Hennessey v. Commissioner of Internal Revenue, No. 1032-01 (U.S.T.C. 5/24/2007), No. 1032-01.

CourtUnited States Tax Court
Writing for the CourtNims
Docket NumberNo. 1032-01.
Decision Date24 May 2007

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T.C. Memo. 2007-131
No. 1032-01.
United States Tax Court.
Filed May 24, 2007.

W. Thomas Finley, Tammy S. Wood, and M. Seth Sosolik, for petitioners.

Kathryn F. Patterson, Abbey B. Garber, and Adam L. Flick, for respondent.


NIMS, Judge.

This matter is before the Court on petitioners' motion for award of reasonable administrative and litigation costs, filed pursuant to section 7430 and Rules 230 through 233, and request for a hearing. Unless otherwise

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indicated, section references are to sections of the Internal Revenue Code in effect at all relevant times hereunder. References to section 7430 are to the version of that section in effect at the time the petition was filed. However, costs incurred on or before January 18, 1999, are subject to section 7430 as amended by the Taxpayer Relief Act of 1997, Pub. L. 105-34, secs. 1285, 1453, 111 Stat. 1038, 1055. Costs incurred after January 18, 1999, are subject to section 7430 as amended by the Internal Revenue Service Restructuring and Reform Act of 1998 (RRA 1998), Pub. L. 105-206, sec. 3101, 112 Stat. 727.

Rule references are to the Tax Court Rules of Practice and Procedure.

Pursuant to section 7443A and Rules 180 and 183, this matter was assigned to and heard by Special Trial Judge Lewis R. Carluzzo. His recommended findings of fact and conclusions of law were filed and served upon the parties by Order of July 5, 2005.

By the abovementioned Order, the parties were also given until August 31, 2005, to make specific written objections to the Special Trial Judge's recommended findings of fact and conclusions of law. In response thereto, respondent filed a timely Notice of No Objection. Petitioners timely filed 26 pages of Objections to Recommendations (Objections).

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Rule 183(d) provides that due regard shall be given to the circumstance that the Special Trial Judge had the opportunity to evaluate the credibility of witnesses, and the findings of fact recommended by the Special Trial Judge shall be presumed to be correct.

We have duly considered petitioners' Objections and are not convinced thereby that the Special Trial Judge's meticulous and exhaustive recommendations are in any substantive way incorrect or incomplete. We therefore conclude that they should be adopted as the report of the Court. We have made no changes to the recommended findings of fact and conclusions of law, except to relocate a footnote into the text and renumber the remaining footnotes, change several headings, insert an explanatory parenthetical sentence, and modify certain introductory provisions. The recommended findings of fact and conclusions of law of Special Trial Judge Lewis R. Carluzzo, as so modified, are hereinafter set forth as the report of the Court.

After concessions by respondent,1 the issues for decision are as follows: (1) Whether respondent's positions in the administrative and court proceedings are substantially justified; (2) whether petitioners unreasonably protracted the

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administrative and court proceedings; and (3) whether the administrative and litigation costs claimed by petitioners are reasonable.


Some of the facts have been stipulated and are so found. Petitioners are husband and wife. They resided in Richardson, Texas, at the time that the petition was filed in this case. References to petitioner are to Audrey Kathleen Hennessey.

In 1982, petitioners formed Beacon Telephone Systems, Inc. (Beacon), a Texas corporation that was an S corporation for all years relevant here. See secs. 1361(a) and 1362. Petitioners have been the sole shareholders of Beacon since its incorporation. According to petitioners, Beacon's business involves the manufacture and installation of telephone systems that control building access. During the years in issue, Beacon's clients were located in Lubbock, Texas.

Petitioner was a professor at Texas Tech University (the University) in Lubbock, Texas, during all periods relevant here. During her 19-year tenure at the University, petitioner directed research at the University's Institute for Studies in Organizational Automation (the Institute).

In 1982, petitioner started an unincorporated consulting business, Industrial Scientific & Office Automation (ISOA Consulting), which shared the same acronym as the Institute.

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In 1994, petitioner and Dr. Youling Lin (also a professor at the University) formed ISOA, Inc., a Texas corporation that was also an S corporation for some of the years in issue. Petitioner and Dr. Youling Lin each owned 50 percent of ISOA, Inc. Initially, ISOA, Inc., conducted business in Lubbock, Texas. In 1995, ISOA, Inc., moved the corporation's business operations to Richardson, Texas. In addition to ISOA, Inc., petitioner continued to operate ISOA Consulting.

As part of an arrangement with the University, ISOA, Inc., licensed intellectual property developed at the Institute to various third-party entities. In turn, ISOA, Inc., distributed a portion of the licensing fees received to the University and to student-inventors as royalty payments. In October 1996, ISOA, Inc., entered into a final royalty fee agreement with the University as to the distribution of the licensing fees received by ISOA, Inc. The licensing agreement between ISOA, Inc., and the University provided that ISOA, Inc., would retain 30 percent of the net licensing fees received, the University would receive 15 percent, student-inventors would receive 50 percent, and a corporate co-inventor would receive 5 percent. Additionally, per the terms of the licensing agreement, ISOA, Inc., could be obligated to refund any licensing fees to the third party if the patents were not approved for the licensed intellectual property. ISOA, Inc., used amounts from the licensing fees to pay various

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expenses (for example, the cost of filing a patent application) before any royalties were paid.

According to petitioner, she typically traveled on approximately 150 trips per year as part of her duties with the University, ISOA Consulting, and ISOA, Inc. She testified that University professors could be reimbursed for employment-related travel expenses only to the extent of $1,000 per year.2 Grants obtained by petitioner on behalf of the University also provided for some paid travel expenses. According to petitioner, any remaining travel expenses were paid by petitioners.

The University's policy required that petitioner provide an expense report for each trip regardless of whether her travel expenses were ultimately reimbursed. According to petitioner: (1) Original travel receipts were attached to the expense reports submitted to the University; (2) a travel reimbursement check from the University was usually received within 5 or 6 months after submitting an expense report; and (3) the reimbursement check did not always identify the specific travel expenses for which petitioner was being reimbursed. Petitioner did not keep records of what travel was reimbursed by the University, nor did

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petitioner reconcile the amounts actually reimbursed by the University with the amounts submitted on the expense reports.

Petitioner also claimed to have paid the travel expenses of students not employed by the University who provided assistance on her trips. Petitioner included the students' travel expenses on her expense reports submitted to the University.3 According to petitioners, Mr. Hennessey often accompanied petitioner on her business trips. For instance, Mr. Hennessey accompanied petitioner on her claimed business trips to the United Kingdom, Singapore, Brazil, and Italy. Petitioners testified that they would often conduct business related to the University, ISOA Consulting, Beacon, and/or ISOA, Inc., on a single trip. Petitioners' claimed business travels also included personal pleasure, for example a trip to their son's wedding in Maryland and to petitioner's mother in Alaska.

According to petitioners, many of their air travel expenses were paid with discounted tickets provided by their daughter, an airline employee. Additionally, petitioners claimed to have received significant discounts on car rentals and hotels. Petitioners testified that they either repaid their daughter in

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cash or paid her various expenses.4 Petitioners did not maintain any receipts or other documentary evidence with respect to the amounts paid to, or on behalf of, their daughter.

I. Federal Income Tax Returns

A. Petitioners' Individual Tax Returns

Some time prior to the end of 1993, petitioners sent to the Internal Revenue Service (IRS) a joint Form 1040, U.S. Individual Income Tax Return, for 1992. That document had "Estimated" written on the top of the first page (1992 "Estimated" return). Petitioners testified that they prepared and sent the 1992 "Estimated" return in that manner because they were not in possession of all their supporting documents and therefore were not able to determine the exact amounts to be reported on the return.

On or about August 12, 1994, petitioners sent to the IRS an unsigned Form 1040 for the 1993 taxable year. Petitioners had written "Estimated" on the top of the first page of the unsigned 1993 return (1993 "Estimated" return). The 1993 "Estimated" return did not have any attached schedules or forms.

Petitioners claimed that they were unable to file a final tax return for either 1992 or 1993 prior to the end of 1994 due to time restraints from their various work responsibilities,

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which included the incorporation of ISOA, Inc., and petitioner's competing work and travel demands, as well as a family crisis. On December 18, 1994, after being contacted by the IRS, petitioners sent a reply letter to the IRS which stated that they planned to have their 1992 and 1993 returns completed by January 15, 1995. Petitioners testified that their...

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