The Tax Court in Brief July 12 – July 16, 2021

The Tax Court in Brief July 12 – July 16, 2021

Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.

For a link to our podcast covering the Tax Court in Brief, download here or check out other episodes of The Freeman Law Project.

Tax Litigation: The Week of July 12 – July 16, 2021

• Tax Court Case: Blossom Day Care Centers, Inc. v. Comm’r, 2021 T.C. Memo 2021-87
• Tax Court Case: Berger v. Commissioner, T.C. Memo. 2021-89
• Morreale v. Commissioner, T.C. Memo. 2021-90

Blossom Day Care Centers, Inc. v. Comm’r, 2021 T.C. Memo 2021-87 

July 13, 2021 | Paris, J. | Dkt. No. 3868-12

Tax Dispute Short Summary:

The case involved various adjustments to the income of the petitioner and the disallowance of various expenses. The case also discusses the applicability of Indian employment tax credits and civil fraud penalties.

Blossom Day Cares Centers Inc. (the taxpayer), a corporation operating child daycare centers, was owned by Mr. and Mrs. Hacker (the Hackers). The Hackers also owned the Hacker Corp. The Hacker Corp. – an S corporation – received management fees from the taxpayer during 2004-2008. The Hackers personally owned multiple real properties where the childcare centers operated. Such properties were transferred in 2005 to the Hacker Corp. The taxpayer made rent payments to the Hacker Corp. or to the bank owing the mortgage on the properties. The Hacker Corp. took depreciation on the buildings.

The IRS examined the taxpayer’s returns for the 2004-2007 period and assessed deficiencies based on adjustments to depreciation, the payment of management fees, gross receipts, interest expense, rental income, repairs and maintenance, wage reduction for the Indian employment credit, wages to shareholders, interest income, supplies’ expense, among others. The taxpayer challenged such deficiencies. The Court issued a ruling on the different adjustments, mostly ruling in favor of the IRS.

Tax Litigation Key Issues:

Whether multiple categories of business expenses were deductible under the different provisions of the IRC.

Primary Holdings: See below.

Key Points of the Laws:

To determine whether the adjustments made by the IRS were appropriate, the Court has determined that the taxpayer bears the burden to prove that the determinations are in error. Moreover, if the case involves unreported income, the IRS’ determination of such unreported income is presumed correct. United States v. McMullin, 948 F.2d 1188 , 1192 (10th Cir . 1991). Under this standard, it is the taxpayer that bears the burden of proof to show that the determination is incorrect.

In this case, the adjustments were analyzed as follows:

• Adjustments to gross receipts. The IRS can use a bank deposit analysis to determine the gross receipt of a taxpayer. Under this approach, bank deposits are prima facie evidence of income. Tokarski v. Commissioner, 87 T.C. 74 , 77 (1986); Bolles v. Commissioner, T.C. Memo. 2019-42. In this case, the taxpayer prepared its returns relying only on its bank statements. The IRS then compared the cash amounts deposited into the bank accounts against the total deposit summaries. The taxpayer did not challenge the use of the bank deposits analysis and offered contradictory evidence on the accuracy of the summaries. Given such inconsistent evidence, the taxpayer did not meet its burden of proof and the adjustments were sustained.
• Depreciation. To properly depreciate property under Section 167, the property must be used in a trade or business. Section 280F allows to depreciate under certain limits, automobiles that are not predominantly used in qualified business. If the qualified business use of the property is below 50%, the taxpayer must include excess depreciation in gross income. In this case, the taxpayer did not offered evidence to support the qualified business use of two vehicles, despite that it claimed 100% business use on one of the vehicles. Thus, the adjustment was sustained.
• Vehicle trade-in. Section 311(a) provides that no gain or loss is recognized by a corporation on the distribution of property. However, if the distribution contains appreciated property to a shareholder, the corporation recognizes gain as if the property was sold at its fair market value. Section 311(b)(1). Here, the taxpayer traded-in a vehicle for another vehicle, which was characterized by the IRS as a distribution to shareholders. The taxpayer did not present any argument or evidence to support the transaction, consequently, the adjustment was sustained.
• Real property transfers. The transfers or real estate to the Hacker Corp. by the Hackers was characterized by the IRS as a distribution to shareholders under Section 311(b)(1). The Court rejected such position for some properties on the basis that the taxpayer did not own the properties and thus, no distribution could be achieved. For the remaining properties (which were owned by the taxpayer) the Court determined that the passage of title or of the benefits and burdens under State law is sufficient to subject such transfer to its tax implications. In this case, the transfer was made by quitclaim deeds and the Hacker Corp. assumed the benefits and burdens ow ownership, which is supported by factors such as a right to possession, an obligation to pay taxes, responsibility for insuring the property, duty to maintain the property, right to improve the property without the seller’s consent among others. Keith v. Commissioner, 115 T.C. at 611-612 . In this case, the transfer was valid under State law and the Hacker Corp. (transferee) carried the benefits and burdens, including the payment of mortgage interest and State taxes. Consequently, the taxpayer should have reported capital gain on the transfer of these properties.
• Disallowed deductions. Deductions are allowed for ordinary and necessary expenses incurred on any trade or business. The taxpayer has the burden of proof to establish such deductions. INDOPCO, Inc. v. Commissioner, 503 U.S. 79 , 84 , 112 S. Ct. 1039 , 117 L. Ed. 2d 226 (1992); Le v. Commissioner, T.C. Memo. 2020-27. In this case, the taxpayer failed to offer evidence supporting deductions for cars (by not establishing business purpose), expense deductions different from supplies (because the expenses were personal in nature).
• The Court ruled favorably to the taxpayer by rejecting the disallowance of a deduction for expenses related to supplies (because the taxpayer offered testimony that additional food or supplies were required regularly for the operation of the daycare and also because the payments were made to wholesalers or suppliers, e. because there was a strong connection of the expense to the business purpose).
• The Court also ruled favorably to the taxpayer by rejecting the disallowance of the payment of the management fees. Specifically, the Court determined that the bank statements supported the payments made to the Hacker Corp. and this last entity duly included the fees within its gross income.
• Indian Employment Credit. The Court sustained the disallowance of the credit because under Section 38, the taxpayer did not offered evidence to support payment of qualified wages to a qualified employee – an employee that is an enrolled member of an Indian tribe or the spouse of an enrolled member-. In this case, only on employee was qualified, therefore, the credit was rejected for wages paid to any other employee.
• Finally, the Court rejected the imposition of fraud penalties under Section 6663(a). This rejection was because the taxpayer did not have the specific purpose of avoiding a tax believed to be owing, which must be proved by the IRS by clear and convincing evidence.

Insight: This case provides a clear example of the multiple issues that arise in an IRS audit. However, the key factor to remember is that the taxpayers must provide proof of the deductions or credits taken. Failure to do so will result in great disadvantage during an examination.

Berger v. Commissioner, T.C. Memo. 2021-89

July 15, 2021 | Nega, J. | Dkt. No. 17196-18 

Tax Dispute Short Summary: 

• Jacob Berger (petitioner husband) and his son entered into a business venture that involved the cultivation of cannabis plants for the purpose of extracting cannabidiol (CBD) oil and selling the oil for medicinal use
  • Petitioner husband provided the necessary funding for the venture, including:
    • Purchase of the equipment used to grow and maintain the cannabis
    • Payment of rent for a greenhouse in Santa Nella, CA
    • Electricity, phone, and water bills associated with the venture
  • Petitioner husband ceased all operations on the venture on August 2014
  • During 2013 and 2014, the years at issue, Petitioners paid for their daughter’s divorce obligations under her visitation agreement
    • The visitation agreement required the Petitioner’s daughter to pay for airfare when her children visit their father in Israel (twice a year)
    • The agreement also required Petitioner’s daughter for her ex-husband’s roundtrip airplane tickets from Israel to the U.S., lodging at a hotel, access to a vehicle, and a stipend of $100/day for up to 14 days
  • Petitioners filed joint tax returns for the years at issue and on each return, they claimed an alimony deduction for travel expenses they paid on their daughter’s behalf to satisfy the conditions of the visitation agreement
  • Petitioners also attached to each return a Schedule F, claiming deductions for gross receipts and expenses associated with the cannabis business venture (reporting “medicinal herbs” as the principal crop or activity of the venture)
  • Respondent Commissioner determined tax deficiencies of $32, 167 and $18,237 for 2013 and 2014, respectively
  • The Commissioner also found the taxpayers liable for accuracy-related penalties of $6, 433 and $3,647 for 2013 and 2014, respectively
    • These penalties were imposed upon the Commissioner’s finding that the taxpayers had substantially understated their income tax liability due to negligence or disregard of rules or regulations for both years
  • The Commissioner had sent the Petitioners a notice of deficiency, attached with Form 886-A, Explanation of Items, wherein the Commissioner explained why he disallowed the claimed alimony deductions and Schedule F gross receipts and expenses
  • Petitioners filed a petition with the Court to seek a redetermination of the deficiencies set forth in the Commissioner’s notice of deficiency

Tax Litigation Key Issue:

• Whether Petitioners are entitled to deduct certain Schedule F expenses on their 2013 and 2014 tax returns
• Whether Petitioners received Schedule F gross receipts of $15,000 and $5,000 for the years at issue, respectively
• Whether Petitioners are entitled to deduct alimony payments made on their daughter’s behalf for the years at issue
• Whether Petitioners are liable for the accuracy related penalties for the years at issue

Primary Holdings: 

• The taxpayer Petitioners still bore the burden of proving that they complied with the requirements of I.R.C. § 7491(a)(2), regarding compliance with substantiation requirements, maintenance of all required records, and cooperation with reasonable requests by the IRS (as they did not present the requisite credible evidence needed to shift the burden to the Commissioner)
• As such, the Commissioner’s determinations were still presumed correct as to all determinations regarding taxpayer’s deficiencies
• The Commissioner had met his burden of proof with respect to the accuracy-related penalties attributable to the taxpayer’s substantial understatements of income tax under I.R.C. § 6662(b)(2) for the years at issue

Key Points of the Laws:

• Generally, the Commissioner’s determinations are presumed correct, and the taxpayer bears the burden of proving otherwise
• The burden of proof shifts to the Commissioner only when the taxpayer has introduced “credible evidence with respect to any factual issue relevant to ascertaining the liability of the taxpayer for any tax”
  • What constitutes credible evidence: evidence that “after critical analysis, the court would find sufficient upon which to base a decision on the issue if no contrary evidence were submitted”
  • What is not credible evidence: when the taxpayer provides only self-serving testimony and inconclusive documentation, or evidence that the Court deems unworthy of belief
• The taxpayer bears the burden of proving his or her entitlement to any deductions claimed
  • To meet this burden, the taxpayer must demonstrate that the claimed deduction is allowable pursuant to a statutory provision
  • In addition, the taxpayer must substantiate the expense giving rise to the deduction
    • The substantiation requirement is met upon:
      • the taxpayer’s maintaining and producing adequate records to enable the Commissioner to determine the taxpayer’s correct liability, AND
      • the taxpayer substantiating that the expense to which the deduction pertains has been paid or incurred
    • If the taxpayer is unable to substantiate the precise amount of a claimed deductible expense, the court may estimate the amount of the deductible expense, bearing heavily against the taxpayer
    • The court will not estimate a deductible expense unless the taxpayer presents evidence sufficient to provide some basis justifying the estimate
  • Ordinary and Necessary Deductions
    • 162(a) of the Internal Revenue Code allows a taxpayer to deduct all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business.
      • An expense is “ordinary” if it is “normal, usual, or customary” in the tax-payer’s trade or business or arises from a transaction “of common or frequent occurrence in the type of business involved.”
      • An expense is “necessary” if it is “appropriate and helpful” to the taxpayer’s business, but it need not be “absolutely essential.”
      • A taxpayer is not permitted to deduct a personal, living, or family expense unless the Code expressly provides otherwise. I.R.C. § 262(a).

• Trade or Business Deductions
  • The disallowed business expenses at issue fall into two categories: (1) those that are subject to the more general substantiation requirements of I.R.C. § 6001, such as rent, utilities, and equipment, and (2) those that are subject to the strict substantiation requirements of I.R.C. § 274(d), such as vehicle expenses.

• Business Deductions subject to the general substantiation requirements
  • These types of business deductions generally include rent, utilities, and equipment
  • The taxpayer must substantiate these deductions by showing:
    • (1) that the expenses were paid or incurred during the tax years at issue and
    • (2) that the expenses were ordinary and necessary to the venture
  • Deductions for Rent
    • It must be clear that the payments made were in fact for the expenses stated
    • Checks made out to satisfy rent payments need to clearly indicate that such checks are made out for rent payments
    • The substantiation requirement may also be satisfied by production of a written lease, or perhaps even at a bare minimum, an address for the rented property
    • Looking for bank statements or other such documents to show consistent monthly withdrawals of rent payments
    • Absent any of these methods (or any similar method), Petitioners failed to meet the substantiation requirement
  • Deductions for Utilities
    • Submitting copies of checks made out to the Water District without any further evidence that the checks were made for water payments is not enough by itself to constitute credible evidence
    • Taken along with the fact that the taxpayers failed to present credible evidence as to the rented property itself, the payment of utilities for that property (without further substantiation) remain disproven
  • Deductions for Equipment- Section 179
    • Section 179: applies to some depreciable property, but the taxpayer must make an election under section 179(a) to accelerate depreciation by deducting its cost as an expense for the taxable year in which the property is placed in service
    • The election must specify the items of section 179 property to which the election applies
    • The election must also specify the portion of the cost of each item which is to be considered under § 179(a) (See I.R.C. § 179(c)(1)(A))
    • The election must also be made on the taxpayer’s first income tax return for the taxable year or a timely filed amended return (See I.R.C. § 179(c)(1)(B); see also Income Tax Regs. § 1.179-5 (a))
  • Deductions for Equipment-Section 167(a)
    • If the taxpayer does not make an election under § 179(a), then § 167(a) allows, in addition to some other deductions, a deduction for “the exhaustion or wear and tear” of property used in a trade or business
    • The taxpayer can claim depreciation deductions only for property he or she owns
    • Depreciation starts only when the taxpayer first places the property into service in its trade or business
    • The taxpayer must establish the property’s depreciable basis by substantiating its cost, recovery period, and any previous allowable depreciation

• Business Deductions Subject to the Strict Substantiation Requirements of Section 274(d)
  • 274(d) imposes stricter substantiation requirements for a taxpayer when deducting certain categories of expenses, including expenses with respect to listed property as defined in section 280F(d)(4)
    • “listed property” includes passenger automobiles (I.R.C. § 280F(d)(4)(A)(i))
  • To satisfy § 274(d), a taxpayer must generally maintain adequate records or produce sufficient evidence corroborating his or her own statement
    • “Adequate records” generally consist of an account book, a log, a diary, trip sheets, a statement of expense, or a similar record made at or near the time of the expenditure or use, along with supporting documentary evidence (See Temporary Income Tax Regs § 1.274-5T(b)(2), (6), (c)(1))
    • Collectively, these records or evidence must establish the amount, the time and place of the travel, and the business purpose for each expenditure
  • Expenses that a taxpayer generally incurs in commuting between his home and his place of business are personal and nondeductible
  • Expenses for traveling between two or more places of business may be deductible under § 162 if the travel was incurred for business reasons.
  • If one of the places of business is the taxpayer’s residence, the residence must be the taxpayer’s principal place of business for the trade or business the taxpayer conducts at those other locations

• Schedule F Gross Receipts
  • Gross income includes all income from whatever source derived
  • Taxpayers are required to keep books and records sufficient to establish their Federal income tax liabilities.
  • If the taxpayers have not maintained adequate records to establish that liability, the Commissioner may reconstruct their income by any method that the Commissioner believes reflects income clearly.
    • The Commissioner’s method does not need to be exact; however, it must be reasonable in the light of the surrounding facts and circumstances.
  • Alimony payments
    • 215(a) allows deductions for alimony payments made during the taxable year
      • Alimony payments are defined under § 71(b)(1)
    • Usually, a deduction for alimony is permitted only to the obligor spouse, and is not allowed to any other person who may pay the alimony obligation of such obligor spouse (See Income Tax Regs 1.251-1(b))

• Accuracy-Related Penalties
  • The Commissioner bears the burden of proving the taxpayer’s liability for accuracy-related penalties
  • R.C. § 6662(a), (b)(1), and (2) authorize a 20% accuracy-related penalty on any underpayment of Federal income tax attributable to a taxpayer’s negligence or disregard of rules or regulations or a substantial understatement of income tax
    • Negligence includes any failure to make a reasonable attempt to comply with the Internal Revenue Code, and also includes any failure by the taxpayer to keep adequate records or substantiate items properly
    • Substantial understatement of income tax with respect to individual taxpayers: if the amount of the understatement for the taxable year exceeds the greater of: (1) 10% of the tax required to be shown on the return for the taxable year; or (2) $5,000 (See I.R.C. § 6662(c) and Income Tax Regs 1.6662-3)

Insight: The key takeaway here is that taxpayers have the burden to prove they qualify for deductions by presenting clear evidence, which needs to be substantiated by showing not only the amount of the expense, but that the expense occurred in the taxable year and that the expense was for the deductible purpose claimed.

Morreale v. Commissioner, T.C. Memo. 2021-90

July 15, 2021 | Marvel, J. | Dkt. No. 24762-17

Tax Dispute Short Summary: 

• Petitioner taxpayer owns several restaurants, including Sketch Restaurants, LLC (Sketch).
• Petitioner failed to timely file income tax returns for tax years 2011 and 2012, and upon referral, Revenue Agent Robert Taurchini (RA Taurchini) was assigned to Petitioner’s case.
• Petitioner submitted delinquent returns in 2016 for the 2011 and 2012 tax years. Using this information, along with other submitted information, RA Taurchini prepared examination lead sheets outlining the proposed adjustments and the underlying calculations.
• The lead sheets revealed two primary issues: (1) whether Petitioner had failed to substantiate any basis in Sketch and (2) whether Petitioner was improperly reporting on the accrual basis of accounting rather than the cash basis of accounting (this difference in reporting methods would result in variance in the deductions claimed)
• With relation to the first issue, Petitioner attempted to substantiate his basis in Sketch by emailing RA Taurchini a spreadsheet containing a detailed summary of his basis in Sketch for tax years 2006 through 2010. RA Taurchini never responded to this email.
• With respect to the second issue, Petitioner quoted section 1.446-(c)(2)(i) of the Income Tax Regs, which requires business that carry inventory to use the accrual method of accounting.
• RA Taurchini rejected Petitioner’s arguments, and then prepared his Revenue Agent’s Report (RAR) along with a 30-day letter indicating his proposed adjustments to Petitioner’s tax years 2010-2013. This letter proposed adjustments to income, along with deficiencies, penalties, and additions to tax. The letter also informed Petitioner of his right to request a hearing with the Appeals Office within 30 days.
• On Sept. 7, 2017, Respondent Commissioner issued the Petitioner a notice of deficiency (notice) stating deficiencies, accuracy-related penalties, and additions to tax. The notice included a Form 886-A (Explanation of Items), explaining the Commissioner’s reasoning for his determinations.
• Petitioner taxpayer and his trustee filed a joint motion in bankruptcy court for a proposed order that would allow the trustee to pay the full amount of the Commissioner’s proposed proof of claim as a deposit out of the Petitioner’s bankruptcy estate, while still permitting Petitioner’s substantive dispute with the IRS to be adjudicated in a deficiency proceeding in Tax Court.
• The Commissioner referred this case to the Appeals Office, where Appeals Officer Rodney Largent (AO Largent) found the following:
• As to issue 1, the taxpayer provided a basis calculation that was sufficient to substantiate basis.
• As to issue 2, there was not sufficient evidence to establish that the taxpayer ever used the cash method of accounting and the accrual books appear to clearly reflect income and expenses.
• The additions to tax for both tax years and the accuracy-related penalty for tax year 2012 should be “conceded in full.
• Upon AO Largent’s conclusions, the taxpayer and Commissioner filed a stipulation that the Petitioner owed deficiencies in a lesser amount, and that would be no imposition of addition to tax or penalties for either tax year.
• Less than a month after the stipulation was filed, Petitioner filed a motion for reasonable litigation or administrative costs. This motion was brought under Section 7430(a) of the Internal Revenue Code, which authorizes an award for “reasonable administrative costs [and] reasonable litigation costs” to the “prevailing party.” Moreover, I.R.C. § 7430(c)(4)(B)(i) states that a prevailing party will not be entitled to an award if the Commissioner can prove that “the position of the United States in the proceeding was substantially justified.”

Tax Litigation Key Issue:
Whether the position of the United States was substantially justified in determining the taxpayer’s tax liabilities, deficiencies, additions to tax, and associated penalties. If the position of the United States was not justified, the issue then becomes: how much can Petitioner recover in reasonable administrative costs and reasonable litigation costs?

Primary Holdings: The position of the United States was not substantially justified, and as such, Petitioner taxpayer was entitled to recover reasonable administrative and reasonable litigation costs associated with this particular proceeding.

Key Points of the Laws:

• As noted above, Section 7430(a) of the Internal Revenue Code authorizes an award for “reasonable administrative costs [and] reasonable litigation costs” to the “prevailing party.” Moreover, I.R.C. § 7430(c)(4)(B)(i) states that a prevailing party will not be entitled to an award if the Commissioner can prove that “the position of the United States in the proceeding was substantially justified.”
• As such, § 7430 allows for a limited waiver of sovereign immunity and is construed narrowly in favor of the government.
• Under § 7430, the Government/Commissioner bears the burden of proving that its position in determining the taxpayer’s tax liabilities was substantially justified.
• Under § 7430, the taxpayer bears the burden of proving the amount of his reasonable administrative and reasonable litigation costs incurred.
• ISSUE 1: Whether the position of the United States was substantially justified as to invoke § 7430:
• The Commissioner bears the burden of proving that his position was substantially justified.
• For a position to be substantially justified, it must have a “reasonable basis both in law and fact.”
• If the Commissioner did not follow the applicable published guidance, then the position of the United States is presumed not to be substantially justified. I.R.C. § 7430(c)(4)(B)(ii).
  • “Applicable published guidance” refers to rules, regulations, revenue, rulings, revenue procedures, information releases, notices, announcements, private letter rulings, technical advice memoranda, and determination letters issued to the taxpayer. I.R.C. § 7340(c)(4)(B)(iv).
• The United States takes a position at the earlier of: (1) the date a taxpayer receives a notice of decision of the Appeals Office, or (2) the date of a notice of deficiency. I.R.C. § 7430(c)(7)(B).
• The ordinary approach to determining whether the position of the United States was substantially justified, the Court identifies the nature of the position (usually applying an item-by-item analysis, whereby the justification for each of the Commissioner’s positions must be independently determined”).
• HOWEVER, here the Court decided to follow the approach used by the U.S. Court of Appeals for the Tenth Circuit in Johnson v. Commissioner, where this item-by-item approach was rejected in favor of a holistic approach to determining the reasonableness of the Commissioner’s position.[1]
  • Under this holistic approach, the Court would look to the position of the United States as a whole, in light of all surrounding circumstances.
  • The proper inquiry under this approach is whether the government acted reasonably in causing the litigation or in taking a stance during the litigation
• Even under this holistic approach, however, the Commissioner must follow applicable published guidance, or else his position is presumed not substantially justified.
  • Under the issue regarding substantiation of basis in Sketch, the Commissioner’s position was not substantially justified because the email communication from Petitioner to RA Taurchini (to which Taurchini did not respond) was sufficient documentation to substantiate the Petitioner’s basis as:
    • (1) it was sent a month before the issuance of the 30-day letter RA Taurchini sent explaining the deficiencies, and
    • (2) the Appeals Office had agreed that this information was sufficient to substantiate the taxpayer’s basis.
  • Under the issue regarding the proper method of reporting (cash versus accrual), the Commissioner’s position was not substantially justified because:
    • (1) the Commissioner did not follow applicable published guidance, as he did not follow the language of Income Tax Regs 1.446-1(c)(2)(i) (requiring the accrual method of accounting to be used for all purchases and sales with respect to businesses that use an inventory, as did the business here), and
    • (2) there was not sufficient evidence to conclude that the Petitioner taxpayer used the cash method of accounting in prior years.
  • Because the Commissioner did not follow applicable published guidance with respect to both issues, the position of the United States is presumed NOT substantially justified.
    • Thus, Petitioner is entitled to an award for reasonable administrative and reasonable litigation costs under § 7430.

• ISSUE 2: Whether the Petitioner taxpayer’s claimed administrative and litigation costs were reasonable under § 7430
  • Reasonable costs under § 7430 refers only to those costs incurred because of the proceeding in which the party prevailed.
  • Such costs refer only to the current proceeding, not to prior proceedings, such as Petitioner’s prior bankruptcy proceeding.
  • The Tax Court Rules of Practices and Procedures Rule 232(d) states that where the parties are in dispute about the amount of reasonable attorney’s fees, then counsel for the moving party shall, within 30 days after the service of the Commissioner’s response, file an additional affidavit or declaration which shall include specifics regarding the moving party’s claimed costs.
    • Petitioner’s failure to comply with this rule presumes unreasonableness on the part of the Petitioner, and the Petitioner’s time spent to rectify this failure or mistake is not included in the calculation of reasonable attorney’s fees.
  • Generally, attorney’s fees are awarded only at the statutory rate, absent any “special factors”. I.R.C. 7430(c)(1)(B)(iii).
  • The simple assertion that it was difficult or impossible for the Petitioner to find qualified counsel at the statutory rate is not enough to constitute departure from the statutory rate (i.e., it is not by itself a “special factor” that justifies departure from the statutory rate).
  • What can qualify as a “special factor” that justifies departure from the statutory rate
    • That the market lacked competent counsel overall at the statutory rate, or
    • That the legal or factual matters litigated were so egregiously complex as to justify an upward departure from the statutory rate
  • Absent these types of special factors, the statutory rate for attorney’s fees is imposed in calculating reasonable litigation costs under § 7430(c)(1)(B)(iii).

Insight: The Tax Court here is taking a stance that would be more favorable to the Commissioner. By interpreting reasonableness considering the entirety of the circumstances, rather than by an item-by-item approach, the Court is granting the Commissioner leeway to make mistakes, so long as he can in some way justify that his actions were reasonable. If this approach continues to be followed, it may pose hurdles to taxpayers seeking to recover reasonable administrative and reasonable litigation costs under Section 7430 of the Internal Revenue Code.

[1] In Johnson, the Tenth Circuit was interpreting the Equal Access to Justice Act (EAJA), which used wording similar to § 7430 here.

For other Tax Court in Brief Insight posts, see:

• The Tax Court in Brief
• The Tax Court in Brief
• The Tax Court in Brief

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