OWENS v. COMMISSIONER

T.C. Memo. 2002-253

UNITED STATES TAX COURT

CHARLES B. OWENS AND SALLY L. OWENS, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 672-01. Filed October 3, 2002.

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 sec. 7430, I.R.C.

1. Held: R’s position with respect to the
discharge of indebtedness issue was substantially
justified within the meaning of sec. 7430(c)(4)(B)(i),
I.R.C.

2. Held, further, R’s position with respect to
the penalty issue was not substantially justified
within the meaning of sec. 7430(c)(4)(B)(i), I.R.C.

3. Held, further, Ps are entitled to recover
costs in the amount of $1,449.58.
 - 2 -

John A. Townsend, for petitioners.

Susan M. Pinner, for respondent.

MEMORANDUM OPINION

HALPERN, Judge: This case is before the Court on

petitioners’ motion for an award of administrative and litigation

costs pursuant to section 7430 and Rules 230 through 233 (the

motion). Respondent objects. All section references are to the

Internal Revenue Code of 1986, as amended, and all Rule

references are to the Tax Court Rules of Practice and Procedure,

unless otherwise indicated.

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 section
 - 3 -

7430(c)(4)(B)(i). Respondent bears the burden of proof on this

issue. Sec. 7430(c)(4)(B).1 Because the parties appear to agree

on the underlying facts, there are no factual disputes to

resolve, and we shall proceed on the basis of the parties’

submissions.

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 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).

1
Sec. 7430(c)(4)(B) applies to proceedings commenced after
July 30, 1996. Taxpayer Bill 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,
see Maggie Mgmt. Co. v. Commissioner, 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.
 - 4 -

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 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
 - 5 -

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 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

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.
 - 6 -

settlements he had reached with creditors. The November 1 letter

concludes with the following language:

Further, as I explained at our meeting, the 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 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.
 - 7 -

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

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.

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).
 - 8 -

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 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

section 6662 (for negligence or disregard of rules or

regulations) of $7,209.60.5

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 and

penalty, and (2) petitioners reserved their right to file a

motion for costs under section 7430.

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.
 - 9 -

Discussion

I. Overview of Section 7430

A. Relevant Provisions

Section 7430(a) provides that a taxpayer may recover certain

costs incurred in connection with any tax proceeding

(administrative or judicial) against the United States if the

taxpayer is the prevailing party in such proceeding(s). Section

7430(c)(4)(B) provides that a taxpayer shall not be treated as

the prevailing party in any such proceeding if the United States

establishes that its position in the proceeding was substantially

justified. In his objection to the motion, respondent seeks to

establish that his position in the proceedings in question was

substantially justified.

B. Position of the United States

1. Issue-by-Issue Analysis

The underlying controversy between the parties presented two

distinct issues: (1) Whether petitioners were liable for the

income tax deficiency of $36,048, and (2) whether petitioners

were liable for the section 6662(a) penalty in the amount of

$7,209.60. We ascertain the reasonableness of respondent’s

position with respect to each issue. E.g., Foothill Ranch Co.

Pship. v. Commissioner, 110 T.C. 94, 97 (1998); Mitchell v.

Commissioner, T.C. Memo. 2000-145 (separate analysis of

Commissioner’s position with respect to the income tax issue and
 - 10 -

the penalty issue, respectively); see also section 301.7430-

5(c)(2), Proced. & Admin. Regs. (governing administrative awards

of costs).

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 sec. 7430(c)(7)(B)(ii);

see also, e.g., Maggie Mgmt. Co. v. Commissioner, 108 T.C. 430,

442 (1997). In the context of a claim for litigation costs, the

position of the United States with respect to any issue is that

set forth in the Commissioner’s answer in the judicial

proceeding. E.g., Maggie Mgmt. Co. v. Commissioner, supra at

442; see sec. 7430(c)(7)(A). Although we normally evaluate the

merits of those positions separately when a taxpayer seeks

recovery of both administrative and litigation costs, there is no

need to do so when, as is the case with each issue here, such

positions are identical and there is no indication that any

factual or legal developments occurred during the interim between

the issuance of the notice of deficiency and the filing of the

answer that would render the Commissioner’s position any more or

less justified. E.g., Tammaro v. Commissioner, T.C. Memo. 2000-

243. Accordingly, we do not distinguish between respondent’s

administrative positions and his litigating positions.
 - 11 -

C. Substantial Justification

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., Maggie Mgmt. Co. v. Commissioner, supra

at 443. We determine the reasonableness of respondent’s

positions on the two issues in this case based upon the facts

available to respondent at the time he took the positions and the

controlling legal precedent at such time. Id. The fact that

respondent conceded both issues does not, by itself, establish

that his positions with respect thereto were unreasonable. Id.

However, it is a factor that may be considered. Id.

II. Application of the “Substantially Justified” Standard

A. The Discharge of Indebtedness Issue

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

7
See, e.g., Friedman v. Commissioner, 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 (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
generally Cozzi v. Commissioner, 88 T.C. 435, 445-448 (1987)
(general discussion of “identifiable event” standard).
 - 12 -

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 basis in both law and fact

and therefore was substantially justified within the meaning of

section 7430(c)(4)(B)(i).

Petitioners cite Portillo v. Commissioner, 988 F.2d 27 (5th

Cir. 1993), revg. T.C. Memo. 1992-99, in support of their

argument that respondent’s position with respect to the discharge

of indebtedness issue was not substantially justified. In

Portillo, the Court of Appeals for the Fifth Circuit reversed a

Memorandum Opinion of this Court that denied the taxpayers’

motion for litigation costs. In so doing, the Court of Appeals

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”).
 - 13 -

held that the Commissioner’s reliance on an “unsubstantiated and

unreliable” Form 1099 to assert a deficiency against the alleged

payee was unreasonable. Id. at 29.9 In the instant case, the

Form 1099-C, upon which respondent relied, was supported by the

FDIC’s internal records. Portillo is therefore distinguishable.

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., Lennox v. Commissioner, 998 F.2d 244, 248 (5th Cir.

1993)(rejecting the implication that the Commissioner had

obtained new information between the date of the notice of

deficiency and the date of the concession), revg. T.C. Memo.

1992-382. However, it is just as clear that the Commissioner’s

position may be substantially justified notwithstanding his

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. Commissioner, 932
F.2d 1128 (5th Cir. 1991), affg. in part and revg. in part T.C.
Memo. 1990-68.
 - 14 -

subsequent abandonment of that position without any additional

factual development. For example, in Coastal Petroleum Refiners,

Inc. v. Commissioner, 94 T.C. 685, 689-690 (1990), the

Commissioner acknowledged “that his post-trial concession was not

based upon new facts presented at trial, but rather upon a

reconsideration of his basic legal position”, and we agreed that

such concession “was based on an abandonment of his legal

position.” We nevertheless found the Commissioner’s position to

be reasonable. Id. at 694-695.

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.” Estes v. Commissioner, T.C.

Memo. 2000-96. Such appears to be the case here. We conclude

that despite respondent’s concession of the underlying dispute

between the parties, his position with respect to the discharge

of indebtedness issue was reasonable.

B. The Penalty Issue

As noted above, respondent asserted that petitioners were

liable for the section 6662 accuracy-related penalty due to

petitioners’ negligence or disregard of rules or regulations.

Section 6662(c) provides that, for purposes of section 6662, the

term “negligence” includes any failure to make a reasonable
 - 15 -

attempt to comply with the provisions of the Internal Revenue

Code, and the term “disregard” includes any careless, reckless,

or intentional disregard. Under section 6664(c), the accuracy-

related penalty of section 6662 does not apply to the extent

there is reasonable cause for, and the taxpayer acted in good

faith with respect to, the underpayment.

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. Mitchell v. Commissioner, T.C. Memo. 2000-145

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.
 - 16 -

(Commissioner’s position regarding “tax home” issue was

substantially justified, but his assertion of accuracy-related

penalty was not). Suffice it to say that a close case is often

indicative of reasonableness and good faith on both sides of the

dispute. We conclude that respondent’s assertion that

petitioners’ position on the discharge of indebtedness issue was

not only incorrect, but unreasonable as well, was itself

unreasonable.11

III. Amount of Recoverable Costs

A. Eligible Costs

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

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. Commissioner, 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;
Eifert v. Commissioner, 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).
 - 17 -

section 7430.12 Accordingly, we first reduce petitioners’ claim

by $2,281.25 (18.25 hours multiplied by the recovery rate of $125

per hour claimed by petitioners), leaving potentially recoverable

costs in the amount of $8,697.49.

B. Allocation of Costs Between the Two Issues

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., Galedrige Constr., Inc. v. Commissioner,

T.C. Memo. 1997-485 (25 percent of costs allocated to issue

regarding 25 percent substantial understatement penalty).13

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. Commissioner,
T.C. Memo. 1991-189, affd. in part and revd. in part 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
(continued...)
 - 18 -

Since the penalty equaled 20 percent of the alleged underpayment

attributable to the discharge of indebtedness issue, the ratio of

nonrecoverable costs to recoverable costs is 5:1. Applying that

ratio to petitioners’ eligible costs of $8,697.49, we determine

that petitioners are entitled to recover $1,449.58.

IV. Summary

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.

13
(...continued)
taxpayers prevailed in that endeavor).