                         T.C. Memo. 1997-44



                      UNITED STATES TAX COURT



                  BEAVER BOLT, INC., Petitioner v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent




     Docket No. 22087-93.                  Filed January 27, 1997.



     Merritt S. Yoelin, for petitioners.

     Cheryl B. Harris, for respondent.



                         MEMORANDUM OPINION


     COLVIN, Judge:    This matter is before the Court on

petitioner’s motion for litigation costs under section 74301 and

Rule 231.   Respondent concedes that petitioner substantially


     1
       Section references are to the Internal Revenue Code. Rule
references are to the Tax Court Rules of Practice and Procedure.
                                   2

prevailed, exhausted its administrative remedies, and meets the

net worth requirements.     Sec. 7430(b)(1), (c)(4)(A)(ii)(I),

(iii).     The remaining issues for decision are:

      1.     Whether respondent’s position in the underlying

proceeding was substantially justified.     We hold that it was not;

and

      2.     whether petitioner's counsel is entitled to be

reimbursed at the rate of $75 per hour plus a cost of living

adjustment, as respondent contends; or at a rate of $125, $150,

and $180 per hour, as petitioner contends.     We hold that the

appropriate hourly rate is $103.95 for 1994 and $107.10 for 1995.

      The parties submitted memoranda and affidavits supporting

their positions.     We decide the motion based on the memoranda and

affidavits provided by the parties.     Neither party requested a

hearing.     There are no significant factual disputes.   We conclude

that a hearing is not necessary to decide this motion.     Rule

232(a)(3).

                              Background

1.    Petitioner

      Petitioner is a corporation, the principal place of business

of which was in Portland, Oregon, during the years in issue and

when it filed its petition.

2.    Underlying Tax Case

      The primary issue in the underlying case, Beaver Bolt, Inc.

v. Commissioner, T.C. Memo. 1995-549, filed November 20, 1995,
                                  3

was whether payments petitioner made to Jane Grecco (Grecco) were

for a covenant not to compete, as petitioner contended, or were

for her stock in petitioner.    Petitioner had a stock purchase

agreement with its officers, including Grecco, which gave

petitioner the option to repurchase its stock owned by a

terminated employee.    The agreement included a formula setting

the purchase price for the stock.     Grecco negotiated a financial

settlement with petitioner under which petitioner paid Grecco

$513,400 when she ceased working for petitioner.    Petitioner

treated $130,000 of this amount as payment for Grecco's stock in

petitioner and $383,400 as payment for the covenant not to

compete.   Petitioner amortized $383,400 for the covenant not to

compete over 3 years.

     Respondent prepared an Engineering and Valuation report,

dated July 31, 1992, which concluded that Grecco's stock in

petitioner was worth $739,000 on June 30, 1988, and the covenant

not to compete was worth $0.    Respondent disallowed petitioner's

amortization deductions in full in the notice of deficiency sent

on July 15, 1993.

     On April 18, 1994, petitioner's expert concluded that

Grecco's stock was worth $190,000.    Petitioner's expert prepared

a stock valuation report, a copy of which respondent received on

June 24, 1994.   On August 22, 1994, respondent's expert concluded

that Grecco's stock was worth $188,600 and that the covenant not

to compete was worth $52,669.    On September 27, 1994, the parties
                                  4

agreed that the fair market value of Grecco's stock in petitioner

was $189,300.   At trial, respondent contended that the value of

the covenant was $52,669.

     Respondent did not contend that petitioner paid the $513,400

to Grecco for anything other than the covenant not to compete and

Grecco's stock in petitioner.    Petitioner argued, and we held,

that the covenant not to compete was worth $324,100, the

difference between the total amount petitioner paid Grecco

($513,400) and the agreed value of Grecco's stock redeemed by

petitioner ($189,300).

                             Discussion

A.   Motion for Litigation Costs:     Introduction

     Generally, a taxpayer who has substantially prevailed in a

Tax Court proceeding may be awarded reasonable litigation costs.

Sec. 7430(a)(2).    To be entitled to an award, the taxpayer must:

     (a)   Exhaust administrative remedies.    Sec. 7430(b)(1).

Respondent concedes that petitioner meets this requirement.

     (b)   Substantially prevail with respect to the amount in

controversy.    Sec. 7430(c)(4)(A)(ii)(I).   Respondent concedes

that petitioner meets this requirement.

     (c)   Show that the position of the United States in the

action was not substantially justified.      Sec. 7430(c)(4)(A)(i).

Respondent contends that petitioner does not meet this

requirement.
                                 5

     (d)   Be an individual whose net worth did not exceed $2

million, or an owner of an unincorporated business, or any

partnership, corporation, etc., the net worth of which did

not exceed $7 million, when the petition was filed.     Sec.

7430(c)(4)(A)(iii); 28 U.S.C. sec. 2412(d)(2)(B).     Respondent

concedes that petitioner meets this requirement.

     (e)   Establish that the amount of costs and attorney's

fees claimed is reasonable.   Sec. 7430(a), (c)(1).    Recoverable

attorney's fees are limited to $75 per hour adjusted for cost of

living increases and special factors.   Sec. 7430(c)(1)(B)(iii).

Respondent contends that petitioner does not meet this

requirement.

     A taxpayer has the burden of proving that it meets each

requirement before the Court may order an award of litigation

costs under section 7430.   Rule 232(e); Estate of Johnson v.

Commissioner, 985 F.2d 1315, 1318 (5th Cir. 1993); Gantner v.

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

Cir. 1990); Minahan v. Commissioner, 88 T.C. 492, 497 (1987).2


     2
       In 1996, legislation was enacted which shifted to the
Commissioner the burden of proving whether the position of the
United States was substantially justified, sec. 7430(c)(4)(B), as
amended by the Taxpayer Bill of Rights 2 (TBR2), Pub. L. 104-168,
sec. 701, 110 Stat. 1452, 1463 (1996), and raised the hourly rate
for attorney's fees to $110, sec. 7430(c)(1)(B)(iii), as amended
by TBR2 sec. 702(a), 110 Stat. 1464. These changes do not apply
here because they are effective for proceedings commenced after
July 30, 1996. TBR2 secs. 701(d), 702(b), 110 Stat. 1464; see
National Industrial Investors, Inc. v. Commissioner, T.C. Memo.
1996-423.
                                   6

B.   Whether Respondent's Position Was Substantially Justified

     1.     Background

     A taxpayer must establish that the position of the United

States in the litigation was not substantially justified to be

entitled to an award for litigation costs.       Sec.

7430(c)(4)(A)(i); Rule 232(e); Bragg v. Commissioner, 102 T.C.

715, 717 (1994).    The position of the United States is the

position taken by the Commissioner:     (a) In the court proceeding,

and (b) in the administrative proceeding as of the earlier of (i)

the date the taxpayer receives the notice of the decision of the

Internal Revenue Service Office of Appeals, or (ii) the date of

the notice of deficiency.     Sec. 7430(c)(7).

     The Equal Access to Justice Act's substantially justified

standard requires that the Government's position be justified

to a degree that would satisfy a reasonable person.        Pierce v.

Underwood, 487 U.S. 552, 565 (1988).     That standard applies to

motions for litigation costs under section 7430.        Nicholson v.

Commissioner, 60 F.3d 1020, 1026 (3d Cir. 1995), revg. T.C. Memo.

1994-280; Comer Family Equity Pure Trust v. Commissioner, 958

F.2d 136, 139-140 (6th Cir. 1992), affg. T.C. Memo. 1990-316;

Powers v. Commissioner, 100 T.C. 457, 470 (1993), affd. on this

issue and revd. in part and remanded on other issues 43 F.3d

172 (5th Cir. 1995).     To be substantially justified, the

Commissioner's position must have a reasonable basis in both law

and fact.    Pierce v. Underwood, supra; Hanover Bldg. Matls., Inc.
                                   7

v. Guiffrida, 748 F.2d 1011, 1015 (5th Cir. 1984); Powers v.

Commissioner, supra at 473.     For a position to be substantially

justified, there must be "substantial evidence" to support it.

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

supra at 473.

     The fact that the Commissioner eventually loses or concedes

the case does not in itself establish that a position is

unreasonable.    Wilfong v. United States, 991 F.2d 359, 364 (7th

Cir. 1993); Hanson v. Commissioner, 975 F.2d 1150, 1153 (5th Cir.

1992).    However, it is   a factor to be considered.   Heasley v.

Commissioner, 967 F.2d 116, 120 (5th Cir. 1992), affg. in part

and revg. in part T.C. Memo. 1991-189; Estate of Perry v.

Commissioner, 931 F.2d 1044, 1046 (5th Cir. 1991); Powers v.

Commissioner, supra at 471.     The taxpayer need not show that the

Commissioner demonstrated bad faith to establish that the

Commissioner's position was not substantially justified for

purposes of a motion for litigation costs under section 7430.

Estate of Perry v. Commissioner, supra; Powers v. Commissioner,

supra.

     2.     Whether Respondent's Position That the Covenant Not To
            Compete Had No or Minimal Value Had a Reasonable Basis
            in Fact and Law

     Respondent's position in Beaver Bolt, Inc. v. Commissioner,

T.C. Memo. 1995-549, was that Grecco's stock was worth $189,300

and that the covenant not to compete was worth $52,669.

Petitioner contends that the position of the United States was
                                   8

not substantially justified once respondent received the August

22, 1994, valuation report of its expert, which estimated that

Grecco's stock in petitioner was worth $188,600 as of June 30,

1988.    Petitioner argues that it is entitled to recover costs

from that time.3



     Respondent argues that petitioner intended that the purchase

price ($513,400) provided in petitioner's stock purchase

agreement was payment solely for Grecco's stock.       Respondent

points out that petitioner was obligated to pay Grecco that

amount even if Grecco had not agreed not to compete and even if

the fair market value of the stock was less than that amount.

Respondent maintains that the fact that petitioner and respondent

agreed to the fair market value for the stock did not alter the

fact that the allocation of any value to the covenant not to

compete lacked economic reality.       Respondent argues that the

amount allocated to the covenant not to compete did not result

from arm's-length negotiations.    Respondent points out that

Grecco and petitioner did not have adverse tax interests with

respect to the allocation of $383,400 to the covenant.

     3
       Generally, the position of the United States in the
judicial proceeding is the position taken in the Commissioner's
answer to the petition. Sec. 7430(c)(7)(A); Huffman v.
Commissioner, 978 F.2d 1139, 1148 (9th Cir. 1992), affg. in part,
revg. in part on other grounds and remanding T.C. Memo. 1991-144.
Respondent filed the answer on Dec. 6, 1993. Petitioner does not
contend that it is entitled to an award for litigation costs
incurred before Aug. 22, 1994.
                                 9

Respondent argues that Grecco was not concerned with the

allocation of the purchase price between her stock in petitioner

and the covenant not to compete, and that she was only concerned

with the total amount she would receive when she left petitioner.

     None of these points establish that respondent had a basis

in fact for continuing to contend, after August 22, 1994, that

the covenant not to compete was worth $52,669.   Respondent had

petitioner's expert's report on June 24, 1994 (3 months before

trial), and had respondent's expert's report on August 22, 1994

(one month before trial).   Respondent did not concede that the

covenant was worth $324,100 (or any amount more than $52,669)

despite the fact that (a) petitioner's expert said that Grecco's

stock in petitioner was worth $190,000, respondent's expert said

it was worth $188,600, and the parties agreed that the stock was

worth $189,300, and (b) respondent presented no fact or theory to

support the conclusion that petitioner paid the remaining

$324,100 ($513,400 - 189,300 = $324,100) to Grecco for anything

other than the covenant not to compete.   Respondent did not offer

a reasonable theory for why the covenant not to compete was worth

less than $324,100.   Respondent's failure to reevaluate that

position after August 22, 1994, was unreasonable.   Frisch v.

Commissioner, 87 T.C. 838, 841 (1986) (the Commissioner's

valuation position was unreasonable where the Commissioner had

the taxpayer's appraisal for 7 months before trial and did not

investigate further or reevaluate the Commissioner's own position
                                 10

as new facts came to light); Williford v. Commissioner, T.C.

Memo. 1994-135 (the Commissioner's valuation position was

unreasonable where the Commissioner was slow to seek an

appraisal, did not contact the taxpayer's valuation expert, and

did not modify her position after receiving the Commissioner's

expert's report 42 days before trial).    Respondent's position in

the instant case is weaker than the Commissioner's position in

Frisch v. Commissioner, supra, because here respondent's expert

substantially agreed with petitioner's expert regarding the value

of Grecco's stock.    We conclude that respondent's position did

not have a reasonable basis in fact or law.

     3.   Amount of Reasonable Attorney's Fees and Litigation
          Costs

     Petitioner seeks an award of litigation costs of $44,737.25,

comprising $42,254.75 for attorney's fees and $2,482.50 for out-

of-pocket expenses.

          a.   Hourly Rate

     Respondent argues that the maximum hourly rate for

attorney's fees is $75, adjusted for increases in the cost of

living, sec. 7430(c)(1)(B)(iii), and that a higher limit should

not apply absent a showing that a special factor justifies a

higher rate, sec. 7430(c)(1)(B)(iii); Stieha v. Commissioner, 89

T.C. 784, 792 (1987).

     Petitioner does not argue that special factors are present

that warrant payment of attorney's fees at a rate higher than
                                  11

$75.    Accordingly, we apply the $75 hourly rate, adjusted for

increases in the cost of living.       Sec. 7430(c)(1)(B)(iii).

            b.    Adjustment of $75 Limit for Increases in the Cost
                  of Living From 1986

       We use the Consumer Price Index (CPI) for all urban

consumers to adjust the $75 hourly limit for increases in the

cost of living.     Powers v. Commissioner, 100 T.C. at 491; Cassuto

v. Commissioner, 93 T.C. 256, 273 (1989), affd. in part and revd.

in part 936 F.2d 736 (2d Cir. 1991).

       We have held that 1981 is the appropriate base year for

calculating cost of living increases under section

7430(c)(1)(B)(iii).     Bayer v. Commissioner, 98 T.C. 19, 23

(1992); Cassuto v. Commissioner, supra at 269.       However, the U.S.

Court of Appeals for the Ninth Circuit, to which this case is

appealable, has held that the appropriate base year for

calculating cost of living increases is 1986.       Huffman v.

Commissioner, 978 F.2d 1139, 1151 (9th Cir. 1992), affg. in part

and revg. in part T.C. Memo. 1991-144.       We follow that holding

here.    Golsen v. Commissioner, 54 T.C. 742, 756-758 (1970), affd.

445 F.2d 985 (10th Cir. 1971).

       In addition to attorney's fees, petitioner incurred

litigation costs of $2,482.50.    Respondent does not argue that

the amount of litigation costs claimed by petitioner is

unreasonable except for the hourly rate issue just decided.       We

treat this as respondent's concession that the number of hours
                                  12

billed by petitioner's attorneys and other litigation costs were

reasonable.   The hours billed by petitioner's attorneys for which

petitioner is entitled to be reimbursed are for work performed

from August 1994 to March 1995.    We award petitioner attorney's

fees at an hourly rate not to exceed $103.95 for 1994 and $107.10

for 1995, and litigation costs in the amount of $2,482.50.



                                       An appropriate order and

                               decision will be entered.
