                         T.C. Memo. 1997-366



                       UNITED STATES TAX COURT



          ESTATE OF LEON SPEAR, DECEASED, JEANNETTE SPEAR,
           HARVEY SPEAR, AND ROBIN SPEAR, ADMINISTRATORS,
                  AND JEANNETTE SPEAR, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3276-87.                       Filed August 11, 1997.



     Barry A. Furman, for petitioners.

     Ruth M. Spadaro and James C. Fee, Jr., for respondent.



                         MEMORANDUM OPINION


     COLVIN, Judge:    This case is before the Court on

petitioners' motion for award of administrative and litigation

costs under section 7430 and Rule 231.1

     1
         We have previously issued opinions in this case at T.C.
                                                     (continued...)
                                - 2 -


     To prevail, petitioners must show that respondent's position

in this case was not substantially justified.   We conclude that

petitioners did not meet this requirement.   Thus, we will deny

petitioners' motion.

     In light of this conclusion, we need not decide respondent's

contentions that petitioners are not entitled to relief because

(1) they unreasonably protracted the proceedings, (2) the amount

of costs they claim is not reasonable, and (3) they did not pay

or incur the amounts claimed.

     The parties have submitted affidavits and memoranda

supporting their positions.   We decide the motion based on the

memoranda, affidavits, and exhibits attached to the affidavits.

The parties do not dispute the material facts in the affidavits

or the authenticity of the exhibits attached to the affidavits.

Respondent requested a hearing, but we conclude that a hearing is

not necessary to properly decide this motion.   Rule 232(a)(3).

     Unless otherwise indicated, section references are to the

Internal Revenue Code.   All references to section 7430 are to the

section as amended by section 1551 of the Tax Reform Act of 1986,

Pub. L. 99-514, 100 Stat. 2752, and by section 6239(a) of the


     1
      (...continued)
Memo. 1993-213, vacated and remanded 41 F.3d 103 (3d Cir. 1994),
and T.C. Memo. 1996-137. In those opinions, we decided whether,
for 1975, 1976, and 1977, petitioners failed to report
substantial amounts of income and whether they were liable for
the addition to tax for fraud.
                               - 3 -


Technical and Miscellaneous Revenue Act of 1988, Pub. L. 100-647,

102 Stat. 3342, 3743-3746.   Rule references are to the Tax Court

Rules of Practice and Procedure.

                             Background

A.   Petitioners

     Leon Spear (the decedent) and Jeannette Spear (Mrs. Spear)

lived in Philadelphia, Pennsylvania, when they filed their

petition.   They operated parking lot businesses from 1956 through

the years in issue and dealt extensively in cash.

     The decedent and Mrs. Spear kept cash in safe deposit boxes

and entered their safe deposit boxes many times from 1972 to

1977.   They destroyed the records of their cash receipts from

their parking lot businesses, including daily settlement sheets,

before respondent's audit.

B.   Respondent's Investigations of the Decedent and Mrs. Spear

     Respondent's agents interviewed the decedent and Mrs. Spear

and sent document requests to them before respondent issued the

notice of deficiency.   Respondent interviewed the decedent and

Mrs. Spear's Federal income tax preparer and a bookkeeper for

their corporations.   Respondent summoned third parties, reviewed

public records, and examined the decedent and Mrs. Spear's bank

accounts and financial statements.

     On December 9, 1977, Revenue Agent Michael McGuckin

(McGuckin) asked the decedent and Mrs. Spear how much cash they
                                - 4 -


had, whether they kept cash at home or at their business, and

whether they carried a significant amount of cash.   Mrs. Spear

said they did not keep cash at home or at the business, and that

they did not carry cash.    In January 1978, McGuckin recommended

that the decedent and Mrs. Spear be prosecuted for criminal

fraud.

     Special Agent Lawrence Trepple (Trepple) conducted a

criminal investigation of the decedent and Mrs. Spear.   He

examined their tax returns, bank accounts, financial statements,

and records that were filed at courthouses.   He interviewed

Adrienne Wolf, the decedent's and Mrs. Spear's bookkeeper.     He

reviewed the revenue agents' work and discussed matters with

them.    Trepple interviewed the decedent and Mrs. Spear on March

13, 1978.

     Trepple found that:    (1) The value of the decedent and Mrs.

Spear's assets had increased substantially during the years in

issue, (2) the decedent and Mrs. Spear destroyed their records of

cash receipts, (3) the decedent and Mrs. Spear reported different

amounts of income on their Philadelphia parking lot tax returns

and Federal income tax returns, and (4) the decedent and Mrs.

Spear used corporate funds for their personal benefit without

reporting them as income.   He did a net worth analysis and

appropriately investigated leads for nontaxable sources of

income.    He learned that the decedent and Mrs. Spear's net worth
                                 - 5 -


increased dramatically during the years in issue.    He concluded

that the decedent and Mrs. Spear skimmed cash from the parking

lot businesses and used corporate funds for their personal

benefit without reporting them as income.

     Trepple attended the decedent's and Mrs. Spear's criminal

trial in December 1982 and January 1983.    During that trial, the

decedent and Mrs. Spear claimed for the first time that the

decedent's father, Abe Spear, had given the decedent $380,000 in

cash in 1957.    The decedent testified about his father's will,

the will contest, and the fact that his father pawned family

jewelry and borrowed money, including $1,000 from the decedent's

sister, Sadie.

C.   Notice of Deficiency

     Respondent issued the notice of deficiency in this case on

December 23, 1986.    On February 6, 1987, the decedent and Mrs.

Spear filed a petition in this Court.    Petitioners did not

contest respondent's use of the net worth method or respondent's

net worth computation, except they contended that they had more

opening cash on hand than respondent allowed, and that payments

to them from their closely held corporations were nontaxable loan

repayments.   Petitioners also disputed that they were liable for

the addition to tax for fraud.
                               - 6 -


                            Discussion

A.   Motion for Administrative and Litigation Costs

     Generally, a taxpayer who has substantially prevailed in

a Tax Court proceeding may be awarded reasonable administrative

and litigation costs.   Sec. 7430(a), (c).    To be entitled to an

award, the taxpayer must:

     1.   Exhaust administrative remedies.2    Sec. 7430(b)(1).

Respondent concedes that petitioners meet this requirement.

     2.   Substantially prevail with respect to the amount in

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

that petitioners meet this requirement.

     3.   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) (1988).

Respondent concedes that petitioners meet this requirement.

     4.   Show that the position of the United States in the

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




     2
       This requirement does not apply to an award for reasonable
administrative costs. Sec. 7430(b)(1).
                                - 7 -


Respondent contends, and we hold, that petitioners do not meet

this requirement.

       5.   Establish that the amount of costs and attorney's fees

claimed by the taxpayers is reasonable.     Sec. 7430(a), (c)(1) and

(2).    Respondent contends that the amount of costs petitioners

claim is not reasonable.    We need not decide this issue.

       A taxpayer has the burden of proving that he or she meets

each of these requirements before the Court may award

administrative and 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).

B.     Whether the Position of the United States Is Substantially
       Justified

       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 administrative and litigation costs.

Sec. 7430(c)(4)(A)(i).

       1.   Position of the United States

       The position of the United States is the position taken

by the Commissioner:    (a) In the judicial proceeding, and (b) in

the administrative proceeding as of the earlier of:    (i) the date
                                 - 8 -


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).   Respondent's position in the

notice of deficiency and in the answer was that the decedent and

Mrs. Spear had no cash hoard and were liable for the addition to

tax for fraud.     Thus, in this case, respondent's position in both

the judicial and the administrative proceeding was the position

taken in the notice of deficiency.

     2.      Substantially Justified Standard

     The 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); Rickel v. Commissioner, 900 F.2d 655, 665 (3d Cir.

1990), affg. in part and revg. in part on other grounds 92 T.C.

510 (1989).     That standard applies to motions for litigation

costs under section 7430.     Nicholson v. Commissioner, 60 F.3d

1020, 1025-1026 (3d Cir. 1995), revg. and remanding T.C. Memo.

1994-280.     To be substantially justified, the Commissioner's

position must have a reasonable basis in both law and fact.

Pierce v. Underwood, supra; Nicholson v. Commissioner, supra at

1026.     For a position to be substantially justified, there must

be "substantial evidence" to support it.        Pierce v. Underwood,
                                - 9 -


supra at 564-565; Powers v. Commissioner, 100 T.C. 457, 473

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

other issues 43 F.3d 172 (5th Cir. 1995), remanded 51 F.3d 34

(5th Cir. 1995).

     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).   However, it is a factor to be considered.    Estate of

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

Powers v. Commissioner, supra at 471.    The taxpayer need not show

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.

C.   Whether Respondent Had a Basis in Fact for the Position in
     the Notice of Deficiency

     1.   Respondent's Investigation Before the Notice of
          Deficiency

     Respondent investigated this case before issuing the notice

of deficiency.   Respondent's agents interviewed the decedent and

Mrs. Spear and sent document requests to them.   Respondent

summoned third parties, reviewed public records, and examined the

decedent and Mrs. Spear's bank accounts and financial statements.
                                - 10 -


As a result, respondent obtained information which provided a

basis in fact for respondent's position in the notice of

deficiency.

     2.     Respondent's Basis in Fact for the Determination

     Petitioners contend that respondent had no basis in fact for

the position that the decedent and Mrs. Spear had no cash on hand

on January 1, 1975, and that petitioners were liable for the

addition to tax for fraud.     We disagree.

     Respondent's basis in fact for determining that the decedent

and Mrs. Spear had no cash on hand on January 1, 1975, was:     (a)

Mrs. Spear told respondent's agents that they did not have cash

at home, at their business, or on their persons; (b) petitioners

borrowed money to buy real estate; and (c) petitioners signed a

financial statement attached to a mortgage application in which

they stated that they had $2,800 in cash, which they used as a

downpayment on the property and listed no other assets or cash

balances.     Respondent's basis in fact for concluding that Abe

Spear did not give petitioners a cash gift was information

indicating that he did not have the means to do so.     For example,

before issuing the notice of deficiency, respondent learned that

Abe Spear pawned family jewelry and borrowed money, including

$1,000 from his daughter Sadie.
                               - 11 -


     Respondent's basis in fact for determining that the decedent

and Mrs. Spear were liable for the addition to tax for fraud for

1975, 1976 and 1977 when the notice of deficiency was issued was:

(a) During the years in issue, the decedent and Mrs. Spear had

unexplained increases in net worth and inadequate records of

their cash transactions; (b) the decedent and Mrs. Spear failed

to supply complete information to their return preparer; (c) the

decedent and Mrs. Spear deducted the rent for their son's

apartment as a corporate expense; (d) the decedent and Mrs. Spear

used corporate funds for their personal benefit and did not

report them as income; (e) the decedent and Mrs. Spear dealt in

cash and had the opportunity to skim it without reporting it; (f)

the decedent and Mrs. Spear had an unlikely explanation about the

source of a claimed cash hoard; and (g) the decedent and Mrs.

Spear destroyed records of their cash receipts.

     3.   Petitioners’ Contentions

     Petitioners contend that respondent's investigation was

deficient.    For example, petitioners contend that respondent's

agents should have asked the decedent and Mrs. Spear about the

contents of the safe deposit boxes but only asked about cash in

their home.    Petitioners also contend that the decedent and Mrs.

Spear kept cash in their safe deposit boxes and that the position
                                - 12 -


that they had no cash on hand on January 1, 1975, was not

warranted.

     Petitioners’ arguments miss the mark.    The issue is not

whether respondent's investigation of the case was flawless

(although we have concluded that it was legally sufficient in all

respects, Estate of Spear v. Commissioner, T.C. Memo. 1996-137,

slip op. at 11-12), or whether petitioners had evidence

supporting their position.    Instead, the issue is whether

respondent had a basis in fact for the position in the notice of

deficiency.    As stated above, we find that respondent did.

     Petitioners contend that Thomas v. Commissioner, 232 F.2d

520, 523 (1st Cir. 1956) (Commissioner may not determine that

there is no cash on hand at the beginning of a specified period

merely because the taxpayer makes no affirmative showing to the

contrary), revg. and remanding T.C. Memo. 1955-46, governs this

case.    We disagree.   Section 7430 was not an issue in Thomas.      As

stated above, respondent had a basis in fact for determining that

the decedent and Mrs. Spear had no cash on hand at the beginning

of the net worth period.

        Petitioners contend that respondent had no basis in fact

for the determination because Trepple testified that the decedent

and Mrs. Spear had a very good paper trail.    We disagree.    They
                              - 13 -


did not have adequate records of their cash transactions.

Trepple's testimony related to money the decedent and Mrs. Spear

withdrew from their corporations and is not in context here.

     Petitioners contend that the source of the decedent and Mrs.

Spear's cash hoard is irrelevant to whether respondent had a

basis in fact to determine that the decedent and Mrs. Spear had

no cash on hand.   Even if the decedent and Mrs. Spear's

contentions were true, it does not change our conclusion that

respondent had a basis in fact for the determination about the

amount of cash on hand.

     4.   Conclusion

     We conclude that respondent's position in the notice of

deficiency that the decedent and Mrs. Spear had no cash on hand

at the beginning of the net worth period and that they were

liable for the addition to tax for fraud for the years in issue

had a basis in fact.

D.   Whether Respondent Had a Basis in Law for the Position in
     the Notice of Deficiency

     1.   Basis in Law

     Petitioners do not dispute that the legal authorities cited

by respondent govern the issues in dispute.   Both parties cite

United States v. Massei, 355 U.S. 595 (1958), Holland v. United
                                 - 14 -


States, 348 U.S. 121 (1954), and their progeny, as establishing

the legal standard for the net worth method, and both parties

make the same legal analysis of fraud and the badges of fraud

under section 6653(b) and the decided cases.     The parties dispute

how those standards apply to the facts in this case.

     2.   Whether Respondent Had a Basis in Law for Determining
          That the Decedent and Mrs. Spear Had No Cash on Hand on
          January 1, 1975

     Petitioners contend that respondent had no basis in law for

determining that the decedent and Mrs. Spear had no cash on hand

on January 1, 1975, because respondent improperly used the net

worth method.   We disagree.

     Respondent's basis in law is clear.     The Commissioner may

use the net worth method to compute a taxpayer's income if the

taxpayer has inadequate records.      Paschal v. Commissioner, 76

AFTR 2d 95-7975, at 95-7977, 96-1 USTC par. 50,013, at 83,047 (3d

Cir. 1995), affg. without published opinion T.C. Memo. 1994-380;

sec. 1.446-1(b), Income Tax Regs.; e.g., Holland v. United

States, supra at 130-132.      Petitioners do not dispute that this

is the applicable legal standard.

     Under the net worth method, a taxpayer's income is equal to

the increase in net worth during the taxable year, plus

nondeductible disbursements, minus nontaxable receipts.      Holland
                              - 15 -


v. United States, supra at 125, 137; Estate of Mazzoni v.

Commissioner, 451 F.2d 197, 199 (3d Cir. 1971), affg. Mazzoni v.

Commissioner, T.C. Memo. 1970-37, supplemented by Estate of

Mazzoni v. Commissioner, T.C. Memo. 1970-144.     To use the net

worth method, the Commissioner must meet three requirements:

     first, the Commissioner must reliably establish a net
     worth for taxpayer as of the beginning of the period
     under review; second, investigation is required of the
     taxpayer's explanation for his net worth increases, if
     such "leads" are "reasonably susceptible of being
     checked;" finally, the government must suggest a
     "likely source" of the unreported income.

Estate of Mazzoni v. Commissioner, supra at 200 (citation and fn.

ref. omitted).   Petitioners do not dispute that this is the

applicable legal standard.

     3.   Whether Respondent Had a Basis in Law for Determining
          That Petitioners Are Liable for the Addition to Tax for
          Fraud

     Respondent's basis in law for determining that petitioners

were liable for the addition to tax for fraud is section 6653(b)

and the many cases which apply it.     The parties do not dispute

what legal standards apply under section 6653(b).    We conclude

that respondent had a basis in law to determine that petitioners

were liable for the addition to tax for fraud.
                             - 16 -


E.   Conclusion

     We conclude that respondent's position in the notice of

deficiency had a reasonable basis in both law and fact.    Thus, we

hold that respondent's position was substantially justified and

that petitioners are not entitled to an award for administrative

and litigation costs under section 7430.   Petitioners' motion for

administrative and litigation costs will be denied.

     To reflect the foregoing,


                                           An appropriate order

                                   will be issued denying

                                   petitioners' motion for

                                   an award of administrative

                                   and litigation costs.
