                         T.C. Memo. 2000-299



                       UNITED STATES TAX COURT



                   ROBERT LLOYD, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 1477-97, 6774-97.       Filed September 25, 2000.



     Irvin W. Fegley, for petitioner.

     Margaret S. Rigg, for respondent.



                         MEMORANDUM OPINION

     DAWSON, Judge:    These cases were assigned to Special Trial

Judge Norman H. Wolfe pursuant to the provisions of Rules 180,

181, and 183.   All section references are to the Internal Revenue

Code in effect at the time the petition was filed, unless

otherwise indicated.   All Rule references are to the Tax Court

Rules of Practice and Procedure.   The Court agrees with and
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adopts the opinion of the Special Trial Judge, which is set forth

below.

                 OPINION OF THE SPECIAL TRIAL JUDGE

     WOLFE, Special Trial Judge:    These cases are before the

Court on petitioner’s motion for an award of reasonable

litigation costs under section 7430 and Rules 230 through 233.

Respondent determined deficiencies in, and additions to,

petitioner’s Federal income taxes as follows:

                                        Additions to Tax
     Year        Deficiency     Sec. 6651(a)(1)     Sec. 6662(a)
     1992          $46,172         $11,543            $9,234
     1993           28,796           7,199             5,759
     1994           73,332             –-             14,666

     After these cases were docketed, the parties filed a

stipulation of settled issues that disposed of all adjustments

without trial.    Thereafter, petitioner filed motions for

litigation costs and respondent filed objections to petitioner’s

motions.    Neither party has requested a hearing, and the Court

concludes that a hearing is unnecessary for the proper

disposition of these motions.    See Rule 232(a)(2).

     These related cases have been consolidated for the purpose

of considering petitioner’s motions.    At the time the petitions

were filed, the petitioner resided in Beijing, People’s Republic

of China.
                                - 3 -

A.   The 1992 Tax Year Audit

     On August, 29, 1994, petitioner filed his 1992 Federal

income tax return using the following mailing address:   67

Rosewood Drive, Atherton, California 94027 (the Atherton

address).   On June 14, 1995, respondent mailed petitioner a

letter informing him that his 1992 Federal income tax return had

been selected for audit.   Respondent’s audit letter requested

that petitioner contact respondent within 10 days to arrange an

interview and bring to the interview complete records concerning

specified claimed deductions.   On July 31, 1995, petitioner

called respondent and arranged an initial interview.   Petitioner

failed to attend the interview.    On August 29, 1995, respondent

mailed a notice of proposed deficiency (30-day letter) to

petitioner at the Atherton address.

     On September 25, 1995, petitioner faxed to respondent a

handwritten letter informing respondent that he had moved to

Beijing, China, and that he needed additional time to furnish the

requested information.   Petitioner further stated that he was

unable to find his business records and that he needed more time

to recreate them using his check register and credit card

statements.

     Petitioner asserts that he responded to respondent’s audit

letter by delivering a letter and three boxes of documents to

respondent on November 30, 1995.   Petitioner contends that the
                                 - 4 -

position respondent took in his answer was not substantially

justified because respondent failed to review the documents prior

to issuing the notice of deficiency.     Respondent asserts that

petitioner did not deliver a letter or records on November 30,

1995.   Respondent’s records do not contain an entry that

indicates that petitioner delivered a letter or documents on

November 30, 1995.

     On August 7, 1996, respondent issued a notice of deficiency

to petitioner using the Atherton address.     On January 15, 1997,

respondent mailed an additional copy of the notice of deficiency

to petitioner in Beijing, China.    In the notice of deficiency,

respondent took the position that petitioner failed to report

income of $175,984 on his 1992 Federal income tax return and

failed to substantiate certain claimed deductions.     Petitioner

filed a petition with this Court on April 9, 1997.

B.   The Audit of the 1993 and 1994 Tax Years

     Petitioner filed his 1993 Federal income tax return on

January 12, 1995, using the Atherton address.     On October 13,

1995, petitioner filed his 1994 Federal income tax return using

the following mailing address:    50 Victoria Avenue, Millbrae,

California 94030 (the Millbrae address).

     On April 4, 1996, respondent mailed a letter to petitioner

informing him that an audit of petitioner’s 1994 Federal income

tax return had been opened.   This letter was sent to the Millbrae
                               - 5 -

address.   The letter requested that petitioner contact respondent

to arrange a conference and also requested substantiation of

petitioner’s claimed deductions.1

     Petitioner asserts that on May 28, 1996, he faxed to

respondent a letter informing respondent that he had moved to

Beijing, China.   Respondent claims that he did not receive this

letter.

     On May 29, 1996 respondent mailed a 30-day letter to both

the Atherton and Millbrae addresses.   This letter proposed

adjustments to petitioner’s 1993 and 1994 tax returns and

indicated that petitioner could request an Appeals Office

conference.

     On July 15, 1996, respondent’s auditors sent petitioner’s

1993 and 1994 administrative files to the Examination Support

Procedure (ESP) unit for the preparation of a notice of



1
     Respondent alleges that on Mar. 26, 1996, respondent sent a
letter to petitioner at both the Atherton and Millbrae addresses
indicating that respondent had opened an audit for the 1993 tax
year. According to respondent, the audit letter requested that
petitioner contact respondent to arrange a conference and to
provide information concerning petitioner’s claimed deductions.
Respondent also states that the audit letter that was sent to the
Atherton address was returned as undeliverable and that the U.S.
Postal Service attached to the letter a mailing label that
indicated that petitioner’s new address was the Millbrae address.
Respondent also claims that the U.S. Postal Service did not
return the letter that was sent to the Millbrae address. These
allegations are supported by the affidavit of Barbara Gee,
manager of the Office Audit Section of the San Mateo Office of
the IRS. Copies of the documents Ms. Gee refers to are not
included in the record.
                                - 6 -

deficiency.    On July 23, 1996, petitioner delivered three boxes

of documents regarding his 1993 and 1994 tax years to

respondent’s auditors.    At this time, petitioner was informed by

Barbara Gee (Gee), respondent’s auditor, that her office no

longer had petitioner’s administrative files and that she could

not review petitioner’s documents without the administrative

files.    Consequently, Gee requested that petitioner contact ESP

to request that his administrative files be sent back to Gee’s

office.    Gee also requested that petitioner make an appointment

to review his documents with respondent’s auditors.   Petitioner

was unwilling to make an appointment.

     On August 16, 1996, respondent sent a notice of deficiency

for the 1993 and 1994 tax years to the Millbrae address.   On

August 27, 1996, another copy of the notice was sent to

petitioner in Beijing, China.   In the notice of deficiency,

respondent determined deficiencies, partly because petitioner

failed to substantiate deductions he claimed on his 1993 and 1994

Federal income tax returns.

     On October 11, 1996, petitioner requested that ESP send the

1993 and 1994 administrative files back to respondent’s auditors.

The administrative files were sent back to respondent’s auditors

on October 18, 1996.

     On November 12, 1996, Peter Phillips (Phillips),

respondent’s auditor, spent 1 day reviewing petitioner’s
                                 - 7 -

documents.   Phillips attempted to organize and analyze the

documents submitted by petitioner.       However, without petitioner’s

explanation and assistance Phillips found it difficult to review

and understand the documents.    After spending a day reviewing the

case, Phillips discussed his difficulties with Gee.       Gee decided

that Phillips should not spend any more time reviewing the

documents.   As a result of Phillips’ review, respondent issued a

supplemental report for 1993 that allowed a substantial portion

of petitioner’s claimed Schedule C, Profit or Loss From Business,

expenses.    The supplemental report did not make any adjustments

to petitioner’s 1994 tax year.    Petitioner in writing disagreed

with the supplemental report, offered to meet with respondent’s

representative, and then filed a petition with this Court on

January 24, 1997.

C.   Post-Petition

     Respondent filed an answer to the petition in the case

concerning the 1993 and 1994 years on March 7, 1997, and filed an

answer to the petition in the case concerning the 1992 year on

May 16, 1997.   In both answers, respondent maintained the

positions taken in the notices of deficiency.

     On June 25, 1997, and June 27, 1997, Ms. Geraldine Melick

(Melick), an Appeals officer, met with petitioner regarding both

cases.   At the meeting petitioner explained many matters that

were not evident from his records.       First, he described the
                               - 8 -

prenuptial agreement between himself and his wife that affected

the division of business income and expenses.    Second, he

disclosed the source of unreported income with respect to his

1992 tax year.   Third, he explained how his business had large

profits in some years and large losses in others.

     On June 27, 1997, Melick offered to concede all adjustments

for the 1992 tax year.   Melick also requested additional

information regarding the 1994 tax year, and she indicated that

respondent would concede the adjustments for the 1993 and 1994

tax years upon the receipt of such information.    On July 2, 1997,

petitioner provided the additional information sought by

respondent.   Upon receipt of the information, respondent conceded

the adjustments for the 1993 and 1994 tax years.

Discussion

     A taxpayer who has substantially prevailed in a Tax Court

proceeding may be awarded reasonable litigation costs incurred in

such proceedings.   See sec. 7430(a)(2).   Under section 7430, a

judgment for litigation costs incurred in connection with a court

proceeding may be awarded only if a taxpayer:    (1) Has exhausted

his administrative remedies within the IRS; (2) has substantially

prevailed with respect to the amount in controversy or the most

significant issue or set of issues presented; (3) has satisfied

the applicable net worth requirement; and (4) did not

unreasonably protract the court proceeding.
                                - 9 -

       However, the taxpayer fails to qualify as the prevailing

party if the Commissioner establishes that his position was

substantially justified.    See sec. 7430(c)(4)(B)(i).   Respondent

bears the burden of proving that respondent’s position was

substantially justified.    See id.

       After concessions by respondent,2 the issues for decision

are:    (1) Whether respondent’s positions were substantially

justified; (2) whether petitioner exhausted his administrative

remedies for the 1993 and 1994 tax years; and (3) whether the

amount of costs and attorney’s fees claimed by petitioner are

reasonable.

A.   1992 Tax Year

       Because of the concessions made by respondent, the sole

issue for determination for the tax year 1992 is whether

respondent’s position was substantially justified.

       For purposes of an award of litigation costs, the position

of the United States is the position taken by the United States

in a judicial proceeding.    See sec. 7430(c)(7)(A).   The United

States took a position in these judicial proceedings when it

filed an answer to the petition.      See Huffman v. Commissioner,

978 F.2d 1139, 1148 (9th Cir. 1992), affg. in part, revg. in part


2
     Respondent concedes that petitioner has: (1) Substantially
prevailed in the proceedings; (2) satisfied the net worth
requirements; and (3) not unreasonably protracted the Court
proceedings. Respondent also concedes that petitioner exhausted
his administrative remedies with regard to 1992.
                               - 10 -

and remanding T.C. Memo. 1991-144; Maggie Management Co. v.

Commissioner, 108 T.C. 430, 442 (1997).

        Whether respondent’s position was substantially justified

turns on a finding of reasonableness, based upon all the facts

and circumstances, as well as the legal precedents relating to

these cases.    See Pierce v. Underwood, 487 U.S. 552 (1988); Sher

v. Commissioner, 89 T.C. 79, 84 (1987).    A position is

substantially justified if the position is justified to a degree

that could satisfy a reasonable person.    See Pierce v. Underwood,

supra at 565; Maggie Management Co. v. Commissioner, supra at

443.    A position must have a reasonable basis both in law and

fact.    See Pierce v. Underwood, supra at 563-565.   The fact that

respondent eventually loses or concedes a case does not by itself

establish that respondent’s position was unreasonable.     See

Maggie Management Co. v. Commissioner, supra at 443; Sokol v.

Commissioner, 92 T.C. 760, 767 (1989).

       Petitioner asserts that he delivered documents regarding the

1992 tax year to respondent on November 30, 1995.     Petitioner

further asserts that the position respondent took in his answer

was not substantially justified because respondent failed to

review the documents prior to filing an answer.    Respondent

contends that he did not receive the documents prior to filing

his answer.
                               - 11 -

     At the time the answer was filed, respondent’s position was

substantially justified because petitioner failed to substantiate

claimed deductions and to disclose the source of unreported

income.    Deductions are a matter of legislative grace, and

taxpayers must substantiate their entitlement to a deduction.

See New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

Moreover, section 6001 imposes on taxpayers a duty to maintain

books and records sufficient to support items reported on their

returns.

     On this record, we are not convinced that respondent

received the documents in question with respect to the 1992

return on November 30, 1995.    Respondent’s records do not contain

an entry that indicates that respondent received the documents.

Moreover, respondent generally provides a receipt to taxpayers

upon delivery of documents, and in the exercise of prudence a

business person delivering important documents would obtain a

receipt or other proof of delivery.     In this case, the record

does not contain any such receipt or credible proof of delivery.

     Even if we were to assume that petitioner delivered the

documents on November 30, 1995, we find that the documents fail

to substantiate petitioner’s tax return positions.     In his

answer, respondent took the position that petitioner failed to

report income of $175,984.    The letter that petitioner supposedly

sent to respondent on November 30, 1995, does not provide an
                                - 12 -

explanation concerning unreported income.     Furthermore,

petitioner’s letter indicates that petitioner attempted to

substantiate some of his claimed business expenses with his

wife’s receipts.    Petitioner’s letter did not describe the

prenuptial agreement between himself and his wife, which affected

the division of business income and expenses.      Petitioner did not

disclose the terms of the prenuptial agreement until the Appeals

conference in June 1997.

     Accordingly, respondent was reasonable in refusing to

concede the adjustments until petitioner substantiated his

deductions and disclosed the source of his unreported income.

See Sokol v. Commissioner, supra at 765.     Therefore, we hold that

respondent’s position was substantially justified at the time the

answer was filed.

B.   1993 and 1994 Tax Years

      Petitioner is not entitled to litigation costs for the tax

years 1993 and 1994 because he failed to exhaust his

administrative remedies.    “A judgment for reasonable litigation

costs shall not be awarded * * * in any court proceeding unless

the court determines that the prevailing party has exhausted the

administrative remedies available to such party within the

Internal Revenue Service.”     Sec. 7430(b)(1).   In general, a

taxpayer has not exhausted the administrative remedies available

within the IRS unless prior to filing a petition in the Tax
                               - 13 -

Court, he participates in an Appeals Office conference or at

least requests such a conference and files a written protest if

one is required in order to obtain an Appeals Office conference.

See sec. 301.7430-1(b)(1), Proced. & Admin. Regs.

     On May 29, 1996, respondent sent a 30-day letter regarding

petitioner’s 1993 and 1994 tax years to both the Atherton and

Millbrae addresses.    The 30-day letter indicated that petitioner

could request an Appeals Office conference.    Petitioner failed to

respond to this letter.

     Petitioner attempts to excuse this failure by relying upon

section 301.7430-1(e), Proced. & Admin. Regs.    Under this

regulation, a party is deemed to have exhausted his

administrative remedies if the party did not receive the notice

of proposed deficiency (30-day letter) prior to the issuance of

the statutory notice and the failure to receive such notice was

not due to actions of the party (such as a failure to supply

requested information or a current mailing address to the

District Director or service center having jurisdiction over the

tax matter) and the party does not refuse to participate in an

Appeals conference while the case is in docketed status.      See

sec. 301.7430-1(e)(2), Proced. & Admin. Regs.

     Petitioner’s reliance on the regulation is misplaced because

petitioner’s own actions contributed to his failure to receive

the 30-day letter.    On September 25, 1995, petitioner mailed
                               - 14 -

respondent a letter indicating that he had moved to Beijing,

China.   However, on October 13, 1995, petitioner filed his 1994

Federal income tax return using the Millbrae address.

Accordingly, we find that respondent sent the 30-day letter to

petitioner’s last known address in Millbrae, California.

Respondent was entitled to rely upon petitioner’s 1994 tax return

in order to determine petitioner’s last known address.    Cf.

Abeles v. Commissioner, 91 T.C. 1019 (1988) (Commissioner is

entitled to treat the address on the taxpayer’s most recent

return as the taxpayer’s last known address absent a clear and

concise notification of an address change).3

     Consequently, we find that petitioner failed to request an

Appeals Office conference prior to filing a petition in the Tax

Court.   Therefore, petitioner failed to exhaust his

administrative remedies, and he is not entitled to litigation

costs with regard to the 1993 and 1994 tax years.

     Moreover, the position that respondent took in his answer

was substantially justified.   When respondent filed his answer,

he did not have sufficient information to conclude that



3
     Even if petitioner faxed, as he alleges, a letter to
respondent on May 28, 1996, indicating that his mailing address
was in Beijing, China, this letter did not constitute a timely
change of address for purpose of the 30-day letter mailed on the
following day. Cf. Rose v. Commissioner, T.C. Memo. 1992-739
(tax return filed 45 days prior to the mailing of a notice of
deficiency did not constitute timely notice of change of
address).
                              - 15 -

petitioner’s claimed deductions were substantiated.   Respondent’s

auditors reviewed petitioner’s records before respondent filed

his answer.   At the time of the review, petitioner was not

available to provide assistance or information concerning his

records.   Without the benefit of petitioner’s assistance,

respondent’s auditors found that the records failed to

substantiate petitioner’s tax return positions.   We are not

persuaded by petitioner’s apparent argument that he is entitled

to leave with respondent a box containing some of his records

without adequate explanation and expect that respondent’s

auditors somehow will figure out the details of his business and

finances without the benefit of assistance or explanation by

petitioner.

     After respondent filed his answer, an Appeals conference was

held promptly.   At the Appeals conference, petitioner disclosed

the terms of his prenuptial agreement, which affected the

division of business income and expenses.   As soon as this

information was disclosed, together with other explanations and

documents requested by the Appeals officer, respondent allowed

petitioner’s claimed deductions and conceded that petitioner was

not liable for the additions to tax.

     For purposes of determining the reasonableness of

respondent’s position, the Court considers the facts known to

respondent at the time the position was taken.    When respondent
                                - 16 -

filed his answer, he did not have the benefit of the

substantiating information and explanations that petitioner

provided at the Appeals conference.      Accordingly, we hold that

respondent was substantially justified at the time the answer was

filed.

Conclusion

     For the foregoing reasons, petitioner is not entitled to a

recovery of litigation costs.    Based on this conclusion, we need

not and do not decide the reasonableness of the claimed expenses.

                                            Appropriate orders and

                                      decisions will be entered.
