Rutana v. Comm'r of Internal Revenue

• Decision Date: 19 May 1987
• Docket Number: Docket No. 6759-84.
• Parties: CHESTER RUTANA AND THERESA M. RUTANA, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

88 T.C. 1329

88 T.C. No. 74

CHESTER RUTANA AND THERESA M. RUTANA, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 6759-84.

United States Tax Court

Filed May 19, 1987.

Ps moved for an award of litigation costs after we decided for Ps in Rutana v. Commissioner, T.C. Memo. 1986-336, the sole issue of which was whether Ps fraudulently intended to evade tax. R's counsel should have known that the facts available to R at trial could not clearly and convincingly establish fraud. R's counsel disregarded Ps' explanations as self-serving but had no supportable basis for believing Ps to be untruthful. HELD, R did not have a reasonable basis in law or fact for believing that he could prove that Ps acted with intent to evade tax, Wyandotte Savings Bank v. N.L.R.B., 682 F.2d 119 (6th Cir. 1982), and his position in this litigation was, therefore, unreasonable; Don Casey Co. v. Commissioner, 87 T.C. 847 (1986). HELD FURTHER, Ps' counsels' hours billed and rates charged were reasonable and a ‘fully compensatory fee‘ is awardable, Hensley v. Eckerhardt, 461 U.S. 424 (1983). HELD FURTHER, litigation costs in the amount of $22,720.56 are awarded. Joseph R. Young, Jr., for the petitioners.

Steven M. Walk, for the respondent.

OPINION

WILLIAMS, JUDGE:

This case is before us on petitioners' motion for award of litigation costs pursuant to section 7430. ¹ The issues we must decide are (1) whether the position of the United States in the litigation against petitioners was unreasonable within the meaning of section 7430(c)(2)(A)(i); and (2) if so, the amount of litigation costs to be awarded.

Respondent determined deficiencies in petitioners' Federal income tax and additions to tax for fraud pursuant to section 6653(b) for the taxable years 1975 and 1976. Petitioners paid the deficiency for 1976 They agreed that the deficiency determined for 1975 was correct, but respondent conceded that the statute of limitations barred assessment and collection of the deficiency unless petitioners' 1975 return was false and fraudulent within the meaning of section 6501(c). The sole issue at trial was whether any part of the underpayment of tax for 1975 or 1976 was due to fraud.

The trial in this case was held on February 24-25, 1986 at Cleveland, Ohio. On August 4, 1986, we filed our opinion ² that petitioners were not liable for the addition to tax for fraud for 1975 and 1976 and that the statute of limitations barred assessment and collection of the deficiency for 1975. On September 3, 1986, petitioners filed their motion for award of litigation costs pursuant to section 7430 and Rules 231 and 232. ³ Pursuant to our order, respondent filed his response on November 17, 1986 and filed a supplemental response on December 22, 1986. On January 15, 1987, we granted the parties' joint notion to submit evidence on the amount of litigation costs incurred by way of affidavit and deposition in lieu of a hearing. Petitioners filed affidavits of counsel on January 20 and March 18, 1987. Petitioners and respondent filed transcripts of depositions of petitioners' counsel on February 26, 1987.

Our opinion filed on August 4, 1986, sets forth the limited education of petitioners, Chester and Theresa Rutana. We found that Chester had difficulty with simple arithmetic and that Theresa had no training in bookkeeping or accounting other than an introductory course in high school in the 1940s. Petitioners' crude records, banking practices, and rudimentary single-entry bookkeeping system were the source of much of the errors that respondent found. Theresa did not know what it meant to reconcile a check register until instructed by John Funcheon, C.P.A., in 1978, whom petitioners retained to assist them during their audit. Until instructed by Funcheon, Theresa was incapable of accurate record keeping. Under her accounting system in 1975 and 1976, it was impossible to determine Rutana Landscaping's income and expenses.

During the audit of petitioners' 1975 and 1976 income tax returns, Scott Simmerman, respondent's agent, discovered a significant disparity between petitioners' gross receipts as listed on monthly receipts sheets that Theresa maintained and the total amount of bank deposits in 1975 and 1976 and requested additional information from Theresa. Theresa cooperated fully with Simmerman. She provided Simmerman consistent explanations for the omitted items. Simmerman also found numerous mathematical errors on Theresa's receipts sheets resulting in understatements of income, including a transposition error on the August 1975 receipts sheet that resulted in a $3,600.00 understatement of gross receipts. For other months, Theresa's mathematical errors resulted in overstatements of income.

Simmerman did not believe Theresa's explanations for the omitted income items. He also did not believe that the $3,600.00 understatement of income on the August 1975 receipts sheet was the result of a transposition error. It was not until trial, however, that Simmerman understood the inadequacy of the bookkeeping system that Theresa used.

At trial, we found petitioners to be thoroughly credible witnesses. Their testimony was wholly consistent with the explanations they gave Simmerman and which he recorded in his interview notes. In part, we discounted Simmerman's testimony because he had little independent recollection of the audit and his testimony was tied almost entirely to his notes. We concluded that petitioners' bookkeeping methods were used out of ignorance and not with an intent to evade taxes.

Section 7430 provides that this Court and other Federal courts may award reasonable litigation costs up to $25,000.00 to the prevailing party in a civil tax proceeding. Section 7430(b)(1). The party seeking litigation costs bears the burden of proving his entitlement to them. Rule 232(e); see Baker v. Commissioner, 83 T.C. 822, 827 (1984), vacated and remanded on other grounds 787 F.2d 637 (D.C. Cir. 1986). Respondent concedes that petitioners have exhausted their administrative remedies and substantially prevailed with respect to the sole issue presented, but contends that he acted reasonably in pursuing this litigation and that petitioners are, therefore, not prevailing parties. See section 7430(b)(2), (c)(2).

This Court has interpreted the requirement that the party seeking litigation costs be the prevailing party ‘in a civil proceeding‘ to mean that only respondent's actions after a petition is filed may be considered in determining whether respondent acted reasonably. Wasie v. Commissioner, 86 T.C. 962 (1986); Baker v. Commissioner, 83 T.C. at 827. ⁴ We do not review the actions of respondent's agents before a petition is filed for reasonableness. We can and must, however, review the events that occur before a petition is filed to determine whether respondent acted reasonably in pursuing the litigation. See Don Casey Co. v. Commissioner, 87 T.C. 847, 862 (1986).

The legislative history of section 7430 provides guidelines for determining whether respondent's conduct was unreasonable:

The committee intends that the determination by the court on this issue is to be made on the basis of the facts and legal precedents relating to the case as revealed in the record. Other factors the committee believes might be taken into account in making this determination include, (1) whether the government used the costs and expenses of litigation against its position to extract concessions from the taxpayer that were not justified under the circumstances of the case, (2) whether the government pursued the litigation against the taxpayer for purposes of harassment or embarrassment, or out of political motivation, and (3) such other factors as the court finds relevant. * * *

H. Rept. 97-404, 97th Cong., 1st Sess. 12 (1981). We find no evidence that respondent used the cost of litigation to extract concessions from petitioners or that he pursued the litigation to harass or embarrass the petitioners, or out of political motivation. Case law interpreting the Equal Access to Justice Act, 28 U.S.C. section 2412(d)(1)(A) (1982), however, sheds some light on the nature of the ‘other factors‘ that we should consider.

Under the Equal Access to Justice Act, a successful litigant must show that the position of the United States was not ‘substantially justified‘ to recover litigation costs. 28 U.S.C. section 2412(d)(1)(A) (1982). The litigating position of the United States is substantially justified if it has a ‘reasonable basis both in law and fact‘. H. Rept. 96-1418, 96th Cong., 2d Sess. 10 (1980), reprinted in 1980 U.S. Code Cong. & Ad. News 4953, 4984, 4989. In Wyandotte Savings Bank v. N.L.R.B., 682 F.2d 119, 120 (6th Cir. 1982), the Sixth Circuit equated the ‘substantially justified‘ standard with the reasonableness test of section 7430(c)(2)(A)(i). The court held, quoting the legislative history of the Equal Access to Justice Act, that the Government's litigating position was substantially justified because it had a ‘reasonable basis both in law and fact.‘ Wyandotte Savings Bank v. N.L.R.B., supra (quoting H. Rept. 96-1418, supra). An appeal in this case would lie to the Sixth Circuit. To determine whether respondent's litigating position was reasonable, we, therefore, consider whether respondent had a reasonable basis in law and fact for believing that he could prove fraud as to petitioners. See Golsen v. Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir. 1971), cert. denied 404 U.S. 940 (1971).

Respondent argues that our decision for petitioners was based solely on a judgment that petitioners were credible witnesses and Simmerman was not, and that we must consider the reasonableness of respondent's position based only on the facts available to him prior to trial. Respondent further contends that the evidence at all times gave him a reasonable basis in law and fact for believing that he could prove fraud. We agree that we must determine the...