                      UNITED STATES COURT OF APPEALS
                           FOR THE FIFTH CIRCUIT

              _________________________________________

                             No. 92-4826
              _________________________________________


                             MICHAEL L. LENNOX AND
                               GLENDA J. LENNOX,

                                                                  Petitioners,


                                      VERSUS


                                COMMISSIONER OF
                               INTERNAL REVENUE,

                                                                  Respondent.

_________________________________________________________________

                 Appeal from the Decision of the
                     United States Tax Court
_________________________________________________________________
                         (August 4, 1993)

Before POLITZ, Chief Judge, REAVLEY, and BARKSDALE, Circuit Judges.

BARKSDALE, Circuit Judge:

       In reviewing the Tax Court's denial of costs to the Lennoxes,

after the government conceded their challenge to its notice of

deficiency, we consider for the first time the definition of the

"position of the United States" on "the date of the notice" as

contained in 26 U.S.C. § 7430(c)(7)(B)(ii), as amended by the

Technical and Miscellaneous Revenue Act of 1988, Pub. L. No. 100-

647,   §   6239(a),    102    Stat.    3342,   3743.    Concluding     that   a

determination of the reasonableness of that position must include

a review of the actions leading to its establishment, we hold that

the    government's     position      was   not   substantially    justified.
Therefore, we REVERSE the denial of costs and REMAND to the Tax

Court for their determination.

                                    I.

     The Internal Revenue Service began to question the Lennoxes'

tax returns during the course of its investigation of Ron Piperi,

an attorney who had represented Glenda Lennox's family since the

early 1970's. Michael Lennox first met Piperi in 1981, when Piperi

handled the probate of Glenda's mother's estate, from which Glenda

Lennox and her children inherited property worth approximately $1

million.    Piperi advised the Lennoxes that they needed a tax

shelter and recommended investing some of the inheritance in

apartment projects.

     The   first   project   was   the   Quail   Creek   Apartments   (the

apartments) in Killeen, Texas, which Piperi was already developing,

and in which he offered to sell the Lennoxes an interest.        In 1983,

he sold his interest to Michael Lennox, making him the sole owner.

At the closing, Lennox executed, among other documents, a $6.25

million note on which he was personally liable.             The loan was

arranged by Piperi through a savings and loan for which he served

as chairman of the board.1         Title was recorded in the county

records.

     After experiencing some difficulty with the company managing

the apartments, Lennox contracted with Asset Plus, a management

company in which Piperi held an interest.           Lennox visited the

1
     Piperi later came under criminal investigation because this
loan, which he arranged in 1983, was a construction loan.
Construction had been completed in 1982.

                                    2
property regularly and handled the insurance and major repairs, but

Asset Plus was to provide him with monthly reports, collect rents,

and administer all expenditures, including making interest payments

on the $6.25 million note.                At the hearing on costs, Lennox

testified that, as far as he knew, those payments were made.

Within the first two years, Lennox realized that the apartments

were not going to generate enough income to service the interest on

the note.     Piperi then approached him with an offer:               his savings

and loan would refinance the loan at a lower rate, but the existing

loan must first be placed in default.              Lennox testified that he

understood Asset Plus was taking the amount it had been paying

toward the interest and placing it in escrow.                   However, Lennox

began to have difficulty obtaining an accounting or other records

from Asset Plus.      The new financing did not go through, the savings

and    loan   foreclosed     on     the    apartments,2   and     Lennox       filed

bankruptcy.

       Meanwhile,     IRS   agent    George    Gilbert,   in     El    Paso,    was

investigating Piperi.       During the course of that investigation, he

discovered that Piperi was receiving the rental income from the

apartments and using it for personal expenses, that no principal or

interest payments had been made on Lennox's $6.25 million note, and

that   Piperi   had    arranged     other     similar   loans,    assuring      the

"borrowers" that they would never have to pay, and in some cases,


2
     In February 1983, Lennox had borrowed an additional $660,000
to use for interest payments on the larger note. He put up 120
acres of land from his mother-in-law's estate as collateral. That,
too, was lost in the foreclosure.

                                          3
paying them $20,000 for signing the notes. This information caused

Gilbert to suspect that Lennox was only a nominee owner of the

apartments, and he concluded that Lennox should be investigated to

determine the true ownership.             On August 10, 1990, Gilbert sent a

memorandum to his branch chief, alerting him to these concerns and

suggesting that the Lennoxes' tax returns be examined.

     On August 22, having received a copy of Gilbert's memorandum,

IRS agent Phelps Brookshire, in Waco, began an examination of the

Lennoxes' returns for 1983, 1984 and 1985.                       For each of those

years,   the     Lennoxes     had       claimed      deductions    related    to   the

apartments, including large net operating losses.                          Brookshire

examined those returns and spoke with Gilbert, but did not conduct

an investigation of his own.               When Brookshire realized, in late

August, that the limitations period would expire that October 27,

he determined that he would "have to do something fast".

     On September 11, Brookshire telephoned Lennox and explained

that all losses associated with the apartments would be disallowed.

Lennox and Brookshire spoke again the following day, and Brookshire

stated that he would have to issue a notice of deficiency unless

Lennox agreed to extend the limitations period.                        Several days

later, Lennox's accountant called Brookshire, advised him that the

tax rolls listed Lennox as the owner of the apartments and that

Lennox had filed bankruptcy because of his debt on them, and

offered,    on   behalf     of    Lennox,       to    sign   a   limited   extension,

extending      the   period      only     as    to    questions    related    to   the

apartments.      Brookshire refused.                 He later testified that his


                                            4
manager said that there was not enough time (in the approximately

35 days remaining in the limitations period) to get approval for

the specific language for a limited extension.

     Not   having   received   an   extension,   Brookshire   issued   a

statutory notice of deficiency on October 2, disallowing the losses

claimed on the apartments due to questions of actual ownership.        On

January 3, 1991, the Lennoxes petitioned the Tax Court for a

redetermination of the deficiencies.     The Commissioner of Internal

Revenue answered on March 5, denying all facts of ownership as

alleged in the petition. On April 10, the Lennoxes' attorney, John

D. Copeland, had a one-hour telephone conversation with an IRS

appeals officer and discussed evidence that Michael Lennox was the

true owner.     (Nothing in the record, however, describes that

evidence.)

     Eight months later, Copeland received settlement documents

from the IRS.       He testified that, after the April telephone

conversation, he intended to send the appeals officer copies of

documents showing ownership but "never got around to sending them

to him, but [the IRS] went ahead and dropped the case, even without

my sending those documents".

     On March 16, 1992, the day this matter was set for trial, the

parties filed a stipulation of settled issues, stating that there

were no deficiencies or additions due from, nor overpayments due

to, the Lennoxes for 1983, 1984 or 1985.         The Lennoxes filed a

motion for administrative and litigation costs that same day, and

the Tax Court heard evidence on the motion on March 19.        On June


                                    5
25, the Lennoxes supplemented their motion, adding additional

costs.    The Tax Court filed an opinion on July 8, concluding that

the government's position, beginning with the date of issuance of

the     notice   of        deficiency,        was     substantially     justified.

Accordingly, costs were denied.

                                         II.

       Internal Revenue Code § 7430 allows the "prevailing party" in

tax proceedings to recoup reasonable costs, including attorney's

fees.    Determining a "prevailing party" includes several factors,

only one of which is at issue here: whether "the position of the

United States in the proceeding was not substantially justified".

26 U.S.C. § 7430(c)(4)(A)(i).            This determination requires us to

resolve two subissues.         Because our court has not interpreted the

applicable definition of "position of the United States", we must

first determine when that position becomes fixed and what actions

can be considered for purposes of this analysis.                     Then, against

that    backdrop,     we    must   determine         whether   the   position   was

substantially justified.

                                         A.

       When § 7430 was first enacted in 1982, the term "position of

the United States" was not defined.                 26 U.S.C. § 7430 (1982).    It

was first defined when the section was amended in 1986, and that

definition was amended in 1988.                Applicable to all proceedings

commenced after November 10, 1988, that version is at issue here,

and reads in pertinent part:




                                          6
          The term "position of the United States" means --

               (A) the position taken by the United States
          in a judicial proceeding to which subsection (a)
          applies, [as quoted in note 3, infra,] and

               (B) the position taken in an administrative
          proceeding to which subsection (a) applies as of
          the earlier of --

                    (i) the date of the receipt by the
          taxpayer of the notice of the decision of the
          Internal Revenue Service Office of Appeals, or

                    (ii) the      date   of   the   notice   of
          deficiency.

26 U.S.C. § 7430(c)(7) (1988).3

     The Lennoxes contend that the position of the United States on

October 2, 1990, the date of the notice of deficiency, was not

substantially justified.      There is no question that it is the

position taken by the United States on that day which we must

consider. The question, however, is what actions the Tax Court can

look to in determining the justification for that position.       This

issue of statutory interpretation is, of course, one of law, which

3
     Subsection (a) provides:

               In any administrative or court proceeding
          which is brought by or against the United States in
          connection with the determination, collection, or
          refund of any tax, interest, or penalty under this
          title, the prevailing party may be awarded a
          judgment or a settlement for --

                    (1) reasonable    administrative  costs
               incurred in connection with such administra-
               tive proceeding within the Internal Revenue
               Service, and

                    (2) reasonable litigation costs incurred
               in connection with such court proceeding.

26 U.S.C. § 7430(a) (1988).

                                   7
we review de novo.   E.g., Dresser Industries v. C.I.R., 911 F.2d

1128, 1132 (5th Cir. 1990); Sliwa v. C.I.R., 839 F.2d 602, 605 (9th

Cir. 1988).

     Although the Tax Court found that there had been sufficient

time to have the limited extension prepared and executed, it

nevertheless refused to consider any actions which took place

before October 2, summarily holding:   "[I]t is clear from section

7430(c)(7)(B) that the only position taken by the United States in

an administrative proceeding which is to be considered in this case

in determining whether [the Lennoxes] are the prevailing part[ies]

is the position taken by [the United States] beginning with the

date of the deficiency notice.   ...   Therefore the reasonableness

of the actions of the revenue agent in not accepting the restricted

[limitations] waiver are not relevant since those actions were

taken prior to October 2, 1990."

     The Lennoxes challenge this interpretation of § 7430, and

contend that such a rule will require courts to decide cases in a

vacuum. We agree. Although we have not previously interpreted the

amended subsection of § 7430 in issue (§ 7430(c)(7)(B)(ii)), at

least one prior opinion by our court foreshadows this result.   In

Hanson v. C.I.R., 975 F.2d 1150 (5th Cir. 1992), in considering the

United States' position in a judicial proceeding, § 7430(c)(7)(A),

our court did so "against the backdrop of the administrative

actions that have gone before", concluding that such a backdrop "is

relevant to a determination whether the government's position in

litigation is substantially justified".   Id. at 1153 n.2 (emphasis


                                   8
in   original).      In   sum,    our     court    declined     to   construe     §

7430(c)(7)(A) (judicial proceeding) as strictly as the Tax Court

here construed § 7430(c)(7)(B)(ii) (administrative proceeding).

Instead, our court interpreted the government's position at a

particular time in the context of what led to the formulation of

that position.

      We   agree   with   the    Hanson      analysis,   and    apply   the    same

interpretation to § 7430(c)(7)(B)(ii).             We hold that the govern-

ment's position on "the date of the notice of deficiency" must be

analyzed in the context of what caused it to take that position.

The IRS would not have issued the notice on October 2 (forcing the

Lennoxes to file suit) if the Lennoxes had extended the limitations

period.     They declined to do so, offering a limited extension

instead.    Because the IRS refused the limited extension, it issued

the notice which set this proceeding in motion.                Certainly we must

consider the reasonableness of that refusal, among other factors,

in determining whether the issuance of the notice was substantially

justified.

                                        B.

      The position of the United States is substantially justified

if it is "justified to a degree that could satisfy a reasonable

person".     Pierce v. Underwood, 487 U.S. 552, 565 (1988).4                  It is

not enough that a position simply possesses enough merit to avoid

4
     Pierce v. Underwood, concerning the Equal Access to Justice
Act (EAJA), 28 U.S.C. § 2412(d), interprets the same words at issue
here. Where the language is the same, "courts read the EAJA and §
7430 in harmony". Kenagy v. United States, 942 F.2d 459, 464 (8th
Cir. 1991).

                                        9
sanctions for frivolousness; it must have a "`reasonable basis both

in law and fact'".        Id.; see, e.g., Hanson, 975 F.2d at 1153.           The

burden     of   proving   no    substantial    justification    is    with    the

taxpayers.      Estate of Johnson v. C.I.R., 985 F.2d 1315, 1318 (5th

Cir. 1993).       We review the Tax Court's ruling on substantial

justification for abuse of discretion, id., and will reverse only

if we have a definite and firm conviction that an error of judgment

was committed.      See TKB International, Inc. v. United States, __

F.2d __, 1993 WL 184021 (9th Cir. June 3, 1993).

     Of course, the ultimate failure of the government's legal

position does not necessarily mean that it was not substantially

justified.      It is, however, a factor to be considered.            Estate of

Perry v. C.I.R., 931 F.2d 1044, 1046 (5th Cir. 1991).                  In this

case, the Tax Court was not swayed by the government's concession,

because    it   concluded      that,   after   the   notice   was   filed,    the

government      "ascertained     the   facts   and   conceded   the    case    as

expeditiously as might be expected".

     To the extent that this is a finding of fact that the IRS

obtained new evidence between notice and concession, we hold that

it is clearly erroneous.         When the notice was issued, the IRS knew

that the tax rolls showed Michael Lennox as the owner of the

apartments and that he had filed for bankruptcy because of his debt

on them.    There is nothing in the record to reveal what information

was later obtained, or how it might have persuaded the IRS to

concede.    It is undisputed that the Lennoxes' attorney spoke to an

IRS appeals officer for one hour on April 10, 1991; but, obviously,


                                        10
the mere length of that conversation is not evidence of its

contents.5

     In the face of the rapidly expiring limitations period, the

government staked its position on October 2, and then, given no

additional information, surrendered that position more than a year

later.   The Lennoxes concede, and we agree, that the IRS had a

basis for suspicion regarding ownership of the apartments. But, on

this record, that suspicion was not a sufficient basis for issuance

of the notice, in light of the opportunity for further, and much

needed, investigation. The restricted extension of the limitations

period, offered by the Lennoxes, would have afforded the government

that opportunity; and, as the Tax Court found, there was sufficient

time to formulate and execute that extension.6   In sum, we conclude

5
     Indeed, at oral argument before us, government counsel
conceded that the "record is scant" regarding any new information
which could have come to light between notice and concession. Also
at oral argument, the Lennoxes' counsel explained that the only
evidence discussed in the telephone conversation was documents from
the public record which would show Michael Lennox's ownership of
the apartments. It is clear that the IRS knew, before issuance of
notice, that title had been transferred to Lennox and that the tax
records reflected such ownership. Moreover, because the IRS has
never contested Lennox's record ownership, it seems unlikely that
it would find such evidence persuasive. Of course, statements made
before us could not have been considered by the Tax Court in
reaching a factual finding.     The statements only reinforce the
conclusion we reached from our review of the record.
6
     The Commissioner cites Harrison v. C.I.R., 854 F.2d 263 (7th
Cir. 1988), cert. denied, 489 U.S. 1053 (1989) (concerned pre-1988
version of § 7430) as authority for its position that it is
reasonable to issue a notice of deficiency in order to toll the
statute of limitations. Harrison, however, is distinguishable, and
entirely consistent with our holding today. In Harrison, the IRS
sent the taxpayers a consent form for extension of the limitations
period.   The taxpayers signed the form and returned it, but it
never reached the IRS.     Faced with imminent expiration of the
period, the IRS issued the notice. Today we conclude that issuance

                                11
that    the   Tax   Court   abused    its   discretion   in   finding   the

government's position substantially justified on issuance of the

notice.

                                     III.

       Accordingly, that part of the Tax Court's Order and Decision

denying costs is REVERSED, and this proceeding is REMANDED for

their determination.

                       REVERSED in part and REMANDED.




of notice to the Lennoxes was unreasonable, partially because the
IRS had, but declined, the opportunity to extend the period as to
the matter in question. We need not decide whether, absent the
Lennoxes' counter-offer, the position of the United States would
have been substantially justified.

                                      12
