Section 7430(a) permits a court to award “reasonable administrative costs” and “reasonable litigation costs” (the largest being attorneys fees) to a taxpayer who is a “prevailing party” in a dispute with the IRS. In Mark C. Klopfenstein v. Commissioner, T.C. Memo 2019-156 (Dec. 9, 2019) (Judge Lauber), Exam assessed a $1.6 million §6707 penalty against the taxpayer. Mr. Klopfenstein eventually secured a closing agreement from Appeals that reduced the penalty to just under $170,000. The IRS abated the assessment to that amount. Mr. Klopfenstein then asked for “reasonable administrative costs” under §7430. The Tax Court said no, because Mr. Klopfenstein was not a “prevailing party.” You will find out why below the fold.
Mr. Klopfenstein got in trouble with the IRS over tax shelters. The good folks in the Examination function were convinced that he was a material advisor who violated the reporting duties of §6111.
In December 2014, Exam proposed to hit him with an §6707 assessable penalty of just over $1.6 million.
In January 2015 Mr. Klopfenstein sent Exam an offer to settle for $10,000. Exam laughed.
In June 2015, Mr. Klopfenstein timely protested the proposed penalty to Appeals. The assigned Appeals Officer (AO) started working the matter, obtaining the file from Exam, receiving a supplemental protest from the taxpayer and a reply from Exam, etc. Events moved at their usual pace in Appeals.
In March 2016, while the matter was still pending in Appeals, Exam went ahead and assessed the $1.6 million.
In August 2016, the AO held a conference with Mr. Klopfenstein and his lawyers. The AO agreed to settle the matter for just under $170,000. The parties signed a Closing Agreement under §7121 and Appeals ordered the $1.6 million assessment to be abated down to the agreed-upon liability. The IRS did that in December 2016. Mr. Klopfenstein then asked for costs. The IRS denied the request and he petitioned the Tax Court.
Lesson: Winning In Appeals Does not Always Make You A Prevailing Party
To get awards of costs and attorneys fees under §7430, a taxpayer must be a “prevailing party.” Taxpayers who jump that hurdle then face a bunch of other requirements, such as a net worth requirement, a very strict administrative exhaustion requirement and, most difficult of all, the requirement that the IRS’s position in the proceeding was not substantially justified. For a lesson on what constitutes substantial justification, see my post “It Takes More Than Winning To Get Attorneys Fees Under §7430.”
Today's lesson is not about substantial justification, however. That is because before a court even looks at justification, the taxpayer must first prevail in an “administrative or court proceeding which is brought by or against the United States in connection with the determination, collection, or refund of any tax, interest, or penalty under this title.” §7430(a).
A taxpayer cannot prevail if there is nothing to prevail against. Both the Tax Court and Courts of Appeal have concluded that the taxpayer must prevail against an actual “position of the United States.” See Fla. Country Clubs Inc, v. Commissioner, 122 T.C. 73 (2004) aff’d 404 F.3d 1291 (11th Cir. 2005). The Tax Court has put this gloss on the statute because Congress generally denies the recovery of costs when the “position of the United States” is substantially justified.
The term “position of the United States” is explicitly defined in §7430(c)(7). There, Congress said that the term means the position taken in either: (1) “the notice of the decision of the Internal Revenue Service Independent Office of Appeals”; or (2) "the notice of deficiency” whichever comes first. The Tax Court has inferred from this statutory definition a Congressional intent to leave the agency space to work out its position before one of those two events occur. Congress did not intend to allow taxpayers to recover costs until after such time as “the IRS’s position has crystallized in an Appeals Office decision or a notice of deficiency.” 122 T.C. at 81.
Judge Lauber applied the Tax Court’s gloss in this case. First, he noted that the IRS had not issued an NOD in this case. That is because the procedures for imposing the §6707 penalty did not include an NOD. The deficiency procedures in §6212 et seq. does not include assessable penalties such as this one. Second, he noted that because Appeals settled the case with the taxpayer, it never got to the point of issuing a decision. A closing agreement is not a notice of decision because a "notice of decision is a final written document notifying the taxpayer that the Appeals Office has made a determination of the entire case (typically, adverse to the taxpayer).” Op. at 8 (internal quotes omitted).
Judge Lauber summarized his reasoning this way:
“In this case the Appeals Office received multiple submissions from petitioner and from Exam, held a settlement conference, and settled the case by making a large concession in petitioner’s favor. That settlement was ultimately embodied in a closing agreement. Because the Appeals Office did not issue a notice of deficiency or a notice of decision, it did not take a “position” contrary to petitioner’s for purposes of section 7430(c)(7). And because the United States did not take a position contrary to petitioner’s, he cannot be treated as “the prevailing party.”
You may be wondering about the assessment. You know, that $1.6 million that the IRS actually assessed? Mr. Klopfenstein argued that the Tax Court should consider the act of assessing that amount “the position of the United States.” After all, if the Tax Court was willing to gloss the language in §7430(a) to infer a requirement that the taxpayer have prevailed over an articulated “position of the United States,” it should be willing to gloss the definition in §7430(c)(7) to acknowledge what seems pretty obvious: an assessment is about as firm a statement on the amount owed as one might imagine.
The taxpayer’s argument has considerable commonsense appeal. It is absolutely true that a proper assessment represents the judgment of the agency itself, not simply an internal component of the agency. Cohen v. Gross, 316 F.2d 521 (3rd Cir. 1963) ("assessment is a prescribed procedure for officially recording the fact and the amount of a taxpayer's administratively determined tax liability, with consequences somewhat similar to the reduction of a claim of judgment."). See also Bull v. United States, 295 U.S. 247, 260 (1935)(“The assessment is given the force of a judgment, and if the amount assessed is not paid when due, administrative officials may seize the debtor's property to satisfy the debt.”). In a strong sense the assessment represents what would be a common, ordinary understanding of the phrase “position of the United States.”
Section 7430(c)(7), however, does not employ a commonsense understanding of the phrase “position of the United States.” The phrase is a term of art, defined by statute. The taxpayer was in effect asking the Tax Court to add language to supplement the statutory definition of “position of the United States.”
Judge Lauber was not willing to go beyond the explicit statutory definition. I think this was a good call. The language in §7430(c)(7) contemplates that "the position of the United States" will be an articulated position that can be then evaluated and compared to the position of the taxpayer. The simple act of assessing, or even of collecting on an assessment, is not an articulation of a position and, therefore, cannot be evaluated the way that an articulated position can be evaluated. See Milligan v. Commissioner, T.C. Memo 2014-259 (act of assessing Trust Fund Recovery Penalty did not establish “position of the United States”).
The explicit definition in §7430(c)(7) simply ignores whether the IRS has assessed a particular amount or not. That cuts two ways, sometimes favoring taxpayers and sometimes not. First, by including “notice of deficiency” in the definition, §7430(c)(7) ignores the fact that the IRS has not made an assessment. And the definition of what costs can be recovered in §7430(c)(2) also can include costs incurred even where the IRS never makes an assessment. Thus, the lack of an assessment is not itself a bar to recovery of costs under §7430. That favors taxpayers. Second, as in this case, the act of assessment is also irrelevant to finding an articulated position when there is neither an NOD or a decision of Appeals that sets out the position of the United States. Here, as Judge Lauber pointed out, Appeals simply settled the matter. Put another way, Appeals and the taxpayer agreed to the same “position.”
Judge Lauber’s refusal to interpolate an additional definition into §7430(c)(7) is consistent with the entire thrust of §7430 taken as a whole: to allow the IRS space to correct its errors internally. You see that policy most clearly expressed in the §7430(b)(1) requirement that taxpayers exhaust administrative opportunities in order to even be eligible to recover administrative or litigation costs under §7430(a). Take this case, for example. Here, Exam proposed to assess the penalty but offered Mr. Klopfenstein an opportunity to protest to Appeals. Had Mr. Klopfenstein declined that invitation, he could have proceeded down the refund route by paying part of the penalty and then filing a claim for refund. Assuming Exam denied the refund claim, it would have again offered him a chance to go to Appeals. To get to court Mr. Klopfenstein would have thus had to decline two opportunities to settle the matter in Appeals. At this point §7430(b)(1) would block any entitlement to attorneys fees because he would have failed to exhaust the offered administrative remedy.
The IRS commits all kinds of errors that cost taxpayers time and treasure to fix. Congress has decided that the government should reimburse taxpayers for costs only after the IRS has solidified its error in an articulated "position of the United States." That did not happen in this case. Mr. Klopfenstein got the IRS to reduce an assessment of $1.6 million to $170,000. He will just have to be satisfied with the cake, without the icing.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law