                        T.C. Memo. 2000-167



                      UNITED STATES TAX COURT



              DARTMOUTH CLUBS, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 13251-98.                       Filed May 22, 2000.


     William F. Patten, for petitioner.

     Ronald F. Hood and David N. Brodsky, for respondent.



                        MEMORANDUM OPINION


     PARR, Judge:   This case is before the Court on petitioner's

motion for reasonable litigation and administrative costs

pursuant to section 74301 and Rules 230 through 232, filed


     1
      References to sec. 7430 in this opinion are to that section
of the Internal Revenue Code as amended by the Taxpayer Bill of
Rights 2 (TBOR 2), Pub. L. 104-168, secs. 701-704, 110 Stat.
1452, 1463-1464 (1996), which is effective with respect to
                                                   (continued...)
                                - 2 -

February 2, 2000.

     The issues for decision are:   (1) Whether petitioner is the

prevailing party in the underlying tax case, within the meaning

of section 7430(c)(4).   We hold it is not.   (2) Whether the

litigation and administrative costs claimed by petitioner are

reasonable, within the meaning of section 7430(c)(1) and (2).

Because of our holding that petitioner is not the prevailing

party, we need not consider whether the costs claimed by

petitioner are reasonable.

     Neither party has requested an evidentiary hearing on

petitioner's motion, and the Court concludes that such a hearing

is not necessary for the proper disposition of petitioner's

motion.   See Rule 232(a)(2).   Accordingly, we decide petitioner's

motion for an award of administrative and litigation costs on the

record of the case, including respondent's objection,

petitioner's response to respondent's objection, and the parties'


     1
      (...continued)
proceedings commenced after July 30, 1996. See TBOR 2 secs.
701(d), 702(b), 703(b), and 704 (b), 110 Stat. 1463-1464. Sec.
7430, as amended by TBOR 2, requires the United States to
establish that the position of the United States was
substantially justified. See sec. 7430(c)(4)(B)(i).
     A judicial proceeding is commenced in this Court with the
filing of a petition. See Rule 20(a); Maggie Management Co. v.
Commissioner, 108 T.C. 430, 438 (1997). Petitioner filed its
petition on July 29, 1998; thus, sec. 7430 as amended by TBOR 2
is applicable. Other section references are to the Internal
Revenue Code in effect for the taxable years in issue.
     All Rule references are to the Tax Court Rules of Practice
and Procedure, unless otherwise indicated.
                               - 3 -

affidavits and exhibits, which are incorporated herein by this

reference.

     Petitioner is an exotic dance club, whose address was

Westport, Massachusetts, at the time the petition in this case

was filed.

Background

     Petitioner filed its Federal income tax returns using a

fiscal year ending on March 31.   In April 1995, respondent began

an examination of petitioner's 1994 and 1995 corporate tax

returns.   The examining revenue agent found that during these

years, petitioner had deducted cash payments made to many

individuals, including Henry Lauzon, Jr. (Lauzon, Jr.),

petitioner's president and sole shareholder, for which no Forms

W-2, Wage and Tax Statement, or Forms 1099-MISC, Miscellaneous

Income, had been issued.   These cash payments totaled $644,743 in

1994 and $733,448 in 1995.

     On July 16, 1995, January 30, 1996, July 12, 1996, and

September 18, 1997, the revenue agent sent petitioner information

document requests for documents that would substantiate that the

cash payments were corporate expenses.   During the course of the

examination, the revenue agent and petitioner had several

meetings regarding the requested documentation.

     Eventually, the revenue agent wrote a report on the disputed

items and proposed adjustments.   In May 1997, petitioner
                               - 4 -

protested the proposed adjustments at an administrative review in

the Internal Revenue Service Office of Appeals (Appeals).

Appeals returned the case to the revenue agent with instructions

to consider whether additional evidence that petitioner had

presented at the administrative review provided the required

substantiation.

     The parties were not able to reach an agreement on the

disputed items, and petitioner refused to agree to a statutory

extension of the time to assess tax.   Accordingly, on April 30,

1998, respondent mailed a notice of deficiency to petitioner.

     In the notice, respondent determined deficiencies of

$219,885 and $249,372, and accuracy-related penalties of $43,977

and $49,874, for petitioner's fiscal years 1994 and 1995,

respectively.   The deficiencies were based on the disallowance of

deductions that petitioner claimed for casual labor, security

expenses, talent scouting expenses, music expenses, and

management consulting fees.

     The notice of deficiency stated that the deductions for the

casual labor, security expenses, music expenses, and management

consulting fees were disallowed because petitioner did not

provide substantiation, including invoices, matching canceled

checks, and Forms 1099, to support its claimed deductions.

Respondent disallowed the deduction for the talent scouting

expenses, because he determined that $104,000 of the amount
                               - 5 -

claimed in each of the years at issue for this expense was a

dividend paid to Lauzon, Jr.

     On July 29, 1998, petitioner filed a petition with this

Court.   On September 28, 1998, respondent's answer was filed.

     On September 25, 1998, respondent sent the case to Appeals

for consideration.   On June 10, 1999, an Appeals officer

contacted petitioner's attorney, William F. Patten (Mr. Patten),

and the parties scheduled a conference for July 2.   The Appeals

officer requested that Mr. Patten bring copies of any Forms 1099

that petitioner had issued, a worksheet reconciling the Forms

1099 to the corporate records, and a list of all persons that

received less than $600 from petitioner.   Mr. Patten brought the

Forms 1099 to the conference, and he stated that the worksheet

and other information would be provided on July 7.   Preparation

of the worksheets took longer than expected, and petitioner was

not able to provide them by the promised date.

     On August 16, 1999, the Appeals officer received the

worksheet and other requested information for both years in

issue, except for any information about the $104,000 payments to

Lauzon, Jr.   After reviewing the worksheets and other

information, the Appeals officer concluded that all the claimed

deductions were allowable as ordinary and necessary business

expenses, except for the $104,000 payments to Lauzon, Jr.

     Petitioner claimed, and respondent allowed, deductions of
                                - 6 -

$309,923 and $326,767 in 1994 and 1995, respectively, for

management consulting fees paid to Lauzon, Jr.   The $104,000

payments were also recorded on petitioners books as management

consultant fees paid to Lauzon, Jr.; however, petitioner later

reclassified these payments as expenses incurred in scouting new

talent.   Considering the amount of the management consultant fees

paid to Lauzon, Jr., the Appeals officer believed that the

$104,000 payments may have been excessive compensation.

     Accordingly, on September 10, 1999, the Appeals officer

initiated a discussion with petitioner's accountant to resolve

this last item.   On September 16, the Appeals officer and

petitioner agreed to split the $104,000--one-half of the amount

claimed was allowed as a deduction in each year, and one-half was

disallowed.

     On September 24, 1999, the Appeals officer received the

audit department's computation and prepared the stipulated

decision document.   The decision document showed income tax

deficiencies of $8,354 and $8,000 for 1994 and 1995,

respectively.   On October 30, 1999, Mr. Patten signed the

stipulated decision document and respondent signed it two days

later.    The Court entered the stipulated decision on November 5,

1999.

     Petitioner thereafter filed a motion to vacate the decision

and a motion for administrative and litigation costs. Petitioner

claims that it incurred $61,632 in administrative and litigation
                               - 7 -

costs from December 1996 to December 1999.    The Court issued an

order granting petitioner's motion to vacate the decision, and we

now consider petitioner's motion for administrative and

litigation costs.

Discussion

     Section 7430(a) provides that the prevailing party may be

awarded:   (1) Reasonable administrative costs incurred in

connection with an administrative proceeding within the Internal

Revenue Service and (2) reasonable litigation costs incurred in

connection with a court proceeding.    For this Court to award

reasonable administrative and litigation costs under section

7430, several conjunctive requirements must be met.     The record

must show that:   (1) The moving party exhausted any

administrative remedies available to him or her within the

Internal Revenue Service.   See sec. 7430(b)(1).   Respondent

concedes that petitioner has met this requirement.     (2) The

moving party did not unreasonably protract the administrative

proceeding or the proceeding in this Court.    See sec. 7430(b)(3).

Respondent concedes that petitioner has met this requirement.

(3) The moving party is the prevailing party.    See sec. 7430(a).

As discussed below, we find that petitioner is not the prevailing

party.

     To be a "prevailing party", a taxpayer must establish that

the taxpayer substantially prevailed with respect to the amount
                               - 8 -

in controversy or with respect to the most significant issue or

set of issues presented, sec. 7430(c)(4)(A)(i), and that the

taxpayer is either an individual whose net worth does not exceed

$2 million, or an owner of any unincorporated business, or any

partnership, corporation, etc., the net worth of which does not

exceed $7 million, at the time the petition is filed, see sec.

7430(c)(4)(A)(ii); 28 U.S.C. sec. 2412(d)(2)(B) (1988).

Respondent concedes that petitioner substantially prevailed with

respect to either the amount in controversy or the most

significant issues and that petitioner meets the net worth

requirements.

     A party, however, will not be treated as the prevailing

party if the United States establishes that the position of the

United States in the proceeding was substantially justified.       See

sec. 7430(c)(4)(B)(i).   Respondent contends that petitioner is

not the prevailing party because the position that respondent

took regarding the disallowed expense deductions was

substantially justified.   We agree with respondent.

     The United States' position is substantially justified if it

is "justified to a degree that could satisfy a reasonable person"

and has a "reasonable basis in both law and fact."     Pierce v.

Underwood, 487 U.S. 552, 565 (1988) (interpreting similar

language in the Equal Access to Justice Act, 28 U.S.C. sec 2412

(1988)); see also Maggie Management Co. v. Commissioner, 108 T.C.
                                - 9 -

430, 443 (1997).    A position has a reasonable basis in fact if

there is such relevant evidence as a reasonable mind might accept

as adequate to support a conclusion.    See Pierce v. Underwood,

supra at 564-565.    The reasonableness of respondent's position

and conduct necessarily requires considering what respondent knew

at the time.   Cf. Rutana v. Commissioner, 88 T.C. 1329, 1334

(1987); DeVenney v. Commissioner, 85 T.C. 927, 930 (1985).    Thus,

in determining whether respondent acted reasonably, this Court

must "consider the basis for respondent's legal position and the

manner in which the position was maintained."    Wasie v.

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

     The fact that the Commissioner eventually loses or concedes

the case is not determinative as to whether the taxpayer is

entitled to an award of administrative or litigation costs.     See

Sokol v. Commissioner, 92 T.C. 760, 767 (1989); Wasie v.

Commissioner, supra at 968-969.    It remains, however, a relevant

factor to consider in determining the degree of the

Commissioner's justification.    See Estate of Perry v.

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

Commissioner, 100 T.C. 457, 470, 472 (1993), affd. in part and

revd. in part 43 F.3d 172 (5th Cir. 1995).

     In some cases courts have adopted an issue-by-issue approach

to section 7430, apportioning the requested awards between those

issues for which the respondent was, and those issues for which
                              - 10 -

respondent was not, substantially justified.   See Powers v.

Commissioner, 51 F.3d 34, 35 (5th Cir. 1995); Swanson v.

Commissioner, 106 T.C. 76, 102 (1996).   In the instant case, both

parties make their respective arguments for all the adjustments

in the notice of deficiency collectively.   Thus, we do not

determine whether to apportion the awards, if any, between those

adjustments for which respondent was, or was not, substantially

justified.

     In deciding this issue, we must identify the point in time

at which the United States is first considered to have taken its

position, and then decide whether the position from that point

forward was substantially justified.   The "substantially

justified" standard is applied as of the separate dates that

respondent took a position in the administrative proceedings as

distinguished from the proceedings in this Court.   See sec.

7430(c)(7)(A) and (B).

     The administrative position of respondent means the position

taken in the administrative proceedings as of the earlier of the

date of receipt of the appeals decision by the taxpayer or the

date of the notice of deficiency.   See sec. 7430(c)(7)(B).    In

this case, respondent took a position in the administrative

proceeding as of April 30, 1998, the date the notice of

deficiency was issued.   See sec. 7430(c)(7)(B)(ii).

     The position taken by the United States, for purposes of
                              - 11 -

litigation costs, refers to the position of the United States in

a judicial proceeding.   See sec. 7430(c)(7)(A).   Respondent's

position in the proceeding before this Court was established on

September 28, 1998, the date respondent filed his answer.    See

Huffman v. Commissioner, 978 F.2d 1139, 1148 (9th Cir. 1992),

affg. in part and revg. in part T.C. Memo. 1991-144.

     Although ordinarily the reasonableness of each of those

positions is considered separately to allow respondent to change

his position, Huffman v. Commissioner, supra at 1144-1147, it

appears in this case that respondent took the same position in

both the notice of deficiency and the answer.   More specifically,

respondent's position was that petitioner failed to substantiate

the deductions for cash payments that it claimed on its returns.

     Petitioner contends that it provided the required

substantiation at the administrative review in May 1997, that the

case should have concluded at that point, and that the "Notice of

Deficiency constituted nothing but harassment".

     The record does not support petitioner's contention.    At

respondent's request in June 1999, petitioner promised to provide

worksheets reconciling the Forms 1099 to the corporate records;

however, petitioner required 2 months to prepare the worksheets.

Therefore, it is apparent that the worksheets did not exist at

the time of the May 1997 conference, and that petitioner did not

provide respondent information sufficient to substantiate its
                              - 12 -

claimed deductions before August 1999.

     On this record, we conclude that respondent's position was

substantially justified.   In the notice of deficiency, respondent

premised the adjustments primarily on petitioner's failure to

substantiate items on its returns.     Taxpayers do not have an

inherent right to take tax deductions.     Deductions are a matter

of legislative grace, and a taxpayer bears the burden of proving

entitlement to any deduction claimed.     See Deputy v. du Pont, 308

U.S. 488, 493 (1940); New Colonial Ice Co. v. Helvering, 292 U.S.

435, 440 (1934).   This includes the burden of substantiating the

amount and purpose of the item claimed.     See sec. 6001; Hradesky

v. Commissioner, 65 T.C. 87, 89-90 (1975), affd. per curiam 540

F.2d 821 (5th Cir. 1976); sec. 1.6001-1(a), Income Tax Regs.      We

find that "It was reasonable for respondent not to concede the

adjustments until * * * [he] had received and verified adequate

substantiation for the items in question."     Simpson Fin. Servs.,

Inc. v. Commissioner, T.C. Memo. 1996-317 (citing Harrison v.

Commissioner, 854 F.2d 263, 265 (7th Cir. 1988), affg. T.C. Memo.

1987-52; Sokol v. Commissioner, supra at 765).

     Petitioner argues that the Commissioner mishandled this

case, and that if it had been administered properly, petitioner

would have incurred much less expense.     Petitioner states that

the Appeals officer raised issues that were not in the revenue

agent's examination report, and that it was denied the
                              - 13 -

opportunity to respond to these issues before respondent issued

the notice of deficiency.

     Petitioner also stated that when it was informed by

respondent that a notice of deficiency would be issued if

petitioner did not agree to an extension of the statutory period

for assessment, that it welcomed the notice as an opportunity to

resolve the issues.   This statement is contrary to petitioner's

statement that the notice of deficiency was issued to harass

petitioner.

     We are not persuaded by petitioner's arguments.   We find

nothing in our review of the record to support petitioner's

claims of overreaching or abusive tactics by respondent's agents.

Rather, we find that respondent promptly conceded that

petitioner's deductions were allowable once petitioner provided

the information necessary to substantiate the disputed items.

Although petitioner attempts in its motion to articulate the

overreaching of respondent's agents, such statements are not

proof.   See Rule 143(b); see also Niedringhaus v. Commissioner,

99 T.C. 202, 214 n.7 (1992); Viehweg v. Commissioner, 90 T.C.

1248, 1255 (1988).
                              - 14 -

     We hold that respondent's positions had a reasonable basis

in law and fact.   Accordingly, petitioner is not entitled to

administrative and litigation costs under section 7430.

     To reflect the foregoing,

                                       An appropriate order will be

                                 issued denying petitioner's

                                 motion for an award of

                                 administrative and litigation

                                 costs, and a decision will be

                                 entered.
