.g.,
We find that (1) respondent's position with respect to the discharge of indebtedness issue was substantially justified, (2) respondent's position with respect to the imposition of the accuracy- related penalty was not substantially justified, and (3) the amount of petitioners' recoverable costs allocable to the penalty issue is $ 1,449.58.
To reflect the foregoing,
An appropriate order and decision will be entered.
Footnotes
1.
Sec. 7430(c)(4)(B) applies to proceedings commenced after July 30, 1996. TaxpayerBill of Rights 2, Pub. L. 104-168, sec. 701(d), 110 Stat. 1452, 1463 (1996). While we have yet to decide the issue of when administrative (as opposed to judicial) proceedings are commenced for purposes of that effective date, seeMaggie Mgmt. Co. v. Comm'r, 108 T.C. 430">108 T.C. 430 , 438↩ (1997), respondent does not dispute petitioners' assertion that respondent bears the burden of proof on the "substantial justification" issue with respect to all of the costs at issue. We therefore proceed under the assumption that petitioners are correct in that regard.2. The form lists principal of $ 596,078 and interest of $ 742,846.32.↩
3. AMRESCO apparently managed certain loan accounts on behalf of the FDIC.↩
4. In general, a cash basis debtor does not realize discharge of indebtedness income upon the cancellation of an accrued but unpaid obligation to pay deductible interest. See sec. 108(e)(2).↩
5. The small differences between the deficiency and penalty figures in the 30-day letter as compared to those in the notice of deficiency appear to be due to the correction of mathematical errors.↩
6. Petitioners resided in San Antonio, Tex., when they filed their petition in this case.↩
7. See, e.g.,
Friedman v. Comm'r, T.C. Memo 1998-196">T.C. Memo 1998-196 (finding "no identifying event or forgiveness on the part of the creditors" that would indicate a discharge of indebtedness during the year in question), affd.216 F.3d 537">216 F.3d 537 (6th Cir. 2000); cf.sec. 1.6050P-1(b)(1) and(2)(i)(G), Income Tax Regs. (for information reporting purposes, debt is discharged upon the occurrence of any of the "identifiable events" specified in the regulation, including a discharge pursuant to a decision by the creditor, or the application of a defined policy of the creditor, to discontinue collection activity and discharge the debt). See generallyCozzi v. Comm'r, 88 T.C. 435">88 T.C. 435 , 445-448↩ (1987) (general discussion of "identifiable event" standard).8. While the term "dormant" does not necessarily signify an intent on the part of the FDIC to cancel the loan, the language of the FDIC's "Dormant Account Status Approval Form" for the loan in some respects evidences such an intent (e.g., "This memorandum is a request for Authorization to write off the remaining balance").↩
9. The Court of Appeals for the Fifth Circuit had previously reversed the portion of a Memorandum Opinion of this Court that upheld the Commissioner's proposed deficiency attributable to the income reported on the Form 1099.
Portillo v. Comm'r, 932 F.2d 1128">932 F.2d 1128 (5th Cir. 1991), affg. in part and revg. in partT.C. Memo 1990-68">T.C. Memo 1990-68↩ .10. We assume for these purposes that respondent asserted the penalty on the ground that petitioners were negligent. The alternative standard (i. e., disregard of rules or regulations) contemplates a specific statutory or administrative rule that is contrary to the taxpayer's reporting position, see sec. 1.6662- 3(b)(2), Income Tax Regs., a circumstance which does not appear to be present here.↩
11.
Sec. 1.6662-3(b)(1)(i), Income Tax Regs. , provides that negligence is "strongly indicated" where a taxpayer omits income reported on an information return (such as a Form 1099). While, ordinarily, that might be the case (which in turn would tend to support a finding that the Commissioner acted reasonably in asserting the negligence penalty under such circumstances), such principle presupposes that, unlike the instant case, the correctness of the information return in question is not in dispute. Cf.Portillo v. Comm'r, 988 F.2d 27">988 F.2d 27 (5th Cir. 1993)(Commissioner's reliance on uncorroborated Form 1099 not reasonable under the circumstances; no separate discussion of negligence penalty in this context), revg.T.C. Memo 1992-99">T.C. Memo 1992-99 ;Eifert v. Comm'r, T.C. Memo 1997-214">T.C. Memo 1997-214↩ (Commissioner's reliance on FDIC's erroneous Form 1099-G, reporting discharge of indebtedness income, not reasonable under the circumstances; no negligence penalty asserted).12. Sec. 3101(b) of the Internal Revenue Service Restructuring and Reform Act of 1998 (1998 Act), Pub. L. 105-206, 112 Stat. 728, pushed back the "start date" for recoverable administrative costs in a deficiency proceeding from the date of the notice of deficiency to the earlier date of the Commissioner's "30-day letter." That amendment applies to costs incurred after Jan. 18, 1999, the date that is 180 days after the date of enactment of the 1998 Act. 1998 Act sec. 3101(g), 112 Stat. 729.↩
13. Because petitioners did not separately address the reasonableness of respondent's position with respect to the discharge of indebtedness issue and the penalty issue, respectively, we do not think it appropriate to allocate petitioners' costs between those issues on a pro rata basis (i.e., 50 percent to each issue). Cf.
Heasley v. Comm'r, T.C. Memo 1991-189">T.C. Memo 1991-189 , affd. in part and revd. in part967 F.2d 116">967 F.2d 116↩ (5th Cir. 1992) (taxpayers challenged the reasonableness of the Commissioner's position with respect to four separate penalties; award of costs proportionate to number of issues on which taxpayers prevailed in that endeavor).