USING IRC 7430(g) AS A STRATEGIC LITIGATION TOOL

Transcription

1 USING IRC 7430(g) AS A STRATEGIC LITIGATION TOOL I. Internal Revenue Code ( IRC ) 7430 grants taxpayers the right to recover costs, including fees of experts and attorneys, paid or incurred in connection with certain federal tax controversies. A. Both litigation costs, and costs incurred in administrative proceedings, are recoverable under IRC The recovery of costs - administrative costs or litigation costs - is rarely easy. Frequently the costs incurred in an effort to recover costs outweigh the financial benefit of the recovery unless the possibility of the recovery of litigation costs is evaluated early in the process of resolving a federal tax controversy as part of a strategic plan for settling a federal tax controversy. a. If consideration is given to the recovery of costs as part of the strategic plan for the settlement of a federal tax controversy, the risk that litigation costs will be recoverable can become a significant factor in the negotiation of the settlement of some federal tax controversies. B. IRC 7430 describes the general requirements for a taxpayer s recovery of administrative costs and litigation costs incurred in connection with a federal tax controversy. The general requirements are: 1. The costs must be incurred in an administrative or court proceeding brought by or against the United States; 2. The taxpayer must be the prevailing party; 3. The costs must be reasonable; 4. The costs must be incurred in connection with the determination, collection, or refund of tax, interest, or penalty imposed pursuant to Title 26; and 5. The costs must be allocable to the United States and not to any other party. C. In addition to the general requirements, the failure to meet certain conditions will disqualify a taxpayer from recovering some or all of the otherwise recoverable controversy costs. 1. A taxpayer must exhaust the available administrative remedies. IRC 7430(b)(1); Reg William E. Taggart, Jr. 2011

2 a. A taxpayer s refusal to extend the statute of limitation on assessment does not constitute failure to exhaust available administrative remedies. IRC 7430(b)(1); Reg (b)(4). 2. Recovery of litigation costs is not available with respect to any portion of the proceedings during which the taxpayer unreasonably protracted the proceedings. IRC 7430(b)(3). D. A taxpayer must be the prevailing party, as defined in IRC 7430(c)(4)(A), in order to recover administrative costs or litigation costs. 1. A taxpayer is the "prevailing party" if the taxpayer prevails with respect to: a. the amount in controversy; OR b. the most significant issue or set of issues presented. IRC 7430(c)(4)(A); See Bragg v. Commissioner, 102 T.C. 715 (1994) (analysis of prevailing party in multi-issue case). E. A taxpayer cannot recover costs under IRC 7430, if the taxpayer s net worth exceeds specified limits. IRC 7430(c)(4)(A)(ii). 1. IRC 7430(c)(4)(A)(ii) specifies that net worth limitations set forth in 28 U.S.C. 2412(d)(1) and (d)(2) apply. a. An individual taxpayer may not have a net worth greater than $2 million. (1) Individuals filing a joint return are treated as two taxpayers. IRC 7430(c)(4)(D)(ii). b. An entity generally may not have a net worth of more than $7 million, or 500 or more employees. 2. A prevailing party generally must meet net worth limitations at the date the action is brought. Lippitz v. Commissioner, T.C.M a. The $7 million limitation applies to estates and trusts, but the limit for an estate is determined at the date of death, and for a trust the limit is determined as of the last day of the tax year involved. IRC 7430(c)(4)(D)(i). F. Even if a taxpayer is the prevailing party under IRC 7430(c)(4)(A), the taxpayer cannot recover litigation costs if the IRS can establish it was substantially justified in its position in litigation within the meaning of IRC 7430(c)(4)(B). William E. Taggart, Jr

3 1. IRC 7430(c)(4)(B)(i) provides: A party shall not be treated as the prevailing party in a proceeding to which subsection (a) applies if the United States establishes that the position of the United States in the proceeding was substantially justified. 2. The position of the IRS will be deemed substantially justified if the position had a reasonable basis both in law and in fact. See Pacific Fisheries, Inc. v. United States, 484 F3d 1103 (9th Cir. 2007) (prelitigation conduct of IRS is not a factor in determining whether the position of the IRS in the judicial proceedings was substantially justified); Goertler v. Commissioner, T.C.M (if a factual determination is required, the IRS is substantially justified until the taxpayer provides adequate substantiation and the IRS has had a reasonable period of time to verify); Kean v. Commissioner, T.C.M (IRS is substantially justified in taking inconsistent positions in an alimony/child support dispute); Trollope v. Commissioner, T.C.M (IRS was substantially justified even though it ultimately conceded); Wiener v. Commissioner, T.C.M (recovery denied in a IRC 6015(f) case because IRS was substantially justified even though relief was granted). a. If the IRS was substantially justified with respect to certain issues, the recovery of litigation costs under IRC 7430 will very likely be limited to those litigation costs attributable to those litigation costs for which substantial justification did not exist for the position of the Internal Revenue Service. b. If the United States unsuccessfully disputes a taxpayer s entitlement to litigation costs, the taxpayer is entitled to an award of reasonable litigation costs for the litigation costs incurred in pursuing the recovery of litigation costs (the fees for fees award). th Powell v. Commissioner, 891 F. 2d 1167 (5 Cir. 1990). II. IRC 7430(g) added qualified offers to the Internal Revenue Code in The addition of IRC 7430(g) provides an opportunity for a taxpayer representative to eliminate the IRS substantial justification defense to the recovery of litigation costs. A. The addition of IRC 7430(g) created an opportunity for a representative of a taxpayer of limited means to establish a credible risk for the Internal Revenue Service that it will be required to pay litigation costs. The addition of IRC 7430(g) created a strategic litigation tool for representatives of taxpayers of limited means. This tool provides an opportunity for some leverage in the negotiation of the settlement of federal tax controversies. B. Federal tax disputes invariably settle. The odds that a federal tax dispute that moves to the level of the Appeals Office of the Internal Revenue Service will not William E. Taggart, Jr

4 settle before being litigated to a judgment is very likely in the range of 1in 10,000. Even in instances in which there is no chance of negotiating a settlement, it is unlikely any single taxpayer s case will be the case that is actually litigated. 1. The principal objective of a representative of a taxpayer should be to establish a foundation for reaching a fair settlement on as cost-effective a basis as possible. 2. Because almost all federal tax controversies settle, it is unlikely litigation costs will be recovered in any particular case. Nevertheless, the use of a qualified offer can make the risk of recovery of litigation costs a significant consideration for the Internal Revenue Service in the negotiation of the settlement of a case. a. If the individual in the Internal Revenue Service who is trying to negotiate a settlement of a tax controversy is convinced by a taxpayer representative that the Internal Revenue Service is at risk to pay litigation costs, and the litigation costs will be significant in relation to the tax liability, which is usually the case for taxpayers who qualify for the recovery of litigation costs, the taxpayer representative has created a useful tool in the negotiation of a settlement of the controversy. C. A qualified offer that meets the requirements of IRC 7430(g)(1) should be made in every federal tax controversy described in IRC (A sample form for a qualified offer is attached to this outline.) 1. IRC 7430(c)(4)(E)(i) provides in relevant part: A party to a court proceeding... shall be treated as the prevailing party if the liability of the taxpayer pursuant to the judgment in the proceeding... is equal to or less than the liability of the taxpayer which would have been so determined if the United States had accepted a qualified offer of the party.... a. A taxpayer s judicious utilization of IRC 7430(c)(4)(E)(i) makes the taxpayer the prevailing party for purposes of IRC 7430 as long as the judgment in the proceeding is as favorable to the taxpayer as the taxpayer s qualified offer. b. In those cases in which the taxpayer secures a decision that is more favorable than a qualified offer of the taxpayer that was not accepted, the failure of the IRS to accept the taxpayer s qualified offer negates the IRS s principal defense to the recovery of litigation costs. William E. Taggart, Jr

5 2. The recovery of litigation costs based on a qualified offer will be limited to those litigation costs that are incurred on or after the date of the qualified offer. a. In order to maximize the impact of a qualified offer, the qualified offer should be made at the earliest possible time at the beginning of the qualified offer period. D. The terms qualified offer and qualified offer period are specifically defined in IRC The impact of these specific definitions must be fully understood in order for a taxpayer representative to use qualified offers as an effective litigation tool. 1. IRC 7430 (g)(1) defines a qualified offer for the purposes of IRC 7430 as:... a written offer which - is made by the taxpayer to the United States during the qualified offer period; specifies the offered amount of the taxpayer s liability (determined without regarding to interest); is designated at the time it is made as a qualified offer for the purposes of this section; and remains open during the period beginning on the date it is made and ending on the earliest of the date the offer is rejected, the date th the trial begins, or the 90 day after the date the offer is made. 2. The term qualified offer period, as defined in IRC 7430(g)(2), begins on the date on which the first letter of proposed deficiency that allows a taxpayer the opportunity for review of the dispute at Appeals is sent. The qualified offer period ends on the date which is thirty days before the date the case is first set for trial. 3. Implicit in the definition of a qualified offer in IRC 7430(g)(1) is the conclusion there can be only one qualified offer with respect to any particular tax controversy. a. The last qualified offer will be the qualified offer for the purpose of determining whether the judgment in a particular case is as favorable to the taxpayer as the taxpayer s qualified offer. William E. Taggart, Jr

6 b. A taxpayer representative can make a settlement offer on behalf of a taxpayer for a greater or lesser amount than the qualified offer, and specify that the settlement offer is not a qualified offer within the meaning of Code Sec. 7430(g)(1)(C). (1) The qualified offer will remain effective as the standard for determining whether the taxpayer is entitled to recover litigation costs even though other settlement offers are made after the qualified offer as long as all other offers of settlement are explicitly not qualified settlement offers. 4. There is another reason for making an early, and reasonable, settlement offer. IRC 7430(g)(1)(D) allows a taxpayer to make a qualified settlement offer that must be accepted within a 90-day period. a. An early and properly-worded qualified offer will expire on the th 90 day after the offer is made. b. If a reasonable settlement offer is made to Appeals as qualified offer, it may convince the Appeals to settle the case for an amount that the taxpayer considers a reasonable settlement. (1) If such a qualified offer does not produce a settlement, the qualified offer will expire without being accepted. (2) The best possible position for the taxpayer representative to be in as a case proceeds out of Appeals and on to Tax Court is to have a reasonable settlement that is a qualified offer, but which is not open for acceptance, but is the standard for the taxpayer s recovery of litigation costs. 5. An award of litigation costs pursuant to a qualified offer will be limited to those costs that are incurred on or after the date of the qualified offer. This is another reason a qualified offer should be made at the earliest possible date. a. A taxpayer is entitled to recovery of litigation costs for periods prior to the date the qualified offer of settlement was made, but the taxpayer will have to establish he or she was the prevailing party in the litigation, and he or she will have to overcome the IRS s substantial justification defense. b. A judgment that equals or exceeds the qualified offer makes the taxpayer the prevailing party, and eliminates the IRS substantial justification defense. William E. Taggart, Jr

7 E. Any recovery of litigation costs will be limited to reasonable litigation costs. 1. Reasonable litigation costs are described in IRC 7430(c)(1) as follows: (A) reasonable court costs; and (B) based upon the prevailing market rates for the kind or quality of services furnished (i) the reasonable expenses of expert witnesses... except that no expert witness shall be compensated at a rate in excess of the highest rate of compensation for expert witnesses paid by the United States, (ii) the reasonable cost of any study, analysis, engineering report, test, or project which is found by the court to be necessary for the preparation of the party s case, and (iii) reasonable fees paid or incurred for the services of attorneys. 2. Attorney s fees are limited to a statutory rate. The hourly rate is adjusted for inflation on an annual basis. The rate for 2009, 2010, and 2011 is $180 per hour. a. The court has the authority under IRC 7430(c)(1)(B)(iii) to determine that a special factor, such as the limited availability of qualified attorneys for such proceeding, the difficulty of the issues presented in the case, or the local availability of tax expertise, justifies a higher rate. (1) The apparent generosity of Code Sec. 7430(c)(1)(B)(iii) is misleading. It is virtually impossible to recover fees at a rate in excess of the statutory rate. F. IRC 7430 applies in all federal courts with jurisdiction over tax controversies that are described in IRC federal district court, including bankruptcy proceedings, and the Court of Federal Claims. 1. The rules of the particular court will determine the procedure for the recovery of litigation costs in any such case, including local court rules. 2. Consideration of local rules, including the rules of an individual federal judge, must not be overlooked. William E. Taggart, Jr

8 3. Federal courts, particularly the Tax Court, generally are not predisposed to an award of the recovery of litigation costs to a taxpayer. 4. An error with respect to the applicable rules can prove fatal to the recovery of litigation costs. G. In cases in Tax Court in which there is no agreement regarding recovery of litigation costs, a motion for litigation costs must be filed within 30 days of the decision in the case. 1. A motion for the recovery of litigation costs in the Tax Court must establish: a. The petitioner is the prevailing party and the basis for such a contention; b. The petitioner meets the net worth requirements; c. The petitioner has exhausted the available administrative remedies; d. The petitioner did not unreasonably protract the proceedings; e. The specific litigation costs that the petitioner seeks to recover (supported by an affidavit); and f. Whether petitioner requests a hearing on the motion. H. Right of Appeal - IRC 7430(f). 1. An Order or Decision regarding litigation costs in a court proceeding will be subject to appeal in the same manner as the decision or judgment in the related court proceeding. 2. The denial of costs from administrative proceeding may be appealed to the Tax Court. 3. A decision of the Tax Court regarding litigation costs is reviewable in the same manner as any other decision of the Tax Court. 4. The Rules of the Tax Court require that a decision regarding litigation costs be part of the substantive decision in the case. William E. Taggart, Jr

9 LAW OFFICES OF TAGGART & HAWKINS A PROFESSIONAL CORPORATION 1901 HARRISON STREET, SUITE 1600 OAKLAND, CA SENDER'S Date TELEPHONE: (510) FACSIMILE: (510) PRIVILEGED COMMUNICATION - SETTLEMENT DECISION John Counsel, Attorney Internal Revenue Service Certified Mail Re: Aggrieved Taxpayer v. Commissioner of Internal Revenue; Docket No ; Tax Year: 2006; Qualified Offer Pursuant to IRC 7430(c)(4) and (g) Dear Mr. Counsel: The purpose of this letter is to propose a settlement of the above referenced case. We are fully authorized by our client, Aggrieved Taxpayer, to make this proposal on her behalf. Our client is prepared to settle the pending case on the following terms: 1. Any adjustment the Service proposes to make with respect to the 2006 joint tax return filed by taxpayer and her ex- husband shall not be made with respect to Aggrieved Taxpayer. 2. Solely for the purposes settlement of this dispute as to our client, Aggrieved Taxpayer, a deficiency in the amount of $ shall be assessed with respect to the joint tax return for the 2006 tax year. The amount offered in settlement is exclusive of interest on the settlement amount. 3. The taxpayer shall be granted relief from any additional joint liability except for the specified settlement amount pursuant to Internal Revenue Code ( IRC ) 6015(c). 4. No other adjustments shall be made in connection with the 2006 income tax year as it relates to Aggrieved Taxpayer. Both your Examination and Appeals Divisions have been provided with sufficient evidence to conclude that Aggrieved Taxpayer had no actual knowledge of the additional tax liability (or any portion thereof) on the return from any failure of the ex-husband of Aggrieved Taxpayer to report additional Schedule C gross income. Each Division has also been provided with sufficient documentation to reflect that Aggrieved Taxpayer is divorced from her ex-husband, is current on her own income tax return filings, did not receive any disqualified assets from her ex-husband (as that term is defined under IRC 6015(c)(4)(B)), and did not participate in any fraudulent tax William E. Taggart, Jr

10 schemes with her ex-husband. There are no impediments to a conclusion that Aggrieved Taxpayer is entitled to complete relief from the entire additional tax liability asserted against Aggrieved Taxpayer and her ex-husband for the 2006 tax year. On behalf of, Aggrieved Taxpayer, we hereby offer to settle the pending Tax Court case relating to the taxpayer's 2006 tax year on the terms outlined hereinabove. This settlement proposal is a qualified offer within the meaning of IRC 7430(c)(4) and (g). This settlement proposal shall remain open for the period specified in IRC 7430(g)(1)(D). Since this letter constitutes a settlement proposal, neither the contents of this letter, nor any communications in furtherance hereof, may be used as evidence in any proceeding relating to the merits of the case. Very truly yours, TAGGART & HAWKINS William E. Taggart, Jr. WET/tw cc: Aggrieved Taxpayer William E. Taggart, Jr