                                T.C. Memo. 2013-59



                          UNITED STATES TAX COURT



      LEE STOREY AND WILLIAM STOREY, DECEASED,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 10230-10.                           Filed February 25, 2013.



      Gregory Alan Robinson and Laurie A. Laws, for petitioners.

      Chris J. Sheldon, for respondent.




      1
        Petitioners’ counsel notified the Court that petitioner William Storey had
died after the petition was filed. Petitioners’ counsel failed to indicate whether an
estate has or will be opened. We changed the caption accordingly.
                                            -2-

[*2]                          MEMORANDUM OPINION


       KROUPA, Judge: This case is before the Court on petitioners’ motion for an

award of administrative and litigation costs under section 7430.2 We are asked to

decide whether petitioners are entitled to recover administrative and litigation costs.

We hold they are not.

                                       Background

       The underlying facts and analysis of this case are set out in detail in Storey v.

Commissioner, T.C. Memo. 2012-115, and are not generally restated here.

Additional evidence relevant to petitioners’ motion is set forth in affidavits and

attachments the parties filed as part of their motion papers. We summarize the

factual and procedural background briefly to rule on the motion.

       Petitioner Lee Storey3 produced and directed a documentary film (film

activity). Petitioners had reported on their tax returns losses from the film activity

for 2003 through 2008.




       2
       All section references are to the Internal Revenue Code in effect at all
relevant times, and all Rule references are to the Tax Court Rules of Practice and
Procedure, unless otherwise indicated.
       3
           For convenience we refer to Lee Storey as petitioner.
                                           -3-

[*3] Respondent audited petitioners’ tax returns for 2003, 2004 and 2005,

questioning whether petitioner had engaged in the film activity for profit.

Respondent’s Appeals Office settled the unagreed audit by issuing a “no-change

letter” in November 2007. Respondent issued the no-change letter because the

presumption in section 183(d) did not apply as petitioner had been engaged in the

film activity for only three years.

      Respondent later audited the returns for 2006, 2007 and 2008 (years at issue),

again questioning whether petitioner had engaged in the film activity for profit.

Respondent issued a 30-day letter that proposed disallowing expenses from the film

activity claimed as deductions and proposed a deficiency for the years at issue. The

30-day letter contained instructions for requesting an Appeals conference if

petitioners did not agree with the proposed adjustments. The 30-day letter also

informed petitioners that their rights, including potential recovery of legal costs,

depended on their fully participating in the administrative consideration of their

case, including consideration by respondent’s Appeals Office. Petitioners did not

request an Appeals conference.

      Respondent issued a deficiency notice to petitioners for the years at issue,

determining that petitioner had not engaged in the film activity for profit and
                                            -4-

[*4] consequently disallowing deductions petitioners claimed in connection with the

film activity. Petitioners timely filed a petition with this Court. Again, petitioners

did not participate in nor request an Appeals conference before they filed the

petition.

       A trial was held, and we issued the Memorandum Opinion in which we found

in petitioners’ favor. Petitioners thereafter filed a motion for $18,9574 of

administrative costs and $141,044 of litigation costs. Respondent filed a response

to the motion. The parties later filed additional materials supplementing the motion

and the response. Neither party requested an evidentiary hearing, and we conclude

that a hearing is unnecessary to resolve the motion. See Rule 232(a)(2).

                                        Discussion

       We now address whether petitioners are entitled to an award of

administrative or litigation costs. A taxpayer may be awarded administrative or

litigation costs in an administrative or court proceeding brought against the United

States in connection with a tax matter if certain requirements are met. Sec. 7430.

The taxpayer must establish that he or she (1) is the prevailing party, (2) has




       4
           All monetary amounts are rounded to the nearest dollar.
                                            -5-

[*5] exhausted the available administrative remedies,5 (3) has not unreasonably

protracted the administrative or court proceeding and (4) has claimed administrative

or litigation costs that are reasonable. Sec. 7430(a) and (b). The moving party

bears the burden of proving that these requirements have been met. Rule 232(e).

      A taxpayer is generally the prevailing party if (1) the taxpayer substantially

prevailed on either the amount in controversy or the most significant issue or set of

issues and (2) meets certain net worth requirements. See sec. 7430(c)(4)(A). A

taxpayer, however, will not be treated as a prevailing party if the Commissioner’s

position in the proceeding was substantially justified. Sec. 7430(c)(4)(B). The

Commissioner has the burden of establishing that his position was substantially

justified. See sec. 7430(c)(4)(B)(i); Rule 232(e).

      We find that petitioners failed to meet the requirements for an award of

litigation costs. We generally so find because they failed to exhaust available

administrative remedies. We also find petitioners fail to meet the requirements for

an award of administrative costs. We generally so find because respondent’s

position in the administrative proceeding was substantially justified, thus precluding

prevailing party status. We now explain each of our findings.




      5
          This requirement applies only to litigation costs. See sec. 7430(b)(1).
                                          -6-

[*6] A. Exhaustion of Available Administrative Remedies

      We first consider whether petitioners exhausted their available

administrative remedies. A taxpayer must have exhausted the administrative

remedies available within the Internal Revenue Service before filing a Tax Court

petition to qualify for an award of litigation costs.6 Sec. 7430(b)(1); Burke v.

Commissioner, T.C. Memo. 1997-127; sec. 301.7430-1(a), Proced. & Admin.

Regs. A taxpayer generally fails to exhaust his or her administrative remedies

with respect to any tax matter for which an Appeals conference is available unless

one of the following two conditions is met. See sec. 301.7430-1(a), (b)(1), (g),

Proced. & Admin. Regs.; see also Shaw v. Commissioner, T.C. Memo. 2005-106;

Burke v. Commissioner, T.C. Memo. 1997-127. The first condition is that the

taxpayer must participate in an Appeals conference before filing a petition.7 Sec.




      6
       There are certain limited exceptions that apply to relieve taxpayers of the
requirement that they pursue administrative remedies. See sec. 301.7430-1(f) and
(g), Examples (4) and (5), Proced. & Admin. Regs.; see also Shaw v.
Commissioner, T.C. Memo. 2005-106. None of those exceptions, however, applies
here.
      7
         The Appeals Office’s mission “is to resolve tax controversies, without
litigation.” Internal Revenue Manual, pt. 8.1.1.1(1) (Oct. 23, 2007). The Internal
Revenue Service (IRS) is seeking facts during the Appeals phase to decide whether
it should determine a deficiency and thereby force a taxpayer to incur litigation costs
or pay the tax. See, e.g., Shaw v. Commissioner, T.C. Memo. 2005-106.
                                           -7-

[*7] 301.7430-1(a), (b)(1), Proced. & Admin. Regs. The second condition is that

the taxpayer must, before the issuance of a deficiency notice, (1) request an

Appeals conference and (2) file a written protest (if required for an Appeals

conference). Id.

      Here, respondent sent petitioners the 30-day letter, providing them the

opportunity to request an Appeals conference to resolve the matter before the

deficiency notice was issued. Moreover, the 30-day letter informed petitioners

that failing to participate in the Appeals process could negatively impact their

right to recover administrative and litigation costs. Petitioners chose,

nevertheless, not to participate in or request an Appeals conference before they

filed the petition.8 And none of the exceptions applies to relieve petitioners of the

requirement that they participate in or request an Appeals conference. We hold,

based on all the facts and circumstances, that petitioners failed to establish that


      8
         It is unclear exactly why petitioners chose to forgo the Appeals process.
Petitioner’s affidavit reflects that she believed respondent was intransigent in his
position with respect to the film activity. Her affidavit also reflects that she believed
that if she did not wage a major counter-attack at the administrative level, she would
face “a life sentence of IRS audits.” It appears that petitioners elected to bypass
Appeals as part of their litigation strategy. This does not relieve them of the
requirement to exhaust all available administrative remedies before filing the petition
if they wish to preserve their right to seek litigation costs. See Haas & Assocs.
Accountancy Corp. v. Commissioner, 117 T.C. 48, 62 (2001), aff’d, 55 Fed. Appx.
476 (9th Cir. 2003).
                                          -8-

[*8] they exhausted their available administrative remedies and that they therefore

are ineligible for an award of reasonable litigation costs.

B. Substantial Justification

       We now consider whether respondent’s position in the administrative

proceeding was substantially justified. We first identify respondent’s position for

purposes of the administrative proceeding. The Commissioner’s position for an

administrative proceeding is the position he takes as of the earlier of (1) the date the

taxpayer receives the decision notice of the Appeals Office, or (2) the date of the

deficiency notice. Sec. 7430(c)(7)(B); sec. 301.7430-5(b), Proced. & Admin. Regs.

Petitioners did not receive a decision notice from the Appeals Office before the

deficiency notice was issued. Accordingly, respondent’s position for the

administrative proceeding is that which was asserted in the deficiency notice issued

to petitioners.

       The Commissioner’s position is substantially justified if, based on all the

known facts and circumstances and relevant legal precedents, the Commissioner

acted reasonably. See Pierce v. Underwood, 487 U.S. 552, 565 (1988); Sher v.

Commissioner, 89 T.C. 79, 84 (1987), aff’d, 861 F.2d 131 (5th Cir. 1988). The

relevant inquiry is whether the Commissioner knew or should have known that his

position was invalid when adopted, given the facts available and any legal
                                           -9-

[*9] precedent related to the case. Nalle v. Commissioner, 55 F.3d 189, 191 (5th

Cir. 1995), aff’g T.C. Memo. 1994-182; Maggie Mgmt. Co. v. Commissioner, 108

T.C. 430, 443 (1987); Prouty v. Commissioner, T.C. Memo. 2002-175. A position

has a reasonable basis in fact if there is relevant evidence that a reasonable mind

might accept as adequate to support a conclusion. Underwood, 487 U.S. at

564-565; Huffman v. Commissioner, 978 F.2d 1139, 1147 n.8 (9th Cir. 1992), aff’g

in part, rev’g in part and remanding T.C. Memo. 1991-144. The Commissioner’s

position may be incorrect yet nevertheless substantially justified “if a reasonable

person could think it correct.” Underwood, 487 U.S. at 566 n.2.

      Respondent’s position during the administrative proceeding was that

petitioner failed to engage in the film activity for profit. This Court considers

whether an activity is engaged in for profit on a case-by-case basis, taking into

account the facts and circumstances involved. See Golanty v. Commissioner, 72

T.C. 411, 426 (1979), aff’d without published opinion, 647 F.2d 170 (9th Cir.

1981). We structure our analysis of whether an activity is engaged in for profit

around nine nonexclusive factors. Sec. 1.183-2(b), Income Tax Regs.

      These nine factors are fact intensive and generally focus on the facts at

issue, not the facts before or after the relevant years. No one factor or set of

factors is controlling, nor is the existence of a majority of factors favoring or
                                          -10-

[*10] disfavoring a profit objective controlling. Keating v. Commissioner, 544 F.3d

900, 904 (8th Cir. 2008), aff’g T.C. Memo. 2007-309; Hendricks v. Commissioner,

32 F.3d 94, 98 (4th Cir. 1994), aff’g T.C. Memo. 1993-396; Golanty v.

Commissioner, 72 T.C. at 426-427; sec. 1.183-2(b), Income Tax Regs. The

individual facts and circumstances of each case are the primary test, with greater

weight to be given to objective facts than to the taxpayer’s statement of intent. See

Indep. Elec. Supply, Inc. v. Commissioner, 781 F.2d 724, 726-727 (9th Cir. 1986),

aff’g Lahr v. Commissioner, T.C. Memo. 1984-472; Abramson v. Commissioner, 86

T.C. 360, 371 (1986); Engdahl v. Commissioner, 72 T.C. 659, 666 (1979); sec.

1.183-2(a) and (b), Income Tax Regs.

      Petitioners contend that respondent’s administrative position was not

reasonably based on the law and facts. We disagree. Evaluating whether an

activity was engaged in for profit is essentially factual in nature and requires a

weighing of factors, all of which may be reasonably interpreted differently. See

Dishal v. Commissioner, T.C. Memo. 1999-110; see also Brennan v. Commissioner,

T.C. Memo. 1997-60; Eldridge v. Commissioner, T.C. Memo. 1996-44; Harrison v.

Commissioner, T.C. Memo. 1995-295; Leaphart v. Commissioner, T.C. Memo.

1993-502, aff’d without published opinion, 31 F.3d 1172 (3d Cir. 1994); Jasienski

v. Commissioner, T.C. Memo. 1993-449.
                                          -11-

[*11] Here, we weighed all the facts and circumstances and considered each of the

relevant factors. We found that petitioner had shown that she engaged in the film

activity for profit. We recognized, however, that some factors indicated no profit

motive. Specifically, we found that petitioner had a history of losses, earned

significant income from other sources and appeared to enjoy filmmaking. We

ultimately decided that these factors were outweighed by the facts, some of which

were first introduced or developed at trial, demonstrating that petitioner did engage

in the film activity for profit.

       Notwithstanding our conclusion regarding the merits, respondent presented

facts supporting his position that petitioner’s primary objective in conducting her

film activity was not to make a profit. And respondent’s arguments with respect to

this highly fact-intensive issue were reasonable. Although we did not ultimately

agree with respondent’s legal conclusion, respondent has persuaded us that his

position had a reasonable basis in fact and law. We hold, therefore, that

respondent’s administrative position regarding the for-profit issue was substantially

justified and that petitioner is not entitled to an award of administrative costs under

section 7430.
                                         -12-

[*12] Based on our holdings, we find that petitioners failed to satisfy necessary

requirements to recover litigation or administrative costs.9 Petitioners’ motion will

therefore be denied.

      We have considered all the arguments of the parties, and, to the extent we

have not addressed them, we find them to be irrelevant, moot or meritless.

      To reflect the foregoing,


                                                An appropriate order and decision

                                        will be entered.




      9
       Because of our holdings, we need not address whether petitioners satisfied
any of the remaining requirements of sec. 7430.
