T.C. Memo. 2013-59
UNITED STATES TAX COURT
LEE STOREY AND WILLIAM STOREY, DECEASED,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 10230-10. Filed February 25, 2013.
Gregory Alan Robinson and Laurie A. Laws, for petitioners.
Chris J. Sheldon, for respondent.
1
Petitioners’ counsel notified the Court that petitioner William Storey had
died after the petition was filed. Petitioners’ counsel failed to indicate whether an
estate has or will be opened. We changed the caption accordingly.
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[*2] MEMORANDUM OPINION
KROUPA, Judge: This case is before the Court on petitioners’ motion for an
award of administrative and litigation costs under section 7430.2 We are asked to
decide whether petitioners are entitled to recover administrative and litigation costs.
We hold they are not.
Background
The underlying facts and analysis of this case are set out in detail in Storey v.
Commissioner, T.C. Memo. 2012-115, and are not generally restated here.
Additional evidence relevant to petitioners’ motion is set forth in affidavits and
attachments the parties filed as part of their motion papers. We summarize the
factual and procedural background briefly to rule on the motion.
Petitioner Lee Storey3 produced and directed a documentary film (film
activity). Petitioners had reported on their tax returns losses from the film activity
for 2003 through 2008.
2
All section references are to the Internal Revenue Code in effect at all
relevant times, and all Rule references are to the Tax Court Rules of Practice and
Procedure, unless otherwise indicated.
3
For convenience we refer to Lee Storey as petitioner.
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[*3] Respondent audited petitioners’ tax returns for 2003, 2004 and 2005,
questioning whether petitioner had engaged in the film activity for profit.
Respondent’s Appeals Office settled the unagreed audit by issuing a “no-change
letter” in November 2007. Respondent issued the no-change letter because the
presumption in section 183(d) did not apply as petitioner had been engaged in the
film activity for only three years.
Respondent later audited the returns for 2006, 2007 and 2008 (years at issue),
again questioning whether petitioner had engaged in the film activity for profit.
Respondent issued a 30-day letter that proposed disallowing expenses from the film
activity claimed as deductions and proposed a deficiency for the years at issue. The
30-day letter contained instructions for requesting an Appeals conference if
petitioners did not agree with the proposed adjustments. The 30-day letter also
informed petitioners that their rights, including potential recovery of legal costs,
depended on their fully participating in the administrative consideration of their
case, including consideration by respondent’s Appeals Office. Petitioners did not
request an Appeals conference.
Respondent issued a deficiency notice to petitioners for the years at issue,
determining that petitioner had not engaged in the film activity for profit and
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[*4] consequently disallowing deductions petitioners claimed in connection with the
film activity. Petitioners timely filed a petition with this Court. Again, petitioners
did not participate in nor request an Appeals conference before they filed the
petition.
A trial was held, and we issued the Memorandum Opinion in which we found
in petitioners’ favor. Petitioners thereafter filed a motion for $18,9574 of
administrative costs and $141,044 of litigation costs. Respondent filed a response
to the motion. The parties later filed additional materials supplementing the motion
and the response. Neither party requested an evidentiary hearing, and we conclude
that a hearing is unnecessary to resolve the motion. See Rule 232(a)(2).
Discussion
We now address whether petitioners are entitled to an award of
administrative or litigation costs. A taxpayer may be awarded administrative or
litigation costs in an administrative or court proceeding brought against the United
States in connection with a tax matter if certain requirements are met. Sec. 7430.
The taxpayer must establish that he or she (1) is the prevailing party, (2) has
4
All monetary amounts are rounded to the nearest dollar.
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[*5] exhausted the available administrative remedies,5 (3) has not unreasonably
protracted the administrative or court proceeding and (4) has claimed administrative
or litigation costs that are reasonable. Sec. 7430(a) and (b). The moving party
bears the burden of proving that these requirements have been met. Rule 232(e).
A taxpayer is generally the prevailing party if (1) the taxpayer substantially
prevailed on either the amount in controversy or the most significant issue or set of
issues and (2) meets certain net worth requirements. See sec. 7430(c)(4)(A). A
taxpayer, however, will not be treated as a prevailing party if the Commissioner’s
position in the proceeding was substantially justified. Sec. 7430(c)(4)(B). The
Commissioner has the burden of establishing that his position was substantially
justified. See sec. 7430(c)(4)(B)(i); Rule 232(e).
We find that petitioners failed to meet the requirements for an award of
litigation costs. We generally so find because they failed to exhaust available
administrative remedies. We also find petitioners fail to meet the requirements for
an award of administrative costs. We generally so find because respondent’s
position in the administrative proceeding was substantially justified, thus precluding
prevailing party status. We now explain each of our findings.
5
This requirement applies only to litigation costs. See sec. 7430(b)(1).
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[*6] A. Exhaustion of Available Administrative Remedies
We first consider whether petitioners exhausted their available
administrative remedies. A taxpayer must have exhausted the administrative
remedies available within the Internal Revenue Service before filing a Tax Court
petition to qualify for an award of litigation costs.6 Sec. 7430(b)(1); Burke v.
Commissioner, T.C. Memo. 1997-127; sec. 301.7430-1(a), Proced. & Admin.
Regs. A taxpayer generally fails to exhaust his or her administrative remedies
with respect to any tax matter for which an Appeals conference is available unless
one of the following two conditions is met. See sec. 301.7430-1(a), (b)(1), (g),
Proced. & Admin. Regs.; see also Shaw v. Commissioner, T.C. Memo. 2005-106;
Burke v. Commissioner, T.C. Memo. 1997-127. The first condition is that the
taxpayer must participate in an Appeals conference before filing a petition.7 Sec.
6
There are certain limited exceptions that apply to relieve taxpayers of the
requirement that they pursue administrative remedies. See sec. 301.7430-1(f) and
(g), Examples (4) and (5), Proced. & Admin. Regs.; see also Shaw v.
Commissioner, T.C. Memo. 2005-106. None of those exceptions, however, applies
here.
7
The Appeals Office’s mission “is to resolve tax controversies, without
litigation.” Internal Revenue Manual, pt. 8.1.1.1(1) (Oct. 23, 2007). The Internal
Revenue Service (IRS) is seeking facts during the Appeals phase to decide whether
it should determine a deficiency and thereby force a taxpayer to incur litigation costs
or pay the tax. See, e.g., Shaw v. Commissioner, T.C. Memo. 2005-106.
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[*7] 301.7430-1(a), (b)(1), Proced. & Admin. Regs. The second condition is that
the taxpayer must, before the issuance of a deficiency notice, (1) request an
Appeals conference and (2) file a written protest (if required for an Appeals
conference). Id.
Here, respondent sent petitioners the 30-day letter, providing them the
opportunity to request an Appeals conference to resolve the matter before the
deficiency notice was issued. Moreover, the 30-day letter informed petitioners
that failing to participate in the Appeals process could negatively impact their
right to recover administrative and litigation costs. Petitioners chose,
nevertheless, not to participate in or request an Appeals conference before they
filed the petition.8 And none of the exceptions applies to relieve petitioners of the
requirement that they participate in or request an Appeals conference. We hold,
based on all the facts and circumstances, that petitioners failed to establish that
8
It is unclear exactly why petitioners chose to forgo the Appeals process.
Petitioner’s affidavit reflects that she believed respondent was intransigent in his
position with respect to the film activity. Her affidavit also reflects that she believed
that if she did not wage a major counter-attack at the administrative level, she would
face “a life sentence of IRS audits.” It appears that petitioners elected to bypass
Appeals as part of their litigation strategy. This does not relieve them of the
requirement to exhaust all available administrative remedies before filing the petition
if they wish to preserve their right to seek litigation costs. See Haas & Assocs.
Accountancy Corp. v. Commissioner, 117 T.C. 48, 62 (2001), aff’d, 55 Fed. Appx.
476 (9th Cir. 2003).
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[*8] they exhausted their available administrative remedies and that they therefore
are ineligible for an award of reasonable litigation costs.
B. Substantial Justification
We now consider whether respondent’s position in the administrative
proceeding was substantially justified. We first identify respondent’s position for
purposes of the administrative proceeding. The Commissioner’s position for an
administrative proceeding is the position he takes as of the earlier of (1) the date the
taxpayer receives the decision notice of the Appeals Office, or (2) the date of the
deficiency notice. Sec. 7430(c)(7)(B); sec. 301.7430-5(b), Proced. & Admin. Regs.
Petitioners did not receive a decision notice from the Appeals Office before the
deficiency notice was issued. Accordingly, respondent’s position for the
administrative proceeding is that which was asserted in the deficiency notice issued
to petitioners.
The Commissioner’s position is substantially justified if, based on all the
known facts and circumstances and relevant legal precedents, the Commissioner
acted reasonably. See Pierce v. Underwood, 487 U.S. 552, 565 (1988); Sher v.
Commissioner, 89 T.C. 79, 84 (1987), aff’d, 861 F.2d 131 (5th Cir. 1988). The
relevant inquiry is whether the Commissioner knew or should have known that his
position was invalid when adopted, given the facts available and any legal
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[*9] precedent related to the case. Nalle v. Commissioner, 55 F.3d 189, 191 (5th
Cir. 1995), aff’g T.C. Memo. 1994-182; Maggie Mgmt. Co. v. Commissioner, 108
T.C. 430, 443 (1987); Prouty v. Commissioner, T.C. Memo. 2002-175. A position
has a reasonable basis in fact if there is relevant evidence that a reasonable mind
might accept as adequate to support a conclusion. Underwood, 487 U.S. at
564-565; Huffman v. Commissioner, 978 F.2d 1139, 1147 n.8 (9th Cir. 1992), aff’g
in part, rev’g in part and remanding T.C. Memo. 1991-144. The Commissioner’s
position may be incorrect yet nevertheless substantially justified “if a reasonable
person could think it correct.” Underwood, 487 U.S. at 566 n.2.
Respondent’s position during the administrative proceeding was that
petitioner failed to engage in the film activity for profit. This Court considers
whether an activity is engaged in for profit on a case-by-case basis, taking into
account the facts and circumstances involved. See Golanty v. Commissioner, 72
T.C. 411, 426 (1979), aff’d without published opinion, 647 F.2d 170 (9th Cir.
1981). We structure our analysis of whether an activity is engaged in for profit
around nine nonexclusive factors. Sec. 1.183-2(b), Income Tax Regs.
These nine factors are fact intensive and generally focus on the facts at
issue, not the facts before or after the relevant years. No one factor or set of
factors is controlling, nor is the existence of a majority of factors favoring or
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[*10] disfavoring a profit objective controlling. Keating v. Commissioner, 544 F.3d
900, 904 (8th Cir. 2008), aff’g T.C. Memo. 2007-309; Hendricks v. Commissioner,
32 F.3d 94, 98 (4th Cir. 1994), aff’g T.C. Memo. 1993-396; Golanty v.
Commissioner, 72 T.C. at 426-427; sec. 1.183-2(b), Income Tax Regs. The
individual facts and circumstances of each case are the primary test, with greater
weight to be given to objective facts than to the taxpayer’s statement of intent. See
Indep. Elec. Supply, Inc. v. Commissioner, 781 F.2d 724, 726-727 (9th Cir. 1986),
aff’g Lahr v. Commissioner, T.C. Memo. 1984-472; Abramson v. Commissioner, 86
T.C. 360, 371 (1986); Engdahl v. Commissioner, 72 T.C. 659, 666 (1979); sec.
1.183-2(a) and (b), Income Tax Regs.
Petitioners contend that respondent’s administrative position was not
reasonably based on the law and facts. We disagree. Evaluating whether an
activity was engaged in for profit is essentially factual in nature and requires a
weighing of factors, all of which may be reasonably interpreted differently. See
Dishal v. Commissioner, T.C. Memo. 1999-110; see also Brennan v. Commissioner,
T.C. Memo. 1997-60; Eldridge v. Commissioner, T.C. Memo. 1996-44; Harrison v.
Commissioner, T.C. Memo. 1995-295; Leaphart v. Commissioner, T.C. Memo.
1993-502, aff’d without published opinion, 31 F.3d 1172 (3d Cir. 1994); Jasienski
v. Commissioner, T.C. Memo. 1993-449.
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[*11] Here, we weighed all the facts and circumstances and considered each of the
relevant factors. We found that petitioner had shown that she engaged in the film
activity for profit. We recognized, however, that some factors indicated no profit
motive. Specifically, we found that petitioner had a history of losses, earned
significant income from other sources and appeared to enjoy filmmaking. We
ultimately decided that these factors were outweighed by the facts, some of which
were first introduced or developed at trial, demonstrating that petitioner did engage
in the film activity for profit.
Notwithstanding our conclusion regarding the merits, respondent presented
facts supporting his position that petitioner’s primary objective in conducting her
film activity was not to make a profit. And respondent’s arguments with respect to
this highly fact-intensive issue were reasonable. Although we did not ultimately
agree with respondent’s legal conclusion, respondent has persuaded us that his
position had a reasonable basis in fact and law. We hold, therefore, that
respondent’s administrative position regarding the for-profit issue was substantially
justified and that petitioner is not entitled to an award of administrative costs under
section 7430.
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[*12] Based on our holdings, we find that petitioners failed to satisfy necessary
requirements to recover litigation or administrative costs.9 Petitioners’ motion will
therefore be denied.
We have considered all the arguments of the parties, and, to the extent we
have not addressed them, we find them to be irrelevant, moot or meritless.
To reflect the foregoing,
An appropriate order and decision
will be entered.
9
Because of our holdings, we need not address whether petitioners satisfied
any of the remaining requirements of sec. 7430.