Estate of Johnson v. C.I.R., 92-4270

CourtUnited States Courts of Appeals. United States Court of Appeals (5th Circuit)
Citation985 F.2d 1315
Docket NumberNo. 92-4270,92-4270
Parties-1184, 93-1 USTC P 50,251 ESTATE of Michael A. JOHNSON, Deceased, Geraldine Johnson, Administratrix, and Geraldine Johnson, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
Decision Date24 March 1993

Michael A. Mayhall, New Orleans, LA, for appellants.

Abraham N.M. Shashy, Jr., Chief Counsel, I.R.S., Edward T. Perelmuter, Gary R. Allen, Chief, Ann B. Durney and Shirley D. Peterson, Asst. Attys. Gen., Tax Div., Dept. of Justice, Washington, DC, for appellee.

Appeal from a decision of the United States Tax Court.


REYNALDO G. GARZA, Circuit Judge:

Taxpayer, Geraldine Johnson, is seeking to recover legal costs under IRC Section 7430 in connection with the litigation leading up to a settlement with the IRS. The Tax Court determined that the IRS was substantially justified in its position and, thus, denied her prevailing party status.

                Consequently, the court denied Geraldine Johnson's request for litigation costs.   We find that the Tax Court abused its discretion in determining that the IRS was substantially justified in denying her innocent spouse status, and find that she is entitled to litigation costs as a prevailing party.   Therefore, we REVERSE and REMAND consistent with the following opinion

On October 20, 1988, Geraldine and Michael Johnson, filed a petition in the United States Tax Court contesting the Commissioner's determination that they had a deficiency in their income tax for the taxable years 1981, 1982, and 1983. The Commissioner had determined that they jointly owed nearly $70,000 in back taxes and penalties. This deficiency emanated from unreported income that Michael had secured from an elaborate embezzlement scheme. 1 Soon after the IRS filed its notice of deficiency, Michael died.

During the tax period in question, Geraldine earned barely any income and the Johnsons filed a joint tax return. 2 Geraldine has contended from the start that she did not know about her husband's illegal enterprise. Therefore, she originally contested, and continues to contest, the notice of deficiency on the ground that she is an innocent spouse.

Soon after the Johnsons contested the notice of deficiency, IRS agent Verna Anderson ("Anderson") commenced an investigation. Anderson issued three summons in order to trace the illegal fruits of Michael Johnson's embezzlement scheme: (i) Metairie Bank & Trust Co.; (ii) Jefferson Guarantee Bank; and (iii) Avondale Shipyard, Inc.--Federal Credit Union. Nothing in the record suggests that these summons were not complied with or incomplete in any way. Further, Geraldine Johnson's affidavit states that she too delivered all of her bank records to Anderson.

Moreover, Anderson made computations utilizing the Johnsons' reported income and known expenses. The computations for 1982 revealed that the Johnsons' reported income exceeded their expenses by $12,932.08. Moreover, nothing in agent Anderson's report indicated that extravagant items, such as expensive cars or jewelry, had been purchased. Anderson concluded, in her report, that Geraldine Johnson was not entitled to innocent spouse status principally because "the wife was not employed for each year under examination."

The next step in the process came the Regional Office of Appeals, which produced the Appeals Officer's ("AO") supporting statements. The report indicates that the AO reviewed the computation of income and expenses made by agent Anderson. The AO concluded that the analysis did not reveal any unreported income. In fact, the entire AO report refers only to Michael Johnson and no specific reference is made to whether or not Geraldine received any benefit from the illegal income at all. In the end, the Regional Office of Appeals denied innocent spouse relief to Geraldine Johnson, despite its admission that independent investigation had revealed no evidence of unreported income.

The case proceeded to trial before the United States Tax Court. On December 15, 1988, Michael died and his estate was substituted as a party. On the eve of trial the parties reached a settlement, which provided that Michael's estate was liable for the bulk of the deficiencies and Geraldine would in large part be relieved of liability on the ground that she was an innocent spouse.

Following the settlement, Geraldine filed a motion in the United States Tax Court for an award of litigation costs in the amount The Tax Court apparently believed that both Geraldine and Michael Johnson had moved for attorneys' fees. However, Michael Johnson was not a party to the motion. The court focused on the fact that the amount of deficiencies originally asserted by the IRS were nearly equal to the amount that it was eventually agreed that the Estate of Michael Johnson was liable. The Tax Court held that in reality the IRS, not Geraldine Johnson, substantially prevailed. Therefore, the court held that Geraldine was not a prevailing party under Section 7430.

                of $21,471.14 pursuant to IRC Section 7430. 3  Her motion for litigations costs was based on her contention that she had "substantially prevailed" with respect to the amount in controversy. 4  The Tax Court, however, denied Geraldine's motion

Geraldine Johnson appealed the decision to a prior panel of our court. Our court approached the analysis on a different tack. It focused on the fact that the IRS contended that Geraldine Johnson owed almost $70,000. However, under the settlement, Geraldine owed only $2,596, less than ten percent of the original amount. Moreover, Geraldine prevailed on the only issue she contested. The settlement stipulated that Geraldine was an innocent spouse with regard to ninety percent of the original deficiency sought against her.

Our prior panel reversed the Tax Court's holding that Geraldine had not substantially prevailed under Section 7430(c)(2)(A)(ii). However, this determination did not end the day because in order to obtain "prevailing party status" one must also establish that "the position of the United States ... was not substantially justified." 26 U.S.C. § 7430(c)(2)(A)(iii). However, the prior panel of our court was reluctant to decide this issue for the first time on appeal and, thus, it remanded the "substantial justification" issue to the Tax Court.

On remand, the Tax Court questioned the logic of our court's determination that Geraldine had "substantially prevailed." The court then tersely stated that the respondent (IRS) was substantially justified for the reasons "expressed in the statutory notice." Consequently, the Tax Court held that Geraldine Johnson was not a prevailing party under Section 7430(c)(2) because the United States was substantially justified "in the first place." Geraldine Johnson appeals.


The sole issue to be decided on appeal is whether the position of the United States in this proceeding was substantially justified. An IRS position is "substantially justified" when its actions are "justified to a degree that could satisfy a reasonable person." See Heasley v. Commissioner, 967 F.2d 116, 120 (5th Cir.1992) (citing Pierce v. Underwood, 487 U.S. 552, 565, 108 S.Ct. 2541, 2550, 101 L.Ed.2d 490 (1988)). The taxpayer bears the burden of establishing entitlement to litigation costs and, thus, must also bear the burden of proving lack of substantial justification. See Smith v. United States, 850 F.2d 242, 245 (5th Cir.1988). Further, we review the Tax Court's finding of substantial justification under the abuse of discretion standard. See Heasley, 967 F.2d at 120.

The government's failure in the underlying litigation does not mandate a finding that they lacked substantial justification. See Estate of Perry v. Commissioner, 931 F.2d 1044, 1046 (5th Cir.1991). Likewise, a settlement agreement that is unfavorable to the government does not In determining whether the position of the IRS was substantially justified we are limited to a review of the position taken by the IRS after the district counsel enters the picture. See Sher v. Commissioner, 861 F.2d 131, 134 (5th Cir.1988). Therefore, we must not consider the position of the IRS prior to the time the district counsel entered the picture. The Tax Court concluded that the IRS was substantially justified based on the reasons expressed in the notice of deficiency "based on the facts as h...

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