                              T.C. Memo. 2013-156



                        UNITED STATES TAX COURT



THOUSAND OAKS RESIDENTIAL CARE HOME I, INC., ET AL.,1 Petitioners
                           v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket Nos. 1448-10, 1480-10,               Filed June 20, 2013.
                  1481-10.



              Ps filed a motion for recovery of reasonable administrative and
      litigation costs pursuant to I.R.C. sec. 7430.

             Held: R’s position was substantially justified. P is not entitled
      to recovery of reasonable administrative and litigation costs.




      1
      Cases of the following petitioners are consolidated herewith: Thousand
Oaks Residential Care Home I, Inc., docket No. 1480-10; and Robert A. Fletcher
and Pearl Fletcher, docket No. 1481-10. On December 15, 2011, we granted
motions to change the captions in docket Nos. 1448-10 and 1480-10.
                                        -2-

[*2] Matthew Taggart, Ryan Andrews, Michael B. Luftman, and Charles

Kolstad, for petitioners.

      Kris H. An, for respondent.



                            MEMORANDUM OPINION


      WHERRY, Judge: This matter is before the Court on petitioners’

motion for administrative and litigation costs filed pursuant to section 7430 and

Rules 230 and 231.2 Respondent filed a response opposing petitioners’ motion.

As discussed in detail below, we conclude that respondent’s position in these

proceedings was substantially justified, and consequently we will deny petitioners’

motion.

                                    Background

      After an exhaustive review of multiple factors, on January 14, 2013, this

Court determined that most of the Fletchers’ compensation was reasonable and

deductible under section 162. Thousand Oaks Residential Care Home I, Inc. v.

Commissioner, T.C. Memo. 2013-10, at *33. Respondent has conceded that

      2
       Unless otherwise indicated, all section references are to the Internal
Revenue Code of 1986, as amended and in effect at all relevant times. All Rule
references are to the Tax Court Rules of Practice and Procedure. These cases are
appealable to the U.S. Court of Appeals for the Ninth Circuit.
                                          -3-

[*3] therefore petitioners have “substantially prevailed with respect to the most

significant issues or set of issues in * * * [their] case[s] and that petitioners meet

the net worth requirements of I.R.C. § 7430.” Respondent, however, argues that

petitioners have not established that they have incurred any of the administrative

and litigation costs and that petitioners were not the prevailing parties because

respondent’s positions were substantially justified.

                                      Discussion

      Pursuant to section 7430(a), a prevailing party may be awarded reasonable

administrative and litigation costs incurred in any administrative or court

proceeding brought by or against the United States in connection with the

determination, collection, or refund of any tax, interest, or penalty. The term

“prevailing party” means any party (other than the United States or a creditor of

the taxpayer) which has substantially prevailed with respect to the amount in

controversy or the most significant issue or set of issues and meets the net worth

requirements of 28 U.S.C. sec. 2412(d)(2)(B). See sec. 7430(c)(4)(A). A party

meeting these requirements shall not be treated as the prevailing party, however, if

the United States establishes that its position in the proceeding was substantially

justified. Sec. 7430(c)(4)(B).
                                         -4-

[*4] In order to establish that the position was substantially justified, respondent

must show that the position was “‘justified to a degree that could satisfy a

reasonable person’” or that it had a “‘reasonable basis both in law and

fact.’” Swanson v. Commissioner, 106 T.C. 76, 86 (1996) (quoting Pierce v.

Underwood, 487 U.S. 552, 565 (1988)). “A position has a reasonable basis in fact

if there is relevant evidence that a reasonable mind might accept as adequate to

support a conclusion.” Corkrey v. Commissioner, 115 T.C. 366, 373 (2000)

(citing Pierce, 487 U.S. at 564-565). In determining whether the position was

substantially justified, we must “‘consider the basis for the * * * legal position and

the manner in which the position was maintained’.” Id. (quoting Wasie v.

Commissioner, 86 T.C. 962, 968-969 (1986)).

      The “position of the United States” is evaluated at two stages of the case:

first at the administrative proceeding level and second at the court proceeding

level. See Huffman v. Commissioner, 978 F.2d 1139, 1147 (9th Cir. 1992), aff’g

in part, rev’g in part T.C. Memo. 1991-144. In these cases, the position of the

administrative proceeding was established by the Appeals Office’s decision and

the position of the court proceeding was that taken in respondent’s answer to the

petition. See sec. 7430(c)(7); Maggie Mgmt. Co. v. Commissioner, 108 T.C. 430,

442 (1997). Respondent argues and we find that his position in both proceedings
                                        -5-

[*5] was substantially the same. Respondent’s position in these cases on the issue

of whether the compensation packages paid to the Fletchers for the 2003, 2004,

and 2005 tax years were deductible under section 162 was substantially justified.

      Section 162(a)(1) provides a deduction for ordinary and necessary business

expenses, including “a reasonable allowance for salaries or other compensation for

personal services actually rendered”. In cases appealable to the U.S. Court of

Appeals for the Ninth Circuit, the reasonableness of the payments is considered

with reference to broad factors set forth in Elliotts, Inc. v. Commissioner, 716 F.2d

1241 (9th Cir. 1983), rev’g T.C. Memo. 1980-282, and Metro Leasing & Dev.

Corp. v. Commissioner, 376 F.3d 1015, 1019 (9th Cir. 2004), aff’g 119 T.C. 8

(2002). The reasonableness of compensation is a question of fact to be determined

on the basis of all the facts and circumstances. Pac. Grains, Inc. v. Commissioner,

399 F.2d 603, 606 (9th Cir. 1968), aff’g T.C. Memo. 1967-7.

      Whether compensation was reasonable is necessarily a question of facts and

circumstances. This Court required a full trial complete with expert witnesses on

both sides in order to make a determination with respect to the reasonableness of

the compensation. Of the factors the Court looked at, it found that three of the six

factors weighed in favor of respondent and noted that another factor only slightly

favored petitioner. After careful analysis and consideration the Court found that
                                         -6-

[*6] most of the compensation paid to the Fletchers was reasonable; however, a

material portion, $282,615, of the compensation package as it related to deferred

compensation provided by the retirement plan was found to be nondeductible and

unreasonable. It was also determined that petitioner Thousand Oaks Residential

Care Home I, Inc.’s owner-employees had drained, through compensation, the

corporation’s profits, essentially leaving no return for shareholders on their capital

investment. The cases, with respect to the owner-employees and their reasonable

compensation, including compensation for earlier years when they were

undercompensated, were competitive. The testimony of respondent’s expert, the

numerous factual issues surrounding the decision, and the total disallowance of all

compensation paid to the owner-employees’ daughter Ms. Strick demonstrate that

respondent acted reasonably given the facts and circumstances.3

      In accordance with the foregoing, we hold that respondent’s position in

these cases was reasonable and substantially justified under section 7430(c)(4)(B).




      3
       We note that had petitioners chosen to submit a qualified offer pursuant to
sec. 7430(g) which recognized not only respondent’s excessive zeal, but also its
own and that of its shareholder owners, much of its $151,503 of litigation costs
and those of respondent might have been avoided. In any event if the qualified
offer had been reasonable, petitioners would have trumped respondent’s sec.
7430(c)(4)(B) defense and might have recovered their costs in this matter. See
sec. 7430(c)(4)(E).
                                        -7-

[*7] It follows that petitioners are not the prevailing party within the meaning of

section 7430, and we will therefore deny petitioners’ motion.4

      To reflect the foregoing,


                                              Appropriate orders and decisions

                                       will be entered.




      4
        Because we concluded that respondent’s position was substantially
justified, we need not address respondent’s argument that petitioners have not
established that they have incurred any of the administrative and litigation costs.
