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.

read more...

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.

read more...

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.

read more...

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.

read more...

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.

read more...

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.

 

Innocent Spouse Denied Attorney’s Fees

In Kazazian v. Commissioner, T.C. Memo 2017-135, the Court denied attorney’s fees to a petitioner who succeeded in gaining innocent spouse status.  The Court determined that she was not a prevailing party under the statutory definition of IRC 7430.  The Court also determined that even if she were a prevailing party she did not prove that she incurred meaningful costs with the respect to the case.

read more...

Petitioner is a lawyer who had a solo practice run as a Schedule C.  She also owned real estate and the joint return reported losses attributable to the rental real estate activities.  The year at issue in the case is 2009.  She separated from her husband in 2010 and divorced in 2011.  The IRS audited the joint 2009 return and disallowed the rental losses, disallowed some of her claimed Schedule C expenses and disallowed each spouses’ claim for innocent spouse relief.  In Appeals, some losses and some expenses were allowed and the husband was granted partial innocent spouse relief.  Appeals did not grant Petitioner innocent spouse relief.  She agreed to the tax adjustments but did not agree to the determination regarding her status as an innocent spouse.  Both spouses alleged abuse by the other.

Petitioner filed her Tax Court petition on the issue of her status as an innocent spouse.  Shortly before the case was calendared, the IRS agreed that she was entitled to relief under 6015(f) and a stipulation of settled issues was filed.  She requested fees.  As a curious person, I would like to know why the IRS granted her innocent spouse relief since the liabilities seem to stem from adjustments related to her if I am reading the opinion correctly.  That, however, will remain a mystery.

The Court addresses her claim for fees and notes that she makes the request both with respect to both the administrative and litigation phases of the case.  Because petitioner did not file a qualified offer, the Court states that the position of the IRS is “substantially justified” if it is “justified to a degree that could satisfy a reasonable person” and has a “reasonable basis both in law and fact.”  Swanson v. Commissioner, 106 T.C. 76, 86 (1996).  The fact that the IRS ultimately loses or concedes a case does not make the position unreasonable but the Court notes that this can be considered in determining reasonableness.

Petitioner argued that the return preparer acting on behalf of her ex-husband made the decision to treat her as a real estate professional without consulting her.  The Court finds that no factual basis for this argument exists.  It finds she actively engaged with the preparer.  The Court goes through a brief analysis of the determination of the Appeals Officer that she did not qualify for innocent spouse relief.  The Court seems to have the same problem I do understanding why Chief Counsel’s office conceded this case.  It finds the determination of the Appeals Officer reasonable and states that “there is no evidence in the record as to the basis for this concession.”  Neither party is required to put such evidence into the record when making a concession but here it would have been very helpful if petitioner had done so.  If we could know why Chief Counsel decided to concede the case perhaps we could understand why they did so and why it was unreasonable for the Appeals Officer to fail to concede the case.

The Court finds that “notwithstanding this concession, we conclude that the AO’s determination that the petitioner was entitled to no relief under section 6015(f) had a ‘reasonable basis both in law and fact’ and was ‘justified to a degree that could satisfy a reasonable person.’”

Aside from the problem of not providing the Court with an understanding of how she came to win the case and how it was unreasonable for Appeals not to have conceded it, petitioner has the problem of not proving the basis for her claim for a specific amount of fees.  She failed to submit the affidavit required by Rule 232(d) and relied on the declaration included with her original motion.  Because she represented herself (and did a great job), she has trouble showing her costs other than her $60 filing fee.  Her time entries and those of her accountants do not break out the time to reflect time worked on the innocent spouse aspect of the case as opposed to the other issues present.  In response to a request by the IRS for more detailed records regarding the time spent on the innocent spouse issue, petitioner made what the Court deemed as a frivolous response stating that she devoted 1,000 hours over four years to resolve the matter and her billing rate is $350 per hour.  So, she argued she should really receive $350,000.

Petitioner’s path to victory on the innocent spouse issue remains a mystery and that mystery makes it hard for the Court to decide the IRS was unreasonable when it initially decided she did not qualify for such relief.  The case makes the point that when the IRS concedes and you want fees and the basis for the concession does not jump out from the available facts, you must take the time and effort to put into the record the basis for the concession.  I hope there is some reason that the Chief Counsel attorneys conceded what looks like from these facts to be a very strong case on their side of the argument.  Whatever reasons that exist for the concession need to be made known by petitioner in order to show the Court that she substantially prevailed.  Without a qualified offer, it is hard enough to show this.  On these facts it seems impossible.

Of course, showing why the IRS was so wrong is only one thing you must do if you want fees.  You also have to show how you calculated the fees you seek.  Petitioner’s somewhat frivolous response to the request for more data further doomed her chances for recovering fees.

 

When Do Attorney’s Fees Start

In Fitzpatrick v. Commissioner, TCM 2017-88, the Tax Court took up the issue of the timing of attorney’s fees in a case in which the taxpayer made a qualified offer several months after the representation had begun.  The Tax Court previously found, in a seven day trial on the merits in a Collection Due Process (CDP) case, that the taxpayer was not a responsible officer.  The Tax Court tries a relatively small number of Trust Fund Recovery Penalty (TFRP) cases and probably a very small number of those cases involve a seven day trial.  A couple of other interesting aspects of this case from the underlying merits perspective are that the Court’s electronic docket sheet goes on for eight pages.  Only a small number of cases have that many entries.  The merits opinion leads me to believe that Ms. Fitzpatrick was the last remaining responsible officer because the IRS had determined the other possible responsible officers were not liable.  If I am correct in that determination, it could explain the effort the IRS put into her case.

Although this attorney’s fees opinion does not break significant new ground, hence its designation as a memorandum opinion, it does provide a good basis for discussion of when the fees begin as well as a few other fee related issues.

read more...

Ms. Fitzpatrick held a position with a company that failed to pay over the withheld income and employment taxes from its employees.  From footnote 3 of the most recent opinion, I draw the conclusion that other persons working at the business sought to pin responsibility on her and made statements which the Court characterized as “misinformation.”  Of course, these statements would also have had the collateral effect of demonstrating that the persons making the statements were not themselves responsible.  The statements became a part of the revenue officer’s report – a report which the Court also indicated may not have provided the appropriate characterization of her role with the business.  For readers wanting more information about the underlying assessment, go to the opinion written last year.

After the IRS made its preliminary determination of liability, it would have mailed that determination to Ms. Fitzpatrick’s last known address.  The case does not find that the IRS improperly mailed the notice, but it does find that she did not receive it.  Her failure to receive the TFRP notice, much like the failure to receive a notice of deficiency, entitles her to litigate the merits of the assessment in her CDP case.  In Mason v. Commissioner, the Tax Court had previously decided, and we posted, that a proposed responsible officer who does not receive the notice proposing the liability and offering an opportunity to go to Appeals prior to the assessment may raise the merits of the TFRP liability in a CDP case.

The IRS did not take issue with her ability to raise the merits, and she made a presentation about the merits of her case to the Settlement Officer in the CDP hearing before she filed the Tax Court case.  Here, the filing of the notice of federal tax lien by the IRS triggered her CDP rights including the right to contest the underlying assessment.

She filed her request for a CDP hearing on July 25, 2012 within 30 days of receiving the CDP notice.  It is worth mentioning that the notice of federal tax lien would have remained on the public record for the four year period between the time of its filing and the decision of the Tax Court that she had no liability for the TFRP.  The filed notice of federal tax lien would have depressed her credit score, her general credit, limited her potential employment opportunities, and generally made life financially difficult for that entire period, which is why I have previously advocated for some type of expedited procedure in CDP cases involving liens.

The parties agreed that she made a qualified offer on November 7, 2012.  The date of the qualified offer comes about three and one half months after the filing of CDP request.  This period likely involved a fair amount of work for her attorney coming up to speed on the case and making a decision on her likely prospects for success but because of the way the qualified offer provisions work, she cannot recover attorney’s fees from the IRS for this period unless she can show that the position of the IRS lacked substantial justification.  After looking at the facts, the Court determined that the Settlement Officer had a file that contained sufficient facts to make the position of the IRS substantially justified.  So, the fees do not begin until the date of the letter.

Section 7430 provides guidance on when a taxpayer can file a qualified offer.  The taxpayer cannot make a qualified offer at the first minute the IRS raises an issue on audit or when the IRS issues a notice and demand.  A qualified offer can only occur at certain stages in the tax procedure continuum.  The time period for filing a qualified offer is set out in subparagraph 7430(g)(2) entitled “Qualified Offer Period.”  That subparagraph provides:

(2) Qualified offer period.  For purposes of this subsection, the term “qualified offer period” means the period—

(A)

beginning on the date on which the first letter of proposed deficiency which allows the taxpayer an opportunity for administrative review in the Internal Revenue Service Office of Appeals is sent, and

(B)

ending on the date which is 30 days before the date the case is first set for trial.

This provision really provides guidance regarding deficiency proceedings and not TFRP cases or CDP cases.  The IRS and the Courts agree that a taxpayer cannot make a qualified offer in a CDP case that simply contests collection alternatives.  [find authority]  Other courts have found that a taxpayer can request a qualified offer as a part of contesting a TFRP determination even though the statute does not appear to contemplate such a result.  [find authority]  Here, the IRS does not contest the ability of the taxpayer to make a qualified offer and does not contest that the timing of the offer is valid.  Based on earlier cases, it appears that the earliest a qualified offer could have been made in Ms. Fitzpatrick’s cases was the time of making the CDP request contesting the merits of the underlying TFRP liability.  The taxpayer waited three months after bring the CDP action before making the qualified offer but considering the circumstances, did not wait very long before making the qualified offer.

This aspect of the statute regarding the making of a qualified offer puts pressure on a representative who wants to protect the client’s ability to recover fees.  The representative does not want to make a qualified offer that has no basis in fact or law but while the representative researches the facts and the law before making the offer, the client must cover those costs unless the representative can ultimately overcome the high hurdle of showing that the IRS lacked substantial justification.  The representative must consider the timing of the qualified offer and make it as quickly as possible after expending as few billable hours as possible and yet not make an offer that will disadvantage their client.  If the representative makes a qualified offer that fails to take into account the litigation risks, then it is possible that through settlement or trial, the IRS will exceed the amount of the offer and the qualified offer provisions which eliminate the need to prove the IRS lacked substantial justification will not apply.  Conversely, if the representative makes an offer that is too high, the IRS might accept the offer to the client’s disadvantage.

After the Court explains why the IRS had substantial justification for its position that Ms. Fitzpatrick owed the TFRP, the Court then turned to other arguments of petitioner most of which arise frequently in these cases.  Petitioner argued the amount of the award should exceed the statutory amount because in Jacksonville, Florida only a limited number of attorneys could have handled a case such as this.  The Court did not agree.  Petitioner argued that her attorney possessed exceptional qualities enabling him to succeed in this case.  Again, the Court found that although her attorney was a qualified attorney he did not have the nonlegal or technical ability referred to by the statute as creating a basis for enhancement based on qualifications.  Petitioner argued that the issue in her case was difficult and that “this was not a simple case to try.”  The Court pointed out that TFRP cases are basically a dime a dozen.  Petitioner argued that the case was undesirable because she did not have the money to front to the firm and it had to absorb significant costs to keep the case going.  The Court found that undesirability of a case does not constitute a special factor warranting an enhanced fee.  Lastly, petitioner argued that the IRS took an unusually litigious position.  The Court basically said that if the IRS prolonged the case through its overly litigious position, her attorneys would receive compensation for the additional hours they spent responding to the positions raised by the IRS.  Here, the length of the trial and the other work done by petitioner’s counsel does result in a fee award of approximately $179,000.  The Court does not say that the IRS took an unreasonable litigation position.

The arguments over enhancements here sound like arguments made in other similar cases in which the Court has made awards.  The interesting feature of this case for me is the timing of the qualified offer.  The decision points to the benefits of an early submission of such a letter although tensions will exist concerning when the practitioner will have enough information to make an informed offer.  Winning a TFRP case is not easy.  Winning and getting attorney’s fees paid for most of the representation deserves recognition.

From A to Z the IRS Throws Every Possible Argument at the Court in Unsuccessful Attempt to Avoid Attorney’s Fees

We have talked about what it takes to recover attorney’s fees from the IRS in prior posts here, here, and here.  The recent Court of Claims case of BASR Partnership v. United States, takes almost all possible defenses to attorney’s fees and puts them on display in one case.  For that reason the case deserves discussion.  One reason the IRS may have tried so hard to avoid attorney’s fees in this case stems from the fact that the taxpayer engaged in what the IRS no doubt considered abusive tax shelter activity and only avoided tax and penalties due to a snafu.  So, the fight over fees just added insult to injury with the IRS feeling that the taxpayers should have paid significant liabilities for its activities and yet ending up with no tax as well as payment by the IRS for the representation it received.

read more...

In 2013, the Court of Federal Claims determined that the IRS did not timely issue an FPAA to BASR.  The IRS appealed to the Federal Circuit and lost again.  The IRS requested a Petition for En Banc Rehearing and the court denied that as well.   The government does not lightly seek en banc review.  It must have felt strongly on the merits of the FPAA issue, but I am not going to discuss that issue in this post.

After winning these significant victories which kept the IRS from making adjustments to the partnership for what the IRS viewed as abusive tax shelter activities, the taxpayer and its attorneys at Sutherland Asbill & Brennan sought attorney’s fees, and they sought fees at a higher rate than the statutory rate for attorney’s fees.  The IRS filed a motion to conduct limited discovery concerning the fees and the taxpayer responded.  After a conference with the court the taxpayer was required to “produce the client’s fee agreement, a copy of all legal bills sent to the client, and any proof of payment from the client.”  Then the IRS filed an objection to the motion for litigation costs and requested oral argument.  The taxpayer requested “fees for fees” seeking to add to its recovery and get reimbursed for the cost of fighting about the existence and amount of the fee award.

The first thing the taxpayer needs to do in seeking to recover fees is show that it is a “prevailing party” which means it must have (1) substantially prevailed with respect to the amount in controversy; (2) the IRS position was not substantially justified; and (3) the statutory requirements regarding net worth are met.  The taxpayer can meet the first two parts of this test, which are otherwise quite difficult to meet, if it makes a proper qualified offer and that is why we have discussed qualified offers to a significant extent in the prior posts cited above.  Making a qualified offer is the most direct path to obtaining fees since it moves the taxpayer past the substantially justified barrier.  In this case BASR made a qualified offer of $1 to the IRS to settle the FPAA issue.  As you can tell from the litigation I described above, the IRS did not settle the FPAA issue and fought it all the way to making the request for en banc reconsideration.  Because the IRS lost completely on the statute of limitation issue, the effect of its loss was that the taxpayer did better in the litigation than the $1 offer it made to the IRS since it owed $0 after winning the statute of limitation argument.  This put the taxpayer over a big hurdle to becoming a prevailing party and appeared to leave it only with net worth requirement.

In addition to showing that it was the prevailing party, BASR also needed to meet statutory tests set out in IRC 7430(b) involving (1) exhaustion of administrative remedies, (2) showing the fees and costs are allocable to the IRS and (3) showing that it did not unreasonably protract the proceeding.  My clients often fail the exhaustion of administrative remedies test because they do not avail themselves of the opportunity to go to Appeals prior to going to Tax Court.  Here, the IRS foreclosed the taxpayer’s option of using Appeals because it said that Appeals would not consider Son of Boss transactions.

Taxpayer argued that it needed the increased fee because it could not find any attorneys with expertise on this issue willing to take the case at the statutory rate.  Because of the billing rates of the firm it used, BASR seeks fees at a rate essentially twice what the statute suggests.  Almost no tax firm bills out at the statutory rate and taxpayers will always argue that their case is novel or complex but getting a higher rate than the one set in the statute is not necessarily easy just because the rate is out of sync with today’s fee schedules.

The IRS makes an argument regarding every possible issue that would prevent BASR from obtaining fees.  First, it argued that BASR did not pay or incur any litigation costs because the engagement letter was with William Pettinati, his wife and his son.  Second, the IRS argued that BASR was not a real party in interest because all of the fees were paid by these individuals.  Third, the IRS argues that the real parties in interest have net worths in excess of the statutory maximum.  Forth, the IRS argues that BASR did not make a qualified offer because the case did not involve a tax liability and the qualified offer provision does not apply to “any proceeding in which the amount of tax liability is not in issue.”  A clear example of this language would be a collection due process case in which the underlying merits of the liability were not at issue.  Fifth, the IRS argued that offer to settle for $1 was not made during the qualified offer period because the IRS never sent a letter of proposed deficiency so no qualified offer period ever began.  Sixth, the IRS argued that the offer of $1 was a sham since it was so low as to not be meaningful or in good faith.  Since I regularly make $1 offers when I make a qualified offer, I followed this particular argument with interest.  I have not encountered this argument from the IRS in the cases in which I have sought recovery.  Seventh, the IRS argued that the court should exercise its discretion not to award attorney’s fees since doing so would be unjust because of taxpayer’s participation in an invalid Son of Boss tax scheme.  Eighth, the IRS argued that the requested fees were unreasonable both because they exceeded the statutory maximum and because some were not in connection with a court proceeding.  Ninth, the IRS argued that BASR should not get paralegal fees for clerical tasks and tenth it argued that it should not receive fees for fighting the fee request.

The court walks through the responses filed by BASR before getting to its own conclusions on each of the issues raised by the IRS.  I will skip the responses and head straight to the court’s analysis.  Spoiler alert – the taxpayer gets attorney’s fees.

The Court found BASR was a prevailing party looking at partnership law.  It found that the individuals paid the costs because BASR was essentially defunct but that under Texas partnership law they had the right to bring the action on behalf of the partnership and to be reimbursed for doing so.  The Court was not persuaded that the form of the action trumped the substance.  It found that BASR had no money and therefore its net worth did not exceed the statutory maximum.  It found that BASR did have a liability at issue and that the offer was made during the qualified offer period.  It found that an offer of $1 was a reasonable amount to offer for a party that thought it did not owe the liability.  It found that even though the taxpayer may have engaged in tax shelter activities, the issue in this case was liability and it was not liable for the taxes so no basis existed for denying the fees on the basis of the shelter scheme.  It found that the fees were reasonable under the circumstances and that the paralegal fees were also reasonable.  It did make slight downward adjustments in fees and costs but these adjustments were minor in the scheme of the requested fees.  Finally, it found, what other courts have also found, that a prevailing party can receive fees for fighting fees.

This case is a handbook for those battling about attorney fees.  While giving fees to a tax shelter promoter may seem galling, the fees result here from the untimeliness of the IRS action.  The case not only provides an issue by issue review of almost all of the issues that come up in an attorney’s fee case but also stands for the proposition that courts should not look at the equities of the underlying tax in determining if the taxpayer should receive attorney’s fees.