T.C. Memo. 2004-220
UNITED STATES TAX COURT
CURTIS AND MARY ETTESVOLD, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15631-98. Filed September 28, 2004.
Jon J. Jenson, for petitioners.
Blaine Holiday, for respondent.
MEMORANDUM OPINION
WHALEN, Judge: This case is before the Court to decide
petitioners’ motion for an award of reasonable litigation
and administrative costs in which they seek attorney’s fees
and expenses of $5,959.87.
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Neither petitioners’ motion nor respondent’s response
thereto requests an evidentiary hearing, and the Court
concludes that such a hearing is unnecessary for the
disposition of petitioners’ motion. See Rule 232(a)(2),
Tax Court Rules of Practice and Procedure. We will decide
petitioners’ motion on the basis of the record in this case,
including petitioners’ motion, respondent’s response, and
the various exhibits attached thereto. At the time they
filed their petition, petitioners resided at Morris,
Minnesota.
Background
Respondent determined deficiencies in petitioners’
self-employment taxes for 1994 of $5,139 and for 1995 of
$5,048. Respondent’s determination was based upon the
contention that certain payments received from petitioners’
farming corporation constituted “net earnings from self-
employment” pursuant to section 1402(a)(1) of the Internal
Revenue Code. Hereinafter, all section references are to
that Code unless stated otherwise.
As a general rule, section 1402(a)(1) defines “net
earnings from self-employment” to exclude rentals of farm
land and personal property, but it sets forth an exception
to the general rule if the rental income is derived under an
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arrangement that requires the material participation of the
owner or tenant in the production or management of the
agricultural or horticultural commodities on the rented
land. Section 1402(a)(1) provides that in computing the
income to be included in “net earnings from self-
employment”:
there shall be excluded rentals from real estate
and from personal property leased with the real
estate (including such rentals paid in crop
shares) together with the deductions attributable
thereto, unless such rentals are received in the
course of a trade or business as a real estate
dealer; except that the preceding provisions of
this paragraph shall not apply to any income
derived by the owner or tenant of land if (A) such
income is derived under an arrangement, between
the owner or tenant and another individual, which
provides that such other individual shall produce
agricultural or horticultural commodities
(including livestock, bees, poultry, and fur-
bearing animals and wildlife) on such land, and
that there shall be material participation by the
owner or tenant (as determined without regard to
any activities of an agent of such owner or
tenant) in the production or management of the
production of such agricultural or horticultural
commodities, and (B) there is material participa-
tion by the owner or tenant (as determined without
regard to any activities of an agent of such owner
or tenant) with regard to any such agricultural or
horticultural commodity * * *
Petitioners filed a petition for redetermination of the
deficiencies determined by respondent. While the case was
pending, petitioners mailed a document purporting to be a
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“qualified offer”, as defined by section 7430(g), which
states: “The taxpayers as their qualified offer agrees
[sic] to establish as the taxpayer’s [sic] liability
(determined without regard to interest) by agreeing to pay
to the United States $0.” Petitioners mailed the “qualified
offer” more than 30 days before the case was called from the
trial calendar. See sec. 301.7430-7(c)(7), Proced. & Admin.
Regs. When the case was subsequently called from the trial
calendar, the parties filed a stipulation of settlement
in which they agreed, as
a basis of settlement * * * that the issue
relating to the applicability of self-employment
tax on these rental payments is the same as the
issue in Johnson v. Commissioner, docket No. 7536-
98 (the controlling case) * * * [and] shall be
resolved as if the petitioners in this case were
the same as the taxpayers in the controlling case.
In due course, the Court issued its opinion in the
controlling case, Johnson v. Commissioner, T.C. Memo. 2004-
56, in which we held that the amounts reported by the
taxpayers for taxable years 1993, 1994, and 1995 as rents
from their wholly owned corporation for the lease of their
farmland and personal property are not included in “net
earnings from self-employment” under section 1402(a)(1) and
are not subject to self-employment tax. In deciding that
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case, this Court followed the analysis of the Court of
Appeals for the Eighth Circuit, the governing circuit, in
McNamara v. Commissioner, 236 F.3d 410 (8th Cir. 2000),
revg. and remanding Bot v. Commissioner, T.C. Memo. 1999-
256, Henner v. Commissioner, T.C. Memo. 1999-306, and
McNamara v. Commissioner, T.C. Memo. 1999-333, and held that
there was no nexus between the rental payments at issue and
the oral agreement between the taxpayers and their farm
corporation under which the taxpayers were to materially
participate in the corporation’s production of agricultural
commodities.
Discussion
According to petitioners, the decision of this Court
in Johnson v. Commissioner, supra, “dictates that Curtis
and Mary Ettesvold do not owe the additional self-employment
taxes that were assessed against them by the Internal
Revenue Service.” Accordingly, they contend that they are
to be treated as the “prevailing party”, pursuant to section
7430(c)(4)(E), on the ground their tax liability is “less
than the ‘qualified offer’ that they offered to the Internal
Revenue Service.” Petitioners further assert that they had
exhausted their administrative remedies available within
the Internal Revenue Service, that they had not unreasonably
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protracted the instant proceedings, and that they meet the
net worth requirement imposed by section 7430(c)(4)(A)(ii).
Respondent concedes that petitioners have substantially
prevailed with respect to the most important issue in the
case, that they had not unreasonably protracted this
proceeding, and that they meet the net worth requirement.
Nevertheless, respondent contends that petitioners are not
entitled to an award of any fees or costs under section
7430.
Respondent’s position is based upon four points.
First, respondent contends that, contrary to petitioners’
assertion, petitioners did not exhaust their administrative
remedies within the Internal Revenue Service as required by
section 7430(b)(1). Second, respondent contends that the
qualified offer rule, on which petitioners rely, is
inapplicable because any judgment in this case will be
issued pursuant to a settlement, not pursuant to a judicial
determination and, further, because petitioners’ tax
liability may be more than the amount offered in their
qualified offer. Third, respondent contends that the
position of the United States was substantially justified,
with the result that petitioners are not to be treated as
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the prevailing party. Finally, respondent raises a factual
question about the fees and costs sought by petitioners.
At the outset, we note that petitioners styled their
motion “Motion for Award of Reasonable Litigation and
Administrative Costs”. In fact, however, the amount sought
by petitioners, $5,959.87, consists entirely of attorney’s
fees and expenses for services in connection with the
instant Tax Court proceeding. As the affidavit attached to
petitioners’ motion makes clear, all of those services were
provided after submission of the “qualified offer”, which
took place approximately 4 years after the filing of
petitioners’ petition in this Court. Thus, the attorney’s
fees and expenses which petitioners seek in the instant
motion are litigation costs, not administrative costs.
See sec. 301.7430-4(c)(3)(ii), Proced. & Admin. Regs.
We agree with respondent’s first point. On the basis
of our review of this case, we cannot determine that
petitioners exhausted the administrative remedies available
to them within the Internal Revenue Service, as required by
section 7430(b)(1). In such a case, section 7430(b)(1)
provides that “A judgment for reasonable litigation costs
shall not be awarded under subsection (a) [of section
7430]”. See sec. 7430(b)(1). Accordingly, we will deny
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petitioners’ motion on the basis of the limitation imposed
by section 7430(b)(1). We need not, and do not, reach the
other issues raised by respondent.
Respondent’s response to petitioners’ motion points out
that a 30-day letter was issued to petitioners. See sec.
601.105(d), Statement of Procedural Rules. A copy of that
30-day letter is attached as an exhibit to respondent’s
response. The letter pointed out that if petitioners did
not agree with the proposed changes in their 1994 and 1995
returns, then they could obtain a conference with the
Regional Office of Appeals. The 30-day letter also
explained the steps necessary to obtain such an Appeals
conference.
Respondent’s brief further represents that after
issuing the 30-day letter, respondent’s agent contacted
petitioners’ representative. According to respondent’s
response, petitioners’ representative advised the agent that
petitioners did not agree to the adjustment, but they would
not file a protest. Petitioners’ representative recommended
that the agent issue a notice of deficiency.
The 30-day letter issued to petitioners proposes
increasing their net earnings from self-employment for 1994
and 1995 by the amount of the real estate rental payments
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received from their farm corporation in each of those years.
These are the same adjustments that respondent determined in
the notice of deficiency which is the subject of this case.
As set forth in the 30-day letter sent to them, petitioners
had the right to appeal the proposed adjustment to the
Appeals Office. See sec. 601.106(b), Statement of
Procedural Rules. Petitioners chose not to pursue an
administrative appeal within the Internal Revenue Service
of the adjustments proposed in the 30-day letter.
The regulations promulgated under section 7430 discuss
the circumstances in which the administrative remedies
available within the Internal Revenue Service shall be
deemed to have been exhausted. See sec. 301.7430-1, Proced.
& Admin. Regs. Generally, under those regulations a party
will not be deemed to have exhausted the administrative
remedies with respect to any tax matter for which an Appeals
Office conference is available under sections 601.105 and
601.106, Statement of Procedural Rules, unless the party
participates in an Appeals Office conference before filing
a petition in the Tax Court. See sec. 301.7430-1(b)(1)(i),
Proced. & Admin. Regs.
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The regulations under section 7430, requiring a party
to pursue administrative remedies within the Internal
Revenue Service, are subject to various limited exceptions.
See sec. 301.7430-1(f), Proced. & Admin. Regs. Petitioners’
motion and accompanying brief, however, give us no reason to
believe that any such exception is applicable in this case,
nor do petitioners’ motion and brief suggest that the
statutory rule requiring exhaustion of administrative
remedies is otherwise unnecessary. The entire discussion
of this issue in petitioners’ brief is as follows: “The
statutory notice of deficiency was issued by the Internal
Revenue Service on August 12, 1998. Curtis and Mary
Ettesvold pursued all of their administrative remedies.”
For the above reasons, we cannot determine, on the
basis of the record, that petitioners exhausted their
administrative remedies in the Internal Revenue Service.
See sec. 301.7430-1(b)(1)(i), Proced. & Admin. Regs.
Accordingly, we hold that petitioners are not eligible,
pursuant to the limitations of section 7430(b)(1), to be
awarded reasonable litigation costs. See Haas & Associates
Accountancy Corp. v. Commissioner, 117 T.C. 48 (2001), affd.
55 Fed. Appx. 476 (9th Cir. 2003); Patel v. Commissioner,
T.C. Memo. 1998-306.
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In accordance with the above,
An appropriate order will
be issued.