                        T.C. Memo. 2006-19




                      UNITED STATES TAX COURT



         IMAGES IN MOTION OF EL PASO, INC., Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 7663-03.                Filed February 7, 2006.


     David P. Leeper, for petitioner.

     Michael K. Park, for respondent.



                        MEMORANDUM OPINION


     GOEKE, Judge:   This matter is before the Court on

petitioner’s motion for award of reasonable litigation costs

under section 7430 and Rule 231.1




     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
                                - 2 -

     After conducting a field examination, the Internal Revenue

Service (IRS) issued to petitioner a Notice of Determination of

Worker Classification (notice of determination), in which it

concluded petitioner erroneously classified its dance instructors

as independent contractors.    Petitioner petitioned this Court for

redetermination of the worker classification.   After petitioner’s

petition was filed with the Court, respondent forwarded the case

to the IRS Appeals Office.    The Appeals officer to whom this case

was assigned conceded the worker classification issue, and a

stipulated decision was entered on the basis of the settlement.

Petitioner filed this motion seeking an award of reasonable

litigation costs.   To proceed with petitioner’s motion, the

stipulated decision was vacated and filed as a stipulation of

settled issues.   After consideration, we hold that petitioner

shall be awarded litigation costs to the extent determined

herein.

                              Background

     The parties agree that the motion for litigation costs may

be disposed of without a hearing.    The stipulation of facts, the

exhibits attached thereto, and the stipulation of settled issues

are incorporated herein by this reference.   When petitioner

petitioned this Court, its principal place of business was in El

Paso, Texas.
                                 - 3 -

The Business

     Petitioner’s business is a dance studio that offers classes

in dance, gymnastics, martial arts, and other fitness-related

activities.

     Petitioner is owned and operated by Denise Lopez (Ms.

Lopez), who, in 1997, purchased the business as a sole

proprietorship, which was doing business as “Champion Studio”.

Ms. Lopez incorporated the business in 1998 under the name

“Images in Motion of El Paso, Inc.”,2 but continued conducting

business as “Champion Studio”.

     In 2001, the IRS examined petitioner’s taxable years 2000

and 2001 to determine whether it had complied with Federal

employment tax laws.    Specifically, the examination was used to

determine whether petitioner had properly classified its dance

instructors (instructors) as independent contractors rather than

employees.    The IRS conducted the examination on the basis of

information provided by an informant--who was an instructor at

petitioner’s studio.    The Form 3449-CG, Referral Report, states

that the instructors were issued “employee manuals” and were

required to follow the directives set out in those manuals.

Additionally, the referral states that the instructors could be

fired if they failed to attend work.



     2
      The record does not indicate whether petitioner is a C or S
corporation.
                                 - 4 -

     An employment tax specialist conducted the examination of

petitioner (the examining agent).    The examining agent

interviewed Ms. Lopez.   The examining agent also received written

responses to questionnaires she provided to four of petitioner’s

instructors whom she had randomly selected from a list Ms. Lopez

provided.

     In the interviews of the four instructors, three

acknowledged they were given “manuals”, but none of them believed

the directives were mandatory.    Two of the three who received the

manuals specifically stated they were not mandatory.    The fourth

instructor denied that any manual was issued.    The documents in

question were not titled “manuals” but rather were guidelines for

conducting dance classes, instructions in first aid, and an

“Employee Code of Conduct”.   The latter merely set forth basic

behavioral norms and prohibited vulgar language.

     After reviewing Ms. Lopez’s statements and the instructors’

responses, the examining agent determined that petitioner and the

instructors had created employer-employee relationships rather

than principal-independent-contractor relationships.

Specifically, the Examining Agent concluded that:    (1) Petitioner

did not qualify for section 530 relief as provided in the Revenue

Act of 1978, Pub. L. 95-600, 92 Stat. 2885, as amended; (2)

petitioner exercised sufficient behavioral and financial control

over its instructors to classify them as employees; and (3)
                                     - 5 -

petitioner’s arrangement with its instructors strongly evidenced

the existence of an employer-employee relationship.

Procedural History

     On October 2, 2002, respondent issued a 30-day letter to

petitioner in which he determined petitioner owed Federal

employment taxes as follows:

                                 Kind of Tax
                Tax Period        and Code
                   Ended           Section       Amount of Tax
                   2000          FUTA, sec.        $2,630.35
                                   3301
               3/31-12/31/00     FICA & FITW1      11,343.96
                                   secs. 3101,
                                   3111, 3402
                   2001          FUTA, sec.         6,306.01
                                   3301

               3/31-12/31/01     FICA & FITW       12,890.36
                                   secs. 3101,
                                   3111, 3402
                   Total                           33,170.68
          1
              Federal income tax withholding.

Respondent enclosed, with the 30-day letter, IRS Publication 5,

Your Appeal Rights And How to Prepare a Protest If You Don’t

Agree (Publication 5).         Respondent referred petitioner to

Publication 5 if it intended to request an Appeals Office

conference.

     On October 16, 2002, petitioner’s counsel, David P. Leeper

(Mr. Leeper), faxed a one-sentence letter requesting an Appeals

Office conference.        The examining agent notified Mr. Leeper that

petitioner was required to submit a formal written protest.        On
                               - 6 -

October 24, 2002, Mr. Leeper stated, in a facsimile sent to the

examining agent, that the instructors were independent

contractors on the basis of the 20 common law factors used to

classify working relationships.   The one-page letter met the

requirements of a small case request as outlined in Publication 5

since the deficiency for each tax period at issue is less than

$25,000.

     The examining agent did not forward this case to the Appeals

Office, and on February 20, 2003, respondent issued the notice of

determination, which stated his determination that petitioner’s

dance instructors were employees.    Accordingly, respondent

asserted liabilities against petitioner under the Federal

Insurance Contributions Act (FICA), the Federal Unemployment Tax

Act (FUTA), and the related income tax withholding provisions in

the total amount of $33,170.68 for its 2000 and 2001 tax years.

     On May 22, 2003, petitioner’s petition challenging

respondent’s assertions in the notice of determination was filed.

The case was then forwarded to the Appeals Office in Austin,

Texas.   In August 2003, the assigned Appeals officer contacted

petitioner’s counsel by telephone.     During this discussion,

petitioner’s counsel agreed to submit a formal written protest

containing petitioner’s arguments supporting its position that

its instructors were independent contractors.     On September 4,

2003, petitioner submitted a 36-page document to the Appeals
                               - 7 -

officer in which it argued that the instructors were independent

contractors, not employees.   Apparently attempting to prevent the

document from being introduced at trial, petitioner qualified the

document as only for settlement purposes.

     After reviewing the information contained in petitioner’s

document, the Appeals officer determined that petitioner had a

significant chance of prevailing on the worker classification

issue.   The Appeals officer conceded the case because “the

Government faces overall litigating hazards in excess of 80

percent in reclassifying the instructors at issue from

independent contractors to employees.”   The Appeals officer

reached this conclusion after reviewing the available information

in this case and finding that “the taxpayer has a substantial

chance of prevailing in its contention that the instructors * * *

were independent contractors as originally classified” under the

20 common law factors and “in establishing that Section 530 safe

haven provisions [of the Revenue Act of 1978] are present”.    On

the basis of the Appeals officer’s settlement, a stipulated

decision was executed by the parties and entered by the Court on

November 5, 2003.

     On December 18, 2003, we granted petitioner’s motion to

vacate decision, which was filed on December 15, 2003, so that

petitioner’s motion for reasonable litigation costs could
                                - 8 -

proceed.   On December 18, 2003, petitioner’s motion for award of

reasonable litigation costs was filed.

                              Discussion

     Petitioner’s motion is for reasonable litigation costs,

which may be awarded only if the taxpayer satisfies all of the

requirements set forth in section 7430.       Goettee v. Commissioner,

124 T.C. 286, 289 (2005); Minahan v. Commissioner, 88 T.C. 492,

497 (1987).   In relevant part, section 7430(a) provides that the

prevailing party may be awarded reasonable litigation costs in

connection with any court proceeding brought by or against the

United States for the determination of any tax.      In addition to

being the prevailing party, to be eligible for litigation costs,

a taxpayer must have:   (1) Exhausted all administrative remedies,

and (2) not unreasonably protracted the underlying proceeding.

Sec. 7430(b)(1), (3).

     A taxpayer is generally the prevailing party if it

substantially prevailed with respect to either the amount in

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

it meets the net worth requirement set forth in the Equal Access

to Justice Act, 28 U.S.C. sec. 2412(d)(2)(B).      Sec.

7430(c)(4)(A).   The taxpayer bears the burden of proving that

these requirements are met.    Rule 232(e).    Even if the taxpayer

satisfies all of the stated requirements, section 7430(c)(4)(B)

expressly provides that a taxpayer shall not be treated as the
                                 - 9 -

prevailing party if the Commissioner establishes his position was

substantially justified.

     Respondent concedes that:    (1) Petitioner meets the net

worth requirement; (2) petitioner’s request for litigation costs

was timely; and (3) petitioner substantially prevailed with

respect to the most significant issue.    However, respondent

contends:   (1) Petitioner is not the prevailing party because his

litigating position was substantially justified; (2) petitioner

failed to exhaust all administrative remedies available to it;

(3) petitioner unreasonably protracted the proceedings; and (4)

petitioner did not adequately substantiate its claimed litigation

costs.

A.   Whether Petitioner Exhausted the Available Administrative
     Remedies

     The parties dispute whether petitioner exhausted all

administrative remedies.   This dispute stems from the following

facts:

     (1) The IRS issued to petitioner a 30-day letter on October

2, 2002, and included Publication 5;

     (2) petitioner faxed a one-sentence letter to the IRS

requesting an Appeals Office conference on October 16, 2002;

     (3) the IRS notified petitioner that it was required to file

a formal written protest to obtain an Appeals Office conference;
                              - 10 -

     (4) petitioner faxed a three-sentence letter on October 24,

2002, which stated: “Our appeal request stands as submitted.

This taxpayer does not exercise sufficient control as described

in the 20 common law factors to be subject to the employment tax,

which you determined.   We seek a conference at an appeals hearing

to review your determination.”; and

     (5) on October 25, 2002, the IRS, by letter, gave petitioner

15 days from the date of the letter to file a “valid protest” to

the 30-day letter since it believed petitioner’s request did not

adequately set forth its legal and factual arguments in

accordance with Publication 5.

     Petitioner urges us to find that its letter dated October

24, 2002, was sufficient to request an Appeals Office conference.

Respondent counters that section 601.105(d)(2)(iii), Statement of

Procedural Rules, required petitioner to file a written protest

to obtain Appeals Office consideration following the field

examination since the total amount of proposed tax including

penalties exceeded $10,000 for a taxable period.    See also sec.

601.106(a)(1)(iii)(b), Statement of Procedural Rules.    We must

review the regulations and the information the IRS provided to

petitioner, to resolve this issue.

     Section 301.7430-1(b)(1), Proced. & Admin. Regs., provides:

     A party has not exhausted the   administrative remedies
     available within the Internal   Revenue Service with
     respect to any tax matter for   which an Appeals office
     conference is available under   §§ 601.105 and 601.106 of
                              - 11 -

     this chapter (other than a tax matter described in
     paragraph (c) of this section) unless--

          (i) The party, prior to filing a petition in the
     Tax Court * * * participates * * * in an Appeals office
     conference; or

          (ii) If no Appeals office conference is granted,
     the party, prior to the issuance of a statutory notice
     in the case of a petition in the Tax Court * * *

          (A) Requests an Appeals office conference in
     accordance with §§ 601.105 and 601.106 * * *; and

          (B) Files a written protest if a written protest
     is required to obtain an Appeals office conference.

     Respondent’s 30-day letter sent to petitioner states:

          If you do not accept our findings, we recommend
     that you request a hearing with our Office of Regional
     Director of Appeals. * * *

          If the proposed change is more than $2,500 but is
     * * * $25,000 or less for any tax period, you must give
     a brief written statement of the disputed issues.

          If the proposed change to you [sic] tax (including
     penalties) is MORE THAN $25,000 for any tax period, we
     will require a written protest. Follow the
     instructions in the enclosed Publication 5, which also
     explains your appeal rights.

     According to Publication 5, a taxpayer must follow the

instructions in the 30-day letter to receive an Appeals Office

conference.   Publication 5 directs a taxpayer to file its formal

written protest or small case request with the office named in

the 30-day letter to receive an Appeals Office conference.

Publication 5 contains the same monetary ranges as the 30-day

letter, which instructs the taxpayer to file either a small case

request or formal written protest.     Additionally, to complete a
                                - 12 -

small case request for an Appeals Office conference Publication 5

states that a taxpayer must send a letter in which it identifies

the IRS’s proposed changes that the taxpayer disagrees with and

the reasons for disagreement.

     Finally, Internal Revenue Manual (IRM) part 8.6.1.1.4(1)

(Dec. 13, 1999), Written Protests and “Small Case Requests” in

Unagreed Cases, states:    “Appeals will consider matters under its

small case request procedures if the total amount for any tax

period is not more than $25,000.”    The small case request

requirements under the IRM are virtually identical to those

stated in Publication 5.    Unlike a written request for a small

case, a written protest is “required to obtain Appeals

consideration if the total amount for any tax period is more than

$25,000.”   IRM pt. 8.6.l.1.4(2) (Dec. 13, 1999).   A written

protest must include, among other things, “the facts supporting

the taxpayer’s position on any disagreed issue, and the law or

authority, if any, on which the taxpayer relies.”    IRM pt.

8.6.1.1.4(2) (Dec. 13, 1999).

     In this case, for each tax period at issue the proposed

change was less than $25,000.    Having reviewed petitioner’s

letter dated October 24, 2002, we find that it complied with the

small case request requirements set forth in the 30-day letter,

Publication 5, and the IRM.    Respondent did not grant

petitioner’s request but instead directed petitioner, in a letter
                              - 13 -

dated October 25, 2002, to file a formal protest since “your

protest has not been completed in accordance with the guidelines

outlined in the enclosed Publication 5.”   Petitioner did not

comply with this request.

     Because the amounts of tax used in the 30-day letter,

Publication 5, and IRM part 8.6.1.1.4 are inconsistent with

section 601.105(d)(2), Statement of Procedural Rules, we must

decide whether petitioner’s compliance with the 30-day letter and

Publication 5 satisfies the statutory requirement to have

exhausted all administrative remedies.   We note that the IRS has

no duty to comply with section 601.105, Statement of Procedural

Rules, or any other rules that do not have the force and effect

of law.   See Luhring v. Glotzbach, 304 F.2d 560, 563 (4th Cir.

1962) (finding section 601.105, Statement of Procedural Rules,

does not have the force and effect of law); see also Ward v.

Commissioner, 784 F.2d 1424, 1430-1431 (9th Cir. 1986) (holding

the IRS has no duty to comply with section 601.601(d), Statement

of Procedural Rules, because it does not have the force and

effect of law), affg. T.C. Memo. 1984-570.

     With this background in mind, we note respondent did issue a

30-day letter, and section 601.105(c)(2)(i), Statement of

Procedural Rules, requires a 30-day letter to provide a detailed

explanation of the available alternatives including consideration

of the case by an Appeals Office.   Similarly, section
                               - 14 -

601.105(d)(1), Statement of Procedural Rules, provides that the

30-day letter must inform the taxpayer of the available appeal

rights in case the taxpayer disagrees with the proposed

determination.   Neither the 30-day letter nor Publication 5

references section 601.105 or 601.106, Statement of Procedural

Rules, for the proposition that a written protest is required for

an Appeals Office conference to be granted following a field

examination where the proposed additional tax exceeds $10,000 for

a tax period.    To the contrary, as stated above, the small case

request limit in Publication 5 and the 30-day letter is $25,000.

Here, the potential liabilities exceeded $10,000 for the two

periods at issue but not $25,000 for any period.

     As noted, the Statement of Procedural Rules, of which

section 601.105 is a part, is directory and not mandatory.

Rosenberg v. Commissioner, 450 F.2d 529 (10th Cir. 1971), affg.

T.C. Memo. 1970-201; Luhring v. Glotzbac, supra; Flynn v.

Commissioner, 40 T.C. 770, 773 (1963).    Petitioner is not

asserting that respondent’s failure to comply with any directives

invalidates any action respondent took.   Instead, petitioner’s

position is that it complied with the instructions that the IRS

provided, and the fact that there is a conflict in the IRS

procedures should be resolved in its favor.   Petitioner complied

with the procedures outlined in Publication 5 and the 30-day

letter to file a brief written request to receive an Appeals
                              - 15 -

Office conference.   Accordingly, we hold petitioner reasonably

attempted to exhaust the administrative remedies available.

     Our analysis is not in conflict with the general rule that

“taxpayers rely on * * * [IRS] publications at their peril.”

Miller v. Commissioner, 114 T.C. 184, 195 (2000), affd. on other

grounds sub nom. Lovejoy v. Commissioner, 293 F.3d 1208 (10th

Cir. 2002); see Carpenter v. United States, 495 F.2d 175 (5th

Cir. 1964).   This rule was adopted since publications are not

binding on the Government, nor can they change the plain meaning

of a statute.   See, e.g., Miller v. Commissioner, supra at 195.

Petitioner satisfied the steps outlined by respondent’s

correspondence, but it was not given an Appeals Office

conference, as discussed in further detail infra.   Thus, there is

no statutory conflict.

     Likewise, this case is distinguishable from Haas &

Associates Accountancy Corp. v. Commissioner, 117 T.C. 48 (2001),

affd. 55 Fed. Appx. 476 (9th Cir. 2003).   Petitioner, unlike the

taxpayers in Haas Associates Accountancy Corp., filed a written

request for an Appeals Office conference in accordance with the

30-day letter and Publication 5.   Moreover, once this case was

forward to the Appeals Office, after being docketed with the

Court, petitioner cooperated with the Appeals Office, unlike the

taxpayers in Haas Associates Accountancy Corp.   Given these
                              - 16 -

factual differences, Haas Associates Accountancy Corp. does not

dictate the result in this case.

     In explaining the exhaustion of administrative remedies

provision the House of Representatives Ways and Means Committee’s

report states:

     * * * This provision of the bill is intended to
     preserve the role that the administrative appeals
     process plays in the resolution of tax disputes by
     requiring taxpayers to pursue such remedies prior to
     litigation. A taxpayer who actively participates in
     and discloses all relevant information during the
     administrative stages of the case will be considered to
     have exhausted the available administrative remedies.
     Failure to so participate and disclose information may
     be sufficient grounds for determining that the taxpayer
     has not exhausted administrative remedies and,
     therefore, is ineligible for an award of litigation
     costs.
          The committee recognizes that the exhaustion of
     remedies requirement may be inappropriate in some
     cases. * * * Therefore, taxpayers are required to
     exhaust available administrative remedies unless the
     court determines that, under the circumstances of the
     case, such requirement is unnecessary. [H. Rept. 97-
     404, at 13 (1981); emphasis added.]

See Staff of Joint Comm. on Taxation, General Explanation of the

Tax Equity and Fiscal Responsibility Act of 1982 (the so-called

Blue Book), at 448 (J. Comm. Print 1982).

     The cited legislative history shows Congress enacted the

exhaustion of administrative remedies requirement because it was

concerned with taxpayers attempting to bypass administrative

review, which would create an incentive to undermine a principal

forum to resolve a dispute.   See also Payment of Attorneys’ Fees

in Tax Litigation:   Hearing Before the Subcomm. on Select Revenue
                              - 17 -

Measures of the H. Comm. on Ways and Means, 97th Cong. 97-29

(1981) (statement of John E. Chapoton, Assistant Secretary for

Tax Policy, Department of the Treasury, and Roscoe L. Egger, Jr.,

Commissioner of Internal Revenue stating their concern that H.R.

3262, 97th Cong., 1st Sess. sec. 2 (1981), did not contain a

requirement that the taxpayer exhaust the available

administrative remedies before attorney’s fees could be awarded).

The record is devoid of any indication that petitioner withheld

relevant facts.   The examining agent’s report supports a

conclusion that Ms. Lopez was forthcoming and cooperative during

the examination process.   Following the issuance of the 30-day

letter, petitioner appropriately requested that this case be

forwarded to the Appeals Office for review.   It is clear the

requirement in section 301.7430-1(b)(1), Proced. & Admin. Regs.,

that attendance at an Appeals Office conference is necessary to

exhaust administrative remedies is conditioned on the

availability of the Appeals Office conference to the taxpayer.

Petitioner attempted to pursue an administrative appeal in the

hope of resolving this case because petitioner complied with the

30-day letter and Publication 5.   Despite petitioner’s efforts,

the Examination Division did not make an Appeals Office

conference available to petitioner.    Cf. Haas & Associates

Accountancy Corp. v. Commissioner, supra at 62.
                               - 18 -

     Finally, we note that Publication 5 and the applicable IRM

section were drafted more than 10 years after section

601.105(d)(2)(iv), Statement of Procedural Rules, was last

amended in 1987.3    While procedural rules and publications are

not laws, they act as guides for the IRS and taxpayers to follow.

     We therefore hold that petitioner satisfied the statutorily

imposed requirement to have exhausted all administrative remedies

available by filing a written request for an Appeals Office

conference.

B.   Whether Respondent’s Litigating Position Was Substantially
     Justified

     In the context of a motion for reasonable litigation costs,

a “court proceeding” is any civil action brought in a court of

the United States.    Sec. 7430(c)(6).   The litigating position of

the United States is the position it takes in the court

proceeding to which section 7430(a) applies.    Sec. 7430(c)(7);

Maggie Mgmt. Co. v. Commissioner, 108 T.C. 430, 442 (1997).

Respondent’s litigating position is found in his answer, which

was filed on June 30, 2003.    Huffman v. Commissioner, 978 F.2d

1139, 1148 (9th Cir. 1992), affg. in part, revg. in part and

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

supra at 442.   Respondent’s position in the answer was that:      (1)


     3
        In 1993, the IRS proposed amendments to the Statement of
Procedural Rules, permitting a small case request dollar
limitation of “not more than $25,000”. Sec. 601.106(b)(4),
Proposed Statement of Procedural Regs., 58 Fed. Reg. 48805 (Sept.
20, 1993). This proposal has yet to be adopted.
                                - 19 -

The workers described in the notice of determination were

properly classified as employees for the tax periods at issue;

(2) petitioner was not entitled to relief under section 530 of

the Revenue Act of 1978 with respect to such individuals; and (3)

petitioner owed $33,170.68 of additional Federal employment

taxes.

     As stated above, respondent contends that his position is

substantially justified.    Respondent’s position is substantially

justified if it has a reasonable basis in both fact and law.

Maggie Mgmt. Co. v. Commissioner, supra at 443; DeVenney v.

Commissioner, 85 T.C. 927, 930 (1985); sec. 301.7430-5(c),

Proced. & Admin. Regs.     We apply the reasonable person standard

to determine reasonableness.    See Pierce v. Underwood, 487 U.S.

552, 565 (1988) (stating that the Commissioner’s position is

substantially justified if it is supported “to a degree that

could satisfy a reasonable person”).     The reasonableness of the

Commissioner’s position is based on the available facts used to

form his position and legal precedents related to the case.

Maggie Mgmt. Co. v. Commissioner, supra at 443.     We shall review

the reasonableness of respondent’s factual and legal positions

together since employment status is generally a factual question.

See Weber v. Commissioner, 103 T.C. 378, 386 (1994), affd. per

curiam 60 F.3d 1104 (4th Cir. 1995).

     A significant factor we use in deciding whether the

Commissioner’s position is substantially justified is whether the
                                - 20 -

taxpayer presented all relevant information under its control and

relevant legal arguments supporting its position to the

appropriate IRS personnel.     Sec. 301.7430-5(c)(1), Proced. &

Admin. Regs.    “Appropriate Internal Revenue Service personnel”

are those employees reviewing the taxpayer’s information or

arguments, or those employees who, in the normal course of

procedure and administration, would transfer the information or

arguments to the reviewing employees.      Id.

     1.   The Dispute:     Employee Versus Independent Contractor

     The employment tax sections of the Internal Revenue Code are

in subtitle C.     Sections 3111 and 3301 impose taxes on employers

under FICA and FUTA, respectively, based on wages paid to

employees.     Section 3101 imposes a tax on employees under FICA

based on their wages paid, which the employer is required to

collect under section 3102.     The term “wages”, as used in these

statutes, generally encompasses “all remuneration for

employment”.     Secs. 3121(a), 3306(b).   The term “employee”, for

FICA taxes purposes, is defined in section 3121(d), and, with

modifications not pertinent here, section 3306(i) makes this

definition applicable for purposes of FUTA taxes as well.

Section 3121(d)(2) provides that an “employee” includes “any

individual who, under the usual common law rules applicable in

determining the employer-employee relationship, has the status of

an employee”.     Section 31.3121(d)-1(c)(2), Employment Tax Regs.,

defines the common law employer-employee relationship as follows:
                              - 21 -

          (2) Generally such relationship exists when the
     person for whom services are performed has the right to
     control and direct the individual who performs the
     services, not only as to the result to be accomplished
     by the work but also as to the details and means by
     which that result is accomplished. That is, an employee
     is subject to the will and control of the employer not
     only as to what shall be done but how it shall be done.
     In this connection, it is not necessary that the
     employer actually direct or control the manner in which
     the services are performed; it is sufficient if he has
     the right to do so. The right to discharge is also an
     important factor indicating that the person possessing
     that right is an employer. Other factors
     characteristic of an employer, but not necessarily
     present in every case, are the furnishing of tools and
     the furnishing of a place to work, to the individual
     who performs the services. In general, if an
     individual is subject to the control or direction of
     another merely as to the result to be accomplished by
     the work and not as to the means and methods for
     accomplishing the result, he is an independent
     contractor. * * *

We have held that even though the determination of employee

status is to be made by common law concepts, a realistic

interpretation should be adopted, and doubtful questions should

be resolved in favor of employment.     Ewens & Miller, Inc. v.

Commissioner, 117 T.C. 263, 269 (2001).

     Section 530 of the Revenue Act of 1978 (section 530)

provides relief from employment tax liability.    Pub. L. 95-600,

92 Stat. 2885 (as amended).   A taxpayer is entitled to relief

under section 530 if it demonstrates:    (1) It did not treat an

individual as an employee for employment tax purposes for any

period, sec. 530(a)(1); (2) it filed all required Federal tax

returns consistent with its treatment of the individual, id.; and

(3) it had “a reasonable basis for not treating an individual as
                                - 22 -

an employee”, sec. 530(a)(2).    A taxpayer is deemed to have a

reasonable basis if the taxpayer established its “treatment of

such individual * * * was in reasonable reliance on”:

     (A) judicial precedent, published rulings, technical
     advice with respect to the taxpayer, or a letter ruling
     to the taxpayer;

     (B) a past Internal Revenue Service audit of the
     taxpayer in which there was no assessment attributable
     to the treatment (for employment tax purposes) of the
     individuals holding positions substantially similar to
     the position held by this individual; or

     (C) long-standing recognized practice of a significant
     segment of the industry in which such individual was
     engaged. [Id.]

Courts have noted that, in addition to the safe harbors of

section 530(a)(2), a taxpayer may demonstrate any other

reasonable basis for the treatment of an employee for tax

purposes.   See, e.g., Springfield v. United States, 88 F.3d 750,

753 (9th Cir. 1996); Boles Trucking, Inc. v. United States, 77

F.3d 236, 239 (8th Cir. 1996).    The legislative history reveals

that the reasonable basis inquiry is to be liberally construed in

favor of the taxpayer.    See H. Rept. 95-1748, at 5 (1978), 1978-3

C.B. (Vol. 1) 629, 633.   Section 530(e)(4) places the burden of

proof on the Secretary if the taxpayer establishes a prima facie

case that it was reasonable not to treat an individual as an

employee, and the taxpayer has complied with the Secretary’s

reasonable requests for tax periods at issue.
                              - 23 -

     2.   Reasonableness

     Respondent argues that his position is substantially

justified because the facts gathered during examination and the

law, taken together, indicate petitioner had improperly

classified its instructors as independent contractors.

Respondent further contends that petitioner did not provide all

relevant legal arguments that its instructors were independent

contractors, not employees.   Before we address whether

respondent’s position was reasonable, the parties dispute whether

the Appeals officer’s determination is relevant to the

reasonableness of respondent’s position.

          a.    Whether the Appeals Officer’s Determination Is
                Relevant to the Reasonableness of Respondent’s
                Litigating Position

     Respondent urges the Court to review the examining agent’s

report as the basis for the position taken in the answer, but to

not consider the Appeals officer’s analysis.   Petitioner argues

that the Appeals transmittal and case memo is relevant in

deciding whether respondent’s position was reasonable.    The

record establishes that respondent’s examining agent had the

relevant facts in her possession before the notice of

determination was issued.   This is significant since the common

law factors and section 530 relief are both fact-intensive

inquiries.   Thus, we find that the Appeals officer’s analysis is

a written document recapitulating the relevant facts of this case

and is relevant.
                               - 24 -

     In addition, respondent’s litigating position in his answer

generally denies petitioner’s allegations.    Because the answer

does not contain any significant analysis, we rely upon the facts

as developed by the examining agent as the reasoning behind

respondent’s contentions.

          b.    Was Respondent’s Litigating Position
                Reasonable?

     Whether petitioner properly classified its instructors as

employees is a question of fact.    See Weber v. Commissioner, 103

T.C. at 386; Packard v. Commissioner, 63 T.C. 621, 629 (1975).

We generally accord significant weight to the amount of control a

taxpayer exercises over its instructors since control is the

“crucial test” in determining the nature of a working

relationship.   Gen. Inv. Corp. v. United States, 823 F.2d 337,

341 (9th Cir. 1987).    In determining the nature of a working

relationship, the threshold level of control for the creation of

an employer-employee relationship varies depending on the nature

of the services the worker provided.    Weber v. Commissioner,

supra at 387-388.

     Respondent conceded the ultimate issue:    whether petitioner

properly classified its instructors as independent contractors.

This concession is not necessarily determinative that

respondent’s prior position on that issue was unreasonable.

Portillo v. Commissioner, 988 F.2d 27, 28 (5th Cir. 1993), revg.

T.C. Memo. 1992-99.    However, it is a factor that we may
                              - 25 -

consider.   See Maggie Mgmt. Co. v. Commissioner, 108 T.C. at 443;

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).   On this point, it was the Appeals officer’s review of the

facts that led him to conclude that “the common law factors do

not support a finding that the taxpayer had the right to control

and direct the work of the instructors as to the details and

means by which they accomplished their work.”

     The facts do not support respondent’s position that the

examining agent had insufficient information to accept

petitioner’s worker classification or that the facts indicated

petitioner’s worker classification was incorrect.   The

examining agent determined that petitioner’s dance instructors

were employees after considering three factors--(1) behavioral

control, (2) financial control, and (3) the relationship of the

parties.4   The examining agent determined the behavioral control


     4
      This Court generally considers seven factors in deciding
whether a worker is an independent contractor or a common law
employee. See, e.g., Ewens & Miller, Inc. v. Commissioner, 117
T.C. 263, 269 (2001); Profl. & Executive Leasing, Inc. v.
Commissioner, 89 T.C. 225, 233 (1987) (reviewing the following
factors to decide the existence of an employment relationship:
(1) The degree of control exercised over the details of the work;
(2) investment in the work facilities; (3) opportunity for profit
or loss; (4) whether the type of work is part of the principal's
regular business; (5) right to discharge; (6) permanency of the
relationship; and (7) the relationship the parties think they are
creating), affd. 862 F.2d 751 (9th Cir. 1988). The Appeals
officer’s review of this case relied on the 20 common law
factors. Rev. Rul. 87-41, 1987-1 C.B. 296. His analysis shows
that the 20 common law factors, when not condensed into only
                                                   (continued...)
                              - 26 -

factor supported an employer-employee relationship.   She relied

on the following facts to make her determination:   (1) Petitioner

provided a worker’s manual to some instructors; (2) Ms. Lopez

held meetings with the instructors; and (3) petitioner required

the instructors to dress appropriately and not play obscene

music.   The examining agent found petitioner had financial

control over the instructors since it had a substantial

investment in the studio and equipment, and the instructors were

remunerated on the basis of either an hourly rate or a percentage

of tuition fees.   Regarding the relationship of petitioner and

its instructors, there were no written contracts and the parties

verbally agreed to the relationship as independent contractors,

but petitioner could terminate the working relationship.    There

is, however, no evidence that any of the instructors were

terminated.   The examining agent likewise determined petitioner

could not benefit from section 530 relief since it did not

establish a reasonable basis for treatment of its instructors as

independent contractors.

     Our review of the examining agent’s analysis demonstrates

that she failed to consider many facts contradicting her

conclusions, failed to consider the facts mitigating an inference



     4
      (...continued)
three factors, overwhelmingly indicate petitioner’s instructors
were independent contractors. We believe the three-factor
approach the examining agent used overly generalized the common
law factors.
                                - 27 -

that the instructors were employees, or failed to give such facts

the appropriate amount of weight.    First, with respect to

behavior control, three of the four instructors interviewed

stated they received a “manual” when they became instructors at

the studio.   However, the instructor interviews do not support

the conclusion that the “manual” was mandatory.    The interviewed

instructors neither recalled the dance class instructions in the

manual ever being enforced nor did they sign anything stating

they had received it.   Having reviewed the portion of the manual

included in the record, we find it provided helpful tips for

instructors and information regarding emergency situations.    We

find it was unreasonable for respondent to rely on the “manual”

as evidence of control given the instructors’ statements and the

overall factual record developed during the audit.    As the

Appeals officer found, the “manual” was no more than a guideline.

Moreover, the instructors selected the classes they wanted to

teach, and these classes represented their individual talents and

experience.   Petitioner never provided the instructors with any

training.   The instructors brought their expertise to the

relationship with petitioner.    The amalgamation of these findings

indicates that it was unreasonable for the examining agent to

conclude petitioner had a sufficient level of control over the

instructors to classify them as employees.

     We also believe that respondent’s litigating position with

respect to financial control was unreasonable.    Petitioner had a
                              - 28 -

substantial financial investment in the studio.     However, each

instructor has a large financial stake in her dance abilities,

and the instructors were required to purchase their own music and

costumes.   In this context, the concept of financial control is

not helpful to resolve the worker classification issue because

the examining agent did not rely on specific facts consistent

with the 20 common law factors or the 7 factors this Court

generally applies.   See Profl. & Executive Leasing, Inc. v.

Commissioner, 89 T.C. 225, 233 (1987), affd. 862 F.2d 751 (9th

Cir. 1988); Rev. Rul. 87-41, 1987-1 C.B. 296 (listing the common

law factors that apply to the worker classification issue); cf.

Vendor Surveillance Corp. v. United States, 116 F.3d 488 (9th

Cir. 1997).

     We also find it was unreasonable for the examining agent to

conclude that petitioner did not qualify for section 530 relief.

Petitioner and the instructors believed their relationship was

that of principal-independent-contractor.     This was orally agreed

between the instructors and petitioner or between the instructors

and the business’s previous owner.     In addition, the previous

owner of the business had always treated the instructors as

independent contractors, the relationships created by petitioner

and its instructors were not permanent, and the instructors

selected the classes they were going to teach each session.     If

an instructor did not sign up to teach in a subsequent session,

the working relationship between that instructor and petitioner
                              - 29 -

ended.   Petitioner, therefore, had a reasonable basis for

classifying the instructors as independent contractors.

     Lastly, respondent argues that petitioner failed to provide

the appropriate IRS personnel with the relevant information under

its control and relevant legal arguments supporting its position.

See sec. 301.7430-5(c)(1), Proced. & Admin. Regs.   Petitioner

cooperated with the audit, and petitioner properly filed a small

case request in accordance with Publication 5 and the 30-day

letter as discussed above.   Petitioner’s request for an Appeals

Office conference stated that on the basis of the 20 common law

factors it did not agree with the conclusions set out in the 30-

day letter.   Determining the type of working relationship, as we

have previously stated, requires a fact-based analysis.     The

record shows that petitioner provided the examining agent with

all of the relevant factual information she sought, including

access to interview its owner and instructors.   We therefore find

that petitioner satisfied the requirement of section 301.7430-

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

     Taking our findings together, we hold respondent’s

litigating position was not substantially justified.

C.   Did Petitioner Unreasonably Protract the Proceedings?

     Respondent argues that petitioner unreasonably protracted

the proceedings by failing to provide a written protest before

the notice of determination was issued.   We disagree.    We have

already concluded that the Examination Division’s failure to
                              - 30 -

forward this case to the Appeals Office after petitioner filed a

valid written request was not the result of a failure of

compliance by petitioner.   Given the facts of this case, we find

petitioner did not unreasonably protract these proceedings within

the meaning of section 7430(b)(3).

D.   Litigation Costs Petitioner Claimed

     Petitioner’s motion is only for litigation costs.     Section

7430 limits the prevailing party to an award of reasonable

litigation costs.5   Section 7430(c)(1)(B)(iii) generally limits

the hourly rate for attorney’s fees.6   A taxpayer may recover

attorney’s fees above the statutory limit if the court determines

the existence of a special factor such as:   (1) Limited

availability of qualified attorneys for the proceeding; (2) the

difficulty of the issues present in the case; or (3) the local

availability of tax expertise.   Id.

     Petitioner claims that its counsel deserves a rate of $250

per hour for the 118.25 hours he spent in connection with these

proceedings.   Respondent challenges the hourly rate claimed since

it is above the statutory limit and questions whether some of the


     5
      Reasonable litigation costs include, inter alia, reasonable
court costs and fees paid or incurred for the services of
attorneys in connection with a court proceeding (attorney’s
fees). Sec. 7430(c)(1).
     6
      Rev. Proc. 2002-70, sec. 3.32, 2002-2 C.B. 845, 850; Rev.
Proc. 2003-85, sec. 3.33, 2003-2 C.B. 1184, 1190; and Rev. Proc.
2004-71, sec. 3.35, 2004-2 C.B. 970, 976, respectively, state
that the hourly rate for attorney’s fees during 2003-2005 is
$150.
                              - 31 -

claimed services were in connection with this court proceeding.

Before we address these issues, we are asked to decide whether

petitioner has provided a detailed affidavit that distinctly sets

forth each item or cost paid or incurred for which an award is

claimed.   See Cassuto v. Commissioner, 93 T.C. 256, 271 (1989),

affd. in part and revd. in part on other grounds 936 F.2d 736 (2d

Cir. 1991).

     1.    Petitioner’s Affidavit

     Rule 232(d) provides that if the parties are unable to agree

as to the amount of attorney’s fees that is reasonable, the

moving party shall file an additional affidavit which includes:

(1) A detailed summary of the time expended by each individual

for whom fees are sought, including a description of the nature

of the services performed during each period; (2) a description

of the fee arrangement; (3) the professional qualifications and

experience of each individual for whom fees are sought; (4) a

statement of whether a special factor exists; and (5) any other

relevant information to assist the Court in evaluating the claim

for costs and fees.

     Attached to petitioner’s opening brief was a detailed

affidavit of the hours petitioner’s counsel spent in connection

with these proceedings.   The affidavit also contained a brief

description of the services provided and the qualifications of

petitioner’s counsel.   Respondent has not objected to the

detailed affidavit’s being attached to petitioner’s opening
                               - 32 -

brief.    We find that the affidavit attached to petitioner’s

opening brief satisfies Rule 232(d).

     2.    Respondent’s Challenge to Petitioner’s Claim for
           Attorney’s Fees Above the Statutory Limit

     Respondent challenges the hourly amount petitioner claims

for attorney’s fees since that rate exceeds the statutory

maximum.    Respondent argues that petitioner has failed to show

the existence of a special factor, such as one of those set forth

in section 7430(c)(1)(B)(iii), to justify a higher rate.

Petitioner counters by arguing that a higher hourly rate is

justified in this case because:    (1) Its counsel has an LL.M. in

taxation and is a board-certified Federal tax attorney; (2) its

counsel is one of three board-certified attorneys in El Paso,

Texas; (3) its counsel possessed special skills necessary to

litigate a worker classification dispute; and (4) its counsel’s

special skills caused respondent to concede the ultimate issue.

We agree with respondent.

     Petitioner’s argument that its counsel has an LL.M. in

taxation and State certification as a tax law specialist does

not, by itself, satisfy the special factor requirement.    Section

7430 provides the mechanism for taxpayers to recover

administrative and litigation costs.    See Cassuto v.

Commissioner, supra at 742.    Congress could not have intended all

attorneys with tax lawyering skills to recover amounts greater
                              - 33 -

than the maximum set forth in the statute since such a reading

would make the limit superfluous.   See id.

     Petitioner’s argument that because its counsel is one of

three board-certified tax attorney’s in the El Paso area a per-

hour rate above the statutory maximum should be awarded also

fails.   The issue in this case was a question of fact, and the

determination of the ultimate issue largely relied on common law

principles.   Thus, petitioner did not demonstrate that there was

a limited availability of attorneys who could adequately

represent it in this case.

     Petitioner’s second argument, that worker classification

litigation requires special skills, also fails.   Petitioner has

not provided us with any information that suggests its counsel

was a worker classification specialist.   Even though petitioner’s

counsel focuses his practice on tax litigation, we do not find

that requires a different result from the one reached with

respect to his education and certifications.   Again, worker

classification is a fact-based inquiry, and we believe that no

special knowledge is needed to set forth the relevant facts and

legal precedents.

     Petitioner’s third argument, that its counsel’s special

skills caused respondent to concede the ultimate issue, is also

unconvincing because the facts the Appeals officer relied on in

making his decision to concede the ultimate issue were

established by the examining agent.    It appears that in drafting
                                  - 34 -

his answer respondent merely relied on the conclusions set forth

in the notice of determination.       The Appeals officer provided a

fresh review of the issue and concluded that petitioner had a

significant chance of prevailing.       Accordingly, respondent’s

concession of the ultimate issue is not a special factor under

section 7430(c)(1)(B)(iii).

     We therefore hold that petitioner is entitled to the

statutory per-hour fee of $150.

     3.     The Specific Items Respondent Takes Issue With

     Section 7430(c)(1) provides that reasonable litigation costs

include, inter alia, “reasonable fees paid or incurred for the

services of attorneys in connection with the court proceeding”.

Respondent takes issue with some of the fees petitioner’s counsel

claims, arguing that they were not in connection with this

proceeding.       The items respondent takes issue with are as

follows:

           Date                  Claimed Item             Hours
          10/8/02          Conference with new             2.25
                            client
          10/9/02          Lengthy analysis of             7.75
                             Federal tax laws per
                             3121, relief under Act
                             530, CSP program
                             relief, procedural
                             circumstances
      10/16/02             Draft of request                .50
                             for Appeals Office
                             conference
                               - 35 -

         10/24/02     Draft of request                 .25
                        for Appeals Office
                      conference
         10/29/02     Draft of request                 .25
                        for Appeals Office
                      conference
  2/28/03 - 3/28/03   Review and analysis            13.25
                        of IRS Notice of
                        Determination of
                        Worker
                      Reclassification,
                      several conferences
                      with client and her
                      workers. Research of
                      Federal tax laws and
                      numerous cases

The issue for decision is whether these are recoverable as

litigation fees.

     Section 301.7430-4(c)(3)(i), Proced. & Admin. Regs.,

provides that litigation costs include “Costs incurred in

connection with the preparation and filing of a petition with the

United States Tax Court or in connection with the commencement of

any other court proceeding”.   Two examples are provided in

section 301.7430-4(c)(4), Proced. & Admin. Regs.,7 and we find

aspects of the reasoning of each to be applicable here.   Section

301.7430-4(c)(4), Examples (1) and (2), Proced. & Admin. Regs.,

provides:



     7
      We note that the Internal Revenue Service Restructuring and
Reform Act of 1998, Pub. L. 105-206, sec. 3101(a)(2), 112 Stat.
727, expanded the period for which administrative costs are
recoverable. See sec. 7430(c)(2)(B). Although the examples have
not been updated to reflect this change, petitioner has requested
only litigation costs; thus, the examples are applicable here.
                              - 36 -

     Example (1). Taxpayer A receives a notice of proposed
     deficiency (30-day letter). A files a request for and
     is granted an Appeals office conference. At the
     conference no agreement is reached on the tax matters
     at issue. The Internal Revenue Service then issues a
     notice of deficiency. Upon receiving the notice of
     deficiency, A discontinues A's administrative efforts
     and files a petition with the Tax Court. A's costs
     incurred in connection with the preparation and filing
     of a petition with the Tax Court are litigation costs
     and not reasonable administrative costs. * * *

     Example (2). Assume the same facts as in Example 1
     except that after A receives the notice of deficiency,
     A recontacts Appeals. Again, A's costs incurred before
     the administrative proceeding date, the date of the
     notice of deficiency as set forth in §
     301.7430-3(c)(3), are not reasonable administrative
     costs. A's costs incurred in recontacting and working
     with Appeals after the issuance of the notice of
     deficiency, and up to and including the time of filing
     of the petition, are reasonable administrative costs.
     A's costs incurred in connection with the filing of a
     petition with the Tax Court are not reasonable
     administrative costs because those costs are litigation
     costs. * * *

     It appears the October 2002 fees were not in connection with

this Court proceeding.   However, petitioner’s counsel’s review of

the notice of determination was in connection with this

proceeding since petitioner had to draft its petition in response

to the conclusions contained therein.    See sec. 301.7430-

4(c)(3)(i), (4), Example (1), Proced. & Admin. Regs.

     Stated differently, we believe that petitioner discontinued

its administrative appeal efforts upon receipt of the notice of

determination.   The examining agent made it clear that she would

not forward this matter to the Appeals Office until petitioner

submitted a formal written protest.    Petitioner did not file a
                               - 37 -

formal written protest, and respondent issued the notice of

determination.    The record shows that after receiving the notice

of determination petitioner’s counsel began to prepare its

petition.   Costs paid or incurred in connection with the

preparation of the petition are litigation costs.    See sec.

301.7430-4(c)(4), Examples (1) and (2), Proced. & Admin. Regs.

E.   Conclusion

     To summarize, we award petitioner litigation costs to the

extent described herein.    In petitioner’s counsel’s detailed

affidavit, he claimed a total of 118.25 hours worked.    However,

we found that 11 of those hours were not in connection with this

court proceeding.    Thus, petitioner is entitled to attorney’s

fees for 107.25 hours at a rate of $150 per hour, totaling

$16,087.50.   Additionally, petitioner is entitled to the $265.40

of expenses it paid for court costs, duplication costs, and

paralegal fees.

     To reflect the foregoing,


                                          An appropriate order and

                                     decision will be entered.
