T.C. Summary Opinion 2006-14
UNITED STATES TAX COURT
KRISTIN J. CALITRI, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 22760-04S. Filed January 30, 2006.
John C. Mullaney, for petitioner.
Michael J. Proto, for respondent.
DEAN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code in
effect at the time the petition was filed. Unless otherwise
indicated, subsequent 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. The decision to
be entered is not reviewable by any other court, and this opinion
should not be cited as authority.
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This matter is before the Court on petitioner’s Motion for
Litigation and Administrative Costs filed pursuant to section
7430 and Rule 231.1 Respondent filed a response to petitioner’s
motion. Respondent agrees that petitioner: (1) Has exhausted
her available administrative remedies within the Internal Revenue
Service (IRS); (2) has not unreasonably protracted the court
proceedings; (3) has claimed a reasonable amount of costs; (4)
has substantially prevailed with respect to the amount in
controversy and with respect to the most significant issue
presented in the court proceedings; and (5) has met the net worth
requirements as provided by law.
Respondent does not agree, however, that petitioner is a
prevailing party, because he contends that his position in the
court proceedings was substantially justified.
The parties have not requested a hearing in this case and
the Court concludes that a hearing is not necessary to decide
this motion. See Rule 232(a)(2). Accordingly, the Court rules
on petitioner’s motion based on the parties’ submissions and the
record in this case.
1
Although petitioner’s motion is captioned Motion for
Litigation and Administrative Costs, all of the costs sought in
the motion are, by definition, litigation costs, because
petitioner’s costs were incurred either in connection with the
preparation or filing of the petition with the Court or after the
filing of the petition with the Court. See sec. 7430(c)(1); sec.
301.7430-4(c)(3), Proced. & Admin. Regs. Therefore, the Court
will treat petitioner’s motion as a motion for the recovery only
of litigation costs.
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Background
At the time the petition in this case was filed, petitioner
resided in Warwick, Rhode Island.
For the years in issue, petitioner was self-employed and
operated a business called K.S. Gabrielle Interiors which
provided the selection and installation of custom-made draperies,
bedspreads, blinds, and floor coverings. As part of her
business, petitioner maintained sample books for fabrics, blinds,
and shades, as well as sample carpeting for display to customers.
Petitioner’s daily routine included several visits to customers’
homes to provide, among other things, advice for selecting proper
styles and colors, measurements, and price estimates.
On November 18, 2003, respondent sent to petitioner an
initial appointment letter, requesting her to meet with an
examining agent on January 8, 2004. At the same time, respondent
issued to petitioner a Form 4564, Information Document Request
(IDR), which was directed at obtaining books and records that
would substantiate petitioner’s cost of goods sold and business
expenses claimed on her returns.
On March 5, 2004, respondent forwarded to petitioner Form
872, Consent to Extend the Time to Assess Tax, and Publication
1035, Extending the Tax Assessment Period, requesting that
petitioner agree to extend the period of limitations for
respondent to assess the 2000 and 2001 taxes. In the absence of
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an extension, respondent’s earliest period of limitations would
have expired on October 16, 2004.
On June 29, 2004, respondent issued a statutory notice of
deficiency for 2000 and 2001 after it was evident that petitioner
would not consent to extend the period of limitations for 2000.
Respondent determined deficiencies in petitioner’s Federal income
taxes of $7,852.28 for 2000 and $2,090.63 for 2001. The
statutory notice of deficiency included adjustments2 to
petitioner’s tax returns, because she failed to substantiate her
cost of goods sold and business expenses.
On October 18, 2004, petitioner filed Form 1040X, Amended
U.S. Individual Income Tax Return, for year 2000, to claim a
dependency exemption deduction for her daughter, a child tax
credit, and head of household filing status. Petitioner did not
sign the Form 1040X, and she did not include any documentation to
support her claims.
Around November of 2004, petitioner retained John C.
Mullaney as her attorney to file a petition with the Court and to
represent her in the appeals process within the IRS. On November
29, 2004, petitioner filed a petition with the Court. The
petition alleges that “Revenue Agent issued Statutory Notice of
deficiency because taxpayer refused to extend statute of
2
The correct computation of petitioner’s self-employment
adjusted gross income adjustments and self-employment taxes for
2000 and 2001 will be determined by the parties’ resolution of
the issues of petitioner’s cost of goods sold and substantiation
of business expenses.
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limitations. He would not accept any documentation to support
deductions. [Eighty percent] of all deductions can be
substantiated”. Moreover, petitioner contends in the petition
that she was entitled to: (1) Head of household filing status,
(2) a dependency exemption for her daughter, (3) an earned income
credit, and (4) a child tax credit.
On September 12, 2005, the parties submitted a stipulation
of settlement, signed by the parties’ counsel, which reflects the
resolution of petitioner’s Federal income tax liabilities for
2000 and 2001.
Discussion
Requirements Under Section 7430
Section 7430(a) authorizes the award of reasonable
litigation costs incurred in a court proceeding which is brought
by or against the United States in connection with the
determination, collection, or refund of any tax, interest, or
penalty under the Internal Revenue Code. The taxpayer must
establish that the taxpayer: (1) Is the prevailing party, (2)
has exhausted available administrative remedies, (3) has not
unreasonably protracted the court proceedings, and (4) has
claimed litigation costs that are reasonable. Sec. 7430(a) and
(b)(1), (b)(3).
A taxpayer must satisfy each of the respective requirements
before litigation costs under section 7430 may be awarded. See
Rule 232(e). Upon satisfaction of these requirements, a taxpayer
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may be entitled to reasonable costs incurred in connection with
the court proceeding. Sec. 7430(a)(1) and (2), (c)(1).
Respondent concedes that petitioner has established all of the
requirements except for the requirement that petitioner be a
prevailing party.
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 requirements under 28 U.S.C. section
2412(d)(2)(B)(2000). Sec. 7430(c)(4)(A). The taxpayer will
nevertheless not be treated as a prevailing party if the
Commissioner’s position in the court proceeding was substantially
justified. Sec. 7430(c)(4)(B). The Commissioner has the burden
of proving that his position was substantially justified. See
sec. 7430(c)(4)(B)(i); Rule 232(e).
Respondent concedes that petitioner has satisfied the
requirements of section 7430(c)(4)(A). Respondent contends,
however, that petitioner should not be treated as a prevailing
party, because respondent’s position in the court proceeding was
substantially justified.
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);
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Anthony v. United States, 987 F.2d 670, 674 (10th Cir. 1993).
The Commissioner’s position may be incorrect but nevertheless be
substantially justified “if a reasonable person could think it
correct”; that is, if the position has a “reasonable basis both
in law and fact”. Pierce v. Underwood, supra at 566 n.2; Huffman
v. Commissioner, 978 F.2d 1139, 1147 n.8 (9th Cir. 1992), affg.
in part, revg. in part and remanding T.C. Memo. 1991-144; sec.
301.7430-5(c)(1), Proced. & Admin. Regs. A position has a
reasonable basis in fact if there is such relevant evidence as a
reasonable mind might accept as adequate to support a conclusion.
Pierce v. Underwood, supra at 564-565; Huffman v. Commissioner,
supra.
The relevant inquiry is “whether * * * [the Commissioner]
knew or should have known that [her] position was invalid at the
onset”. Nalle v. Commissioner, 55 F.3d 189, 191 (5th Cir. 1995),
affg. T.C. Memo. 1994-182. The Court looks 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, 108 T.C. 430,
442-443 (1997); DeVenney v. Commissioner, 85 T.C. 927, 930
(1985).
The fact that the Commissioner eventually loses or concedes
a case does not by itself establish that the position taken is
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unreasonable. Estate of Perry v. Commissioner, 931 F.2d 1044,
1046 (5th Cir. 1991); Swanson v. Commissioner, 106 T.C. 76, 94
(1996); Sokol v. Commissioner, 92 T.C. 760, 767 (1989). It
remains, however, a factor to be considered. 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).
The position of the United States that must be examined in
light of the substantial justification standard with respect to
the recovery of litigation costs is the position taken by the
Commissioner in the answer to the petition. See Huffman v.
Commissioner, supra at 1148; Bertolino v. Commissioner, 930 F.2d
759, 761 (9th Cir. 1991). In this case, no answer was filed
since an answer is not generally required in a small tax case.
See Rule 173(b).
Respondent’s position has not changed between the issuance
of the notice of deficiency and the time petitioner partially
substantiated her claims. It is appropriate to look at the
position maintained by respondent during the pendency of the
case. See sec. 7430(c)(7)(A).
Reasonable Basis in Fact
Petitioner claims that respondent’s position is unreasonable
because: (1) Petitioner was not given an opportunity during the
audit to present documentation that would substantiate her cost
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of goods sold and business expenses, (2) respondent refused to
proceed with the audit unless petitioner agreed to extend the
period of limitations to assess the 2000 and 2001 income taxes,
and (3) respondent failed to follow certain guidelines under
Internal Revenue Manual pt. 4.10.2.2.2 (May 14, 1999), regarding
when returns should be examined.
The Court has reviewed a copy of respondent’s Examining
Officer’s Activity Record (Activity Record), copies of
petitioner’s correspondence with respondent, and other relevant
evidence, and is persuaded that petitioner had numerous
opportunities, prior to the issuance of the statutory notice of
deficiency, to present documentation that would substantiate her
cost of goods sold and business expenses.
According to the Activity Record, petitioner requested and
was granted a rescheduling of the initial January 8, 2004,
meeting to February 3, 2004. On the day before the February 3,
2004, meeting, petitioner phoned and left a message with the
examining agent to cancel the meeting. By letter dated February
13, 2004, petitioner requested a meeting “after the filing season
ends April 15, 2004”, so that her accountant could review her
records and prepare for the examination.
The examining agent made numerous telephone calls to
petitioner during the weeks of March 5, March 12, and March 29,
2004, to reschedule the meeting, but petitioner failed to return
the calls. On March 26, 2004, respondent’s group manager left
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petitioner a voice message stating that a statutory notice of
deficiency for 2000 and 2001 would be issued if petitioner failed
to contact respondent by April 1, 2004. The examining agent made
several more attempts to contact petitioner during the week of
April 5, 2004.
The Activity Record further indicates that on April 8, 2004,
petitioner informed the examining agent by phone that she
declined to extend the assessment period and that she wanted to
schedule a meeting on May 3, 2004. This is corroborated by
petitioner’s followup letter dated April 8, 2004, where she
stated that both she and her accountant would be available on May
3, 2004, and that the additional time would give her accountant
an opportunity to review her records as her accountant was not
the original preparer of the returns.
The examining agent agreed to a May 3, 2004, meeting. The
Activity Record indicates, however, that petitioner appeared
without her accountant on the date of the meeting. While
petitioner could have produced the books and records requested by
respondent at the May meeting, she did not do so. According to
the Activity Record, petitioner told the examining agent that she
needed 3 additional weeks to produce the books and records,
because her accountant was on vacation.
Respondent’s position in the statutory notice of deficiency
of June 29, 2004, premised the adjustments primarily on
petitioner’s lack of substantiation. Tax deductions are a matter
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of legislative grace with a taxpayer bearing the burden of
proving entitlement to the deductions claimed. Rule 142(a)(1);
INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Taxpayers
bear the burden of substantiating the amount and purpose of any
claimed deduction. See Hradesky v. Commissioner, 65 T.C. 87
(1975), affd. per curiam 540 F.2d 821 (5th Cir. 1976). Taxpayers
are required to maintain sufficient records to establish the
amounts of income and deductions. Sec. 6001; Higbee v.
Commissioner, 116 T.C. 438, 440 (2001); sec. 1.6001-1(a), Income
Tax Regs.
It was reasonable for respondent to refuse to concede the
adjustments until he had received and verified adequate
substantiation for the items in question. See Harrison v.
Commissioner, 854 F.2d 263, 265 (7th Cir. 1988), affg. T.C. Memo.
1987-52; Sokol v. Commissioner, supra at 765; 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. Petitioner’s counsel met with respondent’s
Appeals officer on March 8, 2005. He provided documentation to
the Appeals officer to substantiate some of petitioner’s claimed
business expense deductions and head of household filing status
at the conference. Petitioner’s counsel, by letters dated March
9 and May 10, 2005, provided additional supporting documentation
to substantiate some of petitioner’s remaining claims. The
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Appeals officer, after examining the documentation furnished,
sustained some of the adjustments in the statutory notice of
deficiency, but he conceded that petitioner was entitled to head
of household filing status, a dependency exemption, and the
earned income credit. The parties settled shortly thereafter.
A significant factor in determining whether the position of
the Commissioner is substantially justified as of a given date is
whether, on or before the date, the taxpayer has presented “all
relevant information under the taxpayer’s control and relevant
legal arguments supporting the taxpayer’s position to the
appropriate Internal Revenue Service personnel”. Sec. 301.7430-
5(c)(1), Proced. & Admin Regs.
Most of the changes to petitioner’s adjustments were based
on the Appeals officer’s determination that petitioner was
entitled to head of household filing status, child dependency
exemption and earned income credit. Petitioner did not raise any
of these legal arguments or provide the relevant documentation to
the examining agent while her returns were being examined.
Therefore, respondent’s position was not unreasonable even though
respondent eventually conceded that petitioner is entitled to
certain deductions and credits.
Petitioner alleges in her motion that respondent “refused to
deal with [her]” unless she consented to an extension of the
limitations period to assess taxes. As discussed above,
respondent made numerous attempts to “deal” with petitioner,
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prior to the issuance of the statutory notice of deficiency.
From the time when respondent sent petitioner the initial
appointment letter in January 2004, to the time when the parties
finally met in May 2004, petitioner had canceled two meetings and
had established a history of not responding to telephone calls
and document requests from respondent. Therefore, it was not
unreasonable under the circumstances for respondent to issue a
statutory notice of deficiency to avoid the expiration of the
period of limitations when petitioner refused to consent to an
extension. See Wasie v. Commissioner, 86 T.C. 962, 970-971
(1986); Chaum v. Commissioner, 69 T.C. 156, 163 (1977).
Petitioner contends that it was respondent’s delay in
commencing the audit that caused the shortage of time for
examination. Petitioner further contends that respondent failed
to adhere to the guidelines under Internal Revenue Manual pt.
4.10.2.2.2 (May 14, 1999), which provide that the examination and
disposition of income tax returns is to be completed within 26
months for individual returns after the due date of the return,
or the date filed, whichever is later.
There is a rebuttable presumption of no substantial
justification if the IRS “did not follow its applicable published
guidance in the administrative proceeding”. Sec.
7430(c)(4)(B)(ii). “Applicable published guidance” is defined as
“final or temporary regulations, revenue rulings, revenue
procedures, information releases, notices, announcements, and if
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issued to the taxpayer, private letter rulings, technical advice
memoranda, and determination letters”. Sec. 7430(c)(4)(B)(iv).
The Internal Revenue Manual does not constitute “applicable
published guidance”, because it is not among the IRS
pronouncements enumerated under section 7430(c)(4)(B)(iv).
Moreover, the provisions of the Internal Revenue Manual govern
only the internal affairs of the IRS; they do not have the force
and effect of law. Valen Manufacturing Co. v. United States, 90
F.3d 1190, 1194 (6th Cir. 1996); United States v. Horne, 714 F.2d
206, 207 (1st Cir. 1983). See generally Reich v. Manganas, 70
F.3d 434, 437 (6th Cir. 1995) (“Internal operating manuals * * *
do not carry the force of law, bind the agency, or confer rights
upon the regulated entity.”). Procedures in the Internal Revenue
Manual do not confer rights on taxpayers. United States v.
Horne, supra; United States v. Mapp, 561 F.2d 685, 690 (7th Cir.
1977).
Accordingly, the fact that respondent did not complete his
examination of petitioner’s returns within 26 months as
recommended by Internal Revenue Manual pt. 4.10.2.2.2 (May 14,
1999), does not trigger a rebuttal presumption of no substantial
justification pursuant to section 7430(c)(4)(B)(iv).
The Court finds that respondent’s position on the
substantiation issue was reasonable and sufficiently supported by
the facts and circumstances in petitioner’s case and existing
legal precedent. See Pierce v. Underwood, 487 U.S. 552 (1988).
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Petitioner is not a “prevailing party” within the meaning of
section 7430(c)(4)(B), because respondent has established that
his position is substantially justified. Accordingly,
petitioner’s motion for litigation costs is denied.
Reviewed and adopted as the report of the Small Tax Case
Division.
To reflect the foregoing,
An appropriate order and
decision will be entered.