McClellan v. US, 94-CV-70799-DT.

• Decision Date: 12 September 1995
• Docket Number: No. 94-CV-70799-DT.,94-CV-70799-DT.
• Parties: Paul D. McCLELLAN d/b/a Sterling Floors and Kitchens, Plaintiff, v. The UNITED STATES of America, Defendant.
• Court: U.S. District Court — Eastern District of Michigan

900 F. Supp. 101

Paul D. McCLELLAN d/b/a Sterling Floors and Kitchens, Plaintiff, v. The UNITED STATES of America, Defendant.

No. 94-CV-70799-DT.

United States District Court, E.D. Michigan, Southern Division.

September 12, 1995.

Wallace H. Glendening, Gary R. Glenn, Jaffe, Raitt, Detroit, Michigan, for plaintiff.

Doris D. Coles, Department of Justice, Tax Division, Washington, DC, for defendant.

OPINION AND ORDER REGARDING PLAINTIFF'S REQUEST FOR COSTS AND ATTORNEY FEES

ROSEN, District Judge.

I. INTRODUCTION

On March 2, 1994, Plaintiff/Counterclaim-Defendant Paul D. McClellan ("Plaintiff") filed a Complaint for Tax Refund, seeking refund of $200, plus interest, costs and attorney fees for employment taxes¹ erroneously assessed and collected. The Defendant/Counterclaim-Plaintiff United States of America ("Defendant") filed an amended answer and counterclaim on June 27, 1994. In addition to denying liability for the requested refund, Defendant sought $85,617, plus statutory interest and additions, for employment taxes allegedly owed by Plaintiff for tax years 1987, 1988, 1989 and 1990. This Court has jurisdiction over the matter pursuant to 28 U.S.C. § 1346(a)(1) and (c).

Plaintiff claims, and Defendant now admits, that he is entitled to relief from employment tax liability pursuant to § 530(a)(2)(C) of the Internal Revenue Act of 1978, Pub.L.No. 95-600, 92 Stat. 2763, 2885-2886.² That section provides relief for taxpayers who fail to pay employment taxes when their treatment of workers as independent contractors is based on a "long-standing recognized practice of a significant segment of the industry...."

After completion of discovery, Plaintiff filed a motion for summary judgment and request for costs and attorney fees. In its response, Defendant concedes Plaintiff's motion for summary judgment — admitting that Plaintiff's request for refund should be granted and that Plaintiff does not owe an additional $85,617 in taxes — but opposes Plaintiff's request for costs and fees.

Accordingly, the only remaining issue before this Court is whether Plaintiff is entitled to costs and attorney fees pursuant to 26 U.S.C. § 7430. After reviewing the papers filed by the parties and considering arguments made by their counsel at a hearing held on February 23, 1995, and for the reasons stated herein, the Court finds that Plaintiff is entitled to costs and fees.

II. FACTUAL BACKGROUND

Plaintiff has been sole proprietor of a small business known as Sterling Floors and Kitchens since 1978. He installs hard surface flooring (such as linoleum, vinyl and ceramic tile) in homes in the Detroit metropolitan area. Generally, Plaintiff works as an independent contractor for floor surface retailers, installing products they have sold. Plaintiff does much of the work himself, but also subcontracts with other installers for some assignments. Prior to an Internal Revenue Service ("IRS") audit, Plaintiff treated these installers as independent contractors, rather than employees of his business. Before that time, he "never knew there was such a thing as an employee-installer." (Deposition of Paul D. McClellan, November 28, 1994, p. 40).

In 1991 and 1992, the IRS made assessments against Plaintiff for employment taxes allegedly due for tax years 1987, 1988, 1989 and 1990. According to the agency, Plaintiff should have treated his sub-contractors as employees. This conclusion was based on the auditor's application of a twenty-factor common law test designed to distinguish between employees and independent contractors.³ After receiving the assessment, Plaintiff filed a timely protest with the IRS. The protest was ultimately rejected by the IRS Appeals Office. Subsequently, Plaintiff paid the taxes, penalties and interest due for one installer for the last quarter of 1990 ($200), and simultaneously filed a request for refund with the IRS. That request was denied by letter dated October 5, 1992.

Before Plaintiff's protest was rejected by the IRS, Plaintiff exchanged information with and attended a conference held by IRS Appeals Officer Noula Mikhail. Plaintiff argued that in his experience hard surface flooring installers in the Detroit area are invariably treated as independent contractors, and that he relied on this practice. In support of his claim, he personally collected data from area businesses engaged in the installation of hard surface flooring. He telephoned each company, posed as an installer looking for work, and asked whether he would be treated as an employee or independent contractor. Of the 41 companies Plaintiff contacted, 40 indicated that they treat their installers as independent contractors. Plaintiff presented this information to Officer Mikhail in the form of a chart that included each company's name, address and contact person. The Appeals Office received the information with a letter from Plaintiff's attorney on November 27, 1991. In the letter, counsel specifically asked for relief from tax liability based on the provisions of § 530 of the Internal Revenue Act of 1978. See Defendant's Response, Exhibit A (letter from Gary R. Glenn, Plaintiff's counsel, to Noula Mikhail, dated November 12, 1991). Mikhail responded to this request as follows:

Your client may have a point but the survey lacks credibility. There was no information provided by the people he contacted. A letter signed by a responsible person from the business indicating:

— Total number of workers.

— Number of installers (residential and/or commercial), how they are treated.

— Similarity and difference between their work conditions and your client in considering the 20 common-law factors.

— If installers are floor or carpet or both.

Defendant's Response, Exhibit A (letter from Noula Mikhail to Gary R. Glenn, dated December 24, 1991).

Subsequently, Plaintiff made some of the corrections requested by Mikhail. He added information on the number of hard surface flooring installers used by each company, along with some miscellaneous comments (such as number of business locations, and other types of services offered by each business). Plaintiff's attorney sent the revised survey to Mikhail along with a letter dated January 17, 1992. In the letter, Plaintiff's counsel argued that Mikhail's request for a verified analysis of each competitor's relationship with its installers based on the twenty common law factors is too burdensome. He stated:

I do not see how your request can possibly be termed reasonable. The effort and expense required to produce such a document would be astronomical and would greatly exceed any potential tax liability from the taxpayer. In addition, these businesses are competitors of Mr. McClellan. They may hesitate before they assist a competitor to this extent.

(Letter from Gary R. Glenn to Noula Mikhail, dated January 17, 1992, p. 5).⁴ Counsel made a similar argument to the IRS District Director. See Defendant's Response, Exhibit C (letter from Gary R. Glenn to John Hummel, dated February 20, 1992). Furthermore, he encouraged Mikhail "simply to call the contact person listed on the chart and ask a few questions regarding their treatment of the workers. Do not simply dismiss our survey as lacking credibility if you have not tried to verify its contents. Do not place an impossible burden on us." (Letter from Glenn to Mikhail, January 17, 1992, p. 11).

III. ANALYSIS

A. STANDARDS GOVERNING AWARD OF COSTS AND FEES IN TAX REFUND CASES: 26 U.S.C. § 7430.

Title 26 U.S.C. § 7430(a) authorizes the award of costs and attorney fees to the "prevailing party" in administrative and court proceedings brought in connection with the collection or refund of taxes.⁵ In addition to other requirements not at issue here,⁶ in order to be considered a "prevailing party," a taxpayer must "establish that the position of the United States in the proceeding was not substantially justified...." 26 U.S.C. § 7430(c)(4)(A)(i). "Substantially justified" has been defined "as `justified to a degree that could satisfy a reasonable person' or having a `reasonable basis both in law and fact.'" William L. Comer Family Equity Pure Trust v. Commissioner, 958 F.2d 136, 139 (6th Cir.1992) (quoting Pierce v. Underwood, 487 U.S. 552, 563-65, 108 S.Ct. 2541, 2549-2550, 101 L.Ed.2d 490 (1988)). It does not mean "`justified to a high degree,' but rather `justified in substance or in the main'...." Pierce, 487 U.S. at 565, 108 S.Ct. at 2550. A position "can be substantially (i.e., for the most part) justified if a reasonable person could think it correct...." Id., 487 U.S. at 566 n. 2, 108 S.Ct. at 2550 n. 2.

The burden is on the taxpayer to establish lack of substantial justification. Kenagy v. United States, 942 F.2d 459 (8th Cir.1991) (rejecting argument that 1988 amendments to § 7430 had effect of placing burden on government); Goodwin v. United States, 935 F.2d 1061 (9th Cir.1991); Bode v. United States, 919 F.2d 1044 (5th Cir.1990); Smith v. United States, 850 F.2d 242, 245 (5th Cir.1988); Powell v. Commissioner, 791 F.2d 385, 390 (5th Cir.1986). And, even if Plaintiff satisfies the statutory requirements, an award is not mandatory. The statute "authorizes, rather than commands, the court to make an award ... for reasonable litigation costs." Zinniel v. Commissioner, 883 F.2d 1350, 1355 (7th Cir.1989), cert denied, 494 U.S. 1078, 110 S.Ct. 1805, 108 L.Ed.2d 936 (1990).

B. EMPLOYMENT TAX RELIEF: § 530 OF THE INTERNAL REVENUE ACT OF 1978.

Defendant now concedes that Plaintiff is entitled to relief from tax liability for his failure to treat installers working for him as employees.⁷ This concession is based upon application of § 530 of the Internal Revenue Act of 1978. Some familiarity with § 530 is required in order to determine whether the position taken by Defendant at the outset of this litigation was substantially justified.

As originally enacted⁸, the statute provided interim relief to employers who had a "reasonable basis" for treating their workers as...