Although some are unaware of the fact, taxpayers can recover fees and costs from the government if the IRS has taken an unreasonable position against them. The IRS may be responsible for fees due to unreasonable positions that it took during audit, on appeal, in connection with a refund claim or collection matter, or as related to a summons.
Internal Revenue Code (IRC) section 7430 permits courts to award “reasonable litigation costs” and “reasonable administrative costs” to the “prevailing party” in any “administrative or court proceeding … brought by or against the United States in connection with the determination, collection, or refund of any tax, interest, or penalty” under the IRC. These costs can include administrative fees, costs of analyses and studies “necessary for the preparation of the party’s case,” and attorney’s fees [IRC section 7430(a), (c); Treasury Regulations section 301.7430-4(a) & (b)]. Attorney’s fees may be awarded for the fees of any practitioner authorized to practice before the IRS, even if not an attorney [IRC section 7430(c)(3)(A)]. As CPAs are authorized to practice before the IRS (31 CFR. section 10.3), the fees of a CPA for handling an audit, appeal, refund claim, or collection matter, or for assisting with a Tax Court case or other litigation, may be awarded [Ragan v. Comm’r, 135 F.3d 329, 337 (5th Cir. 1998); Han v. Comm’r, T.C. Memo 1993-386].
Fee awards are currently limited to a maximum of $200 per hour, unless the court finds that a higher rate is necessary because of higher cost of living, or because of a “special factor,” such as limited availability of qualified practitioners [IRC section 7430(c)(1); Treasury Regulations section 301.7430-4(b)(2); Revenue Proceeding 2018-57]. Several courts have found a special factor permitting an upward adjustment in complex cases that required the services of a practitioner who specializes in tax cases [e.g., BASR Partnership v. U.S., 130 Fed. Cl. 286, 306 (2017)], but other courts have been skeptical of these claims on the ground that virtually all cases to which section 7430 applies will be handled by practitioners with “tax expertise” [e.g., Fitzpatrick v. Comm’r, T.C. Memo 2017-88; see also Treasury Regulations section 301.7430-4(b)(2)(iii) (example)]. Even if the fee award is capped at $200 per hour, being able to recoup some amount of fees helps remediate the damage when the IRS acts unreasonably.
In order to qualify for an award of reasonable litigation costs under IRC section 7430, a taxpayer must show that—
- the taxpayer meets the net worth requirements;
- the taxpayer substantially prevailed;
- the position of the United States was not substantially justified;
- the taxpayer exhausted administrative remedies; and
- the taxpayer did not unnecessarily protract the proceeding. [IRC section 7430(a)-(c)]
These elements are discussed below, but CPAs should keep in mind that even if each is satisfied, an award of fees is within the court’s discretion [Zinniel v. Comm’r, 883 F.2d 1350, 1355 (7th Cir. 1989)].
Net worth requirement.
To be eligible for an award of attorney’s fees, the taxpayer must be 1) an individual whose net worth at the time of the proceeding does not exceed $2 million; 2) a nonprofit organization or an agricultural cooperative, regardless of net worth; or 3) a partnership, corporation, association, local governmental unit, or the owner of an unincorporated business that, at the time of the proceeding, has a net worth of $7 million or less and no more than 500 employees [28 USC section 2412(d)(2)(B); Treasury Regulations section 301.7430-5(f)(1)].
The taxpayer must submit an affidavit to establish the net worth requirement. This is usually enough, particularly if the government does not challenge the issue nor submit evidence in opposition [Fletcher v. U.S., 2019 WL 763587 (N.D. Okla. Feb. 21, 2019); Estate of Lippitz v. Comm’r, T.C. Memo 2007-93].
The Treasury Department’s position is that net worth should be determined using the fair market value of the taxpayer’s assets because such a standard provides a “more accurate assessment of a taxpayer’s actual and current net worth as of the administrative proceeding date” [Proposed Treasury Regulations section 301.7430-5(g)(1), 74 Fed. Reg. 61589-01 (Nov. 25, 2009), Background and Explanation of Provisions].
The taxpayer is a “prevailing party” if he has substantially prevailed as to either the amount in controversy or “the most significant issue or set of issues presented,” or made a qualified offer [IRC section 7430(c)(4)(A),(E)]. The determination of whether the taxpayer is the prevailing party can be made by agreement with the IRS, or if no agreement can be reached, by the court [IRC section 7430(c)(4)(C); Treasury Regulations section 301.7430-5(g)].
In determining whether the taxpayer substantially prevailed as to the amount in controversy, one looks to the amount of the award in comparison with the amount in controversy. If the taxpayer did not completely prevail against the IRS, this can be difficult to gauge. There are obvious cases, such as in Bontrager v. Comm’r (2019 WL 1936710, *2), in which the Tax Court found that the taxpayer substantially prevailed with a 70% reduction in the liability, and Goettee v. Comm’r [124 T.C. 286, 295 (2005)], in which the Tax Court found that taxpayers had not substantially prevailed when they were awarded “not quite 5% of what they claimed.” It is more difficult to predict the outcome of a case that falls somewhere in the middle.
In one case, the court explained that “substantial” means “being largely but not wholly that which is specified,” and that as a result, “a recovery of slightly more than one-half (½) of the requested amount does not constitute ‘substantially’ prevailing as to the amount in controversy” [Estate of Holmes v. U.S., 1990 WL 10062, *4 (E.D. Pa. 1990)]. Accordingly, the court rejected a request for fees from a taxpayer who recovered 54% of the deficiency. Other cases, however, have found that recoveries in this range were enough [e.g., Keeter v. U.S., 82 A.F.T.R.2d 98–5943 (E.D. Cal. 1998); Cox v. Comm’r, T.C. Memo 1996-103].
Alternatively, a taxpayer is a “prevailing party” if she has prevailed on the most significant issue or set of issues presented, even if the amount of the deficiency is not substantially reduced. For example, in Heasley v. Comm’r [967 F.2d 116, 122 (5th Cir. 1992)], even though the taxpayers conceded liability on the deficiency and challenged only penalties, they substantially prevailed on the most significant issue when they secured a reversal of penalties on appeal.
The determination of whether the taxpayer is the prevailing party can be made by agreement with the IRS, or if no agreement can be reached, by the court.
Finally, if the taxpayer makes a “qualified offer,” the IRS rejects the qualified offer, and the IRS later obtains a court judgment that is less than the dollar amount of the qualified offer, the taxpayer will be treated as the prevailing party [IRC section 7430(c)(4)(E); Treasury Regulations section 301.7430-7; Tolin v. Commissioner, TC Memo 2018-29, *5]. An award of costs under the qualified offer rule includes only “those costs incurred on or after the date of the last qualified offer” [Treasury Regulations section 301.7430-7(a)].
A qualified offer must strictly comply with the statute and Treasury Regulations; it must be made during the period between the date on which the taxpayer is first notified of the opportunity for appeals review, and 30 days before the case is set for trial; and the taxpayer must submit the offer, in writing, designated as an offer under IRC section 7430, to the IRS, specifying the amount of the tax liability [IRC section 7430(g); Treasury Regulations section 301.7430-7(c)].
An offer that falls short of these requirements will not provide a basis for an award under IRC section 7430. For example, in Simpson v. Comm’r [668 Fed. Appx. 241 (9th Cir. 2016)], the court held that a taxpayer’s settlement offer was not a “qualified offer” because it stated that the taxpayers could withdraw it at any time. And in McGowan v. Comm’r (TC Memo 2005-80) and Coccotelli v. U.S. [2009 U.S. Dist. Lexis 83060 (E.D. Pa. July 22, 2009)], the courts held that the offer failed as a “qualified offer” merely because it did not contain designation that it was a qualified offer under IRC section 6430. The IRS’s “Procedures for Evaluating and Responding to Qualified Offers Submitted under Section 7430(g)” [IRS CCN CC-2010-007 (Apr. 2, 2010)], is a useful guide for making sure that a qualified offer is in proper form.
Once the taxpayer clears the hurdles described above, the burden of proof shifts to the IRS to establish that it was substantially justified in maintaining its position [IRC section 7430(c)(4)(B)(i)].
If the taxpayer seeks costs from administrative proceedings and litigation, courts apply the “substantially justified” standard to the IRS’s position on two separate dates. For purposes of the administrative proceeding, the IRS’s position is that taken at the earlier of 1) the date the taxpayer receives the decision of the IRS Appeals Office, or 2) the date of the notice of deficiency [IRC section 7430(c)(7)(B)]. For purposes of litigation, the IRS’s position generally is taken as of the IRS’s “Answer to the Petition or Complaint” [IRC section 7430(c)(7)(B)(i) & (ii); Treasury Regulations section 301.7430-3(a); Bontrager].
Thus, the IRS’s position at the administrative level is the “position of the United States” if that position was upheld by the Appeals Office and included in a notice of deficiency, even if it is later abandoned by IRS Counsel [Treasury Regulations section 301.7430-5(b)]. The IRS’s position in a 30-day letter (i.e., a notice of proposed adjustments/revenue agent’s report) will not be considered a “position of the United States” if it is withdrawn during the Appeals process [Purciello v. U.S., TC Memo 2014-50]. As a result, if the IRS concedes at Appeals, the taxpayer will not be eligible for a fee award under IRC section 7430 for costs incurred prior to the IRS’s concession. The IRS’s position is substantially justified if it has a reasonable basis both in law and fact [Bontrager; Purciello; Treasury Regulations section 301.7430-5(c)(1)]. There is a rebuttable presumption that the IRS was not substantially justified if it did not follow its own published guidance, or private letter rulings, or technical advice [IRC sections 7430(c)(4)(B)(ii), (iv)]. The IRS’s concession of an issue does not, by itself, establish that its position was unreasonable, but it is a factor to be considered by the court (Bontrager; Han). This can be seen in U.S. v. Sam Ellis Stores (768 F. Supp. 286), in which the taxpayer was awarded fees where the IRS conducted an “abbreviated audit” because the statute of limitations was about to run and then conceded the case before trial.
The government’s position also is not substantially justified if the IRS did not reasonably interpret the law. Examples include where the court found that the government’s interpretation of the IRC was unreasonable [Hanson v. Comm’r, 975 F.2d 1150, 1155 (5th Cir. 1992); Perry v. Comm’r, 931 F.2d 1044, 1046 (5th Cir. 1990)], where the IRS ignored case law supporting the taxpayer’s position [Estate of Baird v Comm’r, 416 F.3d 442 (5th Cir. 2005); Filicetti v. U.S., 2013 WL 958641, *2 (D. Idaho 2013)], and where the IRS erroneously interpreted state law [U.S. v. Baker, 2015 WL 114176, *2 (D. N.H. Jan. 8, 2015)].
The IRS is also required to examine information provided by taxpayers before taking a position, and its failure or refusal to do so can lead to the determination that its position was not substantially justified [Estate of Baird; Nicholson v. Comm’r, 60 F.3d 1020, 1029 (3d Cir. 1995); Chapman v. Comm’r, T.C. Summ. Op. 2009-155]. Courts have also determined that the United States was unjustified in its position when it repeatedly changed its position in litigation [Beaty v. U.S., 937 F.2d 288, 293 (6th Cir. 1991)].
Before attorney’s fees will be awarded, a taxpayer must exhaust all available administrative remedies.
The IRS also will be viewed as acting unreasonably when it does not properly interpret the information in its possession. For example, in Filicetti, the court criticized the government for basing its decision on an erroneous and unreasonable interpretation of the taxpayer’s divorce decree. In addition, the IRS has been found to be unjustified when it relied on biased and incredible witnesses and ignored the testimony of witnesses in support of the taxpayer’s position [Snider v. U.S., 468 F.3d 500 (8th Cir. 2006); In re Chambers, 140 B.R. 233, 241 (N.D. Ill. 1992)].
The fact that the IRS’s position may have been reasonable at the outset of a case does not insulate it from a determination that it was substantially unjustified if there were developments in the law or new evidence that made the original position untenable [Grisanti v. U.S., 2006 WL 29086421 (N.D. Miss. Oct. 10, 2006)]. In such a situation, the fee award will include fees incurred after the date on which the IRS should have conceded.
Note that the IRS generally will not be required to pay fees where the underlying issue is one of first impression (Bontrager). Furthermore, the IRS may take inconsistent positions to prevent itself from being “whipsawed” without incurring attorney’s fees [Walker v. U.S., 64 Fed. Cl. 733, 739-40 (2005)].
Exhaustion of administrative remedies.
Before attorney’s fees will be awarded, a taxpayer must exhaust all available administrative remedies [IRC section 7430(b)(1); Treasury Regulations section 301.7430-1(a)]. For example, a taxpayer must request, and participate in, an Appeals Office conference before filing a Tax Court petition or a refund claim [Treasury Regulations sections 301.7430-1(b)(1) and 301.7430-1(f)(3),(4); Whalen v. U.S., 107 Fed. Cl. 775, 777 (2012); Covert v. Comm’r, T.C. Memo 2008-90]. These procedures are not required if the IRS informed the taxpayer that they are not necessary, or if the taxpayer did not receive a 30-day letter and therefore is unable to file a protest or request an Appeals conference, or the taxpayer was not offered an Appeals conference after the case was docketed in the Tax Court [Treasury Regulations section 301.7430-1(f)(2)(i)].
In cases involving summonses, levies, liens and jeopardy assessments, the taxpayer must file a written request for relief with the District Director and wait a “reasonable time” before filing suit [Treasury Regulations sections 301.7430-1(d)(1), 301.7433-1(d)]. Reasonable time is defined as five days before filing a petition to quash a summons or an action demanding the return of wrongfully levied-upon property [Treasury Regulations section 301.7430-1(d)(2)(i), (ii)]. In other situations, the taxpayer must comply with any IRC provision that “expressly provides for the pursuit of administrative remedies” [Treasury Regulations sections 301.7430-1(d)(2)(iii), (iv)], such as IRC section 7429(b)(1)(B), which sets a 16-day period for administrative review of jeopardy assessments).
Protraction of proceedings.
Taxpayers are not entitled to an award of costs or fees if they unreasonably protracted the proceedings [IRC section 7430(b)(3); Hogan v. Comm’r, T.C. Memo 2011-176]. The Tax Court has found that a taxpayer unreasonably protracted proceedings where the taxpayer refused to communicate with the IRS or failed to supply necessary records [In re Southeast Stores, Inc., 156 B.R. 160, 167 (Bkrtcy. E.D. Va. 1993); Polyco, Inc. v. Comm’r, 91 T.C. 963,967 (1988)].
Procedures for Obtaining Awards
A taxpayer may apply to the IRS for administrative costs within 90 days after the date on which the final decision of the IRS is mailed to the taxpayer [IRC section 7430(b)(4)]. The taxpayer can also request fees from the Tax Court or other federal court. A taxpayer can bring a stand-alone action to recover fees in the Tax Court (Tax Court Rule 271), or it can be done in conjunction with a deficiency proceeding in Tax Court, a refund suit in a federal district court or the Court of Federal Claims, or in other judicial actions, such as a summons enforcement action.
Most commonly, requests for fees are heard by the Tax Court after the merits of the tax issues have been decided. The request for fees is not included in the petition; it is handled later, either by stipulation of the parties or by a motion of the taxpayer after the substantive issues have been resolved [TC Rules 34(b)(8), 231(a)(1), 232]. An order awarding or denying costs or fees is incorporated as part of the final judgment in the case and is appealable in the same manner as that judgment [IRC section 7430(f)(1); TC Rule 232(f)]. A taxpayer is also entitled to an award of fees for the time spent litigating the fee award itself, even if the government’s position on the fee issue was not unreasonable [St. Claire v. Comm’r, TC Memo 2016-192; Powell v. Comm’r, 891 F.2d 1167, 1169-72 (5th Cir. 1990)].