                        T.C. Memo. 2004-115



                      UNITED STATES TAX COURT



       ROBERT C. MCKEE AND VALERY W. MCKEE, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 4036-03.              Filed May 12, 2004.


     Donald L. Feurzeig, for petitioners.

     Charlotte Mitchell, for respondent.



                        MEMORANDUM OPINION


     MARVEL, Judge:   This case is before the Court on

petitioners’ motion for reasonable litigation costs filed

pursuant to section 7430 and Rule 231.   Unless otherwise

indicated, all section references are to the Internal Revenue
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Code in effect at the time petitioners filed the petition, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.   When the petition in this case was filed,

petitioners’ mailing address was in Whitethorn, California.

     On October 20, 2003, the day this case was calendared for

trial, the parties filed a stipulation of settled issues.    On

October 31, 2003, petitioners filed their motion for reasonable

litigation costs.   After obtaining an extension of time in which

to respond, on February 2, 2004, respondent filed an objection to

petitioners’ motion.   On February 17, 2004, petitioners filed an

additional affidavit pursuant to Rule 232(d).

     Neither party requested a hearing, and we have concluded

that a hearing on this matter is not necessary.   See Rule

232(a)(2).   In disposing of this motion, we rely on the parties’

filings and attached exhibits.

                            Background

     During 2002, petitioners were selected for audit.    In a

letter to respondent dated August 9, 2002, on behalf of

petitioners, Roland Potter, C.P.A., addressed certain proposed

adjustments to petitioners’ income tax.   Mr. Potter did not

enclose any documents with the letter.

     As an attachment to a letter dated January 9, 2003,

respondent sent to petitioners Form 4549A, Income Tax Examination

Changes, for petitioners’ 1999, 2000, and 2001 taxable years.
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In the letter, respondent provided the following explanation:

     Since the statute of limitations will expire for the
     1999 year on April 15, we cannot issue a 30 day letter
     that would allow you to file a protest to have your
     case heard by our Appeals division. We send [sic] you
     a statute extension earlier, but since you did not sign
     and return the extension[,] April 15 remains the
     statute date. If your case is unagreed, we will send
     you a statutory notice of deficiency. This is a
     certified letter than [sic] will allow you to file a
     petition to have your case heard in Tax Court. * * *

Respondent also sent a copy of the Form 4549A and a brief cover

letter dated January 17, 2003, to petitioners’ attorney, Donald

L. Feurzeig.

     In a notice of deficiency dated March 10, 2003 (the notice),

respondent determined the following deficiencies with respect to

petitioners’ income tax:

               Year            Deficiency

               1999             $42,947
               2000              73,891
               2001              47,927

The notice contained the following errors:   (1) An incomplete

explanation of Schedule E, Supplemental Income and Loss,

adjustments, (2) an alternative minimum tax computational error

twice disallowing petitioners’ 1999 net operating loss (NOL), and

(3) missing computations that would have explained the

adjustments to petitioners’ 1999 NOL.

     On March 13, 2003, petitioners filed a petition with this

Court contesting respondent’s determinations.   On April 24, 2003,

respondent filed an answer.   Soon thereafter, in a letter dated
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May 5, 2003, petitioners submitted to respondent a section

7430(g) qualified offer in the amount of $6,000.   Respondent did

not accept petitioners’ settlement offer.

     On August 12, 2003, respondent held an Appeals conference

with petitioners’ representative.   Before the conference, Appeals

Officer Melvin M. Chinen had provided to petitioners the

information missing from the notice and had agreed to correct the

computational error.   According to Appeals Officer Chinen, the

two main issues in the case were:   (1) Whether petitioner Robert

C. McKee was a dealer in real estate, whose sales of undeveloped

ranch property parcels would be taxed as ordinary income; and (2)

whether certain losses petitioners claimed are limited under

sections 1366(d), 465, and 469.

     As a result of the Appeals conference, the parties reached a

settlement. In resolving the dealer in real estate issue,

pursuant to petitioners’ offer, the parties agreed to treat 50

percent of the parcel sales as sales of dealer property, subject

to ordinary income tax, and the other 50 percent as sales giving

rise to capital gains.

     In June 2002, when petitioners retained Mr. Feurzeig’s law

firm, Titchell, Maltzman, Mark & Ohleyer, P.C. (the law firm),

petitioners agreed to a fee arrangement of $300 per hour.    The

law firm expended a total of 202.8 hours on petitioners’ case.
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Petitioners now seek litigation costs of $31,078.28.1

                            Discussion

     Section 7430(a) authorizes the award of reasonable

litigation costs to the prevailing party in court proceedings

brought by or against the United States in connection with the

determination of income tax.   In order to receive an award of

reasonable litigation costs, a taxpayer must exhaust

administrative remedies and not unreasonably protract the court

proceeding, in addition to being the prevailing party.    Sec.

7430(b)(1), (3).   Unless the taxpayer satisfies all of the

section 7430 requirements, we do not award costs.    Minahan v.

Commissioner, 88 T.C. 492, 497 (1987).

     Respondent concedes that petitioners did not unreasonably

protract the court proceeding.    Respondent contends, however,

that respondent’s position with respect to the issues in the

notice was substantially justified, that petitioners did not


     1
      According to one statement in their motion for reasonable
litigation costs, petitioners “claim litigation costs of $29,800
all of which were incurred after the Statutory Notice of
Deficiency was issued on March 10, 2003”. However, in their
prayer for relief, petitioners ask that we “determine that the
award of litigation costs of $31,078.28 is reasonable”. Both the
supporting affidavit attached to the motion and petitioners’
additional affidavit filed pursuant to Rule 232(d) list costs
totaling $31,078.28. After examining the detailed summary of the
nature and amount of each item of costs, for purposes of
disposing of this motion, we conclude that the court costs and
“fees paid or incurred for the services of attorneys in
connection with the court proceeding” totaled $31,078.28. See
sec. 7430(c)(1).
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exhaust the administrative remedies available to them, and that

the costs petitioners claim are unreasonable.   In contrast,

petitioners contend that they were the prevailing party with

respect to both the amount in controversy and the most

significant issue or set of issues, that they exhausted all

available administrative remedies, and that the amount of

litigation costs sought is reasonable.

     Section 7430(c)(4)(A) and (B)(i) provides that a taxpayer is

a prevailing party if (1) the Commissioner’s position in the

court proceeding was not substantially justified, (2) the

taxpayer substantially prevailed with respect to the amount in

controversy or the most significant issue or set of issues, and

(3) the taxpayer meets the net worth requirements of 28 U.S.C.

section 2412(d)(2)(B) (2000).   See also sec. 301.7430-5(a),

Proced. & Admin. Regs.   Although the taxpayer has the burden of

proving that the taxpayer meets requirements (2) and (3), supra,

the Commissioner must show that the Commissioner’s position was

substantially justified.   See sec. 7430(c)(4)(B)(i); Rule 232(e).

     Respondent concedes that petitioners meet the net worth

requirement of 28 U.S.C. section 2412(d)(2)(B).   We first

consider whether respondent’s position in the court proceeding

was substantially justified.
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     For purposes of deciding a motion for reasonable litigation

costs, section 7430(c)(7)(A) defines the Commissioner’s

“position” as the position taken in the court proceeding.     In the

present case, respondent took a position when respondent filed an

answer to petitioners’ petition.   See Huffman v. Commissioner,

978 F.2d 1139, 1149 (9th Cir. 1992), affg. in part, revg. in part

and remanding T.C. Memo. 1991-144; Maggie Mgmt. Co. v.

Commissioner, 108 T.C. 430, 442 (1997).

     The Commissioner’s position is substantially justified if it

has a reasonable basis in both fact and law and is justified to a

degree that could satisfy a reasonable person.   Huffman v.

Commissioner, supra at 1147 n.8 (citing Pierce v. Underwood, 487

U.S. 552, 565 (1988)); Rosario v. Commissioner, T.C. Memo. 2002-

247; sec. 301.7430-5(c)(1), Proced. & Admin. Regs.    In deciding

whether the Commissioner’s position was substantially justified,

a significant factor is whether, on or before the date the

Commissioner assumed the position, the taxpayer provided “all

relevant information under the taxpayer’s control and relevant

legal arguments supporting the taxpayer’s position to the

appropriate Internal Revenue Service personnel.”2    Sec. 301.7430-



     2
      “Appropriate Internal Revenue Service personnel” are those
employees who are reviewing the taxpayer’s information or
arguments, or employees who, in the normal course of procedure
and administration, would transfer the information or arguments
to the reviewing employees. Sec. 301.7430-5(c)(1), Proced. &
Admin. Regs.
                                - 8 -

5(c)(1), Proced. & Admin. Regs.

     Petitioners contend that respondent’s position in the answer

was not substantially justified because it was “patently

incorrect or not adequately stated to be justified”.    In so

arguing, petitioners rely on the following statements respondent

made in the answer:   (1) Respondent denied that the three errors

in the notice existed, and (2) respondent denied that certain

adjustments to petitioners’ income tax, which respondent

eventually conceded, were incorrect.    In addition, petitioners

assert that Mr. Potter’s letter of August 9, 2002, had addressed

some of the adjustments that respondent later conceded.

According to petitioners, respondent’s position in the answer was

not substantially justified because respondent had been

“presented with undisputed contrary facts” beforehand.

     Although respondent ultimately conceded certain adjustments

to petitioners’ income taxes for 1999, 2000, and 2001, our focus

is on the information that respondent possessed at the time of

filing the answer.    Rosario v. Commissioner, supra.   The only

information petitioners had provided before respondent filed the

answer was the information contained in Mr. Potter’s letter.       In

the letter, Mr. Potter set forth petitioners’ disagreements with

respondent’s proposed adjustment but included no supporting

documents or other proof of his assertions.    Respondent was not

required to concede the case on the basis of Mr. Potter’s letter
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alone.   We agree with respondent that petitioners did not provide

to respondent all relevant information under their control on or

before the date respondent filed the answer.

      Moreover, after reviewing the extracts from Appeals Officer

Chinen’s Appeals closing memorandum, which explains respondent’s

position, it is clear that respondent’s position in the answer

had a reasonable basis in both fact and law that could satisfy a

reasonable person.   The dealer in real estate issue was a close

factual issue, as evidenced by its 50/50 settlement.     In

addition, with respect to the issue of losses petitioners

claimed, the Appeals closing memorandum demonstrates that the

adjustments were reasonable, and errors were attributable to the

complexity of the Code provisions.     Respondent has established

that respondent’s position was substantially justified, and,

accordingly, we do not treat petitioners as the prevailing party.

See sec. 7430(c)(4)(B)(i).

     After concluding that petitioners were not the prevailing

party, we need not consider whether petitioners exhausted their

administrative remedies or whether the costs petitioners claimed

are reasonable.   See Minahan v. Commissioner, 88 T.C. at 497.

     We have considered the remaining arguments of both parties

for results contrary to those expressed herein and, to the extent

not discussed above, find those arguments to be irrelevant, moot,

or without merit.
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To reflect the foregoing,



                                  An appropriate order will

                             be issued.
