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. I use all those scare quotes to emphasize that these are all terms of art. And the scariest, or artiest, one is perhaps “prevailing party.”
Today’s lesson teaches us that a taxpayer is not going to be a prevailing party just because they win a remand in the Court of Appeals and then win in Tax Court on the remand. The case is Champions Retreat Golf Founders, LLC v. Commissioner, T.C. Memo. 2023-143 (Nov. 8, 2023) (Judge Pugh). It is the coda on the taxpayer’s 13 year slog to claim a $10.8 million charitable deduction for a conservation easement on a golf course. The Tax Court initially found that the easement was not a qualified charitable contribution. It got reversed by the Eleventh Circuit.
The parties then battled over the proper valuation of the donation and, again, the taxpayer won, although Judge Pugh cut down the contribution amount by about $3 million. See Lesson From The Tax Court: Fake It Till You Make It, TaxProf Blog (Oct. 24, 2022) (“The lesson is kind of like the old joke that you don’t have to outrun the bear: a taxpayer’s valuation does not have to be the best possible; it just has to be better than the IRS’ valuation.”).
Now the taxpayer is back, asking for the Court to make the government pay its litigation costs per §7430 because it claims to be a prevailing party. Well, without the scare quotes, that may seem intuitively right. After all, the taxpayer won in the Circuit Court and then in Tax Court on remand!
But the lesson we learn is that even a winning taxpayer is not entitled to litigation costs when the government’s losing position was “substantially justified.” Again with the scare quotes! That’s because, dear readers, this term is yet another term of art. We learn today that the term is a facts and circumstances determination. While winning is an important factor, winning isn’t everything. Details below the fold.
Law: The Scare Quotes in §7430
Under long-standing general principals in U.S. law, parties generally bear their own costs in litigation. In contrast to this American rule the English rule requires the loser in court to pay the winner’s costs, including those all-important attorneys fees. There is a robust academic debate on which rule is better and why. Readers who are interested will find fun reading in John Leubsdorf, Does The American Rule Promote Access to Justice? Was That Why It Was Adopted? 67 Duke L. J. Online 257 (Jan. 2019).
Section 7430 modifies the American rule. The idea is that taxpayers can recover reasonable administrative and litigation costs if the taxpayer is a “prevailing party” in the relevant administrative or court proceeding. §7430(a). To be a prevailing party, the taxpayer must show that they “substantially prevailed with respect to the amount in controversy” or “with respect to the most significant issue or set of issues presented.” §7430(c)(4)(A). The taxpayer will not be a prevailing party, however, if the government can show that its loser position was “substantially justified” at the relevant time and as to the issue or issues that the taxpayer won. §7430(c)(4)(B). And note that the burden of persuasion is on the government. Id.
“Substantially justified” is not an entirely intuitive concept; it depends on what you think the word substantial means. It might mean justified to a high degree or it might mean just more than insubstantial. The Tax Court has interpreted it to mean the latter: the IRS position needs to be such that a reasonable person would agree the position had a reasonable basis in law and fact, given the lay of the legal landscape as of the relevant testing date. Maggie Mgmt. Co. v. Commissioner, 108 T.C. 430 (1997). This is consistent with how the Supreme Court has interpreted the same phrase as used in a similar statute, 28 USC §2412(d). Pierce v. Underwood, 487 U.S. 552, 565 (1988) (“To our knowledge, that [phrase] has never been described as meaning ‘justified to a high degree,’ but rather has been said to be satisfied if there is a ‘genuine dispute.’”) In other words, just because the IRS takes a position that turns out to be wrong does not means that position was not substantially justified.
Another non-intuitive wrinkle comes up when the IRS loses on more than one issue. That is, the IRS may well determine a deficiency for multiple reasons. The Tax Court takes a pick-apart approach whereby they analyze the government’s position as to each discrete issue in a case. Foothill Ranch Co. v. Commissioner, 110 T.C. 94, 97 (1998) (justification for each position must be independently determined.). Some Circuit Courts disagree and instead go with a holistic approach, evaluating whether the IRS’s overall position was substantially justified. United States v. Johnson, 920 F.3d 639, 649 (10th Cir. 2019) (“The statutory language and the relevant case law counsel against the issue-by-issue analysis undertaken by the district court.”).
In today’s case, the taxpayer had to win two different issues in order to justify its charitable contribution deduction. So the Tax Court uses the pick-apart approach to ensure that the government's losing position was substantially justified as to each issue. Let’s take a look.
In 2002, the taxpayer Champions Retreat Golf Founders, LLC ("Champions") bought 463 acres of land adjoining the Savannah river. It developed about 366 acres into a private golf club called “Champions Retreat” into a 27-hole course (3 nine-holes) on different parts of the property.
In 2010, Champions donated a conservation easement to a qualified charity. The easement covered about 348 acres of the property (almost all of the golf courses and an adjoining driving range). The easement restricted how Champions could use easement area in the future and prohibited development of the easement area into residential lots.
Champions made the donation to raise badly needed funds to support operations and pay off debt. And how would it raise money from taking a really large deduction? Well, the idea was it would sell the deduction. Investors would contribute capital for a share of the resulting large charitable deduction. How large? $10.5 million large! That’s the deduction taken on the 2010 return, based upon an appraisal done by one Claude Clark, III.
The IRS audited and disagreed that the easement qualified as a charitable donation in the first place. It disallowed the entire deduction. The IRS back-up position was that the value of the easement was a nominal $20,000. So that still pretty much made the golden easement goose lay a very non-golden egg.
The Tax Court agreed with the IRS’s first position, but was reversed by the 11th Circuit who thought the easement qualified as one for “the preservation of open space ... for the scenic enjoyment of the general public" per §170(h)(4)(A)(iii). Even though the golf course was private, and land access was limited, a river ran through it, thus allowing the those lucky members of the general public with boat access to enjoy the scenic grandeur of carefully groomed and manicured golfing surfaces as they floated by. See Champions Retreat Golf Founders, LLC v. Commissioner, 959 F.3d 1033 (11th Cir. 2020). Can you sense my skepticism?
Still, the taxpayer won! And won on a really big issue. But wait, there’s more.
The 11th Circuit remanded the case so the Tax Court could determine the value of the easement. That required the Tax Court to evaluate the IRS back-up position.
Again, the taxpayer won! The main dispute was over the counter-factual determination of the highest and best use of the property if no easement had been granted. Everyone agreed that the highest and best use of the property after the easement was as it was being used: a 27-hole private golf club. The IRS expert thought the highest and best use before the easement was also as a 27-hole private club. So he gave only a nominal value to the easement, of $20,000. The taxpayer, however, was able to convince Judge Pugh that the highest and best use of the property absent the easement was to rip out one of the three courses and put in housing.
Since the IRS appraiser had not evaluated that possibility, the IRS was left with just attacking the taxpayer appraiser’s methodology. And Judge Pugh gave a detailed and careful analysis of the valuation. She ended up reducing the valuation from $10.8 million to about $7.8 million.
Still, it does seem that the taxpayer was a prevailing party! At least until you put in the scare quotes. Let’s do that.
Lesson: Winning Isn’t Everything
The IRS’s primary losing positions were (1) the easement donation did not qualify as a contribution under §170 because it did not have a valid conservation purpose, and (2) even if it did, the value was zero because the contribution did not affect the highest and best use of the property. Following the Tax Court’s preferred approach, Judge Pugh analyzes each loser position for substantial justification.
As to the first IRS position, one might think that was substantially justified because the IRS actually won in Tax Court. But winning is not everything. Judge Pugh cites to Henry v. Commissioner, 34 Fed. Appx. 342, 345 (9th Cir. 2002), where the IRS also won in Tax Court but lost in the Circuit Court. There the Circuit Court decided that just because the IRS won in Tax Court, did not make its position substantially justified because the Tax Court had committed “clear error” in its decision approving that position. Talk about getting no respect!
Judge Pugh therefore analyzes the Circuit Court opinion in this case to see if Circuit Court was dissing the Tax Court. It was not. She concludes ”we see no basis in their analysis for holding that our original conclusion that there was insufficient public access to the property was unreasonable.” Op. at 9. Judge Pugh then goes on to analyze whether, on the facts and law before it, the IRS was substantially justified in its position that the easement was not a qualified contribution. She concludes it was.
As to the second IRS position, on valuation, Judge Pugh also gives a nuanced and detailed review of the remand proceedings. She finds it significant that neither side’s valuation won the day and that the Tax Court reduced the taxpayer’s valuation by some 30%. Therefore, she concludes: “both sides were partly right: Petitioner was right that [the IRS] undervalued the easement, and respondent was right that [the taxpayer] overvalued the easement (by a meaningful amount). But because we agreed with respondent that the easement was overvalued, we conclude that he was substantially justified in rejecting Champions Retreat’s original valuation on its partnership return.” Op. at 11.
Bottom Line: Just because the taxpayer here won, both in its appeal to the 11th Circuit and then again on remand, does not mean it was a prevailing party entitled to attorneys fees and costs under §7430. Rather, the determination of whether a taxpayer is a prevailing party will turn on whether the government position was reasonable under the facts and circumstances before it at the time it asserted the position.
Comment: In my mind, this case actually supports the holistic approach of evaluating the IRS position. As I have argued before, that is more consistent with what I see as the quality control purpose of §7430. See Lesson From The Tax Court: Taxpayer Wins CDP Case But Cannot Recover Costs, TaxProf Blog (Nov. 16, 2020). If the taxpayer here takes another appeal, and if the Circuit Court adopts the Tax Court’s pick-apart approach to evaluating substantial justification, I think the taxpayer has an argument that the IRS “position” that needed to be substantially justified was not the one Judge Pugh framed. The IRS position in the NOD and pleadings was apparently that the easement was worth $20,000. In contrast, note how Judge Pugh says the IRS position was that the taxpayer had “overvalued the easement (by a meaningful amount.)” A holistic approach would, I think, give much more weight to the fact that it was up to the taxpayer to prove its entitlement and so the IRS was indeed substantially justified in its rejection of the taxpayer’s appraiser, for reasons that one can see in Judge Pugh’s opinion. But under the pick-apart approach if one re-frames the IRS position, one might conclude it was not substantially justified.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School of Law. He invites readers to return each Monday (or Tuesday if Monday is a federal holiday) to TaxProf Blog for another Lesson From The Tax Court.
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