                               T.C. Memo. 2018-10



                           UNITED STATES TAX COURT



                  DAVID L. BRUNER, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 13651-16.                         Filed January 30, 2018.



      Yale F. Goldberg, David R. Jojola, and Derek W. Kaczmarek, for petitioner.

      Doreen Marie Susi, Rachael J. Zepeda, Rick V. Hosler, and Katelynn M.

Winkler, for respondent.



                            MEMORANDUM OPINION


      LAUBER, Judge: This case is before the Court on petitioner’s motion for

award of litigation and administrative costs pursuant to section 7430 and Rule
                                          -2-

[*2] 231.1 Neither party requested a hearing on this matter, and no material fact is

in dispute. We will therefore decide petitioner’s motion on the basis of the

parties’ submissions and the existing record. See Rule 232(a)(1).

      We conclude that petitioner is not the “prevailing party” under section

7430(a) and (c)(4) because the position of the United States was “substantially

justified” within the meaning of section 7430(c)(4)(B). We will accordingly deny

petitioner’s motion for fees and costs.

                                    Background

      The following facts are derived from the parties’ pleadings and motion pa-

pers, including the declarations and the exhibits attached thereto. Petitioner resid-

ed in Arizona when he filed his petition.

      During 2011 and 2012, the relevant tax years, petitioner was a member of

Circle Road Financial, LLC (Circle Road), a two-member LLC formed in 2004.

At all relevant times Circle Road has been treated as a partnership for Federal

income tax purposes. Circle Road’s original operating agreement, dated Decem-




      1
        Unless otherwise noted, all statutory 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. We round all monetary amounts to the nearest
dollar.
                                       -3-

[*3] ber 1, 2004, provided that each member had a 50% “participation percentage”

and that profits, losses, and deductions would be allocated 50% to each member.

      On January 1, 2006, Circle Road established a defined benefit plan under

which it made contributions to retirement accounts set up for the members’ ben-

efit. Circle Road contributed to that plan $288,897 in 2011 and $650,454 in 2012

and claimed deductions for those contributions. On Schedules K-1, Partner’s

Share of Income, Deductions, Credits, etc., Circle Road allocated to petitioner ap-

proximately 92% of the 2011 contribution2 (viz., $265,560) and 100% of the 2012

contribution (viz., $650,454). On his Forms 1040, U.S. Individual Income Tax

Return, for 2011 and 2012, petitioner reported flow-through deductions of

$265,560 for 2011 and $640,454 for 2012.3

      The IRS selected Circle Road’s and petitioner’s 2011 and 2012 returns for

examination. During its examination the IRS challenged Circle Road’s allocation

to petitioner of amounts exceeding 50% of the retirement plan contributions. Cir-

cle Road had amended its operating agreement five times between 2008 and 2012



      2
       The balance of Circle Road’s 2011 contribution was made on behalf of its
other member, Eneas Kane, and that portion of the contribution was allocated to
him.
      3
      It is unclear why petitioner for 2012 reported a flow-through deduction of
$640,454, or $10,000 less than the amount reported to him on the Schedule K-1.
                                         -4-

[*4] to make exceptions to the 50-50 allocation of certain partnership items. But

none of these amendments addressed allocation of retirement plan contributions,

and petitioner provided no documentation to substantiate that an amendment

addressing this subject had been made.

      On March 23, 2016, the IRS sent petitioner a notice of deficiency determin-

ing deficiencies of $46,473 for 2011 and $110,330 for 2012. These deficiencies

reflected partial disallowance of flow-through deductions from Circle Road attrib-

utable to the retirement plan contributions. On the attached Form 886A, Explana-

tion of Items, the IRS stated:

      Because your distributive share of the deductions for the contri-
      butions to the retirement plan sponsored by Circle Road Financial,
      LLC are limited to the amounts allowed in the operating agreement
      for Circle Road Financial, LLC, you are allowed deductions for the
      contributions to the Plan in the amounts of $132,780 and $325,227,
      for the taxable years 2011 and 2012, respectively. Therefore, your
      taxable income is increased by $132,780 and $315,227, for the
      taxable years 2011 and 2012, respectively.

      For 2011 the IRS allowed petitioner a deduction for 50% of the amount that

Circle Road had contributed and allocated to him ($265,560 ÷ 2 = $132,780). For

2012 the IRS allowed petitioner a deduction for 50% of the total amount that Cir-

cle Road had contributed and allocated to him ($650,454 ÷ 2 = $325,227). Be-
                                        -5-

[*5] cause petitioner for 2012 had claimed a deduction of only $640,454, the

adjustment to his income for that year was $315,227.

      Petitioner timely petitioned this Court for redetermination. In his petition

he alleged that Circle Road’s members had modified the operating agreement to

permit “a special allocation of the deduction at issue” and that their “established

course of dealing and performance was to specially allocate” this deduction. On

July 13, 2016, respondent filed his answer, denying for lack of substantiation pe-

titioner’s allegation that Circle Road’s operating agreement had been modified in

this way.

      On December 6, 2016, petitioner provided to the IRS Appeals Office a de-

claration from Circle Road’s other member, Eneas Kane. In that declaration Mr.

Kane averred that Circle Road had specially allocated to petitioner “both the cost

and accompanying deduction attributable to the pension benefit.” He also averred

that: (1) Circle Road’s “special allocations were reflected in the respective mem-

ber’s capital accounts”; (2) he “agreed to the special allocations and the way they

were made”; (3) the special allocations were “consistent with our economic shar-

ing arrangements and * * * [the] operating agreement as modified”; and (4) Circle

Road’s “established course of dealing and performance was to specially allocate

the pension deduction.” The IRS Appeals Office accepted Mr. Kane’s declaration
                                         -6-

[*6] as establishing that he and petitioner had orally modified Circle Road’s

operating agreement to allow a special allocation of the defined benefit plan

contributions. On that basis, the parties began discussing a settlement of the

underlying tax issues.

      On April 10, 2017, respondent filed a motion for leave to file an amendment

to answer, which we granted on May 1, 2017. In the amendment to answer re-

spondent noted that petitioner’s allowable deductions were subject to the “earned

income” limitation in section 404(a)(8)(C). (That section provides in part that cer-

tain retirement plan contribution deductions are limited to the earned income an

individual derives from the trade or business with respect to which the plan is es-

tablished.) The parties subsequently agreed that this limitation does not apply for

2011 because petitioner’s adjusted earned income ($520,053) exceeded the alloca-

tion to petitioner that the parties agree is proper ($265,560). The parties agree that

this limitation does apply for 2012 because petitioner’s adjusted earned income

($489,687) was lower than the allocation to petitioner upon which the parties have

agreed ($640,454).

      On May 15, 2017, the parties filed a stipulation of settled issues in which

they agreed that: (1) petitioner’s distributive share of the deduction attributable to

Circle Road’s retirement plan contributions is $265,560 for 2011 and $640,454 for
                                        -7-

[*7] 2012; (2) petitioner is entitled to flow-through deductions of $265,560 for

2011 and $489,687 for 2012; (3) there is no deficiency for 2011; and (4) there is a

deficiency of $52,769 for 2012. This stipulation “resolve[d] all issues in this case

other than petitioner’s claim for litigation and administrative costs.” On June 14,

2017, petitioner filed a motion for reasonable litigation and administrative costs,

and further briefing ensued.

                                     Discussion

A.    Governing Statutory Framework

      Section 7430 provides for the award of litigation and/or administrative costs

to a taxpayer in a proceeding involving the determination of any tax, interest, or

penalty. Such an award may be made where the taxpayer can demonstrate that he:

(1) is the “prevailing party”; (2) has exhausted administrative remedies within the

IRS; (3) has not unreasonably protracted the proceeding; and (4) has claimed “rea-

sonable” costs. Sec. 7430(a), (b)(1), (3), (c)(1) and (2); Polz v. Commissioner,

T.C. Memo. 2011-117; Nguyen v. Commissioner, T.C. Memo. 2003-313. These

requirements are conjunctive; failure to satisfy any one precludes an award of

costs to the taxpayer. See Minahan v. Commissioner, 88 T.C. 492, 497 (1987);

Marten v. Commissioner, T.C. Memo. 2000-186. Respondent concedes that the
                                         -8-

[*8] second, third, and fourth requirements are satisfied here. Thus, the only

question is whether petitioner is the “prevailing party.”

      To be the “prevailing party,” a taxpayer must satisfy a net worth require-

ment. Section 7430(c)(4)(A)(ii) provides, with refinements inapposite here, that a

taxpayer cannot be a “prevailing party” unless he is a “party” within the meaning

of 28 U.S.C. sec. 2412(d)(2)(B). That section provides in pertinent part as

follows:

      “[P]arty” means (i) an individual whose net worth did not exceed
      $2,000,000 * * * , or (ii) any owner of an unincorporated business, or
      any partnership, corporation, association, unit of local government, or
      organization, the net worth of which did not exceed $7,000,000 at the
      time the civil action was filed, and which had not more than 500
      employees * * *

To be a “prevailing party,” the taxpayer must also establish that he “substantially

prevailed” with respect to either the amount in controversy or the most significant

set of issues presented. Sec. 7430(c)(4)(A)(i). The taxpayer has the burden of

proving satisfaction of both requirements. Rule 232(e).

B.    Analysis

      The parties initially dispute whether petitioner satisfies the net worth re-

quirement. Petitioner concedes that his personal net worth has “exceed[ed] seven

million dollars at all times relevant to seeking an award of costs in this matter.”
                                         -9-

[*9] Respondent contends that the $7 million net worth limitation in 28 U.S.C.

sec. 2412(d)(2)(B)(ii) applies to petitioner as “an[] owner of an unincorporated

business” and that he therefore cannot qualify as a “prevailing party” within the

meaning of section 7430(c)(4)(A)(ii). See sec. 301.7430-5(g)(3)(ii), Proced. &

Admin. Regs. Petitioner contends that the $7 million net worth limitation applies

to the “unincorporated business” rather than its owner; that Circle Road had a net

worth of less than $7 million and fewer than 500 employees at all relevant times;

and that petitioner, as an owner of Circle Road, is thus a “party” as defined in 28

U.S.C. sec. 2412(d)(2)(B). Given our disposition, we need not decide this

threshold question.

      Assuming arguendo that petitioner could meet the net worth requirement, he

would still not be the “prevailing party” unless he “substantially prevailed” with

respect to the amount in controversy or the most significant set of issues present-

ed. A taxpayer will not be treated as the prevailing party if “the position of the

United States in the proceeding was substantially justified.” Sec. 7430(c)(4)(B)(i).

      The position of the United States is “substantially justified” if it is “justified

to a degree that could satisfy a reasonable person” and has a “reasonable basis

both in law and fact.” Swanson v. Commissioner, 106 T.C. 76, 86 (1996) (quoting

Pierce v. Underwood, 487 U.S. 552, 565 (1988)); see also Sher v. Commissioner,
                                         - 10 -

[*10] 861 F.2d 131, 134-135 (5th Cir. 1988), aff’g 89 T.C. 79 (1987); Powers v.

Commissioner, 100 T.C. 457, 470 (1993), aff’d in part, rev’d in part, 43 F.3d 172

(5th Cir. 1995). The determination of reasonableness is based on all the facts of

the case and the available legal precedent. Coastal Petrol. Refiners, Inc. v. Com-

missioner, 94 T.C. 685, 688, 694-695 (1990). Where a factual determination is re-

quired, the position of the United States is substantially justified until the taxpayer

has provided substantiation sufficient to justify resolution of that factual issue in

his favor. Goertler v. Commissioner, T.C. Memo. 2003-136, 85 T.C.M. (CCH)

1297, 1299.

      “The Commissioner’s position may be substantially justified even if incor-

rect ‘if a reasonable person could think it correct.’” Fitzpatrick v. Commissioner,

T.C. Memo. 2017-88, at *5-*6 (quoting Maggie Mgmt. Co. v. Commissioner, 108

T.C. 430, 443 (1997)). The fact that the IRS loses a case or makes a concession

“does not by itself establish that the position taken is unreasonable” but is “a fact-

or that may be considered.” Maggie Mgmt. Co., 108 T.C. at 443; see Wilfong v.

United States, 991 F.2d 359, 364 (7th Cir. 1993); Sokol v. Commissioner, 92 T.C.

760, 767 (1989); Fitzpatrick, at *6.

      Where a taxpayer seeks both litigation and administrative costs, we apply

the “substantially justified” standard to the IRS’ position on two separate dates.
                                         - 11 -

[*11] For purposes of the administrative proceeding, the IRS’ position is that

taken at the earlier of: (1) the date the taxpayer receives the determination of the

IRS Appeals Office or (2) the date of the notice of deficiency. Sec. 7430(c)(7)(B).

For purposes of a Tax Court proceeding, the IRS’ position generally is that taken

at the time the Commissioner files his answer. E.g., Sher, 861 F.2d at 134-135.

      Respondent maintained the same position in the notice of deficiency and in

his answer to the petition, viz., that petitioner was not entitled to claim flow-

through deductions for amounts exceeding 50% of Circle Road’s defined benefit

plan contributions. We accordingly evaluate those positions together. See Huff-

man v. Commissioner, 978 F.2d 1139, 1144-1147 (9th Cir. 1992), aff’g in part,

rev’g in part T.C. Memo. 1991-144; Maggie Mgmt. Co., 108 T.C. at 442; Cooley

v. Commissioner, T.C. Memo. 2012-164.

      The regulations provide that, for contributions to a defined benefit plan, a

partner’s distributive share of (i) contributions made on behalf of self-employed

individuals and (ii) deductions for such contributions is determined in the same

manner as his distributive share of partnership taxable income. Sec. 1.404(e)-

1A(f), Income Tax Regs. Section 702(a) provides that a partner (or member of an

LLC treated as a partnership) shall take into account his distributive share of the

partnership’s items of income and deductions. Section 704(a) provides that a part-
                                        - 12 -

[*12] ner’s distributive share generally shall be determined in accordance with the

partnership agreement. Section 761(c) defines a partnership agreement to include

“any modifications * * * made prior to, or at, the time prescribed by law for the

filing of the partnership return for the taxable year * * * which are agreed to by all

the partners, or which are adopted in such other manner as may be provided by the

partnership agreement.” Modifications to a partnership agreement generally may

be made orally or in writing. Sec. 1.761-1(c), Income Tax Regs.

      On the Form 886A, the IRS explained the adjustments in the notice of defi-

ciency by stating that petitioner’s deduction was “limited to the amounts allowed

in the operating agreement for Circle Road.” The operating agreement stated that

petitioner had a 50% “participation percentage” and that all partnership taxable

income and deductions, unless otherwise specified, were to be allocated in accord-

ance with that participation percentage. The adjustments the IRS made, limiting

petitioner’s deduction to 50% of Circle Road’s contributions, comport with its

understanding that his deduction was limited to what was stated in the operating

agreement.

      On December 6, 2016, roughly five months after respondent filed his an-

swer, counsel for petitioner provided to the IRS Appeals Office a declaration from

Mr. Kane, the other member of Circle Road. In that declaration Mr. Kane averred
                                       - 13 -

[*13] that he and petitioner had orally modified the operating agreement to author-

ize a special allocation for retirement plan contributions and the flow-through

deductions attributable thereto. Although petitioner had previously provided the

IRS with written amendments that modified the operating agreement in other

respects, this was the first evidence petitioner had supplied of an oral amendment

affecting retirement plan deductions.4 After reviewing Mr. Kane’s declaration,

respondent agreed to concede the deficiency for 2011 and reduce the deficiency

for 2012. We find this position to be reasonable in fact and in law.

      Respondent properly made a partial concession of this case after petitioner

supplied substantiation concerning the central factual issue in dispute. Before re-

spondent received that substantiation, respondent’s position--disallowing petition-

er’s flow-through deductions to the extent they exceeded 50% of Circle Road’s

contributions--had a “reasonable basis both in law and fact” and was “justified to a

degree that could satisfy a reasonable person.” Swanson, 106 T.C. at 86 (quoting

      4
        During the examination the IRS had issued multiple document requests
seeking copies of Circle Road’s organizational documents, including all “amend-
ments, modifications, supplemental agreements, bylaws, side letters, and all other
agreements” and “an explanation for all special allocation of the Schedule K items
to the respective members.” One document request specifically sought informa-
tion “[t]o determine whether the special allocation of the income and loss items on
Schedule K are appropriate under § 704(b).” Petitioner provided the IRS with
Circle Road’s original operating agreement and the five written amendments but
no evidence of any oral amendments.
                                        - 14 -

[*14] Underwood, 487 U.S. at 565); Rosario v. Commissioner, T.C. Memo. 2002-

247, 84 T.C.M. (CCH) 392, 393. Because the position of the United States was

“substantially justified” under section 7430(c)(4)(B)(i), petitioner was not a

“prevailing party” and thus is not entitled to an award of fees or costs. See sec.

7430(a), (c)(4).5

      To implement the foregoing,


                                                 An appropriate order and decision

                                       will be entered.




      5
        Petitioner cites various documents generated during the 2011 and 2012
audits, including notices of proposed adjustment (NOPAs) issued to Circle Road,
to support his contention that the IRS was pursuing various legal theories, includ-
ing theories based on section 404. But the theory on which the IRS ultimately
settled was that the operating agreement capped petitioner’s deductions at 50% of
Circle Road’s defined benefit plan contributions. The amended NOPA issued to
Circle Road stated that, because petitioner and Mr. Kane “each have a 50% profits
share, the deductions in each tax year are allocated 50/50 to each partner.” And as
explained in the text, the notice of deficiency--the key document in question--ad-
vanced that same position.
