Another Case Denying Attorney’s Fees; TAS Tries to go to Appeals

The case of Jacobs v. Commissioner, T.C. Memo 2021-51 (see the 39th doc on the docket) demonstrates once again how difficult it is to obtain attorney’s fees in Tax Court cases.  Maria Dooner and Linda Galler, the authors of the excellent chapter on attorney’s fees in the 8th Edition of Effectively Representing Your Client Before the IRS coming out this month and available for order now, wrote a post for us earlier this year in which they displayed the results of a FOIA request showing how infrequently petitioners succeed in obtaining attorney’s fees from the Tax Court.  Their data suggests that out of the approximately 25,000 petitioners each year who file a petition in the Tax Court about 10 will receive attorney’s fees or about .004%. 

I was glad for their research because the other clinics at the Legal Services Center at Harvard routinely obtain attorney’s fees in their litigation with the government, but I have not obtained attorney’s fees since my arrival.  Even though I have explained to them the difficulty of obtaining attorney’s fees in Tax Court cases, my colleagues no doubt simply consider me a slacker.  Maria and Linda provided me with some empirical cover to avoid the slacker label.  This post will not get into the disparity in the ability to win attorney’s fees in Tax Court versus other venues, but it is something to think about.  It’s now been almost a quarter century since Congress last tweaked IRC 7430 adding, among other things, the qualified offer provisions in the Restructuring and Reform Act of 1998 yet petitioners in tax cases still get almost no traction in seeking attorney’s fees.  Is the IRS this good compared to other agencies?

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Professor Jacobs, a former Department of Justice attorney turned professor, author and private attorney, claimed a number of deductions for items related to his various professional pursuits.  The IRS audited his 2014 and 2015 returns via its wonderful correspondence exam process.  Unlike a high percentage of the individuals audited via correspondence, Mr. Jacobs responded and seems to have provided the IRS with quite a lot of documentation regarding his claimed expenses. 

In response, in December 2016, Mr. Jacobs submitted a letter of explanation with 28 pages of documentation…. 

In February 2017, the Memphis Correspondence Exam office informed Mr. Jacobs by letter that the information he had provided was insufficient to substantiate his expenses. On April 3, 2017, the Commissioner issued to Mr. Jacobs a notice of deficiency for the 2014 tax year, which disallowed all the deductions Mr. Jacobs had claimed on Schedule C. Both the letter and the notice were sent to the wrong address.

The April 3, 2017, notice was subsequently rescinded after the Taxpayer Advocate Service (“TAS”) opened a case on Mr. Jacobs’ behalf (and at his [*7] request). The TAS assisted Mr. Jacobs in arguing successfully that he had not been given the opportunity to present further substantiating documents.

Mr. Jacobs then made a new submission to the Memphis Correspondence Exam office. That submission included 24 pages of annotated monthly credit card statements. Most of these pages had been provided previously in Mr. Jacobs’ December 2016 submission, but the annotations were new and were intended to replace highlighting in the prior submission that had not been visible to the Memphis Correspondence Exam office because of the way the materials were submitted. The new submission also included several pages of credit card statements that were not part of the December 2016 submission. After reviewing the additional documents, the Memphis Correspondence Exam office determined once more that the information was insufficient to support Mr. Jacobs’ claimed deductions.

He was in California corresponding with an examiner in Memphis.  When the examiner denied the deductions despite his documentation and written explanations, he protested the denial and appears to have been assigned to the Appeals Office in Memphis.

It should be noted that Mr. Jacobs appears not to have been pleased with the customer service he received from the Memphis correspondence unit:

In January 2018, Mr. Jacobs filed a formal request with the U.S. Treasury Inspector General for Tax Administration (“TIGTA”) for an investigation into alleged misconduct by examiners in the Memphis Correspondence Exam office. The request alleged that the Memphis Correspondence Exam office had made unnecessary and “increasingly burdensome” requests for documentation, had threatened to issue an unwarranted deficiency notice, had summarily rejected Mr. Jacobs’ claimed deductions despite the documentation he had provided, and had “stonewalled” for five months Mr. Jacobs’ request for a managerial conference call. TIGTA opened an active investigation into the Memphis Correspondence Exam office and tracked the status of Mr. Jacobs’ case by initiating correspondence with upper-level management of that office.

Mr. Jacobs was perhaps frustrated with his pen pal relationship with the IRS and sought to meet with an actual person.  In a case with lots of documents this can be especially important as keeping a multitude of documents straight over the phone is challenging.

I digress here for a brief mention of my only encounter with the Memphis Appeals Office which occurred more than a decade ago and involved a Collection Due Process case rather than an examination issue.  The Settlement Officer set a time for the telephonic hearing.  The correspondence was a bit unclear because the conference was set at 10:00 CST for a hearing in June when daylight savings time was in effect but I assumed the SO meant 10:00 CDT and called at that time.  No one answered and I got a generic voice mail message saying that the SO was “away from her desk or on the phone.”  I left a detailed message about the hearing and waited for a call back which did not come.  I was covering for a student who could not attend the hearing due to a bar prep session.  She eventually got through to the SO and set up the hearing for the same time one week later.  I called again at 10:00 the following week, received the same generic voice mail message.  I waited a couple hours and did not receive a call back.  I found this very frustrating.  Even more frustrating is the fact that I had no idea who the person’s manager was or how to reach that unknown person.  I happened to know the director of Appeals from having worked together with her at the Chief Counsel’s office and sent her an email message describing my frustration.  That did cause the SO to reach out to me rather promptly, and we were able to conduct the CDP hearing.  I don’t know if Ms. Jacobs’ experience with the Appeals Office in Memphis mirrored mine but it seems he was frustrated with the remote hearing experience.

Meanwhile, the IRS decided to audit Mr. Jacobs for 2015 and this time did so using the correspondence examination unit in Brookhaven.  This exam started four months before he submitted his request to TIGTA regarding the 2014 exam.  It’s not clear why the IRS would audit the same person with essentially the same issues for the subsequent year at a different location but it did and the audit again resulted in him submitting lots of documentation and the correspondence examiner rejecting his explanation.  After some back and forth which no doubt involved detailed explanations from the correspondence exam unit regarding the legal and factual basis for its determination, he requested a hearing with Appeals regarding the 2015 year as well.

Mr. Jacobs succeeded in having his Appeals case assigned from Memphis to Los Angeles.  He provided the AO with a detailed memo and lots of exhibits.  The AO decided that, in keeping with the judicial role of Appeals, she should not evaluate the factual nature of the evidence but send it back to the correspondence examiners in Memphis.  How wonderful for Mr. Jacobs yet he seemed disappointed with this opportunity for more interaction with the correspondence examiners and requested Appeals assign a new AO or at least send his material to an examiner in LA.  Appeals denied his request.  His material went back to Memphis.  The correspondence unit there surprisingly upheld its earlier decision.  An in person meeting was finally set with the AO in LA who by now also had his 2015 year and lots more correspondence from Mr. Jacobs.

This part of the case is interesting because Mr. Jacobs sought to bring his case advocate from TAS to the Appeals conference.  Appeals said no.  The day before the scheduled in person conference with Appeals the case was reassigned to a new AO.  The Court provided this explanation of the discussion regarding TAS attending the conference:

On November 16, Appeals Officer Guerrero was instructed not to schedule a conference with Mr. Jacobs until after management at IRS Appeals had determined a course of action in response to demands from the TAS to be present at Mr. Jacobs’ conference. As best we can tell, this new course of action was attributable to a memorandum the TAS sent to IRS Appeals on November 7, 2018. That memorandum asked that IRS “Appeals should refrain from holding Mr. Jacobs’ hearing until Appeals’ policy is modified” to permit a TAS representative to attend. Discussions between IRS Appeals and the TAS on this topic ensued.

The case does not get any further into the topic of TAS attending the Appeals conference.  I have never thought of bringing someone from TAS into any conference with the IRS but now I am a little intrigued by what happened here and how the issue was resolved.  I would welcome any comments from readers who have brought TAS representatives to Appeals or to other conferences and what role TAS played in those conferences and whether the TAS presence was helpful.

Meanwhile, because the statute of limitations was drawing close, the new AO requested a waiver of the statute of limitations before he would schedule a hearing based on Appeals policy of not working case too close to the statute date.  It’s possible that Mr. Jacobs was frustrated at this point because he declined to extend the statute of limitations causing the issuance of a notice of deficiency, the filing of a Tax Court petition and the resending of his case to Appeals after the IRS answered.

The AO with whom Mr. Jacobs met after filing his Tax Court petition conceded most of the issues and the Chief Counsel attorney promptly conceded the rest.  So, he had a complete victory after a long an arduous process.  Mr. Jacobs then sought attorney’s fees which is all that this case and this blog post is really about.  The Tax Court said no.  He was not a prevailing party within the meaning of IRC 7430.  Why?  Because all of the problems he had prior to filing his petition really did not matter.  The IRS was still justified in not conceding before the petition because it had never met with him and received a detailed explanation of his justification for the positions he took and, therefore, the IRS was substantially justified in issuing the notice of deficiency.  After the filing of the petition, the IRS relatively promptly conceded the case.  The Court noted:

As the Supreme Court has observed, substantially justified means ‘more than merely undeserving of sanctions for frivolousness.’” United States v. Yochum (In re Yochum), 89 F.3d 661, 671 (9th Cir. 1996) (quoting Underwood, [*26] 487 U.S. at 566). The Commissioner’s position may be substantially justified even if incorrect “if a reasonable person could think it correct.” Maggie Mgmt. Co. v. Commissioner, 108 T.C. at 443 (quoting Underwood, 487 U.S. at 566 n.2). Courts have found that the Commissioner’s position was substantially justified in cases that involve primarily factual questions. See, e.g., Bale Chevrolet Co. v. United States, 620 F.3d 868 (8th Cir. 2010). The fact that the IRS loses a case or makes a concession “does not by itself establish that the position taken is unreasonable,” but is “a factor that may be considered.” Maggie Mgmt. Co. v. Commissioner, 108 T.C. at 443.

This case does not break new ground it simply demonstrates again why only .004% of petitioners obtain attorney’s fees in Tax Court cases.  One could argue that he should have made a qualified offer earlier in the case to knock out the substantial justification argument, but Mr. Jacobs seems to have responded at every turn with substantial evidence.  Does the fact that the IRS correspondence examiners were not equipped to process his arguments mean he should not be compensated for the many hours he spent trying to resolve his case. 

Maybe it’s time for a fresh look at the standards for obtaining attorney’s fees in Tax Court cases.

IRS erred in CDP hearing, but taxpayers have no chance to recover administrative costs… absent help from Congress

We welcome first-time guest blogger Maria Dooner to Procedurally Taxing. Maria is the Director of Tax Controversy Services at TaxFirm.com. She chairs the Board of Directors of Community Tax Aid in Washington D.C. and she is a co-author of the chapter, “Recovering Fees and Costs When a Taxpayer Prevails” in the forthcoming edition of Effectively Representing Your Client Before the IRS. Today Maria examines a recent Tax Court opinion denying costs to taxpayers who successfully appealed their CDP determination. Bryan Camp also wrote an excellent post on the case which you can find here. Christine

An award of reasonable administrative and litigation costs under section 7430 was designed to promote effective tax administration by preventing abusive actions and overreaching by the Internal Revenue Service (IRS). But to be effective, a taxpayer must actually recover costs when the government’s position was not substantially justified. A recent Tax Court decision not only continues to expose the challenges faced by taxpayers in recovering reasonable administrative and litigation costs from the IRS, but it also spotlights the need for potential Congressional action.

In Tung Dang and Hieu Pham Dang v. Commissioner, T.C. Memo. 2020-150 (Nov. 9, 2020), the Tax Court held that 1) the petitioners did not incur any reasonable administrative costs as defined by section 7430, and 2) the petitioners were not entitled to an award of reasonable litigation costs since the United States’ litigation position was substantially justified. The court focused almost exclusively on timing — it evaluated when the government’s position was or was not substantially justified and when costs were incurred. Previous PT blog posts have highlighted the difficulties in proving that the government’s position was not substantially justified (see here and here). This post primarily focuses on the challenges with recovering administrative costs due to the timeframe in which they are incurred.

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Facts of Dang

Dang involved a tax collection case where a Revenue Officer denied the taxpayers’ request to levy their individual retirement account (IRA) to pay their outstanding tax liability – a request that would avoid the additional tax on early distributions and the potential sale of other assets. When declining the request, the Revenue Officer stated that the taxpayers had access to alternative sources of funds and she subsequently issued a notice of federal tax lien and notice of intent to levy. In response, the Dangs filed a request for a Collection Due Process (CDP) hearing, but the Settlement Officer sustained the IRS collection actions, stating that a levy is not a collection alternative considered by Appeals. (As an aside, the irony of this case cannot be overlooked – while the taxpayer is contesting the notice of intent to levy, the Appeals Office says “no” to the taxpayer’s specific levy request.)

After receiving an unfavorable notice of determination, the Dangs filed a petition to Tax Court where IRS Counsel conceded the issue in his answer, stating that a substitution of assets (via a levy) is a valid collection alternative, and the Appeals Office abused its discretion. Against the desires of the Dangs who wanted an order to levy their IRA, Special Trial Judge Armen remanded the case back to the Appeals Office to promptly hold another administrative hearing, correct its flawed reasoning and reconsider the taxpayers’ request to levy the IRA. Keith blogged about the remand order on PT here (the taxpayers unsuccessfully argued a remand was unnecessary).

After the Appeals Office concluded that the levy on the IRA was appropriate, and settlement was reached in Tax Court, the taxpayers filed a motion for approximately $13,000 in reasonable administrative costs and approximately $70,000 in litigation costs. The administrative costs claimed by the Dangs included the time spent preparing and participating in the CDP hearing. The litigation costs claimed by the Dangs included all the work that was performed after receiving the Notice of Determination from the Appeals Office. This included time spent preparing the Tax Court petition and work performed while the taxpayers were in Tax Court, including the time spent on the case during the supplemental CDP hearing when it was remanded back to the Appeals Office.

Was the government’s position substantially justified, and when were costs incurred?

To successfully recover costs, the taxpayer must have exhausted administrative remedies with the IRS, have not unreasonably protracted the proceedings, have claimed reasonable costs, and have ultimately prevailed (as well as have satisfied a net worth requirement). Under section 7430(c)(4)(B)(i), a taxpayer cannot be a prevailing party if the United States was substantially justified in their position. When determining whether the government was substantially justified in its position in Dang, Judge Marvel applied a bifurcated analysis.  This involved determining whether the government’s position was substantially justified in 1) its notice of determination in the administrative proceeding, and 2) its answer in the judicial proceeding.  However, before the first question was evaluated, Judge Marvel questioned whether any permissible costs were in fact incurred during the administrative proceeding.

Pursuant to section 7430(c)(2), administrative costs are those incurred by the taxpayer on or after the earliest of: (1) the date of the receipt by the taxpayer of the notice of decision by the IRS Independent Office of Appeals, (2) the date of the notice of deficiency, or (3) the date of the first letter of proposed deficiency that allows the taxpayer to appeal to the IRS Independent Office of Appeals. Because Dang involved a CDP hearing, the only relevant date was the date the taxpayers received the Notice of Determination, which is essentially the notice of decision referenced in the law. So, on or after the notice of determination, the taxpayers could recover any costs incurred from that point forward within an administrative proceeding.

Unfortunately, the notice of determination is probably the worst date to start accruing administrative costs as it concludes a collection case at the administrative level. (The ideal date from a taxpayer’s perspective would be the date the Dangs received a right to a CDP hearing.) But upon receipt of the notice of determination, the Dangs have no move to make in which they could possibly recover any administrative costs. Their only task at hand is to prepare for litigation by reviewing the notice of determination and filing a petition to the Tax Court — time that the Dangs appropriately classified as litigation costs.

Since there were no “administrative costs” (within the scope of the statute) to be awarded, the Tax Court solely evaluated whether the government’s position was substantially justified in the litigation proceeding, relying on Huffman v. Commissioner, 978 F.2d 1148 (1992). Because the IRS promptly conceded its error and moved to remand the case back to the Appeals Office, Judge Marvel found that the IRS’s position was substantially justified. Therefore, no litigation costs could be awarded to the Dangs.

Did the decision to remand create additional administrative costs that could be awarded?

While this case is exceptional in more ways than one, additional costs associated with a supplemental CDP hearing (via a remand) add another twist. Bryan Camp suggests in his post that these costs were incurred after the notice of determination and as part of an administrative proceeding, so there could be an argument that there are administrative costs to be awarded.

This is an interesting point that was not addressed by the Tax Court, which was likely due to the fact these costs were classified as litigation costs by the Dangs. In the Dang case, the supplemental CDP Hearing was held at the direction of the Tax Court, and the hearing was very much connected to the court proceeding, which ultimately concluded the case. (In his order to remand the case back to the Appeals Office, Special Trial Judge Armen still retained jurisdiction over the case.) Thus, it appears that the time spent preparing, traveling, and participating in the remanded appeals hearing was appropriately classified as litigation costs under section 7430(c)(1)(b)(iii).

Why does the definition of “administrative costs” in section 7430 fail to encompass most costs incurred within administrative collection due process proceedings?

Judge Marvel did not analyze whether the government’s position was or was not substantially justified in the administrative proceeding, but we can assume that the position was not substantially justified. (The IRS went against published guidance (i.e. Treas. Reg. 301.6330-1(e)(3)), and this was recognized by IRS Counsel who immediately conceded the issue as well as Special Trial Judge Armen who remanded the case back to the Appeals Office for a do-over.)The question then becomes: why should the Dangs be unable to recover costs for time spent preparing and participating in the original CDP Hearing, which clearly went wrong and did not serve its intended purpose?

As explained above, Judge Marvel’s decision hinges on the definition of “administrative costs” in section 7430(c)(2), which incorporates a timing rule that effectively excludes CDP hearings from consideration. But Regulation § 301.7430-3(a)(4)  appears to go even further, providing that a CDP hearing is not an administrative proceeding for which reasonable administrative costs can be recovered. In their brief, the Dangs argued that this regulation should be disregarded as inconsistent with the statute. The Dangs note, “there is simply no statutory authority for eliminating CDP hearings from the cost recovery regimen.” In their brief, the Dangs emphasize the very first sentence of section 7430, which states that the prevailing party may be awarded reasonable administrative costs in any administrative proceeding in connection with the collection of any tax. They also explain how Regulation § 301.7430-3(a)(4), which precludes most collection actions, particularly a CDP hearing (“the quintessential collection administrative hearing”), from the definition of an administrative proceeding for purposes of section 7430, does not align with the first sentence of section 7430. But despite this being true, it does not change the outcome of the case. Unfortunately, it is the dates that triggered these costs, listed in section 7430(c)(2), that preclude and will continue to preclude the award of administrative costs in most CDP hearings. The dispute over the regulation is a red herring.

Why then did Congress enact a seemingly contradictory statute? An interesting explanation for these dates lies within a small footnote in the Tax Court opinion, indicating that it was Congressional intent to preclude an award for administrative costs arising from a collection action:

In 1988, when Congress amended sec. 7430 to include recovery for administrative costs in addition to litigation costs, the legislative history of the amendment acknowledged that the dates triggering costs precluded an award for administrative costs arising from a collection action. See H.R. Conf. Rept. No. 100-1104, at 226 (1988), 1988-3 C.B. 473, 716 (“Thus, with respect to a collection action, only reasonable litigation costs are recoverable under * * * [sec. 7430].”).

Ironically, a deeper dive into the Technical and Miscellaneous Revenue Act of 1988 shows that its amendment to section 7430 did not even facilitate the recovery of administrative costs for most taxpayers in deficiency proceedings. As passed, this law classified administrative costs as those incurred on or after the earlier of the date of receipt of the notice of the decision of the Appeals Office or the date of the notice of deficiency. Though the Senate bill included a third date, the date of notice of proposed deficiency (often known as the “30-day letter” into the Appeals Office), this was not incorporated into the 1988 Act. Therefore, the 1988 Act added the words “administrative costs” to section 7430, but it failed to provide meaningful impact to taxpayers pursuing administrative costs in deficiency proceedings. By not providing for the effective recovery of administrative costs in proceedings involving both the assessment and collection of tax, the inclusion of “administrative costs” was in many ways meaningless. 

It was not until the passage of the Internal Revenue Service Restructuring and Reform Act of 1998 that Congress approved the award of administrative costs incurred on or after the date of a notice of proposed deficiency. After that, taxpayers were able to recover administrative costs from the moment they received the notice of proposed deficiency and onward. Simultaneously, the 1998 Act created taxpayers’ rights to a CDP hearing — an independent review of a notice of intent to levy and notice of federal tax lien, culminating in a notice of determination and the right to judicial review.

Although we do not know the exact intent of Congress regarding the award of administrative costs in CDP hearings, the legislative history suggests that Congress either lacked an understanding of when these costs were incurred or was not fully committed to awarding them. For example, the fact that Congress did not facilitate the recovery of administrative costs associated with a collection proceeding in the 1998 law could have been an oversight when they were simultaneously creating a collection hearing that did not yet exist. Or maybe more likely, Congress did not understand the dates that triggered these costs. Remember, it took them approximately 10 years, after the law was amended to award administrative costs, to finally incorporate a provision that facilitated the recovery of these costs in deficiency proceedings.

This leads to what may be the main significance of Dang… a successful recovery of administrative costs by taxpayers requires a better understanding of when these costs are actually incurred and a more serious commitment to award them by Congress. The resources exerted in the Dang case where volunteer attorneys spent hours providing financial information, preparing for a CDP hearing, filing motions and briefs, preparing for a second CDP hearing, etc. (all to get back to an answer originally granted by the first Revenue Officer who approved the levy but was replaced by a second Revenue Officer who did not) show the importance of passing a law that allows for the effective recovery of costs and fees when the administrative process goes wrong. 

As a start, Congress could incorporate “costs incurred on or after the date of receipt by the taxpayer of a right to a CDP hearing” into section 7430(c)(2) for the sake of theDangs and thousands of taxpayers in collection cases. By making section 7430 more meaningful, Congress will make it more important for the IRS to follow published guidance in administrative collection due process hearings and will help the IRS achieve its mission in providing top quality service. Ultimately, the purpose of these awards is not to penalize but rather enhance effective tax administration, and to do this, more taxpayers must actually recover costs when the IRS errs.

Attorney’s Fees Following Bad Faith Action by IRS

In True the Vote v. IRS, No. 1:13-cv-00734 (D.D.C. 2020) one of the issues in the most recent opinion regarding this case concerns the calculation of attorneys’ fees.  This case began in 2013, because the IRS denied exempt status to True the Vote.  At that time numerous cases existed based on the allegedly intentional actions of the IRS to deny tax exempt status by improperly characterizing certain groups as political groups who did adhere to certain norms.  You can read about the earlier decisions in this case at True the Vote, Inc. v. Internal Revenue Serv. (“True the Vote I”), 71 F. Supp. 3d 219, 223-25 (D.D.C. 2014) (Walton, J.), aff’d in part, rev’d in part and remanded, 831 F.3d 551 (D.C. Cir. 2016), and the procedural history of this case in its Memorandum Opinion issued on May 30, 2019, see True the Vote, Inc. v. Internal Revenue Serv. (“True the Vote II”), Civ. Action No. 13-734 (RBW), 2019 WL 2304659, at *2 (D.D.C. May 30, 2019) (Walton, J.)

In many ways it seems like peanuts for the government to argue about the attorney’s fees because the issue in this case, and other similarly situated cases, caused the IRS to lose about 20% of its budget over the past decade.  That’s a gross simplification of the situation, but little doubt exists that the IRS paid dearly for the mistakes made by the exempt organization sector of the organization.  Because of the severe budget cuts and their impact on the IRS’s productivity, it could be argued that we have all suffered due to the downturn in government revenue as a result of these events.  Viewed in another light, perhaps we have all benefited.  In any event the amount of attorney’s fees at issue pales in comparison to the true cost to the IRS brought about by this case and other similarly situated cases.

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Here, the court faces a motion for reconsideration by the IRS of the award of attorney’s fees to plaintiff’s attorneys.  The court found the IRS acted in bad faith and, as a consequence, granted fees at the market rate rather than the must less generous rate provided by the Equal Access to Justice (EAJA) act.  Note that most attorney’s fee’s fights with the IRS would occur using IRC 7430 which provides a basis for fees quite similar to EAJA but not identical.

Relying on the Supreme Court precedent set in Goodyear Tire & Rubber Co. v. Haeger, 137 S. Ct. 1178 (2017), the IRS argues that granting the attorneys a market-based fee because of bad faith should only occur during the period of bad faith.  It points out that the bad faith ended in 2013 when the IRS granted tax exempt status to the organization. 

In Goodyear, the Supreme Court explained:

[A] sanction [of attorneys’ fees], when imposed pursuant to civil procedures, must be compensatory rather than punitive in nature. In other words, the fee award may go no further than to redress the wronged party for losses sustained; it may not impose an additional amount as punishment for the sanctioned party’s misbehavior. . . . [A] sanction counts as compensatory only if it is calibrate[d] to [the] damages caused by the bad-faith acts on which it is based. A fee award is so calibrated if it covers the legal bills that the litigation abuse occasioned. But if an award extends further than that — to fees that would have been incurred without the misconduct — then it crosses the boundary from compensation to punishment.

The court agrees.  It determines that its prior decision did not take into account the decision in Goodyear and it should not have granted the fees based on bad faith beyond the point at which the IRS acted in bad faith and agreed that the bad faith action stopped in 2013 with the granting of the exempt status request.  So, it reverses the prior award giving full market rate for attorney’s fees only to the point of the granting of exempt status and EAJA based fees thereafter.

The change in the fee rate based on the end of the bad behavior is the primary issue in this case.  The case has several other fee issues which it addresses and may be worth reading for anyone engaged in fee litigation and looking for a further discussion of the types of issues that can arise in these cases.

Perhaps the IRS feels good to get a least a partial win out of this situation.  As the cases stemming from the misadventures of the exempt organization sector of the IRS slowly come to an end, it can only hope that this chapter is behind it and better days — and better budgets — lie ahead.  For those of us who would like to see the IRS staffed to meet the challenges on all of the issues it faces this will be good as well.

Logic Loses in Taxpayer’s Effort to Recover Attorneys’ Fees

We welcome first-time guest blogger Professor Linda Galler to PT. Professor Galler is a co-author of the chapter, “Recovering Fees and Costs When a Taxpayer Prevails” in the forthcoming edition of Effectively Representing Your Client Before the IRS. Among Professor Galler’s many consulting, teaching, and scholarly pursuits, she directs the tax clinic at Hofstra University’s Maurice A. Deane School of Law.

In this post Professor Galler examines a recent decision denying a taxpayer fees and costs against the IRS. (Bryan Camp also covered the case here.) For those galvanized to learn more about qualified offers after reading this post, I recommend guest blogger Professor Ted Afield’s post on nominal offers, and Stephen Olsen’s grab bag of cautionary tales. Christine

Taxpayers rarely recover attorneys’ fees in tax cases despite the existence of a statute specifically providing for such recoveries. The Tax Court’s recent decision in Klopfenstein v. Commissioner, TC Memo 2019-156 (Dec. 9, 2019), is an example of why: the statutory requirements and the manner in which they are interpreted are overly exacting and counterintuitive. Klopfenstein involved a settlement of assessed penalties at Appeals for ten cents on the dollar – a 90 percent reduction in an assessed penalty – clearly raising the question of whether the government’s position in the case was substantially justified. Yet, in an opinion that relied heavily on established precedent, the court concluded that the IRS never took a “position” within the meaning of the statute and therefore that the taxpayer could not recover attorneys’ fees.

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This essay does not argue the merits of recovery in Klopfenstein or in general. Clearly, there are policy arguments on both sides. Rather, the point is to both demonstrate the fruitlessness of seeking attorneys’ fees and to commend the taxpayer’s attorneys for having tried nonetheless.

Mr. Klopfenstein’s court filings describe him as an “investor, investment banker, and merchant banker” who “earned an MBA in finance and accounting from Emory University” and “is licensed as a CPA and as an investment banker.” In 2005, the IRS commenced a tax shelter investigation for 1998 through 2001 with respect to entities that Mr. Klopfenstein controlled. In November 2014, Exam issued a Notice of Proposed Adjustment (“NOPA”) asserting that Mr. Klopfenstein was a material advisor who failed to disclose reportable transactions as required by section 6111. The NOPA referenced more than 24 alleged transactions, which the IRS asserted should have been registered as tax shelters, and proposed penalties under section 6707 in excess of $1.6 million.

Mr. Klopfenstein timely requested that his case be considered by Appeals, which assigned the case to an Appeals Officer (“AO”) in October 2015. The penalties were assessed in March 2016 and the IRS immediately began collection efforts, culminating in the filing of notices of federal tax lien in two states. Meanwhile, the AO held a pre-conference meeting with Mr. Klopfenstein, his attorneys and Exam personnel in June 2016 and a settlement conference in August. A settlement was reached under which Mr. Klopfenstein agreed that he was liable for a section 6707 penalty of approximately $170,000 for 1998 and that he was not liable for penalties in an any other year. The settlement was memorialized in a closing agreement, which was returned to Mr. Klopfenstein, signed, on November 30, 2016. The following month, the IRS abated more than $1.4 million of the assessed penalties, roughly 90% of the original assessment.

On February 27, 2017, Mr. Klopfenstein submitted a request for reasonable administrative costs (attorneys’ fees) under section 7430(a)(1), contending that he was a “prevailing party” and therefore was entitled to an award for attorneys’ fees and costs incurred during the administrative proceeding. The IRS denied the request and Mr. Klopfenstein filed a petition with the Tax Court seeking review of the IRS’s action. Both parties filed motions for summary judgment limited to the question whether Mr. Klopfenstein was a prevailing party within the meaning of section 7430.

A taxpayer may recover costs under section 7430 by satisfying four requirements:

  1. The costs must be incurred in an administrative or court proceeding in connection with the determination, collection, or refund of tax, interest, or penalties;
  2. the taxpayer must exhaust all administrative remedies;
  3. the taxpayer must not unreasonably protract the proceedings; and
  4. the taxpayer must be the prevailing party.

(In addition, only taxpayers who satisfy certain net worth requirements qualify.) The term “prevailing party” is defined in section 7430(c)(4)(A) as the party who has substantially prevailed with respect to either the amount in controversy or the most significant issue or set of issues presented. Given the difference between the penalties asserted and those ultimately agreed upon in the settlement, the IRS agreed that Mr. Klopfenstein had substantially prevailed with respect to the amount in controversy.

Under section 7430(c)(4)(B), a party may not be considered the prevailing party if the government establishes that its position in the proceeding was substantially justified. Section 7430(c)(4)(B) defines the government’s position in an administrative proceeding as its position on the earlier of (i) the date on which the taxpayer received Appeals’ notice of decision or (ii) the date of the notice of deficiency. The court held in the government’s favor, explaining that a party can never be a prevailing party unless the IRS has taken a position that is “crystallized” into either one of those documents. As to the first, Mr. Klopfenstein’s case was settled at Appeals so no decision was issued. As to the second, taxpayers can never recover fees under this prong in proceedings involving assessed penalties, where a notice of deficiency is not issued. Consequently, Mr. Klopfenstein could not have been a prevailing party.

Mr. Klopfenstein’s losing argument was based on the structure of the statute. Section 7430(c)(4)(B) is an exception to the definition of prevailing party in section 7430(c)(4)(B). (Indeed, it is captioned as an exception.) Thus, if Mr. Klopfenstein substantially prevailed with respect to the amount in controversy (which the government conceded), he is the prevailing party unless the government establishes that its position was substantially justified. Logically, in Mr. Klopfenstein’s view, if the government never took a position (which the government also conceded), then Mr. Klopfenstein must be a prevailing party.

Mr. Klopfenstein’s argument is logical, reasonable and consistent with the statutory language. Indeed, a commonsense definition of “prevailing party” in the context of litigation likely would encompass a party whose adversary “lost” with respect to 90 percent of its claim. Thus, whether or not a denial of attorneys’ fees in cases such as this makes sense as a matter of policy, the viewpoint adopted by this court (based though it was on precedent) is awkward at best.

Had the government conceded that it took a position in the case, Mr. Klopfenstein might not have succeeded in recovering fees in any event. Under section 7430(c)(4)(B), attorneys’ fees are not awarded if the government establishes that its position was “substantially justified.” Substantial justification is a relatively low standard. It requires merely that the position have a reasonable basis in law and in fact. Treas. Reg. § 301.7430-5(d).

The best way to overcome the substantial justification hurdle is to make a qualified offer. Simply stated, if the IRS does not accept a taxpayer’s qualified offer to settle a case and the taxpayer receives a judgment that is equal to or less than the offer, the taxpayer is deemed to be the prevailing party; whether the government’s position was substantially justified or not is irrelevant. (The qualified offer rule is set forth in section 7430(c)(4)(E).) Unfortunately for Mr. Klopfenstein, however, the qualified offer rule applies only if a judgment is entered in a court proceeding. Because the case was settled before a court proceeding had commenced, the qualified offer rule did not apply.

Addendum: The Tax Court has jurisdiction to review IRS decisions whether to grant or deny (in whole or in part) requests for attorneys’ fees. Section 7430(f)(2); Tax Ct. R. 271. In docketed cases, the taxpayer must raise the claim during the case itself; res judicata precludes consideration of costs in a subsequent proceeding to the extent that the issue could have been pursued in the earlier case. Gustafson v. Commissioner, 97 T.C. 85 (1991); Foote v. Commissioner, T.C. Memo. 2013-276. Where the matter has been resolved administratively, the taxpayer must file a petition with the Tax Court within 90 days after the date on which the IRS mails a notice of decision. The taxpayer, not the attorney, is the proper party to file the claim. Greenberg v. Commissioner, 147 T.C. 382 (2016).

Love, Legal Fees, and the Origin of the Claim: Designated Orders September 23 – September 27, 2019

Despite a relatively small number of orders designated during the week of September 23, they were diverse and interesting. I discuss three below, but the orders not discussed addressed: IRS’s motion for summary judgment in a case where petitioner cited the book, “Cracking the Code” to support his position (here); and a motion to stay (here) and a motion to dismiss for lack of jurisdiction (here) from petitioners in a consolidated docket case involving converted partnership items.

Docket No. 15277-17, Maria G. Leslie v. C.I.R. (order here)

This first order piqued my interest because it covers a topic that comes up in the individual income tax class that I teach every year. The order addresses the IRS’s motion for summary judgment and the case involves alimony and the deduction for legal fees under section 212. The Tax Cuts and Jobs Act separately impacted both of these issues by eliminating the income inclusion (and corresponding deduction) of alimony for divorces decreed post-2019, and by suspending miscellaneous itemized deductions (so below-the-line attorney’s fees cannot currently be deducted). The analysis in this order is still helpful and relevant to past, and perhaps, future years.

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A deduction for legal fees is allowed when the fees are incurred to produce or collect income. Since alimony is considered income by virtue of section 71(c) legal fees related to alimony could be deducted, prior to the TCJA changes. Legal fees related to other costs of divorce are not deductible, so it is important that taxpayers (or more importantly, their divorce attorneys) distinguish between the fees paid for each cause of action.

To determine whether the fees are deductible, the Court must look to the origin of the claim and not the taxpayer’s purpose or desired outcome in the case.

In this specific case, there is a lot at stake for the petitioner. Her ex-husband worked with the firm that handled the class action lawsuit against Enron and for which he received a $50 million fee after the marriage ended.

Originally, a marital settlement agreement (“MSA”) was reached which entitled petitioner to 10% of her ex-husband’s earnings. The amount received under the MSA was determined to be alimony income to the petitioner in an earlier Tax Court case.

Later, petitioner had second thoughts about the MSA and incurred legal fees in three separate proceedings: 1) to set aside the MSA for lack of legal capacity, 2) for an order to show cause as to why she should receive the percentage of earnings as dictated by the MSA nevertheless (her ex-husband deposited her percentage into a trust account for her benefit, but she was barred from accessing it), and 3) for damages for breach of fiduciary duty to her with respect to the MSA negotiations under California Family Code which allows a suit for damages if a breach by her ex-husband results in impairment to her undivided one-half interest in the community estate.

The Court looked to origin of the claim for each proceeding and determined that petitioner was only entitled to deduct legal fees for the second proceeding, because it related to the alimony income in the trust account and her ability to collect it. The IRS’s motion for summary judgment was denied with respect to this part.

The other proceedings were not entitled to a legal fee deduction because the origin of the claim in the first proceeding was related to a flaw in the MSA, and in the third proceeding arose from a duty that her ex-husband had to her as a result of their marriage. In other words, the origin of the first and third claims did not involve the production or collection of income. The IRS’s motion for summary judgement was granted with respect to these parts.

The parties were ordered to submit settlement documents or a status report by the end of November.

Docket No. 6446-19L, Wendell C. Robinson & May T. Jung-Robinson (order here)

In this order the petitioners have filed a motion for summary judgment because they believe they have already paid their 2012 liability of $88,000 with a combination of withholding and a check sent with their return. They argue that as a result of the liability being paid in full, and since the assessment statute is closed, the IRS’s proposed levy cannot be sustained.

In response, the IRS explains that the petitioners’ return contained mathematical errors, so they owed $13,267.20 more than what their return originally reflected. The IRS used its math error authority to correct the returns, so no notice of deficiency was issued. There has been considerable coverage by PT on various math error authority issues (for example: here and here) and it was an “Area of Focus” in former NTA, Nina Olson’s Fiscal Year 2019 Objectives Report to Congress.

The Court has an issue with the IRS’s use of math error authority in this case – mainly that Appeals’ notice of determination makes no mention of the mathematical corrections permitted by section 6213(b)(1), nor of whether the petitioners were notified of the corrections, as required, to give them an opportunity to request abatement. Abatement can be requested under section 6213(b)(2)(A) and doing so entitles the taxpayer to deficiency procedures.

The Court would like more evidence on this issue, so it denies petitioner’s motion.

Docket No. 17799-18L, Michael Balice v. C.I.R. (order here)

This case involves an interesting scenario in the CDP world that I have not encountered – it is one where a taxpayer timely requests a CDP hearing but is not provided with one. Keith covered the topic in 2015 (here), and in 2016 (here) after the IRS provided guidance on how its attorneys should handle the issue in Chief Counsel Notice (“CC”) 2016-008. The issue has also come up in at least one other designated order post (here).

In this order, it appears that Counsel may not have adhered its own guidance and the IRS has moved to dismiss the case alleging that the petitioner took only frivolous positions in his CDP requests for a levy and lien.

The IRS argues that the Court should grant summary judgment in their favor because they did not violate petitioner’s due process rights by denying him a CDP hearing. In the IRS’s view, petitioner had an opportunity to raise issues regarding his liability and the validity of the lien in other courts (because the DOJ had the case for a period of time) and petitioner’s request was properly disregarded because it only raised frivolous issues. IRS also argues that there is no benefit to remanding the case to Appeals, which the Court may be permitted to do, because of petitioner’s frivolous arguments and because Appeals lacks the authority to compromise petitioner’s liability due to the DOJ’s involvement.

The Court isn’t convinced by the IRS’s arguments and reviews the history of the case. Earlier on, as a result of the Office of Appeals’ view that the petitioner’s request was frivolous, it did not communicate with the petitioner in any of the usual ways. The petitioner did not receive an explanation of the process and Appeals did not request any financial information.

The only correspondence Appeals sent to petitioner was a notice of determination sustaining the NFTL (petitioner’s request related to his proposed levy was not timely). This denial of a CDP hearing is permitted under section 6330(g), but Thornberrypermits the Tax Court to review the “non-hearing” for an abuse of discretion.

That opportunity for review is potentially helpful for petitioner in this case. The Court reviews the form letter that petitioner submitted with his CDP request and nothing seems frivolous about it.  If only some portions of petitioner’s request are frivolous, then Appeals may have abused its discretion in denying the CDP hearing. The Court also identifies a section 6751 supervisory approval issue and the IRS has not demonstrated it has met its burden. As a result, rather than grant the IRS’s motion, the Court sets the motion for argument during the upcoming trial session.

Friends of the Benedictines in the Holy Land Wins Tax Exempt Status but Loses Request for Fees Associated with Application Delays

In a precedential opinion, the Tax Court ruled on the request of an applicant for tax-exempt status for administrative and litigation fees. The Court denied those fees in Friends of the Benedictines in the Holy Land, Inc. v. Commissioner, 150 T.C. No. 5 (2018). I think the case merits a precedential opinion because of the ruling on the administrative proceeding period in a case involving exempt status. No aspect of the opinion addresses the substance of the request for exempt status because the IRS conceded that issue at the very outset of the case in the fall of 2013. Since that time, the case focused on whether the taxpayer could receive an award for administrative costs and attorney’s fees.

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Friends of the Benedictines requested exempt status on July 12, 2012, about the time the IRS exempt organization sank deeply into the mire of the allegations of improper treatment of certain applications. Perhaps because of the distractions going at the time in the Exempt Organizations Division of the IRS or perhaps due to the normal time lag for consideration of certain exemption requests, the IRS did not act on the request. The docket sheet in the case indicates that Marcus Owens, a former head of the Exempt Organization Division, was initially counsel in the case. The opinion states that counsel for petitioner called an IRS attorney around September 18, 2013, to ask about the status of the case. Petitioner’s counsel was told that the case was still in process and no definite date of disposition was known.

IRC 7428(a), (b)(2) provides that an applicant for exempt status can petition the Tax Court for a determination of that status if the IRS denies the request or if 270 days passes and the IRS fails to act upon the request. On Friday, September 20, Friends of the Benedictines filed a Tax Court petition. On Sunday, September 22, the IRS issued a determination letter recognizing Friends of the Benedictines as a 501(c)(3) organization. I have occasionally filed petitions which the IRS has conceded before answer but I have never had a two-day turn around with a concession on the weekend. This was impressive. I guess all of the exempt organization people were working overtime anyway to deal with the other problems that existed at the time.

Because of some non-relevant procedural issues, it took three months to get the decision entered by the Court but there was no fight in the Tax Court case since the IRS immediately granted what the taxpayer requested. Having won the substance of the case, taxpayer then requested that the IRS pay its administrative costs and attorney’s fees. Here the IRS balked. There was no two-day turn around to concession on this issue. The case settled in for a 4 and ½ year visit to the Tax Court despite the concession on the merits two days after filing.

Petitioner’s counsel submitted a series of billing statements related to the work done on the case. Some identify a different part as the client. After some back and forth to get more clarity to the billing statements and more clarity concerning the request and whether it was for administrative or litigation expenses, the material was submitted and it became clear that petitioner wanted reimbursement for both administrative and litigation expenses. The court decided the case without hearing based on the materials submitted by April of 2014.

No qualified offer existed in this case. We recently discussed a case in which the taxpayer succeeded in obtaining attorney’s fees without a qualified offer but that is difficult. The Tax Court recounted the statutory requirements of IRC 7430(b) and (c) the petitioner needed to establish in order to win: 1) it is the prevailing party; 2) it did not unreasonably protract the proceedings; 3) the amount of the costs requested is reasonable; and 4) it exhausted the administrative remedies available. The IRS conceded that taxpayer met 2 and 4, but contested the other two elements necessary for petitioner to win. To succeed, the taxpayer must meet all four elements.

The IRS first argued that there were no administrative proceedings in a case involving a request for exempt status. The Court disagreed. Unlike a private letter ruling request that the IRS need pay no attention to, a request for exempt status leads to a Tax Court proceeding if the IRS fails to respond after the appropriate interval and the petitioner wants judicial redress. Looking at all of the elements of the exempt status request and the broad definition of administrative status, the Court concluded that the request did indeed involve an administrative proceeding that could give rise, in appropriate circumstances, to an award of costs.

The IRS then argued that petitioner could not be the prevailing party with respect to administrative costs because the IRS never took a position. How could the petitioner prevail over the IRS which did not say yea or nay to its request? Petitioner argued that administrative costs should not be “limited to those incurred after the issuance or receipt of a notice or letter.” The Court responded to this argument by stating that to agree with petitioner, “we would have to find an unwritten exception to the statute and hold that the notice or letter requirement is inapposite when the claim for administrative costs rests on the fact that the IRS has failed to act.” In the end, however, the Court takes a pass on this issue finding that petitioner only provided evidence of litigation costs.

I wondered how you would measure administrative costs if the administrative issue begins with the submission of the request for exempt status. At the point of submission, all of the initial “administrative” work is done.   In a case like this in which the IRS does not but also requests nothing of the taxpayer, it does not seem as though the taxpayer has administrative costs. It costs nothing to sit and wait, as frustrating as that might be.

Nonetheless, the Court passes over the issue by finding that all of the fee requests from petitioner really relate to the “litigation” of the case. Litigation here is a two-day period over the weekend when the IRS cranks into gear on the exemption requests and pumps out a thumbs up. The IRS argued that its position in the judicial proceeding was substantially justified. The Court notes that the applicable statute, IRC 7430(c)(7), “does not specify when the United States takes a ‘position’ in a judicial proceeding.” The Tax Court has generally held that the IRS establishes its litigating position when it files its answer but notes that it could be established earlier under certain circumstances.

Here, the lightening quick concession of the case, 58 days before the answer was due, establishes that the IRS position in litigation was justified. In reaching this conclusion, the Tax Court rejected the reasoning of a pair of district court cases, Grisanti v. United States, No. 3:05CV12-D-A (N.D. Miss 2006) and Powell v. Commissioner, 791 F.2d 385 (5th Cir. 1986), that held unreasonable delays or positions during the administrative process could not be cured by a quick concession in the court proceeding. The Tax Court said that it bifurcates the administrative and court aspects of a case and could not accept the reasoning of these cases that a bad position during the administrative aspect of a proceeding washes over into a determination of the justification of the IRS’s litigating position.

Before closing, the Tax Court expresses sympathy for the position of the petitioner. Unless a case is brought where the appeal will go to the 5th Circuit, it looks like concessions before or near the filing of the answer will insulate the IRS from attorney’s fees except in those cases in which the taxpayer makes a qualified offer during the pre-notice visit to Appeals. The case shows again the difficulty facing taxpayers who seek attorney’s fees in Tax Court cases.

 

 

 

Winning Attorney’s Fees the Old Fashioned Way

For those who enjoy watching basketball, you occasionally hear the announcer say that a player has completed a 3 point play the old fashioned way.  Fans who are old enough to remember a time before the institution of the three point line allowing shots behind that line to receive 3 points if made understand that the announcer is referring to a play in which the player shooting the ball is fouled while shooting and making a basket.  The foul allows the player to make a third point from the free throw line.  This type of three point play has existed for many decades while the 3 point shot from behind a certain line is only a few decades old.  A similar situation exists with respect to attorney’s fees.  The ability to obtain attorney’s fees has existed for several decades; however, the creation of qualified offers a couple of decades ago changed the game and only occasionally does someone win attorneys fees the old fashioned way – without the aid of a qualified offer.

We have written several times about attorney’s fees issues, here, here, here, and here. In writing about attorney’s fees, we have almost always referenced the qualified offer provisions because obtaining attorney’s fees without a qualified offer is very difficult to do. In fact, that difficulty led to the creation of the qualified offer provisions which allow a prevailing taxpayer to overcome the substantially justified language in IRC 7430. Many taxpayers prevail and meet all of the other criteria for an award of attorney’s fees; however, few taxpayers can show, without the benefit of a qualified offer, that the position of the IRS was not substantially justified. The case of United States v. Johnson, No. 2:11-cv-00087 (D. Utah 2018) provides a rare example of a taxpayer who obtains attorney’s fees without the benefit of a qualified offer.

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The IRS brought this suit against the children of Anna S. Smith, seeking to collect an estate tax deficiency. The complaint was brought on January 21, 2011. Ms. Smith died in 1991. Not surprisingly, the defendants filed a motion to dismiss arguing that the IRS suit was time barred. They also argued that they had no personal liability with respect to funds from the estate except for insurance proceeds and that because the estate had sufficient assets to pay the taxes at the time of their distribution the personal liability provisions of 31 USC 3713 did not apply. The court initially found for the IRS. The defendants filed an amended answer asserting that they had a defense to personal liability because they tendered a special lien under IRC 6324A. After further argument, the court reversed and found for the defendants on all counts except for some of the life insurance benefits. The defendants requested attorney’s fees, which the court addresses in this memorandum opinion.

The court finds that the defendants meet the definition of prevailing party based on the dollar amounts and issues in controversy. It finds that that the defendants have a net worth less than $2 million and settles into a lengthy discussion of the issue of substantial justification that usually trips up taxpayers seeking fees. The court notes that the IRS position should be presumed not to have substantial justification if the IRS did not follow its published guidance, which is defined as “regulations, revenue rulings, revenue procedures, information releases, notices, and announcements.”

The defendants wisely segregated their fee requests according to the claims at issue in the case. They did not request fees on the issues of statute of limitations, transferee liability, discovery, and other uncategorized issues. Their fee request focused on the issues of whether the trust assets were includible in the estate, whether the beneficiaries received a discharge because of the special lien, and whether attempts to enforce the distribution agreement were improper. The court, in turn, addressed each of the three bases for fees. Although it is not clear exactly how the court calculated the amount of fees it ultimately awarded, the defendants would have had to provide the time spent by their attorneys on each of these issues with specificity in order to obtain the award.

IRS position on discharge of fiduciary liability was not substantially justified

The IRS argued that the defendants never made a written application for discharge and that it never accepted the proposed section 6324A lien. The court found that the IRS never identified any “form, method, procedure, or policy by which a ‘written application’” is properly made nor did it point to any specific format, form or wording to make the application. It stated “this is nearly fatal to the government’s claim that it had a reasonable basis in law and fact for its position.” The IRS pointed to the case of Baccei v. United States, 632 F.3d 1140, 1145-6 (9th Cir. 2011) in support of its position and the court examined that case. The court found that Baccei “placed the government on notice that in the absence of a ‘clear statutory prerequisite that is known to the party seeking to apply the doctrine,’ combined with the government’s utter inability to identify an ‘proper’ form or method of providing a written application for discharge, its position on this point was not substantially justified.” The court also found that its position that it could reject the section 6324A lien “contradicted its own published guidance, misinterpreted the plain language of statues and regulations, ignored relevant provisions of other statutes and regulations and conflicted with the undisputed purpose of section 6166.”

IRS position on liability as trustees was not substantially justified

The court acknowledged that this issue was difficult but still concludes that the IRS position was not substantially justified. The defendants acknowledged that the issue of the proper code section of inclusion was a novel issue but the IRS position merely restated their litigating position without discussing how their litigating position was reasonable. This is a very taxpayer favorable determination after an acknowledgement that the court struggled to find the right answer and that the taxpayer’s position was novel. Both of those factors normally preclude a determination that the IRS was not substantially justified. The court points to its conclusion that the IRS position contradicted a technical advice memorandum and a revenue ruling.

IRS attempts to enforce the distribution agreement and foreclose its tax lien were not substantially justified

The court found that the IRS sat too long on its right to enforce the distribution agreement and failed to release the tax lien twice. It found a parade of legal and factual errors in the way it pursued the agreement and the lien that was not overcome by the IRS arguments that recited the same facts contained in their losing brief.

Conclusion

This case should give heart to those pursuing attorney’s fees after successful litigation that if you can find something in the IRS actions that does not follow its own rules you can succeed in obtaining attorney’s fees even without the assistance of a qualified offer. Of course, the taxpayers’ victory here does not suggest the better course is not to file a qualified offer but this case does offer hope that fees are a possibility even without such an offer.

 

Attorney’s Fees Awarded in Penalty Case Arising From Late Payment of Excise Taxes

As in Keith’s post yesterday, today’s post also involves attorney’s fees, though the subject of toady’s post, C1 Design Group v US, involves a qualified offer and whether the awarding of fees justifies a rate higher than the statutory cap of $200/hour. C1 Design Group is a magistrate’s order from a federal district court in Idaho, and as I describe below is a helpful case for practitioners wanting insights into recovering attorney’s fees under Section 7430.

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The underlying case involved a refund action that considered whether C1 Design’s failure to timely pay its excise taxes was due to willful neglect. C1 argued that a car crash involving the company’s founder led to financial difficulties, which led to the late excise tax payments. IRS agreed with that excuse for the first four quarters but litigated the effect of the crash on later quarters. The taxpayer argued that the injury triggered financial difficulties, which amounted to reasonable cause for the late payments.

The matter went to trial, with a jury rendering its verdict in favor of the taxpayer for the full amount of the refund, about $28,000. About a year after filing its claim, C1 Design made a qualifying offer, essentially agreeing to accept as a settlement a refund of about half of what the jury found the taxpayer was ultimately entitled to receive.

Following the verdict, C1 Design filed its motion for fees, seeking about $76,000; approximately $50,000 was attributable to the period after it made the qualifying offer.

The court agreed that C1 was entitled to fees for the period after the IRS  rejected the qualifying offer, but found that rejecting the offer was “substantially justified”, thus not warranting fees for the period prior to the qualifying offer. In addition, the court reduced the lead lawyer and his associates’ hourly rate, based on a finding that the taxpayer did not prove that there were special factors that warranted an increase over the statute’s $200 cap. The net result was that the taxpayer was awarded attorneys’ fees of about $33,000, not the $70,000 that the taxpayer sought.

There are some things in the opinion worth highlighting.

One, just because a taxpayer wins on the merits, it does not mean that the government position is not substantially justified, especially on a fact intensive issue like reasonable cause involving late payment penalties. As the opinion discusses, the “United States’ position was substantially justified if it is ‘justified to a degree that satisfies a reasonable person,’” or has reasonable basis in both law and fact. Pac. Fisheries Inc. v. United States, 484 F.3d 1103, 1108 (9th Cir. 2007) (citing Pierce v. Underwood, 487 U.S. 552 (1988). That inquiry, under the statute, has a focus on whether the “United States has lost in courts of appeal for other circuits on substantially similar issues.”

In this case (as in most), the judge deciding the fees motion presided at the trial. She noted that while the taxpayer won, its victory was “no slam dunk” for either side. Pointing out evidence that favored the government, including the taxpayer’s decisions to pay other creditors and pay healthy salaries while not paying Uncle Sam, the magistrate judge emphasized that had the taxpayer’s main witness (the person whose crash caused the taxpayer’s financial spiral) been less credible, the US would have won on the merits.

The order also discusses the lack of circuit court authority on the issue as to whether financial difficulties equate to reasonable cause for late payment of excise taxes; the slim authority the taxpayer relied on was out of the Third Circuit and involved an analogous issue, employment taxes rather than excise taxes.

Finally worth noting is the court’s unwillingness to allow the full hourly rate for the partner and associate’s fees. The statute caps the fees at $200/hour; the taxpayer sought the $300 that the partner charged and that were the bulk of the fees. Section 7430 provides that the $200 cap is what the taxpayer gets “unless the court determines that a special factor, such as the limited availability of qualified attorneys for such proceeding, the difficulty of the issues presented in the case, or the local availability of tax expertise, justified a higher rate.”

To justify the fee, the lead attorney filed an affidavit, stating that he practiced law for over 37 years, that for the last 16 years his main focus was tax resolution and that his fees were equivalent to what other attorneys with similar expertise charged. For good measure he noted that he believed he was only one of a couple of attorneys in the Idaho area that “solely represents” clients in tax controversy matters.

The order found that the affidavit was insufficient:

While Mr. Martelle [the partner] “believes” he is one of few tax attorneys in the Boise, Idaho market, he does not identify in his affidavit who those other attorneys are or the rates charged by those attorneys. Mr. Martelle’s belief, without other evidence to corroborate it, is not sufficient to establish that Boise, Idaho, is lacking in qualified tax attorneys. Moreover, the Court finds the issues presented in this matter were not so difficult as to warrant an upward adjustment of attorney fees. The issues presented were not technical—neither side found it necessary to hire an expert, and the trial (including deliberations) was over in just two days. Finally, while the Court does not doubt Mr. Martelle’s vast experience in tax law, such expertise alone is not a special factor to justify attorney’s fees in excess of the statutory cap. For these reasons, the Court will award attorney’s fees at the maximum statutory rate of $200 per hour for Mr. Martelle.

Conclusion

Keith has previously discussed how qualifying offers are an important tool for taxpayers and practitioners. The qualifying offer in C1 Design was crucial, and allowed for the recovery of some fees. While the order and the underlying refund case is a victory for the taxpayer, it is not the complete victory that it sought. It is expensive to try tax cases. Assuming that the taxpayer is paying the balance of the attorney fees, that amount almost washes out the recovery of the late payment penalties that were the subject of the underlying refund case.