                      T.C. Memo. 2004-220



                  UNITED STATES TAX COURT



         CURTIS AND MARY ETTESVOLD, Petitioners v.
       COMMISSIONER OF INTERNAL REVENUE, Respondent



    Docket No. 15631-98.         Filed September 28, 2004.



    Jon J. Jenson, for petitioners.

     Blaine Holiday, for respondent.



                      MEMORANDUM OPINION


     WHALEN, Judge:   This case is before the Court to decide

petitioners’ motion for an award of reasonable litigation

and administrative costs in which they seek attorney’s fees

and expenses of $5,959.87.
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     Neither petitioners’ motion nor respondent’s response

thereto requests an evidentiary hearing, and the Court

concludes that such a hearing is unnecessary for the

disposition of petitioners’ motion.    See Rule 232(a)(2),

Tax Court Rules of Practice and Procedure.    We will decide

petitioners’ motion on the basis of the record in this case,

including petitioners’ motion, respondent’s response, and

the various exhibits attached thereto.    At the time they

filed their petition, petitioners resided at Morris,

Minnesota.

                          Background

     Respondent determined deficiencies in petitioners’

self-employment taxes for 1994 of $5,139 and for 1995 of

$5,048.   Respondent’s determination was based upon the

contention that certain payments received from petitioners’

farming corporation constituted “net earnings from self-

employment” pursuant to section 1402(a)(1) of the Internal

Revenue Code.   Hereinafter, all section references are to

that Code unless stated otherwise.

     As a general rule, section 1402(a)(1) defines “net

earnings from self-employment” to exclude rentals of farm

land and personal property, but it sets forth an exception

to the general rule if the rental income is derived under an
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arrangement that requires the material participation of the

owner or tenant in the production or management of the

agricultural or horticultural commodities on the rented

land.   Section 1402(a)(1) provides that in computing the

income to be included in “net earnings from self-

employment”:


     there shall be excluded rentals from real estate
     and from personal property leased with the real
     estate (including such rentals paid in crop
     shares) together with the deductions attributable
     thereto, unless such rentals are received in the
     course of a trade or business as a real estate
     dealer; except that the preceding provisions of
     this paragraph shall not apply to any income
     derived by the owner or tenant of land if (A) such
     income is derived under an arrangement, between
     the owner or tenant and another individual, which
     provides that such other individual shall produce
     agricultural or horticultural commodities
     (including livestock, bees, poultry, and fur-
     bearing animals and wildlife) on such land, and
     that there shall be material participation by the
     owner or tenant (as determined without regard to
     any activities of an agent of such owner or
     tenant) in the production or management of the
     production of such agricultural or horticultural
     commodities, and (B) there is material participa-
     tion by the owner or tenant (as determined without
     regard to any activities of an agent of such owner
     or tenant) with regard to any such agricultural or
     horticultural commodity * * *


     Petitioners filed a petition for redetermination of the

deficiencies determined by respondent.   While the case was

pending, petitioners mailed a document purporting to be a
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“qualified offer”, as defined by section 7430(g), which

states:   “The taxpayers as their qualified offer agrees

[sic] to establish as the taxpayer’s [sic] liability

(determined without regard to interest) by agreeing to pay

to the United States $0.”   Petitioners mailed the “qualified

offer” more than 30 days before the case was called from the

trial calendar.   See sec. 301.7430-7(c)(7), Proced. & Admin.

Regs.   When the case was subsequently called from the trial

calendar, the parties filed a stipulation of settlement

in which they agreed, as


     a basis of settlement * * * that the issue
     relating to the applicability of self-employment
     tax on these rental payments is the same as the
     issue in Johnson v. Commissioner, docket No. 7536-
     98 (the controlling case) * * * [and] shall be
     resolved as if the petitioners in this case were
     the same as the taxpayers in the controlling case.


     In due course, the Court issued its opinion in the

controlling case, Johnson v. Commissioner, T.C. Memo. 2004-

56, in which we held that the amounts reported by the

taxpayers for taxable years 1993, 1994, and 1995 as rents

from their wholly owned corporation for the lease of their

farmland and personal property are not included in “net

earnings from self-employment” under section 1402(a)(1) and

are not subject to self-employment tax.   In deciding that
                            - 5 -

case, this Court followed the analysis of the Court of

Appeals for the Eighth Circuit, the governing circuit, in

McNamara v. Commissioner, 236 F.3d 410 (8th Cir. 2000),

revg. and remanding Bot v. Commissioner, T.C. Memo. 1999-

256, Henner v. Commissioner, T.C. Memo. 1999-306, and

McNamara v. Commissioner, T.C. Memo. 1999-333, and held that

there was no nexus between the rental payments at issue and

the oral agreement between the taxpayers and their farm

corporation under which the taxpayers were to materially

participate in the corporation’s production of agricultural

commodities.

                          Discussion

     According to petitioners, the decision of this Court

in Johnson v. Commissioner, supra, “dictates that Curtis

and Mary Ettesvold do not owe the additional self-employment

taxes that were assessed against them by the Internal

Revenue Service.”   Accordingly, they contend that they are

to be treated as the “prevailing party”, pursuant to section

7430(c)(4)(E), on the ground their tax liability is “less

than the ‘qualified offer’ that they offered to the Internal

Revenue Service.”   Petitioners further assert that they had

exhausted their administrative remedies available within

the Internal Revenue Service, that they had not unreasonably
                            - 6 -

protracted the instant proceedings, and that they meet the

net worth requirement imposed by section 7430(c)(4)(A)(ii).

     Respondent concedes that petitioners have substantially

prevailed with respect to the most important issue in the

case, that they had not unreasonably protracted this

proceeding, and that they meet the net worth requirement.

Nevertheless, respondent contends that petitioners are not

entitled to an award of any fees or costs under section

7430.

     Respondent’s position is based upon four points.

First, respondent contends that, contrary to petitioners’

assertion, petitioners did not exhaust their administrative

remedies within the Internal Revenue Service as required by

section 7430(b)(1).   Second, respondent contends that the

qualified offer rule, on which petitioners rely, is

inapplicable because any judgment in this case will be

issued pursuant to a settlement, not pursuant to a judicial

determination and, further, because petitioners’ tax

liability may be more than the amount offered in their

qualified offer.   Third, respondent contends that the

position of the United States was substantially justified,

with the result that petitioners are not to be treated as
                             - 7 -

the prevailing party.    Finally, respondent raises a factual

question about the fees and costs sought by petitioners.

     At the outset, we note that petitioners styled their

motion “Motion for Award of Reasonable Litigation and

Administrative Costs”.    In fact, however, the amount sought

by petitioners, $5,959.87, consists entirely of attorney’s

fees and expenses for services in connection with the

instant Tax Court proceeding.    As the affidavit attached to

petitioners’ motion makes clear, all of those services were

provided after submission of the “qualified offer”, which

took place approximately 4 years after the filing of

petitioners’ petition in this Court.    Thus, the attorney’s

fees and expenses which petitioners seek in the instant

motion are litigation costs, not administrative costs.

See sec. 301.7430-4(c)(3)(ii), Proced. & Admin. Regs.

     We agree with respondent’s first point.   On the basis

of our review of this case, we cannot determine that

petitioners exhausted the administrative remedies available

to them within the Internal Revenue Service, as required by

section 7430(b)(1).   In such a case, section 7430(b)(1)

provides that “A judgment for reasonable litigation costs

shall not be awarded under subsection (a) [of section

7430]”.   See sec. 7430(b)(1).   Accordingly, we will deny
                              - 8 -

petitioners’ motion on the basis of the limitation imposed

by section 7430(b)(1).   We need not, and do not, reach the

other issues raised by respondent.

     Respondent’s response to petitioners’ motion points out

that a 30-day letter was issued to petitioners.    See sec.

601.105(d), Statement of Procedural Rules.    A copy of that

30-day letter is attached as an exhibit to respondent’s

response.   The letter pointed out that if petitioners did

not agree with the proposed changes in their 1994 and 1995

returns, then they could obtain a conference with the

Regional Office of Appeals.    The 30-day letter also

explained the steps necessary to obtain such an Appeals

conference.

     Respondent’s brief further represents that after

issuing the 30-day letter, respondent’s agent contacted

petitioners’ representative.    According to respondent’s

response, petitioners’ representative advised the agent that

petitioners did not agree to the adjustment, but they would

not file a protest.   Petitioners’ representative recommended

that the agent issue a notice of deficiency.

     The 30-day letter issued to petitioners proposes

increasing their net earnings from self-employment for 1994

and 1995 by the amount of the real estate rental payments
                             - 9 -

received from their farm corporation in each of those years.

These are the same adjustments that respondent determined in

the notice of deficiency which is the subject of this case.

As set forth in the 30-day letter sent to them, petitioners

had the right to appeal the proposed adjustment to the

Appeals Office.    See sec. 601.106(b), Statement of

Procedural Rules.    Petitioners chose not to pursue an

administrative appeal within the Internal Revenue Service

of the adjustments proposed in the 30-day letter.

     The regulations promulgated under section 7430 discuss

the circumstances in which the administrative remedies

available within the Internal Revenue Service shall be

deemed to have been exhausted.    See sec. 301.7430-1, Proced.

& Admin. Regs.    Generally, under those regulations a party

will not be deemed to have exhausted the administrative

remedies with respect to any tax matter for which an Appeals

Office conference is available under sections 601.105 and

601.106, Statement of Procedural Rules, unless the party

participates in an Appeals Office conference before filing

a petition in the Tax Court.    See sec. 301.7430-1(b)(1)(i),

Proced. & Admin. Regs.
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     The regulations under section 7430, requiring a party

to pursue administrative remedies within the Internal

Revenue Service, are subject to various limited exceptions.

See sec. 301.7430-1(f), Proced. & Admin. Regs.    Petitioners’

motion and accompanying brief, however, give us no reason to

believe that any such exception is applicable in this case,

nor do petitioners’ motion and brief suggest that the

statutory rule requiring exhaustion of administrative

remedies is otherwise unnecessary.    The entire discussion

of this issue in petitioners’ brief is as follows:    “The

statutory notice of deficiency was issued by the Internal

Revenue Service on August 12, 1998.    Curtis and Mary

Ettesvold pursued all of their administrative remedies.”

     For the above reasons, we cannot determine, on the

basis of the record, that petitioners exhausted their

administrative remedies in the Internal Revenue Service.

See sec. 301.7430-1(b)(1)(i), Proced. & Admin. Regs.

Accordingly, we hold that petitioners are not eligible,

pursuant to the limitations of section 7430(b)(1), to be

awarded reasonable litigation costs.    See Haas & Associates

Accountancy Corp. v. Commissioner, 117 T.C. 48 (2001), affd.

55 Fed. Appx. 476 (9th Cir. 2003); Patel v. Commissioner,

T.C. Memo. 1998-306.
                      - 11 -

In accordance with the above,


                         An appropriate order will

                    be issued.
