                        T.C. Memo. 1998-119



                      UNITED STATES TAX COURT



         WILLIAM AND ARLENE G. KINGSTON, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket No. 15409-95.             Filed March 25, 1998.


     William and Arlene G. Kingston, pro se.

     Elizabeth Flores, for respondent.



                        MEMORANDUM OPINION


     WELLS, Judge:   This case was assigned to Special Trial Judge

D. Irvin Couvillion pursuant to section 7443A(b)(4)1 and Rules

180, 181, and 183.   The Court agrees with and adopts the opinion

of the Special Trial Judge, which is set forth below.


1
      Unless otherwise indicated, section references are to the
Internal Revenue Code. All Rule references are to the Tax Court
Rules of Practice and Procedure.
                               - 2 -




                OPINION OF THE SPECIAL TRIAL JUDGE

     COUVILLION, Special Trial Judge:    This case is before the

Court on petitioners' motion for administrative and litigation

costs2 pursuant to section 7430 and Rule 231.   Neither party

requested a hearing, and the Court concludes that a hearing is

not necessary for the proper disposition of this motion.   Rule

232(a)(3).   Accordingly, the Court disposes of this motion on the

basis of the parties' submissions and the record in the instant

case as a whole.   The Court incorporates herein by reference

those portions of the opinion on the merits in this case set

forth in Kingston v. Commissioner, T.C. Memo. 1997-512, that are

relevant to the disposition of this motion.

                            Background

     On November 17, 1997, the Court issued its opinion on the

substantive issues in this case.   The primary issue was whether

petitioner husband was "protected from loss", within the meaning

of section 465(b)(4), with regard to his investment in a

partnership known as Hambrose Leasing 1985-3 (the partnership).

The Court held that petitioner husband was not "protected from

loss", within the meaning of section 465(b)(4), with respect to

2
      Although petitioners' motion is styled "Petitioners Motion
for Award of Reasonable Litigation Cost", the substance of the
motion evidences an intent to move for administrative costs as
well as litigation costs. The Court, therefore, considers the
motion accordingly.
                                - 3 -


this investment, and, thus, petitioners were entitled to loss and

investment interest expense deductions claimed on their 1985 and

1986 Federal income tax returns.

                            Discussion

     A taxpayer who substantially prevails in an administrative

or court proceeding may be awarded a judgment for reasonable

costs incurred in such proceedings.     Sec. 7430(a)(1) and (2).   A

judgment may be awarded under section 7430 if a taxpayer (1) is

the "prevailing party", (2) exhausted the administrative remedies

available to the taxpayer within the Internal Revenue Service

(IRS),3 and (3) did not unreasonably protract the proceedings.

Sec. 7430(a) and (b)(1), (4).   A taxpayer must satisfy each of

these three requirements to be entitled to a judgment under

section 7430.   Respondent concedes that petitioners exhausted the

administrative remedies available and did not unreasonably

protract the proceedings.   Therefore, the Court is left to decide

whether petitioners were the prevailing party.

     To qualify as the "prevailing party", the taxpayer must

establish that (1) the position of the United States in the

proceeding was not substantially justified,4 (2) the taxpayer

3
     This requirement does not apply to an award for reasonable
administrative costs. Sec. 7430(b)(1).
4
      In relevant part, the Taxpayer Bill of Rights 2 (TBOR 2),
Pub. L. 104-168, secs. 701-704, 110 Stat. 1452, 1463-1464 (1996),
amended sec. 7430 to place on the Commissioner the burden of
                                                   (continued...)
                               - 4 -


substantially prevailed with respect to the amount in controversy

or with respect to the most significant issue or set of issues

presented, and (3) the taxpayer satisfies the applicable net

worth requirements.   Sec. 7430(c)(4)(A).   Respondent concedes

that petitioners meet the second and third criteria listed above;

however, respondent contends that the position taken in both the

administrative and litigation aspects of the proceedings was

substantially justified.   Rule 232(e); Dixson Corp. v.

Commissioner, 94 T.C. 708, 714-715 (1990); Gantner v.

Commissioner, 92 T.C. 192, 197 (1989), affd. 905 F.2d 241 (8th

Cir. 1990).   Accordingly, the issue is whether "the position of

the United States in the proceeding was not substantially

justified."   Gantner v. Commissioner, 905 F.2d at 245.

     In deciding this issue, the Court must first identify the

point at which the United States is considered to have taken a

position and then decide whether the position taken from that

point forward was not substantially justified.    The "not

substantially justified" standard is applied as of the separate

dates that respondent took a position in the administrative


4
 (...continued)
proving that the Commissioner's position in the administrative
proceeding and the proceeding in this Court was substantially
justified. However, the provisions of TBOR 2 are effective only
with respect to proceedings commenced after July 30, 1996. The
provisions of TBOR 2 do not apply to this case because
petitioners filed their petition on Aug. 14, 1995. See Maggie
Management Co. v. Commissioner, 108 T.C. 430, 441 (1997).
                               - 5 -


proceeding and in the proceeding in this Court.   Sec.

7430(c)(7)(A) and (B); Han v. Commissioner, T.C. Memo. 1993-386.

For purposes of the administrative proceeding, respondent took a

position on May 19, 1995, the date of the notices of deficiency.

Sec. 7430(c)(7)(B).5   For purposes of the proceeding in this

Court, respondent took a position on October 13, 1995, the date

respondent filed the answer.   See Huffman v. Commissioner, 978

F.2d 1139, 1143-1147 (9th Cir. 1992), affg. in part and revg. in

part on other grounds and remanding T.C. Memo. 1991-144.   In this

case, respondent's position on each of these dates was the same.

More specifically, respondent's position was that petitioner

husband was "protected from loss", within the meaning of section

465(b)(4), with regard to his investment in the partnership, and,

therefore, petitioners were not entitled to loss and investment

interest expense deductions claimed on their 1985 and 1986

Federal income tax returns.

     Whether respondent's position was not substantially

justified turns on a finding of reasonableness, based upon all

the facts and circumstances, as well as the legal precedents

5
      Sec. 7430(c)(7)(B) provides that the Commissioner takes a
position in an administrative proceeding on the earlier of "the
date of the receipt by the taxpayer of the notice of the decision
of the * * * [IRS] Office of Appeals" or "the date of the notice
of deficiency." No notice of decision of the IRS Appeals Office
was ever issued or received by petitioners before the date of the
notices of deficiency. Therefore, respondent is considered to
have taken a position on the date the notices of deficiency were
issued.
                                  - 6 -


relating to the case.     Pierce v. Underwood, 487 U.S. 552 (1988);

Sher v. Commissioner, 89 T.C. 79, 84 (1987), affd. 861 F.2d 131

(5th Cir. 1988).   A position is substantially justified if the

position is "justified to a degree that could satisfy a

reasonable person."     Pierce v. Underwood, supra at 565; Powers v.

Commissioner, 100 T.C. 457, 470-471 (1993), affd. in part and

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

merely possesses enough merit to avoid sanctions for

frivolousness will not satisfy this standard; rather, it must

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

Underwood, supra at 564-565.

     The 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

respondent eventually loses or concedes a case does not establish

an unreasonable position.      Sokol v. Commissioner, 92 T.C. 760,

767 (1989); Baker v. Commissioner, 83 T.C. 822, 828 (1984),

vacated on other issues 787 F.2d 637 (D.C. Cir. 1986).        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).     Petitioners have the

burden of establishing that respondent's position was

unreasonable.   Rule 232(e).    To show lack of substantial
                               - 7 -


justification, petitioners must demonstrate "that the legal

precedent does not substantially support respondent's position

given the facts available to respondent."   Coastal Petroleum

Refiners, Inc. v. Commissioner, 94 T.C. 685, 688 (1990).

     Petitioners argue that respondent's position was not

reasonable as a matter of law or fact.6   Petitioners contend that

respondent ignored the "worst-case scenario" test applied by the

Court of Appeals for the Sixth Circuit in Emershaw v.

Commissioner, 949 F.2d 841 (6th Cir. 1991), affg. T.C. Memo.

1990-246, and Martuccio v. Commissioner, 30 F.3d 743 (6th Cir.

1994), revg. T.C. Memo. 1992-311, in determining whether a

taxpayer is "protected from loss" within the meaning of section

465(b)(4).   Petitioners contend further that respondent

erroneously relied on the "economic reality" test applied by the

majority of Courts of Appeals in determining whether a taxpayer

is "protected from loss" under section 465(b)(4).   Petitioners

argue that, since the instant case is appealable to the Court of

Appeals for the Sixth Circuit, and the material facts of the

substantive issues in the instant case parallel the facts in

Emershaw v. Commissioner, supra, and Martuccio v. Commissioner,

6
      In their motion, petitioners do not distinguish between
reasonableness "as a matter of law" or "as a matter of fact";
therefore, the Court assumes that petitioners intended to dispute
the reasonableness of respondent's position both in law and in
fact. Consequently, the Court treats the two items in
conjunction with one another as petitioners have done in their
motion.
                                - 8 -


supra, respondent's position was not supported by the relevant

legal precedent based on the facts available to respondent.7

     Respondent contends that respondent's position did not

ignore the "worst-case scenario" standard but, rather,

acknowledged that it would apply to the instant case.      Respondent

argues that the facts pertinent to the substantive issues in the

instant case could be readily distinguished from the facts in

Emershaw v. Commissioner, supra, and Martuccio v. Commissioner,

supra.   Therefore, respondent contends that respondent's position

was substantially supported by legal precedent given the facts

available to respondent and, thus, was reasonable as a matter of

law and fact.

     The Court agrees that respondent acknowledged the "worst-

case scenario" test should be applied to the facts of the instant

case.    Nevertheless, respondent failed to sufficiently

distinguish the facts of the instant case from those in Emershaw

v. Commissioner, supra, and Martuccio v. Commissioner, supra, to

show that the result reached in the instant case should be

different from that in Emershaw and Martuccio.    In fact, in the

opinion on the merits herein, this Court found that the sale-


7
     In both Emershaw v. Commissioner, 949 F.2d 841 (6th Cir.
1991), affg. T.C. Memo. 1990-246, and Martuccio v. Commissioner,
30 F.3d 743 (6th Cir. 1994), revg. T.C. Memo. 1992-311, the Court
of Appeals held that, under the "worst-case scenario" test, the
taxpayers were not "protected from loss" within the meaning of
sec. 465(b)(4).
                                - 9 -


leaseback transaction in the instant case was "indistinguishable"

from the sale-leaseback transactions in Emershaw v. Commissioner,

supra, and Martuccio v. Commissioner, supra.   Although respondent

may have acknowledged the application of the "worst-case

scenario" test, respondent's position failed to properly apply

that test to the facts of the instant case, as clearly mandated

by the legal precedent of Emershaw v. Commissioner, supra, and

Martuccio v. Commissioner, supra.

     In cases with facts similar to those in the instant case and

to those in Emershaw v. Commissioner, supra, and Martuccio v.

Commissioner, supra, other Courts of Appeals have applied the

"economic reality" test and have found that the taxpayers in

those cases were "protected from loss" within the meaning of

section 465(b)(4).   It is the opinion of this Court that,

although respondent acknowledged the application of the "worst-

case scenario" test in the instant case, the substance of

respondent's position indicated that respondent was actually

analyzing the facts of the instant case under the reasoning of

the "economic reality" test.8   This was in direct conflict with

the legal precedent set by the Court of Appeals for the Sixth

Circuit.9   Respondent was fully aware that, "where the Court of

8
     This is readily apparent in respondent's trial memorandum
and in respondent's posttrial briefs.
9
     Respondent argues that respondent's position was
                                                   (continued...)
                               - 10 -


Appeals to which appeal lies has already passed upon the issue

before us, efficient and harmonious judicial administration calls

for us to follow the decision of that court."    Golsen v.

Commissioner, 54 T.C. 742, 757 (1970), affd. 445 F.2d 985 (10th

Cir. 1971).

                             Conclusion

     On this record, the Court concludes that respondent's

position on the substantive issues in the instant case had no

basis in fact or law at the time respondent issued the notices of

deficiency or during the litigation of this case.10   It follows

that respondent's position was not substantially justified either

when respondent issued the notices of deficiency or during the

litigation herein.    Accordingly, the Court holds that petitioners

are entitled to an award for administrative and litigation costs

under section 7430.   Petitioners' motion, therefore, will be

granted.




9
 (...continued)
substantially justified because it was supported by Hayes v.
Commissioner, T.C. Memo. 1995-151, and Levien v. Commissioner,
103 T.C. 120 (1994), affd. without published opinion 77 F.3d 497
(11th Cir. 1996). Respondent overlooks the fact that both of
these cases applied the "economic reality" test rather than the
"worst-case scenario" test, and that neither case was appealable
in the Sixth Circuit.
10
     Both Emershaw v. Commissioner, supra, and Martuccio v.
Commissioner, supra, were decided by the Court of Appeals before
respondent's issuance of the notices of deficiency.
                             - 11 -


     Since respondent concedes that the amount of administrative

and litigation costs claimed by petitioners is reasonable, it is

not necessary for the Court to decide the amount of petitioners'

reasonable administrative and litigation costs.   The Court holds

that petitioners are entitled to reasonable administrative and

litigation costs of $2,402, as claimed in their motion.

Additionally, this Court has recognized that "'So long as the

government's position justifies recovery of fees, any reasonable

fees to recover such fees are recoverable.'"   Galedrige Constr.,

Inc. v. Commissioner, T.C. Memo. 1997-485 (quoting Huffman v.

Commissioner, 978 F.2d at 1149).   Thus, the Court holds that the

fees incurred by petitioners for their motion for administrative

and litigation costs are recoverable.

                                         An appropriate order and

                                    decision will be entered.
