                         122 T.C. No. 6



                     UNITED STATES TAX COURT



THOMAS E. JOHNSTON and THOMAS E. JOHNSTON, SUCCESSOR IN INTEREST
        TO SHIRLEY L. JOHNSTON, DECEASED, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent*

   THOMAS E. JOHNSTON, Petitioner v. COMMISSIONER OF INTERNAL
                       REVENUE, Respondent



     Docket Nos. 26005-96, 2266-97.       Filed February 11, 2004



          Ps made a qualified offer, pursuant to sec. 7430,
     I.R.C., to resolve Ps’ tax liabilities for the 1989,
     1991, and 1992 tax years. R accepted Ps’ qualified
     offer, without negotiation.

          Thereafter, Ps sought to reduce the amounts stated
     in the qualified offer by the amount of net operating
     losses (NOLs) sustained in the 1988, 1990, 1993, and
     1995 tax years. R refused to allow such a reduction,
     claiming that R’s acceptance of Ps’ qualified offer
     prevented Ps from reducing the agreed-upon amounts.



     *
      This opinion supplements our opinion in Johnston v.
Commissioner, 119 T.C. 27 (2002).
                                    - 2 -

          Held: The parties entered into a contract to
     settle the docketed cases, as evidenced by Ps’
     qualified offer and R’s acceptance of that offer.

          Held, further, Ps are not now allowed to reduce
     the amounts stated in the qualified offer for the years
     at issue by the amount of NOLs sustained in the 1988,
     1990, 1993, and 1995 tax years.



     Lorraine G. Howell and Kenneth M. Barish, for petitioners.

     Nicholas J. Richards and Kevin W. Coy, for respondent.



                            SUPPLEMENTAL OPINION


     NIMS, Judge:        Respondent determined the following

deficiencies and penalties with respect to petitioners’ Federal

income taxes:

                                                          Penalties
       Petitioner           Year   Deficiency   Sec. 6662(a)     Sec. 6663
Thomas E. Johnston and *    1989   $1,546,160      $309,232     $1,159,620
* * Shirley L. Johnston,
Deceased
   Docket No. 26005-96
Thomas E. Johnston          1991    289,396          --           217,047
   Docket No. 2266-97       1992    341,908          --           256,431


By answer respondent also asserted increased deficiencies and

penalties in docket Nos. 26005-96 and 2266-97.

     These consolidated cases are presently before the Court on

respondent’s motion for summary judgment filed on September 2,
                                - 3 -

2003.    Petitioners filed an opposition to respondent’s motion,

and respondent filed a reply to petitioners’ opposition.

     The issue for decision is whether respondent’s acceptance of

petitioners’ qualified offer precludes petitioners from reducing

the amounts stated in the qualified offer for the years at issue

by the amount of net operating losses (NOLs) sustained in the

1988, 1990, 1993, and 1995 tax years.     We express no opinion as

to whether the claimed NOLs are valid for Federal income tax

purposes.    Solely for the purpose of this adjudication, we assume

that the claimed NOLs are valid.

     Unless otherwise indicated, all section references are to

sections of the Internal Revenue Code in effect at all relevant

times, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

                             Background

     These cases were set for trial on a special trial calendar

to commence on March 3, 2003.    On January 31, 2003, petitioners

made a qualified offer, pursuant to section 7430, to resolve

petitioners’ tax liabilities for the 1989, 1991, and 1992 tax

years.    Petitioners’ qualified offer stated, in part:

          Pursuant to Internal Revenue Code (“IRC”) Section
     7430(g) and * * * Section 301.7430-7T(c)[Temporary
     Proced. & Admin. Regs., 66 Fed. Reg. 727 (Jan. 4,
     2001)], this letter shall constitute the above-
     referenced taxpayer’s [sic] qualified offer to resolve
     all adjustments at issues in the matters listed above.
                                   - 4 -

     The taxpayer’s [sic] qualified offer is as follows
     according to the case docket number and tax years
     involved:

     Docket No.       Tax Year             Amount of Qualified Offer
     26005-96         1989                      $ 35,000
     2266-97          1991, 1992                $ 70,000
                                                $105,000

          This $105,000 offer is made as a qualified offer
     for purposes of IRC §7430(g). Therefore, in making the
     offer, the taxpayer is aware that his offer is to
     resolve all adjustments in the court proceeding. Such
     offer will fully resolve the taxpayer’s [sic] liability
     as to those adjustments.

     By letter dated February 10, 2003, respondent accepted

petitioners’ qualified offer, without negotiation.

     After respondent accepted petitioners’ qualified offer,

petitioners raised with respondent the issue of reducing the

agreed-upon amounts by applying NOLs from the 1988, 1990, 1993,

and 1995 tax years.

     On February 14, 2003, the Court held a conference call with

counsel for the parties.   Counsel for the parties informed the

Court that the parties had reached a basis for settlement and

that there remained the issue of whether petitioners are allowed

to reduce the agreed-upon amounts for the 1989, 1991, and 1992

tax years by applying NOLs from the 1988, 1990, 1993, and 1995

tax years.
                                 - 5 -

       On March 19, 2003, the parties filed a stipulation of

settled issues, which reserved the issue of whether petitioners

“can offset tax deficiencies * * * through net operating loss

carry forwards or carrybacks.”

       On April 22, 2003, which was after respondent had accepted

petitioners’ qualified offer, petitioners filed an amendment to

petition in each docket in which petitioners claimed deductions

for the NOLs in question.    After the supplemental pleadings were

closed, respondent filed the subject Motion for Summary Judgment,

which petitioners now challenge.

                             Discussion

I.    Summary Judgment

       Petitioners do not challenge as a procedural matter

respondent’s motion for summary judgment, see Rule 121(a) and

(b), and it appears that all prerequisites for summary

adjudication have been satisfied, id.; Rule 121(d).

II.    Contentions of the Parties

       Respondent contends that respondent’s acceptance of

petitioners’ qualified offer completely resolved the issue of

petitioners’ liabilities for the 1989, 1991, and 1992 tax years.

Respondent asserts that petitioners are not now able to raise new

issues relating to their 1989, 1991, and 1992 liabilities.

       Petitioners contend that petitioners’ qualified offer

included only items in dispute in the cases at the time the offer
                                - 6 -

was made.    Petitioners argue that because the issue of the NOLs

was not in dispute when they made the qualified offer, the

qualified offer was exclusive of the amounts related to the NOLs.

Consequently, petitioners contend that they are entitled to

reduce the agreed-upon amounts for the 1989, 1991, and 1992 tax

years by applying NOLs from the 1988, 1990, 1993, and 1995 tax

years.

III.    Analysis

       The parties agree that petitioners’ offer, as stated in

their January 31, 2003, letter, was a qualified offer within the

meaning of section 7430(g).    In now seeking to reduce the agreed-

upon settlement amounts for the 1989, 1991, and 1992 tax years by

the NOL amounts, petitioners are in effect asking us to treat the

settlement amounts as though they resulted from a court decision

in which various issues were resolved, but where entry of

decision awaited the availability, if any, of various NOLs.      See,

e.g., Gen. Signal Corp. & Subs. v. Commissioner, 104 T.C. 248

(1995).    We must therefore decide whether an agreement reached by

way of the qualified offer provision may be dealt with in the

manner petitioners request, and thus should be treated

differently from the way this Court treats settlement agreements

reached outside the parameters of the qualified offer provision.

       Section 7430 provides for the award under certain

circumstances of administrative and litigation costs to a
                                - 7 -

taxpayer.    An award of administrative and litigation costs may be

made where the taxpayer (1) is the “prevailing party”, (2) has

exhausted available administrative remedies (in the case of

litigation costs), (3) did not unreasonably protract the

administrative or judicial proceeding, and (4) claimed reasonable

costs.   Sec. 7430(a), (b)(1), (3), (c).        One way for a taxpayer

to establish that the taxpayer is the prevailing party is by a

comparison of the amount of the last qualified offer with the

portion of the judgment attributable to the adjustments at issue

when that qualified offer was made.         Sec. 7430(c)(4)(E); sec.

301.7430-7T(b)(3), Temporary Proced. & Admin. Regs., 66 Fed. Reg.

727 (Jan. 4, 2001).

     Section 7430(c)(4)(E) and (g) provides, in part, as follows:

     SEC. 7430(c).    Definitions.--For purposes of this
section--

                 *    *    *    *       *      *    *

         (4) Prevailing party.--

                 *    *    *    *       *      *    *

               (E) Special rules where judgment less than
            taxpayer’s offer.--

                   (i) In general.--A party to a court proceeding
               meeting the requirements of subparagraph (A)(ii)
               shall be treated as the prevailing party if the
               liability of the taxpayer pursuant to the judgment
               in the proceeding (determined without regard to
               interest) is equal to or less than the liability of
               the taxpayer which would have been so determined if
               the United States had accepted a qualified offer of
               the party under subsection (g).
                              - 8 -

               *    *    *    *       *   *    *

     (g) Qualified Offer.--For purposes of subsection
     (c)(4)--

         (1) In general.--The term “qualified offer” means a
     written offer which--

             (A) is made by the taxpayer to the United
          States during the qualified offer period;

             (B) specifies the offered amount of the
          taxpayer’s liability (determined without regard to
          interest);

             (C) is designated at the time it is made as a
          qualified offer for purposes of this section; and

             (D) remains open during the period beginning on
          the date it is made and ending on the earliest of
          the date the offer is rejected, the date trial
          begins, or the 90th day after the date the offer
          is made.

     The legislative history of section 7430 provides insight

into the purpose of section 7430:

          The Committee believes that settlement of tax
     cases should be encouraged whenever possible.
     Accordingly, the Committee believes that the
     application of a rule similar to FRCP 68 [rule 68 of
     the Federal Rules of Civil Procedure] is appropriate to
     provide an incentive for the IRS to settle taxpayers’
     cases for appropriate amounts, by requiring
     reimbursement of taxpayer’s costs when the IRS fails to
     do so. [S. Rept. 105-174, at 48 (1998), 1998-3 C.B.
     537, 584.]

Additionally, we have previously stated that “The purpose

underlying the qualified offer provision of section 7430(c)(4)(E)

* * * is to encourage settlements by imposing litigation costs on

the party not willing to settle.”     Gladden v. Commissioner, 120

T.C. 446, 450 (2003).
                                 - 9 -

     As the very purpose of the qualified offer provision is to

encourage settlements, we conclude that there is no persuasive

reason why a settlement reached by way of the qualified offer

provision should be treated any differently from the way this

Court treats settlement agreements reached outside the parameters

of the qualified offer provision.

     As contracts, settlements are governed by general principles

of contract law.   Dorchester Indus. Inc. v. Commissioner, 108

T.C. 320, 330 (1997), affd. without published opinion 208 F.3d

205 (3d Cir. 2000).   Settlement of an issue before the Court does

not require any particular method or form and can be accomplished

by letters of offer and acceptance.      Id.   Settlement agreements

are effective and binding once there has been an offer and an

acceptance; filing the agreement with the Court is not required

for the agreement to be effective and binding.       Id. at 338.

     We are convinced that the proposed figures conveyed to

respondent’s counsel by way of the January 31, 2003, letter from

petitioners’ counsel constitute the definite and material terms

of an offer to settle the docketed cases, and we so hold.      The

terms of that offer were accepted by respondent, as evidenced by

the February 10, 2003, letter.    We believe that the parties

entered into a contract to settle the docketed cases, and we so

hold.
                             - 10 -

     Petitioners contend that temporary regulations promulgated

under section 7430 support their position that new issues may be

raised after an agreement is reached if the agreement is reached

by way of the qualified offer provision.   We reject this

contention.

     Section 301.7430-7T(c)(3), Temporary Proced. & Admin. Regs.,

66 Fed. Reg. 728 (Jan. 4, 2001), provides, in part:

     A qualified offer specifies the offered amount if it
     specifies the dollar amount for the liability of the
     taxpayer * * *. This amount must be with respect to
     all of the adjustments at issue in the administrative
     or court proceeding at the time the offer is made and
     only those adjustments. The specified amount must be
     that amount, the acceptance of which by the United
     States will fully resolve the taxpayer’s liability, and
     only that liability, (determined without regard to
     adjustments stipulated by the parties to be fully
     resolved through another pending court or
     administrative proceeding, or interest, unless interest
     is a contested issue in the proceeding) for the type or
     types of tax and the taxable year or years at issue in
     the proceeding.

     Thus, the regulation contains three requirements:   (1) The

offered amount must specify the dollar amount for the liability,

(2) the offered amount must be with respect to all adjustments at

issue and only those adjustments, and (3) the offered amount must

be an amount that will fully resolve the taxpayer’s liability for

the type(s) of tax and tax year(s) at issue.

     Petitioners focus on the second requirement of this

regulation, arguing that the language “and only those
                              - 11 -

adjustments” prohibits taxpayers from including in the offered

amount any items that were not in dispute at the time the

qualified offer was made.

     Respondent argues that petitioners misinterpret the

regulatory language.   Respondent argues that the plain language

of the third requirement, which provides that the offered amount

be that amount which will fully resolve the taxpayer’s liability,

prevents taxpayers from raising new issues once a qualified offer

is accepted.   Hence, respondent argues that petitioners’

interpretation of the second requirement conflicts with the third

requirement.   As an alternative to petitioners’ interpretation of

the second requirement, respondent argues that the second

requirement is primarily concerned with the consequences of the

rejection of a qualified offer.   As respondent notes, if new

issues are raised after the rejection of a qualified offer, the

amount of liability attributable to those new issues is not

considered when comparing the amount of an eventual judgment to

the amount of the last qualified offer.   Sec. 7430(c)(4)(E); sec.

301.7430-7T(b)(3), Temporary Proced. & Admin. Regs., 66 Fed. Reg.

727 (Jan. 4, 2001).

     Respondent argues that, in order to comply with the third

requirement, if petitioners wanted to apply the NOLs to reduce
                                - 12 -

the liabilities set forth in the qualified offer, petitioners

should have at least stated that the offered amount was subject

to reduction by application of NOLs.     We agree with respondent.

     Petitioners’ interpretation of the regulation renders the

third requirement meaningless.    In order to give effect to the

third requirement, an offered amount must be one that will fully

resolve a taxpayer’s liability for the type(s) of tax and tax

year(s) at issue.   If taxpayers were allowed to reduce the amount

of the qualified offer after the qualified offer was made, then

the qualified offer would not be one that, if accepted, would

fully resolve the taxpayer’s liability, thus giving no effect to

the third requirement.   In the current case, petitioners’

qualified offer would not fully resolve their liabilities for the

type of tax and tax years at issue if petitioners were now able

to apply the NOLs to reduce the offered amount.

     Additionally, the fact that the NOLs were not in dispute at

the time the qualified offer was made is a matter of petitioners’

own doing.   Petitioners admittedly raised the issue of the NOLs

for the first time after the agreement was entered into.     In

petitioners’ Opposition to Respondent’s Motion for Summary

Judgment, petitioners state that, immediately upon acceptance of

the qualified offer by respondent, petitioners “reminded”

respondent that petitioners had several years of tax loss

carryforwards and carrybacks.
                              - 13 -

     Petitioners could have included the NOLs among the

“adjustments at issue in the administrative or court proceeding”

by the simple expedient of moving to amend their petitions to

claim the NOL deductions before, rather than after, making their

qualified offer.   Had that motion been made and granted, which

under the postulated conditions would appear to have been likely,

cf. Cloes v. Commissioner, 79 T.C. 933 (1982), the NOLs would

have become an “adjustment at issue” for purposes of this court

proceeding.   Instead of moving to amend the petitions before

making the qualified offer, petitioners waited until after

respondent accepted the qualified offer to move to amend their

petitions to claim the NOL deductions.   These motions to amend

their petitions made after their qualified offer was accepted are

obviously too late.   As we stated in Korangy v. Commissioner,

T.C. Memo. 1989-2, affd. 893 F.2d 69 (4th Cir. 1990):     “The time

for petitioners to make a thorough examination of their case is

prior to the date of trial, not subsequent to their execution of

a settlement agreement.”

     Petitioners assert that it would have been premature to

raise the issue of the NOLs prior to arriving at the agreement,

which included taxable income for the years in issue.     Contrary

to this assertion, petitioners could have pleaded the NOL

deductions as an alternative position.   Rule 31(c) allows

pleading in the alternative, and the Court generally requires it.
                              - 14 -

See also Cloes v. Commissioner, supra at 937; Vest v.

Commissioner, T.C. Memo. 1995-188, affd. without published

opinion 89 F.3d 839 (7th Cir. 1996).

     In a situation similar to the one here, the taxpayers in Yoo

Han & Co. v. Commissioner, T.C. Memo. 1991-308, attempted to

claim a number of deductions, including a net operating loss

carryback deduction by the corporate taxpayer, after reaching a

settlement agreement with the Commissioner.   The taxpayers in

that case also claimed that it would have been premature to claim

the net operating loss carryback prior to arriving at the

settlement that increased their taxable income.    In that case, we

declined to insert into the settlement agreement terms that the

taxpayers for whatever reason failed to include.    Id.

Additionally, respondent made concessions by accepting the offer,

and “we will not force further concessions upon respondent.”     Id.

     We conclude that respondent’s acceptance of petitioners’

qualified offer fully resolved the issue of petitioners’

liabilities for the 1989, 1991, and 1992 tax years.   Petitioners

are not now allowed to add additional terms to that agreement by

applying NOLs from other years to reduce the agreed-upon amounts.

     One final note.   On December 29, 2003, the Commissioner

published final regulations, pursuant to section 7430, that

relate “to the qualified offer rule, including the requirements
                                - 15 -

that an offer must satisfy to be treated as a qualified offer

under section 7430(g)”.   Preamble to sec. 301.7430-7, Proced. &

Admin. Regs., 68 Fed. Reg. 74848 (Dec. 29, 2003).    We note that

the final regulations added Example 4 to sec. 301.7430-7(e),

Proced. & Admin. Regs., which briefly discusses whether a

taxpayer may reduce the amount the taxpayer will pay pursuant to

a qualified offer, after the offer is accepted by the

Commissioner, by applying net operating loss carryovers.     The

language of Example 4 is as follows:

     Example 4. Offer must resolve full liability. Assume
     the same facts as in Example 1, except that A makes a
     qualified offer that is accepted by the IRS. After the
     offer is accepted, A attempts to reduce the amount A
     will pay pursuant to the offer by applying net
     operating loss carryovers to the years in issue.
     Because the net operating losses were not at issue when
     the offer was made, A’s offer was a qualified offer.
     Whether A is entitled to apply net operating losses to
     reduce the amount stated in the offer will depend upon
     the application of contract principles, local court
     rules, and, because net operating losses are at issue,
     section 6511(d) and related provisions.

As stated, Example 4 was not part of the temporary regulations.

See sec. 301.7430-7T(e), Temporary Proced. & Admin. Regs., 66

Fed. Reg. 728 (Jan. 4, 2001).    The final regulations are

applicable to qualified offers made after December 24, 2003.

Sec. 301.7430-7(f), Proced. & Admin. Regs.    Petitioners’ offer

was made before that date.
                             - 16 -

     We have considered all of the other arguments made by the

parties, and to the extent that we have not specifically

addressed them, we find them to be without merit.

     To reflect the foregoing,


                                      An appropriate order granting

                                 respondent’s motion for

                                 summary judgment will be issued,

                                 and decisions will be entered

                                 under Rule 155.
