                        T.C. Memo. 1997-66



                      UNITED STATES TAX COURT



                DONALD S. HAZELTON, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 24786-95.                    Filed February 4, 1997.



     James E. Merritt, for petitioner.

     Laurel M. Robinson, for respondent.




                        MEMORANDUM OPINION



     DAWSON, Judge:   This case was assigned to Special Trial

Judge D. Irvin Couvillion pursuant to section 7443A(b)(4)and
                               - 2 -


Rules 180, 181, and 183.1   The Court agrees with and adopts the

opinion of the Special Trial Judge, which is set forth below.

                OPINION OF THE SPECIAL TRIAL JUDGE

     COUVILLION, Special Trial Judge:   This case is before the

Court on petitioner's motion for administrative and litigation

costs2 pursuant to section 7430 and Rule 231.

     Respondent determined a deficiency of $8,214 in petitioner's

Federal income tax for 1992, an addition to tax under section

6651(a)(1) of $1,965.75, and an addition to tax under section

6654(a) of $341.21.   After the case was calendared for trial, but

prior to trial, the parties filed a stipulation of settled issues

that disposed of all adjustments in the notice of deficiency.

The parties agreed that there was an overpayment in tax for 1992,

and respondent conceded that no additions to tax were due for

that year.   Petitioner thereafter filed the motion for

administrative and litigation costs, and respondent, pursuant to

this Court's order, filed an objection to petitioner's motion.

Neither party requested a hearing, and the Court concludes that a



1
      Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the year in issue. All Rule
references are to the Tax Court Rules of Practice and Procedure.
2
      Although petitioner's motion is styled "Motion for Award of
Reasonable Litigation Costs", the substance of the motion
evidences an intent to move for administrative costs as well as
litigation costs. The Court, therefore, considers the motion
accordingly.
                                  - 3 -


hearing is not necessary for the proper disposition of this

motion.    Rule 232(a)(3).

                               Background

       During the year at issue, petitioner was married and had one

son.    His primary occupation during this year was painting, as an

independent contractor.      In early 1992, petitioner was awarded a

contract to reconstruct the canopy area and paint the hallways

for Seton Medical Center in Daly City, California.     For reasons

not fully delineated to the Court, petitioner's financial and

family situations deteriorated during 1992.     In September 1992,

petitioner's wife left him and their son and moved in with her

mother.    Shortly thereafter, petitioner and his son were evicted

from their apartment.    In addition, petitioner's truck, which he

used in his painting business, was repossessed.

       As a result of these circumstances, petitioner failed to

keep track of his financial records and, apparently, lost those

records he had accumulated prior to his eviction.     Petitioner

developed severe problems with alcohol and drugs and was once

beaten and shot by a group of drug addicts.     He required

hospitalization as a result of this beating and subsequently

attempted suicide.

       In April 1993, circumstances began to turn around for

petitioner.    He applied for, and received from the San Francisco

County Department of Social Services, homeless aid for temporary
                               - 4 -


shelter and immediate need assistance for food.   Also during this

month, petitioner (along with his estranged wife) filed with the

Internal Revenue Service (IRS) a Form 4868, application for an

automatic 4-month extension for filing their income tax return

for 1992.

     Nevertheless, petitioner failed to file a Federal income tax

return for 1992.   Respondent received information from third

party payers that reflected amounts paid as income to petitioner

during 1992.   Based on such information, respondent determined

petitioner's 1992 tax liability.

     Prior to issuance of the notice of deficiency, on July 7,

1995, respondent mailed a letter (30-day letter) to petitioner

setting out the proposed deficiency in tax and the additions to

tax recited above.   In the computations, respondent allowed

petitioner the standard deduction of $3,000, a personal exemption

of $2,300, and a withholding credit of $351.   The 30-day letter

informed petitioner that respondent had no record of his filing a

return for 1992, that respondent had computed the tax liability

based on information provided by payers, that this computation

did not give full credit for exemptions or deductions, and that

petitioner would have to respond within 30 days from the date of

the letter to avoid an assessment based on such computation.

     On August 7, 1995, petitioner's attorney mailed respondent a

letter purporting to be a written protest (protest) to the
                               - 5 -


proposed adjustments in the 30-day letter.   In this protest,

petitioner requested an appeals conference and further asserted

that (1) respondent had failed to account for petitioner's

deductible losses and business expenses, (2) petitioner was

married during 1992, and, therefore, the income from third-party

payers was community property income of which only 50 percent was

taxable to him, (3) respondent had failed to allow petitioner the

correct standard deduction as well as a dependency exemption for

his son, (4) respondent had failed to account for an overpayment

from petitioner's 1994 tax year that had already been applied

toward his proposed deficiency for 1992, and (5) the additions to

tax should not be imposed because petitioner's failure to file a

return and pay estimated taxes was due to reasonable cause.     The

protest contained a detailed recitation of facts and legal

arguments to support petitioner's assertions; however, very

little relevant supporting documentation was submitted with the

protest.   Specifically, petitioner submitted:   (1) A Form 2848,

power of attorney; (2) the aforementioned Form 4868, request for

a filing extension for 1992; (3) his wife's Federal income tax

return for 1992 (filed March 15, 1994); (4) a profit and loss

statement that was prepared by the petitioner with regard to his

1992 contract work at Seton Medical Center;3 (5) two "Notices of


3
      Petitioner also reported on this statement that his truck
was repossessed by G.M.A.C. during 1992, entitling him to a loss.
                               - 6 -


Action" from the San Francisco County Department of Social

Services approving the aforementioned housing and food assistance

for petitioner; and (6) an illegible document purporting to be an

acknowledgment by respondent, dated December 20, 1994, of receipt

of petitioner's request for an installment arrangement to pay his

taxes, with no indication for which year such request was made.

No other supporting documentation was submitted with petitioner's

protest.

     On August 23, 1995, respondent issued the notice of

deficiency for petitioner's 1992 tax year for the amounts recited

earlier.

     On November 27, 1995, petitioner filed a timely petition

with this Court.   At the time the petition was filed,

petitioner's legal residence was San Francisco, California.     In

his petition, he reasserted allegations similar to those

contained in the written protest.

     Respondent filed an answer on January 16, 1996.     Shortly

after the answer was filed, respondent forwarded the case file to

respondent's Appeals Office in San Francisco.   On February 7,

1996, the appeals officer assigned to the case, Margaret Gerdine

(Ms. Gerdine or appeals officer), sent a letter to petitioner's

attorney requesting that the parties schedule an informal

conference (appeals conference) to discuss the underlying issues

of the case, and at which petitioner could present facts and
                               - 7 -


legal authority to support his asserted positions.   Also in this

letter, Ms. Gerdine requested that petitioner produce, at such

conference, documentation "to establish facts concerning

[petitioner's] circumstances that were mentioned in the Tax Court

petition" and "to substantiate [petitioner's] filing status,

dependent and expenses mentioned in the Tax Court petition."

     The appeals conference was held on April 17, 1996.

Petitioner's attorney presented documentation supporting the

deductions and dependency exemption claimed by petitioner.

Petitioner's attorney informed Ms. Gerdine that he had requested

additional documentation from third parties and would forward

such information to her upon his receipt of the same.    Two days

later, petitioner's attorney forwarded this additional

documentation to Ms. Gerdine, including job descriptions and

invoices of payments from the Seton Medical Center to petitioner

in 1992.

     Based upon the appeals conference and the substantiating

documentation submitted by petitioner, the case was settled.    In

the settlement, petitioner agreed that he had received $31,598 in

income during 1992, and that he was entitled to a $3,000 standard

deduction for that year.   Respondent agreed to allow petitioner

(1) a dependency exemption for his son in the amount of $2,300,

(2) Schedule C expenses in the amount of $22,059, (3) a loss of

$962 resulting from the repossession of his car, and (4) a
                               - 8 -


casualty loss of $600 resulting from the theft of petitioner's

tools.   Based on these figures, computational adjustments were

made with regard to petitioner's self-employment tax.   Respondent

conceded that petitioner was not liable for the additions to tax

under sections 6651(a)(1) and 6654(a).    The revised tax liability

as a result of the settlement was $598.   Petitioner's withholding

from 1992 of $351 coupled with his overpayment from the 1994 tax

year of $953 (which was being held by respondent for petitioner's

1992 tax liability) resulted in $1,304 total payments for 1992,

thereby creating an overpayment for that year in the amount of

$706.

     On August 20, 1996, the parties filed a stipulation with the

Court reflecting, for the 1992 tax year, the settlement above

described.   On August 21, 1996, pursuant to the foregoing

stipulation, this Court entered an agreed decision in this case

that reflected the parties' settlement.

     Thereafter, on October 3, 1996, petitioner filed his motion

for administrative and litigation costs (motion), seeking a total

of $10,307.65 in "reasonable litigation costs"4 plus additional

attorneys' fees to be incurred in prosecution of the motion.




4
      The $10,307.65 in "litigation costs" consisted of a filing
fee of $60, attorneys' fees and "related costs incurred in
preparing the Tax Court petition" of $10,176.25, and
"reproduction charges" of $71.40.
                               - 9 -


     As a result of the filing of petitioner's motion, the Court

ordered that the decision entered on August 21, 1996, be vacated

and set aside, and that the vacated decision be refiled as a

stipulation of settlement.   Respondent was ordered to file a

written response to petitioner's motion.    See Rules 232(f),

231(c).   In the response, respondent objected to petitioner's

motion, contending that respondent's position was substantially

justified both in the administrative proceeding and in the Court

proceeding.

                             Discussion

     A taxpayer who substantially prevails in an administrative

or Court proceeding may be awarded a judgment for reasonable

costs incurred in such proceedings.    Sec. 7430(a)(1) and (2).   A

judgment may be awarded under section 7430 if a taxpayer (1) is

the "prevailing party", (2) exhausted the administrative remedies

available to the taxpayer within the IRS (if the judgment is for

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

proceedings.   Sec. 7430(a), (b)(1), (b)(4).   A taxpayer must

satisfy each of these three requirements to be entitled to a

judgment under section 7430.   Respondent concedes that petitioner

exhausted the administrative remedies available and did not

unreasonably protract the proceedings.    Therefore, the Court is

left to decide whether petitioner was the prevailing party.
                              - 10 -


     To qualify as the "prevailing party", the taxpayer must

establish that (1) the position of the United States in the

proceeding was not substantially justified,5 (2) the taxpayer

substantially prevailed with respect to the amount in controversy

or with respect to the most significant issue or set of issues

presented, and (3) the taxpayer satisfies the applicable net

worth requirements.   Sec. 7430(c)(4)(A).   Respondent concedes

that petitioner meets the second and third criteria listed above;

however, respondent contends that the position taken in both the

administrative and litigation aspects of the proceedings was

substantially justified.   Rule 232(e); Dixson Intl. Serv. Corp.

v. Commissioner, 94 T.C. 708, 714-715 (1990); Gantner v.

Commissioner, 92 T.C. 192, 197 (1989), affd. 905 F.2d 241 (8th

Cir. 1990).   Accordingly, the issue is whether "the position of

the United States in the proceeding was not substantially

justified."   Gantner v. Commissioner, 905 F.2d at 245.

     In deciding this issue, the Court must first identify the

point in time at which the United States is considered to have

taken a position and then decide whether the position taken from

that point forward was not substantially justified.    The "not

5
      In relevant part, the Taxpayer Bill of Rights 2 (TBR2),
Pub. L. 104-168, secs. 701-704, 110 Stat. 1452, 1463-1464 (1996),
amended sec. 7430 to place on the Commissioner the burden of
proving that respondent's position in the administrative
proceeding and the proceeding in this Court were substantially
justified. The provisions of TBR2 are effective only with
respect to proceedings commenced after July 30, 1996.
                              - 11 -


substantially justified" standard is applied as of the separate

dates that respondent took a position in the administrative

proceeding as distinguished from the proceeding in this Court.

Sec. 7430(c)(7)(A) and (B); Han v. Commissioner, T.C. Memo. 1993-

386.   For purposes of the administrative proceeding, respondent

took a position on August 23, 1995, the date of the notice of

deficiency.   Sec. 7430(c)(7)(B).6   For purposes of the proceeding

in this Court, respondent took a position on January 16, 1996,

the date respondent filed the answer.    See Huffman v.

Commissioner, 978 F.2d 1139, 1143-1147 (9th Cir. 1992), affg. in

part and revg. in part on other grounds, and remanding T.C. Memo.

1991-144.   In this case, respondent's position as of each of

these dates was the same.   More specifically, respondent's

position was that petitioner failed, without reasonable cause, to

file a Federal income tax return for 1992, failed to pay

estimated taxes, failed to report income earned by him during

1992, and failed to substantiate deductions to which he claimed

he was entitled.



6
      Sec. 7430(c)(7)(B) provides that respondent takes a
position in an administrative proceeding on the earlier of "the
date of the receipt by the taxpayer of the notice of the decision
of the [IRS] Office of Appeals" or "the date of the notice of
deficiency." No notice of decision of the IRS Appeals Office was
ever issued or received by petitioner prior to the date of the
notice of deficiency. Therefore, respondent is considered to
have taken a position on the date the notice of deficiency was
issued.
                                - 12 -


     Whether respondent's position was not substantially

justified turns on a finding of reasonableness, based upon all

the facts and circumstances, as well as the legal precedents

relating to the case.    Pierce v. Underwood, 487 U.S. 552 (1988);

Sher v. Commissioner, 89 T.C. 79, 84 (1987), affd. 861 F.2d 131

(5th Cir. 1988).   A position is substantially justified if the

position is "justified to a degree that could satisfy a

reasonable person."     Pierce v. Underwood, supra at 565; Powers v.

Commissioner, 100 T.C. 457, 470-471 (1993).    A position that

merely possesses enough merit to avoid sanctions for

frivolousness will not satisfy this standard; rather, it must

have a "reasonable basis both in law and fact".    Pierce v.

Underwood, supra at 564-565.

     The Court must "consider the basis for respondent's legal

position and the manner in which the position was maintained."

Wasie v. Commissioner, 86 T.C. 962, 969 (1986).    The fact that

respondent eventually loses or concedes a case does not establish

an unreasonable position.    Sokol v. Commissioner, 92 T.C. 760,

767 (1989); Baker v. Commissioner, 83 T.C. 822, 828 (1984),

vacated on other issues 787 F.2d 637 (D.C. Cir. 1986).     The

reasonableness of respondent's position and conduct necessarily

requires considering what respondent knew at the time.     Cf.

Rutana v. Commissioner, 88 T.C. 1329, 1334 (1987); DeVenney v.

Commissioner, 85 T.C. 927, 930 (1985).
                              - 13 -


     Petitioner argues that respondent's position was not

reasonable as a matter of law or fact.   In support of his

argument, petitioner claims he was never allowed any

administrative consideration of his case prior to issuance of the

notice of deficiency, and, therefore, when the notice of

deficiency was issued, he was compelled to petition this Court

for relief.   Petitioner contends that, "if respondent had not

disregarded [his] request for an appeal's office conference, [he]

would not have incurred the added costs of preparing the Tax

Court petition and subsequent stipulation documents."    He

supports this contention by alleging that, after he received the

notice of deficiency and filed his petition, he "resubmitted his

written protest" at the conference with Ms. Gerdine, and that she

thereby "determined that such expenses were adequately

documented" and allowed his claimed deductions.7   The Court

dismisses this argument.   Under section 7430(c)(7), respondent's

"position" for purposes of this motion, is not considered first

7
      Petitioner seems to be suggesting that the documentation he
presented to Ms. Gerdine at the appeals conference was identical
to that which he had filed with his written protest, and that, if
it was sufficient substantiation at the time of the appeals
conference, it should have been sufficient as a written protest
to prevent the issuance of a notice of deficiency. The Court
does not agree. It is clear from the record that petitioner's
written protest, prior to issuance of the notice of deficiency,
consisted of a letter that contained certain statements of fact
and arguments of law, and a few documents purporting to support
the allegations contained in the letter. The limited documentary
evidence provided was clearly insufficient to substantiate any of
the facts claimed in the letter.
                              - 14 -


taken until the date the notice of deficiency was issued.    The

documentary evidence provided to the Internal Revenue before the

issuance of the deficiency notice was insufficient.

     In Lennox v. Commissioner, 998 F.2d 244 (5th Cir. 1993),

revg. in part T.C. Memo. 1992-382, the Fifth Circuit Court of

Appeals held that, in determining whether respondent's position

is substantially justified on the date of issuance of the notice

of deficiency under section 7430(c)(7)(B)(ii), the position must

be analyzed in the context of what caused respondent to take the

position set out in the notice of deficiency.    The Court

reiterated the holdings in Pierce v. Underwood, supra, and Powers

v. Commissioner, supra, that respondent's position is

substantially justified if the position is "justified to a degree

that could satisfy a reasonable person".   However, the Court

noted that respondent's position is not substantially justified

if, at the time the notice of deficiency is issued, respondent

had merely a "suspicion" of the taxpayer's liability, and the

opportunity existed for further investigation.

     In this case, respondent had a great deal more than a

suspicion of petitioner's liability at the time the notice of

deficiency was issued.   Respondent had received credible third-

party information from payers that petitioner had been the

recipient of income during 1992 that he had not reported.

Respondent's records reflected that petitioner had not filed a
                              - 15 -


return for 1992 and had not made estimated tax payments that

year.   Petitioner's written protest admitted that he had failed

to file a return and make estimated tax payments but did not

adequately substantiate with documentary evidence that these

failures to file the return were due to reasonable cause.

Petitioner admitted further in his written protest that he had

received income during 1992 in amounts different from that which

respondent calculated in the 30-day letter, but he failed to

substantiate with documentary evidence the amounts of income he

admitted receiving and failed to provide additional documentary

evidence to support the deductions and exemptions to which he

claimed he was entitled.

     Respondent's position on the date of the notice of

deficiency was that petitioner had unreasonably failed to file a

Federal income tax return for 1992, had failed to pay estimated

taxes, had failed to report income received by him during 1992,

and had failed to substantiate deductions and exemptions to which

he claimed he was entitled.   Respondent's position on that date

was clearly justified to a degree that could satisfy a reasonable

person, and, thus, respondent was substantially justified in the

context of Lennox v. Commissioner, supra, Pierce v. Underwood,

supra, and Powers v. Commissioner, 100 T.C. 457 (1993).

Consequently, respondent's position on the date the notice of

deficiency was issued was substantially justified.
                               - 16 -


     In deciding whether petitioner is entitled to administrative

costs, the Court takes into account the information available to

respondent from the date the notice of deficiency was mailed and

from that point forward through the date respondent's answer was

filed in the legal proceeding.    Between the time that the notice

of deficiency was mailed and the time respondent's answer was

filed, petitioner provided no records or pertinent documentation

to respondent.    Accordingly, respondent was substantially

justified in maintaining the positions determined in the notice

of deficiency, and, therefore, respondent's position in the

administrative proceeding was substantially justified.

     The Court next addresses the reasonableness of respondent's

position in the litigation aspects of the case.     After the

petition was filed and before respondent filed the answer, there

were no contacts or efforts to settle the case between petitioner

and respondent.   At the time the answer was filed, respondent did

not have sufficient information to consider that petitioner's

claims were properly substantiated.     After respondent filed an

answer, an appeals conference was held with petitioner, and, as a

result of that conference, the case settled.     On this record, as

soon as proper documentation was submitted to respondent by

petitioner, at the appeals conference with the appeals officer,

respondent allowed petitioner's claimed deductions, conceded that
                              - 17 -


petitioner was not liable for the additions to tax, and the

parties reached a basis for settlement.

     For purposes of determining the reasonableness of

respondent's position in the answer, the Court considers those

facts known to respondent at the time the answer was filed.       At

the time the answer was filed, respondent did not have the

benefit of the substantiating information petitioner later

provided at the appeals conference.    Consequently, the Court

holds that respondent's position was reasonable and, therefore,

substantially justified at the time the answer was filed.

Further, the Court holds that respondent was substantially

justified in maintaining the positions taken in the answer up to

the time of settlement.   Petitioner, therefore, is not entitled

to a recovery of litigation costs.

     Since respondent's position was substantially justified in

both the administrative and the litigation aspects of this case,

it is not necessary to decide the amount of petitioner's

reasonable administrative and litigation costs.    Petitioner's

motion, therefore, will be denied.



                                           An appropriate order and

                                      decision will be entered.
