                  T.C. Summary Opinion 2006-14



                     UNITED STATES TAX COURT



                KRISTIN J. CALITRI, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 22760-04S.             Filed January 30, 2006.


     John C. Mullaney, for petitioner.

     Michael J. Proto, for respondent.



     DEAN, Special Trial Judge:     This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed.    Unless otherwise

indicated, subsequent section references are to the Internal

Revenue Code of 1986, as amended, and all Rule references are to

the Tax Court Rules of Practice and Procedure.    The decision to

be entered is not reviewable by any other court, and this opinion

should not be cited as authority.
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     This matter is before the Court on petitioner’s Motion for

Litigation and Administrative Costs filed pursuant to section

7430 and Rule 231.1    Respondent filed a response to petitioner’s

motion.   Respondent agrees that petitioner:   (1) Has exhausted

her available administrative remedies within the Internal Revenue

Service (IRS); (2) has not unreasonably protracted the court

proceedings; (3) has claimed a reasonable amount of costs; (4)

has substantially prevailed with respect to the amount in

controversy and with respect to the most significant issue

presented in the court proceedings; and (5) has met the net worth

requirements as provided by law.

     Respondent does not agree, however, that petitioner is a

prevailing party, because he contends that his position in the

court proceedings was substantially justified.

     The parties have not requested a hearing in this case and

the Court concludes that a hearing is not necessary to decide

this motion.   See Rule 232(a)(2).   Accordingly, the Court rules

on petitioner’s motion based on the parties’ submissions and the

record in this case.



     1
      Although petitioner’s motion is captioned Motion for
Litigation and Administrative Costs, all of the costs sought in
the motion are, by definition, litigation costs, because
petitioner’s costs were incurred either in connection with the
preparation or filing of the petition with the Court or after the
filing of the petition with the Court. See sec. 7430(c)(1); sec.
301.7430-4(c)(3), Proced. & Admin. Regs. Therefore, the Court
will treat petitioner’s motion as a motion for the recovery only
of litigation costs.
                              - 3 -

                           Background

     At the time the petition in this case was filed, petitioner

resided in Warwick, Rhode Island.

     For the years in issue, petitioner was self-employed and

operated a business called K.S. Gabrielle Interiors which

provided the selection and installation of custom-made draperies,

bedspreads, blinds, and floor coverings.   As part of her

business, petitioner maintained sample books for fabrics, blinds,

and shades, as well as sample carpeting for display to customers.

Petitioner’s daily routine included several visits to customers’

homes to provide, among other things, advice for selecting proper

styles and colors, measurements, and price estimates.

     On November 18, 2003, respondent sent to petitioner an

initial appointment letter, requesting her to meet with an

examining agent on January 8, 2004.   At the same time, respondent

issued to petitioner a Form 4564, Information Document Request

(IDR), which was directed at obtaining books and records that

would substantiate petitioner’s cost of goods sold and business

expenses claimed on her returns.

     On March 5, 2004, respondent forwarded to petitioner Form

872, Consent to Extend the Time to Assess Tax, and Publication

1035, Extending the Tax Assessment Period, requesting that

petitioner agree to extend the period of limitations for

respondent to assess the 2000 and 2001 taxes.   In the absence of
                              - 4 -
an extension, respondent’s earliest period of limitations would

have expired on October 16, 2004.

     On June 29, 2004, respondent issued a statutory notice of

deficiency for 2000 and 2001 after it was evident that petitioner

would not consent to extend the period of limitations for 2000.

Respondent determined deficiencies in petitioner’s Federal income

taxes of $7,852.28 for 2000 and $2,090.63 for 2001.    The

statutory notice of deficiency included adjustments2 to

petitioner’s tax returns, because she failed to substantiate her

cost of goods sold and business expenses.

     On October 18, 2004, petitioner filed Form 1040X, Amended

U.S. Individual Income Tax Return, for year 2000, to claim a

dependency exemption deduction for her daughter, a child tax

credit, and head of household filing status.   Petitioner did not

sign the Form 1040X, and she did not include any documentation to

support her claims.

     Around November of 2004, petitioner retained John C.

Mullaney as her attorney to file a petition with the Court and to

represent her in the appeals process within the IRS.    On November

29, 2004, petitioner filed a petition with the Court.     The

petition alleges that “Revenue Agent issued Statutory Notice of

deficiency because taxpayer refused to extend statute of

     2
      The correct computation of petitioner’s self-employment
adjusted gross income adjustments and self-employment taxes for
2000 and 2001 will be determined by the parties’ resolution of
the issues of petitioner’s cost of goods sold and substantiation
of business expenses.
                                - 5 -
limitations.    He would not accept any documentation to support

deductions.    [Eighty percent] of all deductions can be

substantiated”.    Moreover, petitioner contends in the petition

that she was entitled to:    (1) Head of household filing status,

(2) a dependency exemption for her daughter, (3) an earned income

credit, and (4) a child tax credit.

     On September 12, 2005, the parties submitted a stipulation

of settlement, signed by the parties’ counsel, which reflects the

resolution of petitioner’s Federal income tax liabilities for

2000 and 2001.

                             Discussion

Requirements Under Section 7430

     Section 7430(a) authorizes the award of reasonable

litigation costs incurred in a court proceeding which is brought

by or against the United States in connection with the

determination, collection, or refund of any tax, interest, or

penalty under the Internal Revenue Code.    The taxpayer must

establish that the taxpayer:    (1) Is the prevailing party, (2)

has exhausted available administrative remedies, (3) has not

unreasonably protracted the court proceedings, and (4) has

claimed litigation costs that are reasonable.    Sec. 7430(a) and

(b)(1), (b)(3).

     A taxpayer must satisfy each of the respective requirements

before litigation costs under section 7430 may be awarded.      See

Rule 232(e).    Upon satisfaction of these requirements, a taxpayer
                                - 6 -
may be entitled to reasonable costs incurred in connection with

the court proceeding.    Sec. 7430(a)(1) and (2), (c)(1).

Respondent concedes that petitioner has established all of the

requirements except for the requirement that petitioner be a

prevailing party.

     To be a prevailing party, the taxpayer must substantially

prevail with respect to either the amount in controversy or the

most significant issue or set of issues presented, and satisfy

the applicable net worth requirements under 28 U.S.C. section

2412(d)(2)(B)(2000).    Sec. 7430(c)(4)(A).   The taxpayer will

nevertheless not be treated as a prevailing party if the

Commissioner’s position in the court proceeding was substantially

justified.    Sec. 7430(c)(4)(B).   The Commissioner has the burden

of proving that his position was substantially justified.      See

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

     Respondent concedes that petitioner has satisfied the

requirements of section 7430(c)(4)(A).    Respondent contends,

however, that petitioner should not be treated as a prevailing

party, because respondent’s position in the court proceeding was

substantially justified.

Substantial Justification

     The Commissioner’s position is substantially justified if,

based on all of the facts and circumstances and the legal

precedent relating to the case, the Commissioner acted

reasonably.    See Pierce v. Underwood, 487 U.S. 552 (1988);
                               - 7 -

Anthony v. United States, 987 F.2d 670, 674 (10th Cir. 1993).

The Commissioner’s position may be incorrect but nevertheless be

substantially justified “if a reasonable person could think it

correct”; that is, if the position has a “reasonable basis both

in law and fact”.   Pierce v. Underwood, supra at 566 n.2; Huffman

v. Commissioner, 978 F.2d 1139, 1147 n.8 (9th Cir. 1992), affg.

in part, revg. in part and remanding T.C. Memo. 1991-144; sec.

301.7430-5(c)(1), Proced. & Admin. Regs.   A position has a

reasonable basis in fact if there is such relevant evidence as a

reasonable mind might accept as adequate to support a conclusion.

Pierce v. Underwood, supra at 564-565; Huffman v. Commissioner,

supra.

     The relevant inquiry is “whether * * * [the Commissioner]

knew or should have known that [her] position was invalid at the

onset”.   Nalle v. Commissioner, 55 F.3d 189, 191 (5th Cir. 1995),

affg. T.C. Memo. 1994-182.   The Court looks to whether the

Commissioner’s position was reasonable given the available facts

and circumstances at the time that the Commissioner took his

position.   See Maggie Mgmt. Co. v. Commissioner, 108 T.C. 430,

442-443 (1997); DeVenney v. Commissioner, 85 T.C. 927, 930

(1985).

     The fact that the Commissioner eventually loses or concedes

a case does not by itself establish that the position taken is
                                  - 8 -

unreasonable.   Estate of Perry v. Commissioner, 931 F.2d 1044,

1046 (5th Cir. 1991); Swanson v. Commissioner, 106 T.C. 76, 94

(1996); Sokol v. Commissioner, 92 T.C. 760, 767 (1989).   It

remains, however, a factor to be considered.    Estate of Perry v.

Commissioner, supra; Powers v. Commissioner, 100 T.C. 457, 471

(1993), affd. in part, revd. in part and remanded on another

issue 43 F.3d 172 (5th Cir. 1995).

     The position of the United States that must be examined in

light of the substantial justification standard with respect to

the recovery of litigation costs is the position taken by the

Commissioner in the answer to the petition.    See Huffman v.

Commissioner, supra at 1148; Bertolino v. Commissioner, 930 F.2d

759, 761 (9th Cir. 1991).   In this case, no answer was filed

since an answer is not generally required in a small tax case.

See Rule 173(b).

     Respondent’s position has not changed between the issuance

of the notice of deficiency and the time petitioner partially

substantiated her claims.   It is appropriate to look at the

position maintained by respondent during the pendency of the

case.   See sec. 7430(c)(7)(A).

Reasonable Basis in Fact

     Petitioner claims that respondent’s position is unreasonable

because:   (1) Petitioner was not given an opportunity during the

audit to present documentation that would substantiate her cost
                               - 9 -

of goods sold and business expenses, (2) respondent refused to

proceed with the audit unless petitioner agreed to extend the

period of limitations to assess the 2000 and 2001 income taxes,

and (3) respondent failed to follow certain guidelines under

Internal Revenue Manual pt. 4.10.2.2.2 (May 14, 1999), regarding

when returns should be examined.

     The Court has reviewed a copy of respondent’s Examining

Officer’s Activity Record (Activity Record), copies of

petitioner’s correspondence with respondent, and other relevant

evidence, and is persuaded that petitioner had numerous

opportunities, prior to the issuance of the statutory notice of

deficiency, to present documentation that would substantiate her

cost of goods sold and business expenses.

     According to the Activity Record, petitioner requested and

was granted a rescheduling of the initial January 8, 2004,

meeting to February 3, 2004.   On the day before the February 3,

2004, meeting, petitioner phoned and left a message with the

examining agent to cancel the meeting.   By letter dated February

13, 2004, petitioner requested a meeting “after the filing season

ends April 15, 2004”, so that her accountant could review her

records and prepare for the examination.

     The examining agent made numerous telephone calls to

petitioner during the weeks of March 5, March 12, and March 29,

2004, to reschedule the meeting, but petitioner failed to return

the calls.   On March 26, 2004, respondent’s group manager left
                             - 10 -
petitioner a voice message stating that a statutory notice of

deficiency for 2000 and 2001 would be issued if petitioner failed

to contact respondent by April 1, 2004.    The examining agent made

several more attempts to contact petitioner during the week of

April 5, 2004.

     The Activity Record further indicates that on April 8, 2004,

petitioner informed the examining agent by phone that she

declined to extend the assessment period and that she wanted to

schedule a meeting on May 3, 2004.    This is corroborated by

petitioner’s followup letter dated April 8, 2004, where she

stated that both she and her accountant would be available on May

3, 2004, and that the additional time would give her accountant

an opportunity to review her records as her accountant was not

the original preparer of the returns.

     The examining agent agreed to a May 3, 2004, meeting.      The

Activity Record indicates, however, that petitioner appeared

without her accountant on the date of the meeting.    While

petitioner could have produced the books and records requested by

respondent at the May meeting, she did not do so.    According to

the Activity Record, petitioner told the examining agent that she

needed 3 additional weeks to produce the books and records,

because her accountant was on vacation.

     Respondent’s position in the statutory notice of deficiency

of June 29, 2004, premised the adjustments primarily on

petitioner’s lack of substantiation.    Tax deductions are a matter
                                - 11 -

of legislative grace with a taxpayer bearing the burden of

proving entitlement to the deductions claimed.    Rule 142(a)(1);

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).      Taxpayers

bear the burden of substantiating the amount and purpose of any

claimed deduction.    See Hradesky v. Commissioner, 65 T.C. 87

(1975), affd. per curiam 540 F.2d 821 (5th Cir. 1976).      Taxpayers

are required to maintain sufficient records to establish the

amounts of income and deductions.    Sec. 6001; Higbee v.

Commissioner, 116 T.C. 438, 440 (2001); sec. 1.6001-1(a), Income

Tax Regs.

     It was reasonable for respondent to refuse to concede the

adjustments until he had received and verified adequate

substantiation for the items in question.    See Harrison v.

Commissioner, 854 F.2d 263, 265 (7th Cir. 1988), affg. T.C. Memo.

1987-52; Sokol v. Commissioner, supra at 765; Beecroft v.

Commissioner, T.C. Memo. 1997-23; Simpson Fin. Servs., Inc. v.

Commissioner, T.C. Memo. 1996-317; McDaniel v. Commissioner, T.C.

Memo. 1993-148.      Petitioner’s counsel met with respondent’s

Appeals officer on March 8, 2005.    He provided documentation to

the Appeals officer to substantiate some of petitioner’s claimed

business expense deductions and head of household filing status

at the conference.    Petitioner’s counsel, by letters dated March

9 and May 10, 2005, provided additional supporting documentation

to substantiate some of petitioner’s remaining claims.      The
                              - 12 -
Appeals officer, after examining the documentation furnished,

sustained some of the adjustments in the statutory notice of

deficiency, but he conceded that petitioner was entitled to head

of household filing status, a dependency exemption, and the

earned income credit.   The parties settled shortly thereafter.

     A significant factor in determining whether the position of

the Commissioner is substantially justified as of a given date is

whether, on or before the date, the taxpayer has presented “all

relevant information under the taxpayer’s control and relevant

legal arguments supporting the taxpayer’s position to the

appropriate Internal Revenue Service personnel”.    Sec. 301.7430-

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

     Most of the changes to petitioner’s adjustments were based

on the Appeals officer’s determination that petitioner was

entitled to head of household filing status, child dependency

exemption and earned income credit.    Petitioner did not raise any

of these legal arguments or provide the relevant documentation to

the examining agent while her returns were being examined.

Therefore, respondent’s position was not unreasonable even though

respondent eventually conceded that petitioner is entitled to

certain deductions and credits.

     Petitioner alleges in her motion that respondent “refused to

deal with [her]” unless she consented to an extension of the

limitations period to assess taxes.    As discussed above,

respondent made numerous attempts to “deal” with petitioner,
                              - 13 -
prior to the issuance of the statutory notice of deficiency.

From the time when respondent sent petitioner the initial

appointment letter in January 2004, to the time when the parties

finally met in May 2004, petitioner had canceled two meetings and

had established a history of not responding to telephone calls

and document requests from respondent.   Therefore, it was not

unreasonable under the circumstances for respondent to issue a

statutory notice of deficiency to avoid the expiration of the

period of limitations when petitioner refused to consent to an

extension.   See Wasie v. Commissioner, 86 T.C. 962, 970-971

(1986); Chaum v. Commissioner, 69 T.C. 156, 163 (1977).

     Petitioner contends that it was respondent’s delay in

commencing the audit that caused the shortage of time for

examination.   Petitioner further contends that respondent failed

to adhere to the guidelines under Internal Revenue Manual pt.

4.10.2.2.2 (May 14, 1999), which provide that the examination and

disposition of income tax returns is to be completed within 26

months for individual returns after the due date of the return,

or the date filed, whichever is later.

     There is a rebuttable presumption of no substantial

justification if the IRS “did not follow its applicable published

guidance in the administrative proceeding”.   Sec.

7430(c)(4)(B)(ii).   “Applicable published guidance” is defined as

“final or temporary regulations, revenue rulings, revenue

procedures, information releases, notices, announcements, and if
                                - 14 -
issued to the taxpayer, private letter rulings, technical advice

memoranda, and determination letters”.    Sec. 7430(c)(4)(B)(iv).

     The Internal Revenue Manual does not constitute “applicable

published guidance”, because it is not among the IRS

pronouncements enumerated under section 7430(c)(4)(B)(iv).

Moreover, the provisions of the Internal Revenue Manual govern

only the internal affairs of the IRS; they do not have the force

and effect of law.     Valen Manufacturing Co. v. United States, 90

F.3d 1190, 1194 (6th Cir. 1996); United States v. Horne, 714 F.2d

206, 207 (1st Cir. 1983).    See generally Reich v. Manganas, 70

F.3d 434, 437 (6th Cir. 1995) (“Internal operating manuals * * *

do not carry the force of law, bind the agency, or confer rights

upon the regulated entity.”).    Procedures in the Internal Revenue

Manual do not confer rights on taxpayers.     United States v.

Horne, supra; United States v. Mapp, 561 F.2d 685, 690 (7th Cir.

1977).

     Accordingly, the fact that respondent did not complete his

examination of petitioner’s returns within 26 months as

recommended by Internal Revenue Manual pt. 4.10.2.2.2 (May 14,

1999), does not trigger a rebuttal presumption of no substantial

justification pursuant to section 7430(c)(4)(B)(iv).

     The Court finds that respondent’s position on the

substantiation issue was reasonable and sufficiently supported by

the facts and circumstances in petitioner’s case and existing

legal precedent.     See Pierce v. Underwood, 487 U.S. 552 (1988).
                             - 15 -

Petitioner is not a “prevailing party” within the meaning of

section 7430(c)(4)(B), because respondent has established that

his position is substantially justified.    Accordingly,

petitioner’s motion for litigation costs is denied.

     Reviewed and adopted as the report of the Small Tax Case

Division.

     To reflect the foregoing,



                                           An appropriate order and
                                   decision will be entered.
