                       T.C. Memo. 2001-74



                     UNITED STATES TAX COURT



     JOHN S. GIBSON, f.k.a. JOHN S. MACTAVISH, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 7628-98.                     Filed March 23, 2001.


     Peter L. Milinkovich, for petitioner.

     John C. Schmittdiel, for respondent.



                       MEMORANDUM OPINION



     PANUTHOS, Chief Special Trial Judge:    This case is before

the Court on petitioner’s Motion for Litigation and

Administrative Costs filed pursuant to section 7430 and Rule 231.

All references to section 7430 are to that section as in effect

at the time the petition was filed.   Unless otherwise indicated,

all other section references are to the Internal Revenue Code in
                                - 2 -

effect for the years in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.

     We must decide whether petitioner is entitled to

administrative and litigation costs.    After concessions,1 the

issue for decision is whether respondent’s position in the

underlying proceeding was substantially justified.    We hold that

respondent’s position was substantially justified, and,

therefore, petitioner is not entitled to an award of

administrative and litigation costs.

     Petitioner seeks fees and costs totaling $5,655.40.    The

parties submitted memoranda and affidavits supporting their

positions.    We decide the motion on the basis of those memoranda,

affidavits, and the record in this case.     Neither party requested

a hearing, and we conclude that a hearing is not necessary to

decide this motion.    See Rule 232(a)(2).

     Petitioner resided in Ramsey, Minnesota, at the time he

filed his petition.

Background

     Respondent began an examination of petitioner’s Federal

income tax returns for tax years 1991 through 1993 sometime in

1995.    Petitioner did not file a Federal income tax return for



     1
          Respondent concedes that petitioner (1) substantially
prevailed with respect to the amount in controversy, (2) met the
net worth requirement as provided by sec. 7430, and (3) exhausted
his administrative remedies.
                                      - 3 -

tax year 1994, and this tax year was also included as part of the

examination.

       During the examination, respondent obtained petitioner’s

accounts receivable book (redbook).           Respondent computed gross

receipts and proposed adjustments to income relying on the

redbook.      Petitioner sent respondent a letter on at least one

occasion to dispute the method by which respondent interpreted

the redbook in proposing adjustments to gross receipts.2             Each

time petitioner or his representative identified errors,

respondent considered the information and modified the

adjustments to income.

       Respondent issued a notice of deficiency to petitioner on

January 30, 1998.       Respondent determined deficiencies in

petitioner’s Federal income taxes, penalties, and additions to

tax as follows:

                               Additions to Tax             Penalties
Year       Deficiency    Sec. 6651(a)(1)   Sec. 6654      Sec. 6662(a)

1991         $3,272            $790                ---        $654
1992          3,455             ---                ---         691
1993         58,640           2,932                ---      11,728
1994        150,431          37,608             $7,750         ---




       2
          Petitioner did not attach to his motion for costs a
copy of the correspondence, but the notice of deficiency makes
reference to unspecified allegations of error by petitioner.
                                - 4 -

Respondent computed gross receipts for 1992 through 1994 by

relying on petitioner’s redbook.   Respondent reconstructed income

for the 1991 tax year using the bank deposits method.

     Petitioner timely filed a petition with this Court.

Petitioner disagreed with respondent’s method of calculating

gross receipts.    Petitioner alleged in the petition as follows:

     The Petitioner disagrees with each and every adjustment
     set forth in Respondent’s notice of deficiency. The
     respondent has recomputed Petitioner’s income based on
     a method that is so flawed and full of errors that it
     lacks all basis in reality. Furthermore, since the
     income computation is incorrect, the penalties which
     are applied against the income are not appropriate and
     are therefore disputed.

Petitioner did not specifically identify the alleged errors made

by respondent in the notice of deficiency.

     In his answer, respondent generally denied the allegations

of error.   At some point in 1999, respondent, with petitioner’s

assistance, calculated income for 1992 and 1993 via the bank

deposits method.   Petitioner provided information to respondent’s

Appeals officer to establish that certain deposits for 1991,

1992, and 1993 were not taxable.   The parties agreed to the

amount of unreported gross receipts for tax years 1991 through

1993 shortly thereafter.

     Between May 1999 and May 2000, the parties reconstructed

petitioner’s income and expenses for tax year 1994.   The parties

also reached agreement regarding the adjustment to business gross

receipts for 1994.   The gross receipts per the notice of
                                      - 5 -

deficiency and the gross receipts per the agreement are set forth

below:

       Year             Notice of Deficiency          Agreed Amount

       1991                 $11,363                         $5,000
       1992                  15,031                          6,107
       1993                 200,457                         13,992
       1994                 574,759                        571,259

           Total            801,610                       596,358

       A stipulation of settlement based on the agreement of the

parties was filed on September 11, 2000.        The deficiencies,

additions, and penalty agreed to are as follows:

                                 Additions to Tax          Penalty
Year       Deficiency      Sec. 6651(a)(1)   Sec. 6654   Sec. 6662(a)

1991        $1,489             $331             ---         None
1992           955              ---             ---         $191
1993          None             None             ---         None
1994         7,753            1,938            None          ---


       Petitioner argues that respondent was not substantially

justified because respondent used a flawed method of determining

income by treating the redbook as a cash receipts journal instead

of including as income the amounts petitioner actually received.3

Petitioner contends that respondent’s determination resulted in

an overstatement of income.        Petitioner further argues that

respondent should have used a bank deposits or net worth method



       3
          We note that while neither party presented evidence as
to whether petitioner reported income and expenses by the cash or
accrual method, we assume that the method of accounting and
reporting is not in issue in this case.
                               - 6 -

to verify income.   Finally, petitioner asserts that the “need to

independently verify the calculation [gross receipts] arose from

the IRS’ distrust of the taxpayer, not the inadequacy of the

records.”

     Respondent contends that he was substantially justified

because he relied on petitioner’s books and records in

determining income pursuant to section 446(a), and, when it

became apparent that petitioner’s books and records were

inaccurate, respondent, in concert with petitioner’s counsel,

employed the bank deposits method.     Further, respondent claims

that he was substantially justified as to tax year 1994 because

petitioner did not file a tax return, and, therefore, respondent

was required to compute income.   It was by use of the bank

deposits method that the parties were able to resolve the amounts

in dispute.

Discussion

     A.   Section 7430

     Section 7430(a) provides that the prevailing party in any

administrative or court proceeding may be awarded a judgment for

(1) reasonable administrative costs incurred in connection with

such administrative proceedings within the Internal Revenue

Service (IRS), and (2) reasonable litigation costs incurred in

connection with such court proceedings.     See sec. 7430(a), (c).

The prevailing party must exhaust his administrative remedies,
                               - 7 -

and the prevailing party must not protract either the

administrative or court proceedings.   See sec. 7430(b)(1), (3).

The parties agree that petitioner exhausted his administrative

remedies.4

     A prevailing party is defined as a taxpayer who

substantially prevails as to the amount in controversy or with

respect to the most significant issue or set of issues.   See sec.

7430(c)(4)(A)(i); sec. 301.7430-5(a)(2), Proced. & Admin. Regs.

Respondent concedes that petitioner substantially prevailed as to

the amount in controversy or with respect to the most significant

set of issues.   Petitioner will nevertheless fail to qualify as

the prevailing party if respondent can establish that

respondent’s position in the administrative and court proceedings

was substantially justified.   See sec. 7430(c)(4)(B).

     B.   Substantial Justification

     The Commissioner will be substantially justified where his

position has a reasonable basis in both law and fact.    See Pierce

v. Underwood, 487 U.S. 552 (1988); Rickel v. Commissioner, 900

F.2d 655, 665 (3d Cir. 1990), affg. in part and revg. in part on

other grounds 92 T.C. 510 (1989); Hanover Bldg. Materials, Inc.

v. Guiffrida, 748 F.2d 1011, 1015 (5th Cir. 1984).




     4
          As a result of our conclusion herein, we need not
decide whether petitioner protracted the proceeding.
                                - 8 -

     A position is substantially justified if the position is

“justified to a degree that could satisfy a reasonable person.”

Pierce v. Underwood, supra at 565 (construing similar language in

the Equal Access to Justice Act).    The Commissioner’s position

may be incorrect but nevertheless be substantially justified “‘if

a reasonable person could think it correct.’” Maggie Management

Co. v. Commissioner, 108 T.C. 430, 443 (1997) (quoting Pierce v.

Underwood, supra at 566 n.2).

     The fact that the Commissioner eventually loses or concedes

a case does not establish that his position was unreasonable.

See Wilfong v. United States, 991 F.2d 359, 364 (7th Cir. 1993);

Hanson v. Commissioner, 975 F.2d 1150, 1153 (5th Cir. 1992);

Estate of Perry v. Commissioner, 931 F.2d 1044, 1046 (5th Cir.

1991); Sokol v. Commissioner, 92 T.C. 760, 767 (1989).     However,

it does remain a factor to be considered.    See Estate of Perry v.

Commissioner, supra; Powers v. Commissioner, 100 T.C. 457, 471

(1993), affd. in part, revd. in part and remanded on another

issue 43 F.3d 172 (5th Cir. 1995).

     As relevant herein, we review the Commissioner’s position as

of the date of the notice of deficiency to determine whether he

was substantially justified with respect to the recovery of

administrative costs.   See sec. 7430(c)(7)(B).   We examine the

Commissioner’s position in his answer to the petition to

determine whether he was substantially justified with respect to
                                - 9 -

the recovery of litigation costs.   See Bertolino v. Commissioner,

930 F.2d 759, 761 (9th Cir. 1991); Sher v. Commissioner, 861 F.2d

131, 134-135 (5th Cir. 1988), affg. 89 T.C. 79 (1987).

Ordinarily, we consider the reasonableness of each of these

positions separately.   See Huffman v. Commissioner, 978 F.2d

1139, 1144-1147 (9th Cir. 1992), affg. in part, revg. in part and

remanding on other issues T.C. Memo. 1991-144.   In the present

case, however, we jointly consider the positions because there is

no indication that respondent’s position changed between the

issuance of the notice of deficiency (on January 30, 1998) and

the filing of the answer to the petition (on May 22, 1998).     See

Swanson v. Commissioner, 106 T.C. 76, 87 (1996).

     C.   Reasonable Basis in Law and Fact

     Taxpayers are required to maintain books and records in

accordance with rules and regulations prescribed by the

Secretary.   See sec. 6001.   Generally, taxpayers must “keep such

permanent books of account or records” sufficient to establish

gross income, deductions, or other matters required to be shown

on the return.   Sec. 1.6001-1(a), Income Tax Regs.   Accounting

records include the taxpayer’s regular books and other records

and data necessary to support entries on books and tax returns.

See sec. 1.446-1(a)(4), Income Tax Regs.

     Taxable income is generally computed under the method of

accounting on the basis of which the taxpayer regularly computes
                                - 10 -

his income in keeping his books.    See sec. 446(a).   However, if

the method of accounting or the books do not clearly reflect

income, the Commissioner may compute income through any method

that clearly reflects income.    See sec. 446(b); Holland v. United

States, 348 U.S. 121, 132 (1954); Mallette Bros. Constr. Co.,

Inc. v. United States, 695 F.2d 145, 148 (5th Cir. 1983);

Meneguzzo v. Commissioner, 43 T.C. 824 (1965); Zamzam v.

Commissioner, T.C. Memo. 2000-371.

     The Commissioner’s reconstruction of income need only be

reasonable; it need not be exact.    See Holland v. United States,

supra; Giddio v. Commissioner, 54 T.C. 1530, 1533 (1970);

Schroeder v. Commissioner, 40 T.C. 30, 33 (1963); Diesel Country

Truck Stop, Inc. v. Commissioner, T.C. Memo. 2000-317.          The

Commissioner need not concede an adjustment until he has

“received and verified adequate substantiation for the items in

question.”   Simpson Fin. Services v. Commissioner, T.C. Memo.

1996-317 (citing Harrison v. Commissioner, 854 F.2d 263, 265 (7th

Cir. 1988), affg. T.C. Memo. 1987-52); see Sokol v. Commissioner,

supra at 765.

     Respondent relied on petitioner’s books and records in

computing gross receipts for 1992 through 1994.    Respondent

determined in the notice of deficiency for tax years 1992, 1993,

and 1994 that petitioner omitted gross receipts totaling
                               - 11 -

$790,247.5    Although respondent’s method of computing gross

receipts was not error free, respondent was 75 percent accurate

in the determination in the notice of deficiency using

petitioner’s books and records.6    After respondent filed his

answer, petitioner and third parties provided documents to

respondent that led respondent to adjust the computation of

income.   Respondent had a reasonable basis in law and fact in

relying on petitioner’s records in determining the deficiencies.

     Petitioner argues that respondent was not substantially

justified because respondent should have used the bank deposit

method in his determination rather than relying on the redbook.

Petitioner further asserts that respondent’s agent misconstrued

the redbook.    According to petitioner, the only reason respondent

sought to substantiate the gross receipts reported, and in the

case of 1994, not reported, was respondent’s vendetta against

petitioner.    In essence, petitioner refutes the accuracy of his

own books and records.    Petitioner repeatedly emphasizes that

respondent was not substantially justified because respondent did

not verify gross receipts through another method.    We reject



     5
           We do not address 1991 since respondent employed the
method (bank deposits) which petitioner argues respondent should
have used.
     6
          The notice of deficiency determined gross receipts for
1992 through 1994 of $790,247. The parties agreed that, under
the bank deposits method, petitioner failed to report gross
receipts of $591,358 for those years.
                               - 12 -

petitioner’s nonsensical arguments.     Even assuming the agent

misconstrued petitioner’s books and records, it is apparent that

the records did not accurately reflect income.     Further, each

time petitioner provided additional information to respondent,

recomputations were made to the proposed adjustment to income.7

     D. Conclusion

     We hold that petitioner is not entitled to an award of

administrative and litigation costs because respondent’s position

was substantially justified.   In so holding, we have carefully

considered the remaining arguments made by the parties, and to

the extent not discussed above, we consider those arguments to be

without merit.

     In order to reflect the foregoing,



                                           An appropriate order and

                                      decision will be entered.




     7
          As indicated, petitioner did not file a return for tax
year 1994. In 1999, a year after respondent filed his answer to
the petition, the parties began a yearlong process of calculating
petitioner’s gross receipts. Respondent was not unreasonable in
his initial determination or the consideration of documentation
to verify gross receipts for 1994.
