Weiss v. C.I.R.

• Decision Date: 27 June 1988
• Docket Number: D,No. 1162,1162
• Citation: 850 F.2d 111
• Parties: -5115, 57 USLW 2040, 88-2 USTC P 9419 Herbert WEISS and Estate of Roberta Weiss, Deceased, Herbert Weiss, Personal Representative, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee. ocket 88-4017.
• Court: U.S. Court of Appeals — Second Circuit

Page 111

850 F.2d 111

62 A.F.T.R.2d 88-5115, 57 USLW 2040, 88-2

USTC P 9419

Herbert WEISS and Estate of Roberta Weiss, Deceased, Herbert

Weiss, Personal Representative, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

No. 1162, Docket 88-4017.

United States Court of Appeals,

Second Circuit.

Argued May 18, 1988.

Decided June 27, 1988.

Robert F. Hermann, New York City (Saltzman & Holloran, New York City, Michael I. Saltzman, Barbara T. Kaplan, of counsel), for appellants.

Linda E. Mosakowski, Atty., Tax Div., Dept. of Justice, Washington, D.C. (William S. Rose, Jr., Asst. Atty. Gen., Tax Div., Dept. of Justice, Gary R. Allen, Ann Belanger Durney, Attys., of counsel), for appellee.

Before LUMBARD, MESKILL, and WINTER, Circuit Judges.

LUMBARD, Circuit Judge:

Herbert Weiss and the Estate of Roberta Weiss appeal from an order of Judge B. John Williams, Jr., of the Tax Court entered on October 23, 1987, denying their motion for litigation costs in the amount of $1,184.86 which were incurred when they successfully challenged a deficiency notice issued by the Internal Revenue Service for the 1982 tax year.

Reversed and remanded.

I.

During 1982, Herbert Weiss and Roberta Weiss ("taxpayers") purchased an interest in a limited partnership known as Transpac Drilling Venture ("Transpac"). Transpac was formed and commenced business after September 3, 1982. Taxpayers received a form K-1 from Transpac for 1982. That form indicated that their distributive share of the losses of Transpac for 1982 was $42,837. Taxpayers claimed this amount as a loss deduction on their 1982 tax return.

The Commissioner of Internal Revenue sent a statutory notice of deficiency to taxpayers for 1982 in the amount of $10,972 on April 9, 1986. An accompanying statement explained that the Internal Revenue Service ("IRS") had recomputed taxpayers' income--the income they had reported for 1982 was increased by the amount of the partnership loss they had deducted because, the statement explained, they had failed to establish under any provision of the Internal Revenue Code (the "Code") that they were entitled to any portion of those losses. No non-partnership items were raised by the deficiency notice.

On July 7, 1986, taxpayers timely filed a petition in the Tax Court which alleged that the Tax Court lacked jurisdiction because Transpac was a partnership formed after September 3, 1982. They explained that because of its time of formation, the partnership was subject to the partnership audit and litigation procedures of Sec. 6221 et seq. of the 1986 Code ¹ and that in disallowing their deduction for the partnership loss for 1982, the Commissioner had failed to comply with those provisions by not conducting a partnership level audit before issuing the deficiency notice. On September 12, 1986, the Commissioner's District Counsel filed a motion to extend time to answer the taxpayers' petition until November 15, 1986, because he had not yet received the administrative file and was consequently unable to respond. The Tax Court granted this motion.

After receiving and reviewing the administrative file, the District Counsel filed a motion to dismiss for lack of jurisdiction on November 3, 1986. The Commissioner conceded that Transpac was a partnership to which the partnership audit and litigation procedures of Sec. 6221 et seq. of the Code apply and that the IRS had not complied with those procedures in issuing the deficiency notice to the taxpayers. The taxpayers did not object and, on November 14, 1986, the Tax Court ordered the case dismissed for a lack of jurisdiction.

On January 9, 1987, taxpayers filed a motion for an award of $1,184.86 of litigation costs under Sec. 7430 of the Code. ² In support of this motion they alleged that they met Sec. 7430's requirements for the award of litigation costs: (1) they had prevailed with respect to the most significant issue presented in the action (i.e., that the deficiency notice was improperly issued); (2) the position of the Commissioner was not "substantially justified" within the meaning of Sec. 7430(c)(4); (3) they had exhausted their administrative remedies since none was available to them; and (4) the amount they claimed was reasonable.

The Commissioner filed a notice of objection on February 5, 1987 arguing that the Tax Court lacked jurisdiction to hear this petition because the underlying action had been dismissed for lack of jurisdiction. In an opinion dated April 23, 1987, the Tax Court rejected this argument and found that it had jurisdiction to consider the motion for litigation costs but that it would not decide the merits until the Commissioner responded to the allegations in taxpayers' motion.

The Commissioner's response of July 27 agreed that the taxpayers had substantially prevailed with respect to the amount in controversy, had exhausted their administrative remedies and had satisfied the net worth requirement for the award of litigation costs applied by Sec. 7430. ³

The Commissioner opposed the award of litigation costs, however, on the grounds that his conduct in this case was justified and that the amount of attorneys' fees requested was not reasonable. In addition, the IRS District Counsel attorney assigned to the case, Michael Goldbas, submitted an affidavit in which he maintained that he had reviewed all known files and documents related to the administrative action leading to the Commissioner's issuance of the deficiency notice. He also asserted that the District Counsel had not reviewed the notice of deficiency prior to its issuance and that the District Counsel first became involved in the case when the taxpayers' petition was served on the Commissioner. This absence of involvement by the District Counsel in the issuance of the deficiency notice, the IRS argued, meant that, under Sec. 7430(c)(2)(B), the notice did not constitute the "position of the United States." As a consequence, the IRS argued, the taxpayers had not shown that the "position of the United States" was not substantially justified and, therefore, they were not entitled to an award of litigation costs.

On October 8, 1987, the Tax Court denied the taxpayers' request for litigation costs. The Tax Court held that the taxpayers had failed to prove that they were prevailing parties as defined by Sec. 7430(c)(2). The court rejected their argument that the deficiency notice constituted the "position of the United States" as that term is employed in Sec. 7430(c)(2). The court noted that the District Counsel had no role in the Commissioner's issuance of the deficiency notice to the taxpayers and that it was the taxpayers' filing of their petition, rather than any act by the IRS, which began the litigation in the Tax Court. From these facts, the court reasoned that the position of the United States in this case was to be determined by examining the Commissioner's actions after the petition was filed rather than from his prelitigation position in the deficiency notice.

The court also rejected the taxpayers' argument that the Commissioner's position included any administrative action or inaction by the IRS's District Counsel on the ground that the District Counsel's review of tax shelters such as Transpac is "broadbrush" rather than focused on individual taxpayers. Hence, the court reasoned, the fact that the District Counsel never reviewed the deficiency notice did not constitute "administrative inaction" as that term is employed in Sec. 7430(c)(4)(B).

Taxpayers filed timely notice of appeal under Sec. 7482(a) of the Code.

II.

We agree with the Tax Court that Sec. 7430 is designed to provide for the award of litigation costs to the taxpayer when the taxpayer has incurred costs in defending against an improper assessment by the IRS. Section 7430 requires that the costs be related to a civil proceeding brought by or against the United States in a matter related to a tax, a penalty, or interest charges that arise under the Code. As relevant here, it also requires (1) that the taxpayer exhaust all his administrative remedies before proceeding in a civil action; (2) that the costs be reasonable; and (3) that the taxpayer prove that he was the prevailing party. Section 7430(c)(2) defines a prevailing party as one which (1) establishes that the position of the United States was not substantially justified; (2) has substantially prevailed with respect to the amount in controversy or the most significant issue or set of issues presented; and (3) has a net worth not in excess of $2 million at the time of the civil proceeding.

The Tax Court found that the taxpayers here had exhausted all their administrative remedies, that they met the net worth requirement, and that they had substantially prevailed with respect to the amount in controversy. The court did not reach the issue of whether the fees claimed were reasonable. The court did not reach this issue and did not award litigation costs to the taxpayers because the court found that they had not established that they were the prevailing parties because they had not demonstrated that the position of the Commissioner was not substantially justified. The court based this finding on its interpretation of the term "position of the United States" to mean only the position taken by the Commissioner once litigation has commenced. Thus, to decide whether the taxpayers in this case were prevailing parties within the meaning of Sec. 7430, we need only determine whether the Commissioner's position in the statutory notice of deficiency issued to the taxpayers constituted a "position of the United States."

The Commissioner maintains, and the Tax Court found, that the time for determining whether the Commissioner's position was not substantially justified under Sec. 7430(c)(4)(A) was subsequent to the filing of the taxpayers' petition in the court. The rationale advanced by both the IRS and the Tax Court for using this approach is that the civil proceeding is commenced...