by Harris L. Bonnette, Jr.
The answer to the question posed in the above parenthetical is, of course, yes. Although not popular within the IRS, §7430 of the Internal Revenue Code (I.R.C.) is a fee shifting statute which compels the IRS to pay attorneys’ fees and costs incurred by a taxpayer in most administrative proceedings before the IRS and court proceedings before most U.S. federal courts, provided a series of requirements are met.
This article is a primer on the recovery of attorneys’ fees and costs from the IRS in administrative and court proceedings. Given the IRS’ recent proposed regulations interpreting I.R.C. §7430 in November 2009 (and published in the Internal Revenue Bulletin on December 28, 2009, 2009-52 I.R.B. 1000), this article also addresses those proposed regulations.
Section 7430 speaks in terms of administrative and litigation “costs.” To be consistent with the statute, references in this article to “costs” include those costs we traditionally think of as costs, such as court filing fees, administrative fees, and court reporter costs, as well as attorneys’ fees and expert witness fees.1
The flow chart at the end of this article assists in evaluating the eligibility for an award of costs. The flow chart is divided into two sections, one for administrative costs incurred in proceedings before the IRS and the other for litigation costs incurred in court proceedings. Litigation costs are addressed first. Thereafter, qualified offers and administrative costs are addressed.
The flow chart first asks whether the taxpayer was involved in litigation of a tax matter in a U.S. court. Tax matters are matters relating to the determination, collection, or refund of any tax, interest, or penalty, and the litigation can be brought by or against the United States.2 The most common instances are, for example, when the IRS audits a tax return and concludes that adjustments should be made. If the taxpayer does not settle those adjustments, the IRS issues a notice of deficiency permitting the taxpayer to file a petition in the U.S. Tax Court to resolve the dispute.3 In this example, the taxpayer is involved in litigation of a tax matter (the adjustments to the tax return) in the Tax Court, a U.S. court. Alternatively, if the taxpayer chose to pay the determined tax instead of petitioning the Tax Court, the taxpayer could later file suit in U.S. district court for a refund of the tax paid.4 Another example is when the United States, through its agency the IRS, initiates a law suit in a U.S. district court seeking to reduce a federal tax lien to judgment.5 This lawsuit is brought by the IRS as a part of its effort to collect unpaid tax.
Other than pro bono and contingent fee cases discussed below, most taxpayers pay or incur costs in litigation of a tax matter. Fees are “incurred” when there is a legal obligation to pay them.6 When a third party having no direct interest in the litigation pays costs on behalf of taxpayer, the taxpayer “incurs” such costs so long as the taxpayer assumes 1) an absolute obligation to repay costs regardless of whether taxpayer is successful in a motion for an award under I.R.C. §7430, or 2) a contingent obligation to pay the costs in the event taxpayer is able to recover them under I.R.C. §7430.7
In cases when an attorney is representing a taxpayer on a pro bono basis, the taxpayer does not “incur” any costs. However, I.R.C. §7430(c)(3)(B) permits the recovery of costs in excess of what the taxpayer paid or incurred (which is usually nothing in pro bono cases), provided that the award of costs is paid directly to the attorney or the attorney’s employer (such as a legal aid organization). The proposed regulations expand these requirements by providing that 1) the legal services must be provided on a no fee or nominal fee basis; 2) the legal services were provided to or on behalf of persons with limited financial means and are eligible for programs offered by legal aid organizations; and 3) the attorney intended to perform services for a no fee or a nominal fee from the outset of the representation.8
A taxpayer must meet the net worth requirements to qualify for an award of litigation costs.9 A taxpayer’s net worth is computed using fair market value of the assets at the time the civil proceeding is commenced.10 The taxpayer’s net worth must be equal to or less than the following thresholds: 1) $2,000,000 for individuals,11 estates,12 and trusts;13 2) $7,000,000 and less than or equal to 500 employees for unincorporated businesses, partnerships, corporations, associations, and units of local government; and 3) unlimited net worth for 501(c)(3) organizations and cooperative associations. The burden to prove the taxpayer meets the net worth requirements is on the taxpayer.14
A taxpayer must exhaust all available administrative remedies within the IRS prior to initiating litigation in order to recover litigation costs.15 Exhausting administrative remedies means that if the taxpayer is given an opportunity for an IRS appeals office conference prior to initiating litigation, the taxpayer must seek that appeals office conference. An opportunity to participate in an appeals office conference is typically given through a so-called “30-day letter” in tax return audit cases,16 and denial of a claim for refund notices in refund cases.17 Specific notices of appeal rights are given when liens are filed;18 notices of intent to levy are issued;19 and proposed offers in compromise and installment agreements are denied.20
If the taxpayer is given an opportunity for an appeals office conference, the taxpayer must timely and properly exercise the right to have that conference.21 Thus, for example, if the IRS issues a 30-day letter at the conclusion of an audit, the taxpayer must file an adequate administrative appeal22 within 30 days.23 The appeals office’s guidelines require a certain amount of time to remain on the statute of limitations on assessment before it will take a case.24 Although the taxpayer may consent to extend that statute, in most cases pursuant to I.R.C. §6501(c)(4), the taxpayer is not required to do so. Indeed, if the taxpayer refuses to consent to extend the statute, that fact is not considered in determining whether the taxpayer exhausted administrative remedies.25 The risk that the appeals office may not accept the appeal because there is insufficient time left on the statute does not excuse the taxpayer from seeking an appeals office conference. A taxpayer must request an appeals office conference despite possible lapse of statute of limitations, which is the IRS’ problem, not the taxpayer’s.26
It is not enough for a taxpayer to timely and properly request an appeals office conference (if one is offered) prior to initiating litigation. The taxpayer must also “participate” in such conference. Participation means that the taxpayer must disclose to the appeals office all relevant information to the extent such information and its relevance was known or should have been known at the time of the conference.27
When a taxpayer is not given a right to an appeals office conference prior to litigation (such as when the statute of limitations on assessment is about to expire, and the taxpayer did not consent to extend the statute of limitations on assessment), often the IRS will offer the taxpayer an appeals office conference after the case is docketed.28 The ability to recover costs under §7430 is forfeited if the taxpayer refuses to participate in the offered conference.29
A taxpayer cannot unreasonably protract either the administrative or court proceeding, and if the taxpayer does so, the taxpayer is not entitled to an award of fees or costs during the period of time the proceeding was unreasonably protracted.30
Assuming the taxpayer did not make a qualified offer — discussed below — the next step is to determine if the taxpayer substantially prevailed in the litigation. A taxpayer must substantially prevail with respect to the amount in controversy or with respect to the most significant issue or set of issues determined either by settlement with the IRS or by a court.31 The taxpayer bears the burden to prove he or she substantially prevailed.32
An often litigated issue in §7430 cases is, despite a taxpayer win, whether the IRS was substantially justified in the position it took in the court proceeding. If the IRS was substantially justified, no litigation costs are awardable.33 The IRS is substantially justified if its position (taken in either its notice of deficiency, its answer filed in court, or in its trial memorandum) is justified to a degree that could satisfy a reasonable person and has a reasonable basis in both law and fact.34 A significant factor is whether the taxpayer provided the IRS 1) relevant information under the taxpayer’s control, and 2) relevant legal arguments for the IRS to evaluate and determine its position.35 There is a rebuttable presumption of no justification if the IRS does not follow its published guidance as defined in I.R.C. §7430(c)(4)(B)(iv).36 In evaluating whether the IRS was substantially justified, the court must consider whether the IRS lost on substantially similar issues in other circuit courts.37 The IRS must evaluate information in its possession,38 and the IRS is not substantially justified if it fails to adequately investigate its case.39 The fact that the IRS loses the case does not establish that its position was not justified, but the loss of the IRS is a factor.40 The IRS may be justified as to some issues and not others.41 Costs are only recoverable for issues over which the IRS was not justified.42 The IRS may be justified during a portion of the court proceeding, but not during other portions.43 Costs are only recoverable when incurred during the portion when the position of the IRS is not justified.44 The IRS has the burden to prove its position was substantially justified.45
A taxpayer’s claim for litigation costs made in the court proceeding must be timely. For Tax Court cases, the time is 30 days after the court’s opinion is served or, if all issues other than costs are settled, the motion for costs is filed when the parties submit their stipulation of settlement.46 The Tax Court can entertain motions for litigation costs after a decision is entered.47
Finally, a taxpayer’s claimed litigation costs must be reasonable.48 Litigation costs become awardable and accrue at the time fees and costs are incurred to prepare the initial court pleading.49 Reasonable litigation costs include attorneys’ fees, court costs, expert witnesses, and engineering reports necessary to prepare the party’s case.50 For 2010, the hourly rate for attorneys is capped at $180.51 This rate can increase if special factors exist, such as limited availability of qualified attorneys,52 difficulty of issues presented, or local availability of tax expertise.53 The prevailing local hourly rate is not a special factor.54 Paralegal fees are recoverable.55 Fees incurred to seek litigation costs (“fees on fees”) are awardable.56 The fees of a taxpayer who is an attorney representing himself or herself are not recoverable.57 For litigation costs awardable under the qualified offer rules (discussed below), only reasonable costs paid or incurred from the date of the last qualified offer are awardable.58 However, litigation costs paid or incurred prior to the date of a qualified offer may nevertheless be awarded if the substantially prevailed and substantial justification requirements are met.59
One of the most litigated issues in §7430 cases is whether the IRS was substantially justified in its position in tax cases. The qualified offer rules provide that if a taxpayer makes a settlement offer during a specified window of time which the IRS does not accept and the taxpayer does equal to or better than the offer at trial, the taxpayer is deemed to be the prevailing party, and the IRS is deemed not to be substantially justified.60
Qualified offers do not apply when a tax liability is not at issue, because a qualified offer is made by reference to a precise amount of tax or a percentage of the tax determined to be due.61 Thus, qualified offers do not apply to declaratory judgment, summons enforcement, or disclosure issue cases.
A qualified offer must 1) be in writing, 2) indicate it is a “qualified offer pursuant to I.R.C. §7430(g),” and 3) specify the offered amount of the taxpayer’s liability for all adjustments at issue in the proceeding at the time the offer is made.62 The offer is expressed in terms of a specific dollar amount of the total liability or as a percentage of all of the adjustments at issue at the time offer is made.63 An offer is made without regard to accrued interest unless interest is an issue in the proceeding pursuant to I.R.C. §6404(e).64 The offer must address all tax years at issue unless there are distinct issues in other years, in which case a taxpayer can make an offer for each year, provided the offer resolves all of the issues for the year.65 Offers are not required to specify payment terms. One commentator suggests refraining from discussing payment terms until after the liability in an accepted offer is assessed by the IRS.66
A taxpayer may make a qualified offer during the period that begins on the date of the 30-day letter in tax deficiency cases (or, if none, the date of the notice of deficiency) or the date of the notice of claim disallowance in refund cases (or, if none, then on the date when the answer or other responsive pleading is filed by the U.S.) and ends on the earlier of 1) the date the offer is rejected; 2) the 90th day after the offer is received by the IRS; or 3) 30 days before the date the case is first set for trial.67 An offer can expire at a later date and can be subsequently extended.68
New issues raised after an offer is made are ignored in determining if the litigation result is less than or equal to the offer.69 For those new issues, the qualified offer rules do not apply and, instead, the substantially prevail and substantial justification tests must be met to recover costs on those new issues.70 No costs are awarded if the IRS timely accepts an offer.71
When more than one offer is made, the judgment must be less than or equal to the last offer made.72 If an offer is made, and later the court resolves some but not all issues in the offer and the remaining issues are later settled, the offer is viable despite the settlement of the remaining issues.73 If the judgment results in tax greater than the offer, the taxpayer may still qualify for an award of costs if the taxpayer satisfies the substantially prevail and substantial justification tests.74 The qualified offer provisions are designed to encourage the IRS to take seriously any settlement offer made by a taxpayer.75
Section 7430 provides that the taxpayer’s costs incurred during an administrative proceeding can be paid by the IRS if certain requirements are satisfied. This takes a bit of explanation. If the IRS takes an unjustified “position” during an administrative proceeding, the reasonable costs incurred by a taxpayer from a point in time (discussed below) are recoverable from the IRS provided 1) the taxpayer did not unreasonably protract the administrative proceeding; 2) the taxpayer met the net worth requirements; 3) the taxpayer substantially prevailed; 4) the IRS was not substantially justified at the time it took its position; and 5) the taxpayer timely filed a request with the IRS for an award of administrative costs.
The IRS only takes a position in an administrative proceeding when either 1) the appeals office issues a notice of decision, or 2) a notice of deficiency is issued.76 Once the IRS takes a position, you can then determine if the five requirements discussed above are satisfied. The analysis of these five requirements is similar to the requirements to recover litigation costs. If the five requirements are satisfied, the taxpayer is eligible for an award of reasonable administrative costs incurred from the earlier of 1) the date the taxpayer receives the appeals office’s notice of decision, 2) the date of a notice of deficiency, or 3) the date the IRS first issues a letter allowing the taxpayer an opportunity for administrative review by the appeals office (e.g., the 30-day letter).77
The time the IRS first takes a position is different than the period in which costs incurred are recoverable.78 The IRS only takes a position when a decision letter or a notice of deficiency is issued. However, if the IRS takes a position, then awardable administrative costs can be costs that were incurred from the date of the first letter of proposed deficiency (e.g., 30-day letter), which is earlier than an appeals office decision or a notice of deficiency.
The definition of “administrative proceeding” is a bit deceptive. Although the I.R.C. defines an administrative proceeding as “any procedure or other action before the IRS,”79 the regulations narrow that definition.80 The procedure or other action before the IRS does not include 1) collection actions, such as collection due process (CDP) and collection appeals program (CAP) proceedings pursuant to I.R.C. §§6320 and 6330 (except when the underlying tax liabilities are at issue);81 2) matters of general application (e.g., regulation hearings);82 and 3) requests for private letter rulings83 or technical advice.84
A request for administrative costs must be filed within 90 days after date of the final decision of the IRS with respect to all tax and penalties at issue in the administrative proceeding is sent to the taxpayer.85 The request must contain the appropriate information and statements outlined in Treas. Reg. §301.7430-2(c)(3). If the IRS does not respond to the merits of the request for administrative costs within six months, the failure to respond is deemed to be the IRS’ denial of the request.86 If the IRS denies a taxpayer’s request, the taxpayer may file a petition for review of that denial to the Tax Court.87
The IRS will not grant a request for reasonable administrative costs when the underlying substantive issues or issues of administrative costs are before any U.S. court.88 However, a taxpayer can seek an award of administrative costs as a part of the judicial proceeding when the tax, interest, or penalty is before such court.89
Yes, it is possible to recover costs from the IRS. Learn the facts and the law and submit a reasonable qualified offer as early as possible. If your offer is reasonable, the IRS is likely to accept the offer. If not, recovery of your costs may be had under the normal §7430 procedures.
1 See I.R.C. §§7430(c)(1) and (2).
2 I.R.C. §7430(a).
3 I.R.C. §§6212 and 6213.
4 I.R.C. §§7422(a) and (e).
5 I.R.C. §7403.
6 I.R.C. §7430(a)(2); Treas. Reg. §301.7430-4(b); Grigoraci v. Commissioner, 122 T.C. 272, 277-278 (2004).
7 Morrison v. Commissioner, 565 F.3d 658 (9th Cir. 2009).
8 Prop. Treas. Reg. §301.7430-4(d).
9 I.R.C. §7430(c)(4)(A)(ii).
10 Stieha v. Commissioner, 89 T.C. 784 (1987); Prop. Treas. Reg. §301.7430-5(g); but see Swanson v. Commissioner, 106 T.C. 76, n. 24 (1996).
11 I.R.C. §7430(c)(4)(D)(ii). Joint tax return filers treated as separate individuals.
12 Determined as of date of death, I.R.C. §7430(c)(4)(D)(i)(I); net worth is of the probate estate, not the gross estate. Cameron v. U.S., 2005-1 U.S.T.C. (CCH) ¶60,503 (W.D. Pa. 2005).
13 I.R.C. §7430(c)(4)(D)(i)(II).
14 Corson v. Commissioner, 123 T.C. 202 (2004).
15 I.R.C. §7430(b)(1) and Treas. Reg. §§301.7430-1(a) and (f).
16 IRM 126.96.36.199 and Treas. Reg. §601.105(b)(4).
17 Treas. Reg. §601.105(e)(2).
18 I.R.C. §6320(b).
19 I.R.C. §6330(b).
20 I.R.C. §7122(e).
21 Treas. Reg. §301.7430-1(b)(1).
22 The document to administratively appeal is often called a “protest.” IRM 188.8.131.52.5, ¶2.
23 The 30-day period can be extended. IRM 184.108.40.206.5, ¶3.
24 IRM 220.127.116.11 and 18.104.22.168, ¶3.
25 I.R.C. §7430(b)(1).
26 Haas & Assoc. Accounting Corp. v. Commissioner, 117 T.C. 48 (2001), aff’d, 55 Fed. Appx. 476 (9th Cir. 2003).
27 Allen v. Commissioner, T.C. Memo 2002-302.
28 See Rev. Proc. 87-24, 1987-1 C.B. 720.
29 Treas. Reg. §301.7430-1(f)(2)(ii); Swanson v. Commissioner, 106 T.C. 76 (1996).
30 I.R.C. §7430(b)(3); Treas. Reg. §301.7430-2(d); and Nguyen v. Comm., T.C. Memo 2001-41.
31 I.R.C. §7430(c)(4); Goettee v. Commissioner, 124 T.C. 286 (2005), aff’d, 192 Fed. Appx. 212 (4th Cir. 2006).
32 Corson v. Commissioner, 123 T.C. 202 (2004).
33 I.R.C. §7430(c)(4)(B); Treas. Reg. §301.7430-5.
34 Corkrey v. Commissioner, 115 T.C. 366 (2000).
35 Treas. Reg. §301.7430-5(c).
36 I.R.C. §7430(c)(4)(B)(ii).
37 I.R.C. §7430(c)(4)(B)(iii).
38 Nguyen v. Commissioner, T.C. Memo 2001-41.
39 Owen v. Commissioner, T.C. Memo 2005-115 (pgs. 22 and 24).
40 Sokol v. Commissioner, 92 T.C. 760 (1989).
41 Blasius v. Commissioner, T.C. Memo 2005-214 (pg. 17).
42 I.R.C. §7430(c)(4)(B).
43 Blasius, T.C. Memo 2005-214 (pg. 17).
44 Treas. Reg. §301.7430-5(c)(2).
45 I.R.C. §7430(c)(4)(B)(i) and Corson v. Commissioner, 123 T.C. 202 (2004).
46 See Rule 231(a) of the Tax Court Rules of Practice and Procedure.
47 Corson v. Commissioner, 123 T.C. 202 (2004).
48 I.R.C. §7430(a)(2).
49 I.R.C. §7430(c)(6); Treas. Reg. §301.7430-4(c)(3); and Shaw v. Commissioner, T.C. Memo 2005-106, n. 4 and 5.
50 I.R.C. §7430(c)(1)(B).
51 Rev. Proc. 2009-50.
52 Dixon v. Commissioner, T.C. Memo 2006-97.
53 I.R.C. §7430(c)(1)(B)(iii).
54 Huffman v. Commissioner, 978 F.2d 1139, 1149 (9th Cir. 1992).
55 Howard’s Yellow Cab v. U.S., 987 F. Supp. 469 (W.D.N.C. 1997).
56 Huffman v. Commissioner, 978 F.2d 1139, 1148-1149 (9th Cir. 1992).
57 Dunaway v. Comm., 124 T.C. 80 (2005).
58 I.R.C. §7430(c)(4)(E)(iii)(II).
59 Treas. Reg. §301.7430-7(e), last sentence of ex. 10 and 11.
60 I.R.C. §7430(c)(4)(E); Jondahl v. Commissioner, T.C. Memo 2006-142 (pgs. 4 and 5).
61 Treas. Reg. §301.7430-7(a).
62 Treas. Reg. §301.7430-7(c).
63 Treas. Reg. §301.7430-7(c)(3).
64 I.R.C. §7430(g)(1)(B).
65 Treas. Reg. §301.7430-7(e) ex. 5, 6, and 7; Haas & Assoc. Accounting Corp. v. Commissioner, 117 T.C. 48 (2001), aff’d, 55 Fed. Appx. 476 (9th Cir. 2003).
66 Philip N. Jones, Final Regs. on Qualified Offers: Making it Easier to Make the IRS Pay Attorney’s Fees, J. of Taxation at 114 (Feb. 2004).
67 I.R.C. §7430(g)(2); Treas. Reg. §§301.7430-7(c)(5) and (c)(7).
68 Treas. Reg. §301.7430-7(c)(5).
69 Treas. Reg. §301.7430-7(c), ex. 10.
70 Treas. Reg. §301.7430-7(e) ex. 10.
71 Treas. Reg. §301.7430-7(e) ex. 8.
72 I.R.C. §7430(c)(4)(E)(iii)(I).
73 Gladden v. Commissioner, 120 T.C. 446 (2003); Treas. Reg. §301.7430-7(b)(1).
74 I.R.C. §7430(c)(4)(E)(iv); Treas. Reg. §301.7430-7(b)(1).
75 Haas & Assoc. Accounting Corp. v. Commissioner, 117 T.C. 48 (2001), aff’d, 55 Fed. Appx. 476 (9th Cir. 2003).
76 I.R.C. §7430(c)(7)(B); Treas. Reg. §301.7430-3(c).
77 I.R.C. §7430(c)(2), flush language; Treas. Reg. §301.7430-3(c)(1); and Prop. Treas. Reg. §301.7430-(c)(4).
78 Florida Country Clubs, Inc. v. Commissioner, 122 T.C. 73 (2004), aff’d, 404 F.3d 1291 (11th Cir. 2005).
79 I.R.C. §7430(c)(5).
80 Treas. Reg. §301.7430-3(a).
81 Treas. Reg. §§301.7430-3(a) and (d), ex. 6; Prop. Treas. Reg. §301.7430-3(b).
83 Treas. Reg. §301.7430-3(a)(2).
84 Treas. Reg. §301.7430-3(a)(3).
85 Treas. Reg. §301.7430-2(c)(5).
86 Treas. Reg. §301.7430-2(c)(6).
87 I.R.C. §7430(f)(2); Treas. Reg. §301.7430-2(c)(7); and Rule 270 of the Tax Court Rules of Practice and Procedure.
88 Treas. Reg. §§301.7430-2(b)(1)(i) and (b)(2).
89 Shaw v. Commissioner, T.C. Memo 2005-106 (pg. 11).
Harris L. Bonnette, Jr., is a shareholder in Ivan, Cole & Bonnette in Jacksonville. He received his J.D. from the University of Miami in 1989 and an LL.M. in taxation from Washington University in St. Louis in 1990. Mr. Bonnette specializes in all federal tax controversies. He is board certified in taxation.
This column is submitted on behalf of the Tax Section, Frances D. McCoid Sheehy, chair, and Michael D. Miller and Benjamin Jablow, editors.