In the
United States Court of Appeals
For the Seventh Circuit

No. 00-3335

NEW HOPE SERVICES, INCORPORATED,

Plaintiff-Appellant,

v.

UNITED STATES OF AMERICA,

Defendant-Appellee.

Appeal from the United States District Court
for the Southern District of Indiana, New Albany Division.
No. 96 C 116--David F. Hamilton, Judge.

ARGUED MARCH 29, 2001--DECIDED APRIL 1, 2002



  Before EASTERBROOK, ROVNER, and DIANE P.
WOOD, Circuit Judges.

  ROVNER, Circuit Judge. New Hope Services
is a non-profit organization dedicated to
providing rehabilitation and therapeutic
services to persons with developmental
disabilities, mental retardation, and
chronic mental illness. In 1996, New Hope
filed a complaint in district court
seeking the refund of employment taxes
paid with respect to its clients for
their work in its sheltered workshops as
part of its program to prepare them for
regular employment. The IRS eventually
conceded the case on the merits, and the
parties filed a Stipulation for Dismissal
and Entry of Judgment providing that New
Hope was entitled to a refund in the
amount of $204,593.32 plus interest, and
reserving to New Hope the right to file a
motion for attorneys’ fees and costs. New
Hope then sought attorneys’ fees totaling
$56,657.54 pursuant to 26 U.S.C. sec.
7430. Under sec. 7430, New Hope is
entitled to a fee award if : (1) it is a
prevailing party; (2) the claim is
reasonable; (3) it did not unreasonably
protract the proceeding; and (4) it
exhausted all administrative remedies.
The United States concedes that the first
three criteria are satisfied and argues
only that New Hope failed to exhaust its
administrative remedies. The district
court held that New Hope had failed to
exhaust its administrative remedies
because it knew that the IRS had been
evaluating its claim and therefore it
needed to take some further step before
proceeding to court. The court held that
"[a] request for an appeals conference--
stating that the IRS had already taken
more than six months without making a
preliminary determination, despite having
issued the July 1995 letter that
certainly encouraged New Hope to believe
that its claim for refund would be
honored--would have sufficed, even if it
had been denied, to give the IRS an
opportunity to make a decision one way or
the other and to know that it faced the
prospect of a fee award." Dist. ct. order
at 10. We certainly agree that such
notice to the IRS might have been the
better practice, but the question here is
whether that action is required in order
for New Hope to exhaust its remedies. In
resolving that question, we consider
first the procedural background of this
case.

  On April 13, 1995, New Hope filed a
claim for a refund of its 1992 taxes and
a request for a "determination letter,"
which sought a determination from the IRS
of whether the class of workers described
in the refund claim should be considered
New Hope’s employees for employment tax
purposes. The IRS Service Center in
Cincinnati, Ohio sent that determination
letter to New Hope on July 28, 1995,
stating that "it is our determination
that any individual in a sheltered
workshop being operated to train them to
overcome or accept their disability and
to reenter the workforce is not an
employee of the organization . . . ." New
Hope then forwarded a copy of that letter
to the IRS District Director in
Indianapolis on August 4, 1995,
requesting again that the IRS process its
claim for a refund. In January of 1996,
New Hope was contacted by Revenue Agent
Dennis Theurer by phone, followed by
Theurer’s visit to New Hope’s facility in
February. New Hope did not hear further
from Theurer after that point. In April
of 1996, New Hope filed another claim for
a refund, this time raising the same
issues for the years 1993 and 1994.
Finally, on August 13, 1996,
approximately 16 months after filing its
claim for a refund and still without a
decision from the IRS on its claim, New
Hope filed this action in district court.
  The sole issue in this case is whether
New Hope failed to exhaust its
administrative remedies because it never
requested an appeals conference before
filing in federal court. Section 7430
allows the recovery of attorneys’ fees
only if the exhaustion requirement is
first met. In defining what constitutes
exhaustion, however, 26 C.F.R. sec.
301.7430-1(e) sets forth an exception for
satisfying the exhaustion requirement:

(e) Exception to the requirement that
party pursue administrative remedies. If
the conditions set forth in paragraph
(e)(1), (e)(2), (e)(3) or (e)(4) of this
section are satisfied, a party’s
administrative remedies within the
Internal Revenue Service shall be deemed
to have been exhausted for purposes of
section 7430.

(3) In the case of a civil action for
refund . . . the party --

(iii) Did not receive either written or
oral notification that an Appeals office
conference had been granted within six
months from the date of the filing of the
claim for refund and thefailure to
receive such notice was not due to
actions of the party (such as the failure
to supply requested information or a
current mailing address to the district
director or service center having
jurisdiction over the tax matter).

The plain language encompasses the
situation in this case. New Hope did not
receive notification of an appeals
conference within six months--in fact, it
did not receive such notice within 16
months--and the failure to receive the
notice was not due to any actions on the
part of New Hope. It did not receive the
notice because the IRS failed to provide
the initial decision within the 6-month
period, and therefore the IRS could not
grant any appeals conference in that time
period.

  Seeking to avoid the plain language of
that provision, the IRS argues that the
failure to receive notice of an appeals
conference was indeed due to the actions
of New Hope, specifically its failure to
request an appeals conference. Because
the request must precede the granting of
an appeals conference, the IRS reasons
that New Hope deprived it of the
opportunity to grant the conference by
failing to request one before filing suit
in district court, and therefore it does
not fall within this exception to the
exhaustion requirement.

  There are myriad problems with that
argument, not the least of which is that
the IRS has pointed to no authority for
the proposition that New Hope could seek
an appeals conference absent a decision
to be appealed. In fact, the language of
the regulations suggests the opposite. As
the district court acknowledged, "[26
C.F.R.] sec. 601.106(b) makes it clear
that what the taxpayer appeals from is a
preliminary determination--sometimes
called a ’30-day letter’-- issued by a
district director." Dist. Ct. order at 8.
That letter informs the taxpayer of the
appeals rights available, sec.
601.105(d)(1)(iv), and instructs the
taxpayer as to how to file a written
protest, sec. 601.105(d)(2)(v). Because
appeals are from that preliminary
determination, and New Hope never
received one, it had no basis in the
regulation for requesting an appeals
conference. Furthermore, the notification
of its appeals rights set forth in IRS
Publication 5 is sent with that
preliminary determination, and again
makes clear that an appeal must be
premised upon the findings in the
preliminary determination. ("This
Publication tells you how to appeal your
tax case if you don’t agree with the
Internal Revenue Service (IRS) findings.
. . . If you don’t agree with any or all
of the IRS findings given you, you may
request a meeting or a telephone
conference with the supervisor of the
person who issued the findings." "You may
appeal most IRS decisions with your local
Appeals Office." "Include in your protest
. . . (3) a copy of the letter showing
the proposed changes and findings you
don’t agree with . . . ."). Furthermore,
the procedures for perfecting an
administrative appeal repeatedly refer to
the letter sent to taxpayers with that
preliminary determination ("If you want
an Appeals conference, follow the
instructions in our letter to you." "When
you request an appeals conference, you
may also need to file a formal written
protest for a small case request with the
office named in our letter to you." "When
a protest is required, send it within the
time limit specified in the letter you
received. [emphasis in original]") It is
difficult to see how a person lacking the
preliminary determination or the letter
setting forth the instructions,
appropriate office, and time limits,
could properly pursue an administrative
appeal. In fact, that same notice of
appeals rights also informs the taxpayer
that:

If you file a formal refund claim with
the IRS, and we haven’t responded to you
on your claim within six months from the
date you filed it, you may file suit for
refund immediately in your District Court
or the Court of Federal Claims. If we
send you a letter that proposes
disallowing or disallows your claim, you
may request Appeals review of the
disallowance.

At no point does it indicate that a
taxpayer may seek appeals review of the
IRS’ failure to respond on the claim.
Those provisions make clear that a
taxpayer can only appeal from a
preliminary determination, and that New
Hope could not pursue that avenue before
it filed suit given the absence of any
determination from the IRS. The failure
to grant an appeals conference within the
six-month period, then, is attributable
solely to the delay by the IRS, and not
to any failure by New Hope to pursue
avenues available to it.

  Moreover, the IRS seeks a meaningless
gesture from New Hope in this case, and
would elevate that to an essential
component of the exhaustion requirement.
The IRS complains that New Hope failed to
request a conference in August 1996
before filing suit. Had it done so and
the IRS immediately granted the
conference, however, New Hope would have
fallen squarely within the language of 26
C.F.R. sec. 301.7430-1 as the IRS
interprets it, in that it would have
taken all actions necessary to secure an
appeals conference, but no conference
would have been granted "within six
months from the date of the filing of the
claim for refund." In other words, the
request for the conference would not have
mattered at that point, because it could
not be granted within that six month time
period. The only alternative reading
would be that sec. 301.7430-1 would not
apply at all to New Hope once the IRS
delayed the initial decision past the
six-month period, and that New Hope would
then have to proceed through the entire
process, however lengthy and delayed,
before it could be deemed to exhaust its
administrative remedies. Nothing in the
IRS’ brief suggests such a tortured
reading of the regulation, and indeed
that would put the IRS in the position of
being able to end-run the time limits of
the regulation by simply delaying its
initial decision, in contravention of the
apparent purpose of the provision to
allow taxpayers to seek fees in court
where the IRS fails to grant a conference
within six months. Therefore, the IRS’
insistence that New Hope had to request
an appeals conference before proceeding
to court is an insistence on a formality
with no practical effect because even
under the IRS’ interpretation, once New
Hope submitted such a request it would
have been entitled to proceed to federal
court and collect attorneys’ fees
regardless of the IRS’ response to that
request.

  Finally, as suggested above, the IRS’
view of the regulation would transform
the regulation from one that allows the
taxpayer the discretion to file in
federal court and collect fees if the IRS
does not timely grant an appeal, to one
in which the IRS would control the
ability of the taxpayer to so act, and
where delay by the IRS in the initial
decision would increase, rather than
decrease, its ability to avoid fees.
Nothing in the language or intent of the
provision supports such an inconsistent
reading of the language.

  The IRS relies for this reading on a
decision by the Claims Court in Lawler v.
United States, 16 Cl. Ct. 53 (1988). In
that case, the court held that a taxpayer
had failed to exhaust administrative
remedies because he failed to request an
appeals conference and that was a
condition precedent to the granting of
the conference. That case, however, is
unhelpful to the IRS because it was
undisputed that the IRS in Lawler issued
a decision, and thus that Lawler had the
opportunity to request a conference and
failed to do so. The court held that it
would be fruitless for the IRS to review
at a higher level every denied
claimwithout any indication from the
taxpayer that he/she wants to pursue the
matter. Id. at 57-58. Accordingly, it
held that a taxpayer dissatisfied with
the denial must seek review in order to
have exhausted administrative remedies.
Id. at 58. In Lawler, then, the taxpayer
had received the denial from which an
appeal was possible, but had failed to
pursue that administrative appeal. In
that case, the failure of the appeals
office to grant the conference is
attributable to the taxpayer, who could
have sought the appeal but failed to do
so. In contrast, New Hope never received
a denial in this case from which an
appeals conference could be sought, and
it was the IRS’ failure to issue the
denial that resulted in the failure to
grant an appeals conference within the
six-month period, not any action by New
Hope. Because in Lawler the appeal was
prevented by the actions, or inaction, of
the taxpayer not the IRS, it is
inapplicable to this case.

  In fact, other courts that have
addressed situations analogous to that of
New Hope have held that the exhaustion
requirement is satisfied. For instance,
in Swanson v. Commissioner of Internal
Revenue, 106 T.C. 76 (1996), the court
interpreted an exception to the
exhaustion requirement that required
that: "The party does not refuse to
participate in an Appeals office
conference while the case is in docketed
status." The IRS in that case argued that
the language mandated an affirmative act
by the petitioner, specifically a request
for an appeals office conference. Id. at
98. Petitioners countered that the
language places the burden on the IRS,
reasoning that petitioners cannot refuse
to participate unless the IRS makes an
offer of a conference. The court decided
the matter by looking at the
circumstances in which a conference is
offered. The regulations specific to the
Swanson situation declared that for cases
docketed in Tax Court, the case will be
referred by district counsel to the
appeals office, and that office will
arrange settlement conferences within 45
days of receipt of the case. Id. at 99.
Moreover, the court noted that "there is
no provision in the procedural rules for
a taxpayer request for an Appeals Office
conference" in those circumstances. Id.
at 99-100. Accordingly, the court held
that the petitioners had exhausted
administrative remedies. Similarly, the
appeals provisions in this case require
an initial denial, and there is no
provision for an appeal absent that
initial action by the IRS. Because here
as in Swanson the IRS rather than the
taxpayer had failed to take the actions
necessary to make an appeal available,
the administrative remedies are
exhausted.

  Similarly, in McConaughy v. United
States, 833 F. Supp. 534 (D. Md. 1993),
aff’d 34 F.3d 1066 (4th Cir. 1994), the
court considered a refund claim in which
attorneys’ fees were sought pursuant to
sec. 7430. The court held that the
plaintiffs who had filed a refund claim
with the IRS and waited a year for a
decision had exhausted their
administrative remedies, because
"[a]lthough taxpayers ordinarily must
avail themselves of IRS internal
procedures to be entitled to attorneys’
fees, [citation omitted] in this case
there was no initial decision from the
IRS either granting or rejecting their
requests for the taxpayer to appeal." Id.
at 537. The McConaughy court recognized
that an appeals procedure is unavailable
to a taxpayer who has not received an
initial decision from the IRS, and that
administrative remedies may be exhausted
even absent that appeal. Thus, the
limited cases relevant to the issue here
support New Hope’s position that it has
exhausted administrative remedies, and
that interpretation is faithful to the
plain language of the regulation.
Accordingly, consistent with the language
and purpose of the regulations, we hold
that New Hope has exhausted
administrative remedies in this case.
Because that was the only contested issue
concerning fees here, New Hope is
entitled to the fee award. The decision
of the district court is reversed and the
case remanded for the court to enter
judgment for fees in favor of New Hope.
