Heasley v. C.I.R.

• Citation: 967 F.2d 116
• Decision Date: 20 July 1992
• Docket Number: No. 91-4526,91-4526
• Parties: -5398, 92-2 USTC P 50,412 David E. HEASLEY and Kathleen Heasley, Petitioners-Appellants, Cross-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee, Cross-Appellant.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 116

967 F.2d 116

70 A.F.T.R.2d 92-5398, 92-2 USTC P 50,412

David E. HEASLEY and Kathleen Heasley, Petitioners-Appellants, Cross-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee,

Cross-Appellant.

No. 91-4526.

United States Court of Appeals, Fifth Circuit.

July 20, 1992.

John D. Copeland, Dallas, Tex., for petitioners-appellants, cross-appellees.

Abramam N.M. Shashy, Jr., Chief Counsel, I.R.S., Kimberly S. Stanely, Atty., Gary R. Allen, Chief, William S. Estabrook, Appellate Section, Tax Div., Dept. of Justice, Washington, D.C., for C.I.R.

Appeals from the Decision of the United States Tax Court.

Before BRIGHT, ¹ JOLLY, and BARKSDALE, Circuit Judges.

BRIGHT, Senior Circuit Judge:

David and Kathleen Heasley (The Heasleys) appeal from the decision of the Tax Court denying a portion of their request for attorneys' fees and litigation costs under 26 U.S.C. § 7430 (1988). The Heasleys incurred the sought-after fees and costs during prior litigation before the Tax Court and on appeal to this court. The Internal Revenue Service cross-appeals, challenging the Heasleys' entitlement to any fee award and disputing the manner in which the Tax Court calculated the award. We affirm in part, reverse in part and remand in part.

I. BACKGROUND

The facts that led to the underlying litigation have been set forth in an earlier decision by this court. Heasley v. Commissioner, 902 F.2d 380 (5th Cir.1990) [Heasley I ]. We elaborate only as necessary to frame our analysis of the issues raised on this appeal.

Prompted by Gaylen Danner, who purported to be a financial and securities dealer, the Heasleys invested in an energy conservation plan in December 1983. Under the plan, which was sponsored by the O.E.C. Leasing Corporation [O.E.C.], the Heasleys leased two energy savings units from O.E.C. at a yearly cost of $5,000 per unit. O.E.C. ascribed a value of $100,000 to each unit.

Neither Heasley graduated from high school. Both had limited investment experience. As a return on their investment, the Heasleys thought they would receive a percentage of the energy savings yielded by the end users of the units. Although Danner discussed the investment's tax advantages, the Heasleys viewed the O.E.C. leasing plan as a source of future income. ²

At Danner's suggestion, the Heasleys employed Gene Smith, a C.P.A., to prepare their 1983 tax return. Smith claimed a $10,000 deduction on the advance rent of the units and a $20,000 investment tax credit, which he carried back to 1980 and 1981. After investing $14,161 in the O.E.C. plan, the Heasleys received in excess of $23,000 in refunds from the Internal Revenue Service [IRS] for the three years. The O.E.C. investment never generated any income. The Heasleys lost all the money they invested with Danner, over $25,000.

After sending the Heasleys a prefiling notification letter in 1986, the IRS totally disallowed the $10,000 deduction and $20,000 investment tax credit. The Heasleys became liable for the $23,000 deficiency, plus interest. The IRS also assessed $7,419.75 in penalties: a $1,153.05 negligence penalty under I.R.C. § 6653(a)(1) (1988); a $5,940.90 valuation overstatement penalty under I.R.C. § 6659 (1988); a $325.80 substantial understatement penalty under I.R.C. § 6661 (1988) and an additional interest penalty on the disallowed investment tax credit under I.R.C. § 6621 (1988).

After exhausting their administrative remedies, the Heasleys sued the IRS. They conceded their liability for the deficiency and only challenged the assessment of the penalties and additional interest. The Tax Court upheld the assessment of the penalties and interest. Heasley v. Commissioner, 55 T.C.M. (CCH) 1748 (1988). A panel of this court reversed the Tax Court on July 20, 1990. Heasley I, 902 F.2d at 382-86. The Tax Court revised its decision accordingly on October 26, 1990.

On November 19, 1990, the Heasleys moved for an award of $40,221.86 in attorneys' fees and litigation costs under I.R.C. § 7430 (1988), which permits a "prevailing party" in a tax proceeding against the IRS to recover reasonable litigation costs. The Heasleys' attorney, John D. Copeland, submitted a supporting affidavit. Copeland did not submit billing records with the motion for litigation costs.

The Tax Court held that the Heasleys were entitled to reasonable litigation costs for the section 6661 substantial understatement penalty only. Heasley v. Commissioner, 61 T.C.M. (CCH) 2503 (1991). This was the sole instance in which they demonstrated that the position of the IRS was "not substantially justified." I.R.C. § 7430(c)(4)(A)(i). The Tax Court awarded $198.99 in costs, or one-fourth of the requested award of $795.94. The Tax Court disallowed the Heasleys' request for reimbursement in excess of the statutory rate of $75.00 per hour. See id. § 7430(c)(1)(B)(iii). In addition, the Tax Court determined that the statutory reimbursement rate, indexed to account for an increase in the cost-of-living, was $91.43 per hour.

The Tax Court noted that the Heasleys failed to provide a breakdown of specific hours and hourly rates as provided by Tax Court Rule 231(d). ³ The Tax Court also observed that after the IRS disagreed with the reasonableness of the fee request, the Heasleys failed to submit a more detailed affidavit, as required by Tax Court Rule 232(d). Consequently, the Tax Court divided the total fee award claimed by the Heasleys ($39,425.92) by Copeland's hourly rate ($200) and yielded a figure of 197 hours. After dividing this number by four and yielding a figure of forty-nine hours, the Tax Court determined that the total award for attorneys' fees was $4,480.07.

The Heasleys filed a motion for reconsideration with a supplemental affidavit that broke down their request for fees by attorney, hourly rate and the number of hours worked by each attorney. The Tax Court denied the motion. This appeal and the Government's cross-appeal followed.

II. DISCUSSION

A. Substantial Justification

The Heasleys argue that they are entitled to an award of fees and costs incurred in litigating the three remaining penalties. The Heasleys assert that they established that the position of the IRS with respect to each penalty was "not substantially justified." I.R.C. § 7430(c)(4)(A)(i). We agree only in part.

In order to recover an award of attorneys' fees from the Government, a tax litigant must qualify as a "prevailing party" under section 7430(c)(4)(A). ⁴ First, the litigant must "establis[h] that the position of the United States ... was not substantially justified." Id. Second, the taxpayer must also "substantially prevail[ ]" with respect to either "the amount in controversy" or "the most significant issue or set of issues presented." Id. § 7430(c)(4)(A)(ii).

A position is "substantially justified" when it is "justified to a degree that could satisfy a reasonable person." Pierce v. Underwood, 487 U.S. 552, 565, 108 S.Ct. 2541, 2550, 101 L.Ed.2d 490 (1988) (interpreting similar language in 28 U.S.C. § 2412(d), the Equal Access to Justice Act). The Government's failure to prevail in the underlying litigation does not require a determination that the position of the IRS was unreasonable, but it clearly remains a factor for our consideration. Perry v. Commissioner, 931 F.2d 1044, 1046 (5th Cir.1991). Nor does a trial court ruling in the government's favor preclude a finding of unreasonableness, although this acts as a similarly important consideration. Huckaby v. Department of the Treasury, 804 F.2d 297, 299 (5th Cir.1986) (per curiam). We review the Tax Court's determination on the issue of substantial justification for abuse of discretion. Pierce, 487 U.S. at 557-63, 108 S.Ct. at 2546-49 (requires abuse of discretion review for analogous EAJA provision); Cassuto v. Commissioner, 936 F.2d 736, 740 (2d Cir.1991) (citing Pierce, 487 U.S. at 557-63, 108 S.Ct. at 2546-49).

1. Negligence Penalty

As this court explained in Heasley I, the IRS may penalize taxpayers for any underpayment due to negligence or disregard of the rules and regulations. Heasley I, 902 F.2d at 383 (citing I.R.C. § 6653(a)(1)). "Negligence" includes any failure to make a reasonable attempt to comply with the Tax Code, including the failure to do what a reasonable person would do under similar circumstances. Id. (citations omitted); I.R.C. § 6653(a)(3). "Disregard" includes any careless, reckless or intentional disregard. Heasley I, 902 F.2d at 383 (citing section 6653(a)(3)). Due care does not require moderate income investors, like the Heasleys, to investigate independently their investments; they may rely upon the expertise of their financial advisors and accountants. Id.

The Heasleys assert that they made reasonable efforts to comply with the Tax Code and the Government unreasonably asserted the negligence penalty. We agree. The Heasleys demonstrated that they are moderate income investors with a limited education and minimal investment experience. They relied on the expertise of their financial advisor, whom they believed to be knowledgeable and trustworthy. Although the Heasleys had always prepared their own tax returns in the past, they hired a C.P.A. to handle the more complicated tax matters created by their ill-fated investment. The Heasleys also monitored their investment. Heasley I, 902 F.2d at 384.

Under these circumstances, we cannot say that a reasonable person would have been satisfied with the IRS's position on the negligence penalty. See Pierce, 487 U.S. at 565, 108 S.Ct. at 2550. The Heasleys thus demonstrated that the position of the IRS with respect to the negligence penalty was "not substantially justified." I.R.C. § 7430(c)(4)(A). Accordingly, the Tax Court's holding to the contrary was abuse of discretion and we reverse.

2. Valuation Overstatement Penalty

The IRS may impose a valuation overstatement penalty for any underpayment "attributable to a valuation overstatement." I.R.C. § 6659(a)(2). A "valuation...