                          T.C. Memo. 1997-541



                        UNITED STATES TAX COURT



         PATRICIA WILLIAMS, a.k.a. PATRICIA RICHARDSON,
              a.k.a. TISH MARTINSON, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 9143-96.                   Filed December 9, 1997.



     Barry L. Guterman, for petitioner.

     Edwin A. Herrera and Linas N. Udrys, for respondent.




                          MEMORANDUM OPINION


     JACOBS,   Judge:      This   matter    is   before   the   Court   on

petitioner's motion for award of litigation and administrative

costs pursuant to section 74301 and Rule 231.

     1
          References to sec. 7430 are to that section as amended
                                                   (continued...)
                                       - 2 -


       Unless otherwise indicated, all section references are to the

Internal Revenue Code in effect for the matter under consideration,

and all Rule references are to the Tax Court Rules of Practice and

Procedure.

        Respondent    determined     the     following       deficiencies    in,   and

additions to, petitioner's Federal income taxes:

                                           Additions to Tax
                        Sec.          Sec.           Sec.             Sec.      Sec.
Year   Deficiency    6651(a)(1)   6653(a)(1)(A) 6653(a)(1)(B)      6653(a)(1)   6654
                                                         1
1987       $62,203   $15,551        $3,110                            ---    $3,359
1988        28,777     7,194          ---            ---            $1,439    1,843
1989        78,170    19,543          ---            ---              ---     5,287
1
      50 percent of the interest payable under sec. 6601 on the portion of the
underpayment attributable to negligence or disregard of rules or regulations.


       The underlying matter herein was resolved pursuant to a

stipulation of settled issues filed with the Court on June 20,

1997.       In the settlement, respondent conceded all deficiencies and



       1
      (...continued)
by sec. 1551 of the Tax Reform Act of 1986, Pub. L. 99-514, 100
Stat. 2752 (applicable to all proceedings commenced after Dec.
31, 1985), and by sec. 6239(a) of the Technical and Miscellaneous
Revenue Act of 1988, Pub. L. 100-647, 102 Stat. 3342, 3743-3747
(effective for all proceedings commenced after Nov. 10, 1988).
Sec. 7430 was again amended by the Taxpayer Bill of Rights 2
(TBOR2), Pub. L. 104-168, sec. 701, 110 Stat. 1452, 1463-1464
(1996), effective for all proceedings commenced after July 30,
1996. The amendments to that section place on the Commissioner
the burden of proving that the position of the United States was
substantially justified. Sec. 7430(c)(4)(B).
     A judicial proceeding is commenced by the filing of a
petition. Rule 20(a). Petitioner filed her petition on May 10,
1996. Accordingly, the amendments to sec. 7430 by TBOR2 are
inapplicable here. See Maggie Management Co. v. Commissioner,
108 T.C. 430 (1997).
                                  - 3 -


additions to tax for 1987 and 1988, and the parties agreed that

petitioner was liable for a 1989 deficiency of $2,831 and an

addition to tax pursuant to section 6651(a)(1) for 1989. The

relevant facts are taken from the parties' submissions and the

existing record.

     At the time the petition was filed, petitioner resided in

Rancho Mirage, California.

Background

     In January 1989, the Internal Revenue Service (IRS) began an

investigation of petitioner's failure to file Federal income tax

returns for years 1982 through 1987. The investigation was later

expanded to include 1988 and 1989.

Investigation by Revenue Officer Lepkojus

     Revenue Officer Ted Lepkojus investigated petitioner from

approximately December 18, 1990, to November 5, 1992.                 During the

course    of   his   investigation,      Revenue    Officer     Lepkojus     had

difficulty locating petitioner due to her failure to file Federal

tax returns and her use of several different names.                  Letters and

postal tracers were sent to petitioner at her last known address,

but these efforts proved unsuccessful in locating her.                Her former

attorney of record, Norman Axe, was also unsure of her whereabouts.

     In March 1991, Revenue Officer Lepkojus was contacted by

Michael   Kazanjian    who   indicated    that     he   had   paid    petitioner

$124,000 in 1987 in exchange for her services as an interior
                                            - 4 -


decorator. However, in a letter dated June 10, 1991, from Mr.

Kazanjian's accountant, Revenue Officer Lepkojus was informed that

the    $124,000      was     not   for     services    rendered,        but   rather      for

petitioner's share in a real estate venture which was sold in 1987.

In    March    1991,     Revenue     Officer      Lepkojus      spoke    with       Dr.   John

Williams, petitioner's former husband, who stated that he had paid

petitioner alimony during the years in issue.

        In September 1991, Revenue Officer Lepkojus issued a summons

for petitioner's bank records, and in October 1991 he received the

records which included checks in large amounts.

        On    December     16,     1991,    Revenue    Officer     Lepkojus         obtained

information relating to petitioner's residence in Los Angeles,

California, and subsequently confirmed that address.                            Petitioner

was not present when he visited the home on January 29, 1992.

        Revenue Officer Lepkojus referred petitioner's case to the

U.S. Department of Justice, Criminal Investigation Division (CID).

The    case    was    returned      to     him   in   November    1992,       and    shortly

thereafter he forwarded it to the IRS examination division.

Examination by Revenue Agent Kropp

       Revenue       Agent    David      Kropp      conducted     an    examination        of

petitioner for her unpaid Federal income taxes for 1987, 1988, and

1989.        His investigation took place from approximately May 22,

1995, to October 10, 1995.
                                    - 5 -


      On May 22, 1995, Revenue Agent Kropp mailed a notice to

petitioner scheduling an appointment for June 15, 1995.                  Neither

petitioner nor a representative on her behalf appeared at the

meeting.

      Revenue Agent Kropp mailed a "30-day letter" dated September

5, 1995, to petitioner, along with his examination findings of

unreported income for the years in issue.            The 30-day letter stated

that if petitioner disagreed with the findings, she could either:

(1)   Mail   additional    evidence   or     information;        (2)   request    a

discussion of the findings with the examiner; or (3) discuss her

position with a group or senior manager. The letter further stated

that if petitioner did not want to take any of these courses of

action, she could either call or write the IRS within 30 days from

the date of the letter.

      On September 25, 1995, petitioner contacted Revenue Agent

Kropp and informed him that she disagreed with the findings in the

30-day letter and would provide additional information to him.

      On October 10, 1995, not having received any information from

petitioner,    Revenue    Agent    Kropp    closed    petitioner's      case     as

"unagreed" and forwarded it to the appropriate section of the IRS

for issuance of a notice of deficiency.

      On October 26, 1995, petitioner retained Barry L. Guterman to

represent her in the tax matters.              On November 6, 1995, Mr.

Guterman     informed    Revenue   Agent    Kropp     of   his    retention      by
                                    - 6 -


petitioner and requested copies of the bank records he used as the

basis of his findings. Mr. Guterman also requested additional time

to file a written protest to the findings.           On November 7, 1995,

Revenue Agent Kropp advised Mr. Guterman that because petitioner

had not furnished the information she promised, petitioner's case

had been closed as unagreed and that the administrative file had

been sent to the notices section of the Laguna Niguel district of

the IRS.   Mr. Guterman requested that the file be retrieved so that

petitioner could provide the necessary information; but on December

15, 1995, Revenue Agent Kropp informed Mr. Guterman that a notice

of deficiency was about to be issued and that petitioner's file

would not be returnable to him (i.e., to Revenue Agent Kropp).

FOIA Request

     On    December   15,   1995,   Mr.   Guterman   filed   a   Freedom   of

Information Act (FOIA) request with the IRS to determine the basis

of Revenue Agent Kropp's examination adjustments.                On or about

April 16, 1996, Mr. Guterman received copies of petitioner's

examination files, including a partially redacted investigation

history, bank printouts, and bank deposit and withdrawal items for

the years in issue.    The exam work papers for 1989 stated that "All

income is based on BDA [bank deposits analysis] done by Criminal

Investigation Division from LA District: Deposits being added to

income: $259,952."     Similar work papers were prepared for 1987 and

1988.
                                  - 7 -


Notice of Deficiency

     On February 15, 1996, respondent issued a notice of deficiency

to petitioner. The notice stated that upon conducting a bank

deposit analysis of petitioner's City National Bank accounts, the

Commissioner determined that petitioner failed to report taxable

income of $167,693 in 1987, $85,204 in 1988, and $259,957 in 1989.

On May 10, 1996, petitioner filed a petition with this Court,

denying that she had any unreported taxable income during the years

in issue.    In the answer filed on June 24, 1996, respondent

asserted that some of the bank deposit sources were verified.

Settlement Negotiations

     In late July 1996, Mr. Guterman received a letter from Appeals

Officer Steve Millang requesting a settlement conference for August

12, 1996.   The meeting was never scheduled due to the fact that

Mr. Guterman was awaiting the result of a bank deposit analysis

conducted by Steve Slatkin, an expert retained by Mr. Guterman.

Additionally,   Mr.    Guterman   was     awaiting   the   production   of

additional bank deposit documents in the IRS's possession. Appeals

Officer Millang forwarded the additional documents to Mr. Guterman.

     On or about September 24, 1996, Mr. Guterman wrote District

Counsel Linas Udrys and requested the latter to obtain additional

bank deposit information from the CID.           On November 5, 1996,

Appeals Officer Millang wrote Mr. Guterman advising that the CID
                                      - 8 -


files contained no canceled checks, bank statements, or bank

deposit slips.

      A "Branerton letter", dated November 26, 1996, from District

Counsel   Udrys    was   sent    to   Mr.     Guterman   informing   him   that

respondent was preparing for trial.                The letter specifically

requested any documentation in Mr. Guterman's possession that would

demonstrate the nontaxable sources of petitioner's bank deposits.

Mr. Guterman requested (and received) additional time to prepare

answers to the Branerton letter questions and complete his own bank

deposits analysis.       By letter dated February 24, 1997, District

Counsel Edwin Herrera again asked for Mr. Guterman's responses and

bank deposit analysis.         On March 13, 1997, Mr. Guterman forwarded

his   Branerton    letter   responses       and   bank   deposit   analysis   to

district counsel's office.

      On April 30, 1997, following several telephone conferences

between   respondent     and    Mr.   Guterman,    Appeals   Officer   Millang

formally offered a settlement proposal which subsequently led to

the stipulation of settled issues.

      Petitioner     then       sought        reasonable     litigation       and

administrative costs from respondent, which respondent rejected.

On June 20, 1997, petitioner filed the instant motion for award of

litigation and administrative costs.

Discussion
                                         - 9 -


      A taxpayer who is a prevailing party in an administrative or

court     proceeding     may     be     awarded   reasonable      litigation       and

administrative costs incurred in such proceedings.                  Sec. 7430(a).

A prevailing party is a taxpayer who establishes: (1) The position

of the United States in the proceeding was not substantially

justified; (2) the taxpayer substantially prevailed with respect to

either the amount in controversy or on the most significant issues;

and (3) the taxpayer's net worth does not exceed $2 million.                    Sec.

7430(c)(4)(a).       Additionally, to recover costs the taxpayer must

have exhausted his/her administrative remedies, sec. 7430(b)(1),2

not have unreasonably protracted the proceedings, sec. 7430(b)(4),

and     demonstrated    that     costs     incurred      were   reasonable,     sec.

7430(c)(1) and (2).

        Petitioner must establish all of the above requirements before

this Court may award litigation and administrative costs under

section 7430.        Minahan v. Commissioner, 88 T.C. 492, 497 (1987).

Petitioner     has     the     burden    of   proof   with      respect    to   each

requirement.     Rule 232(e).

        The parties primarily dispute whether respondent's position in

both the administrative and judicial proceedings was substantially

justified.    Respondent        also    asserts   that    petitioner      failed    to

exhaust her administrative remedies and claims that her costs were

not reasonable.

      2
             This requirement applies only to litigation costs.
                                   - 10 -


       Petitioner contends that respondent's position in both the

administrative and litigation proceedings was not substantially

justified.   Specifically,      petitioner    claims   that   prior   to   the

issuance of the notice of deficiency, respondent knew or had reason

to know that a substantial portion of the bank deposits came from

nontaxable sources, most notably nontaxable child care payments or

property settlement proceeds.          Petitioner further claims that the

IRS lost or destroyed much of the evidence supporting these facts,

thus forcing petitioner to prove her case again.

       Disagreeing with petitioner, respondent asserts that from the

district counsel's first involvement in this matter, diligent and

reasonable    efforts   were    made    to   verify   petitioner's    claims.

Respondent further claims that the IRS's activity prior to district

counsel's    involvement   is     irrelevant     in    determining    whether

petitioner is entitled to reasonable litigation and administrative

costs.

       For the reasons set forth below, we shall deny petitioner's

motion for award of litigation and administrative costs.

       Respondent generally takes a position in a judicial proceeding

upon the filing of the answer to the petition.                  Huffman v.

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

and revg. in part on other grounds, and remanding T.C. Memo. 1991-

144.    Respondent takes a position in an administrative proceeding

as of the earlier of the date the taxpayer receives an IRS Appeals
                                         - 11 -


decision      or    the    date    of    the       notice     of    deficiency.         Sec.

7430(c)(7)(B).        In Egan v. Commissioner, 91 T.C. 705, 711 (1988),

and Sher v. Commissioner, 89 T.C. 79, 86 (1987), affd. 861 F.2d 131

(5th   Cir.    1988),      we   held    that       the    Court    may    only    consider

respondent's position and actions after the involvement of district

counsel.      These cases were legislatively superseded by section

7430(c)(7).         Brice v. Commissioner, T.C. Memo. 1990-355, affd.

without published opinion 940 F.2d 667 (9th Cir. 1991).

       Respondent's       position      is   substantially         justified      if    that

position    could     satisfy     a    reasonable         person    and   if     it   has    a

reasonable basis in both fact and law.                     Pierce v. Underwood, 487

U.S. 552, 565 (1988); Swanson v. Commissioner, 106 T.C. 76, 86

(1996).     We examine the facts known to respondent at the time the

position      was    taken.       Coastal      Petroleum          Refiners,      Inc.       v.

Commissioner, 94 T.C. 685, 689 (1990).                     The fact that respondent

eventually loses or concedes a case is not determinative of whether

petitioner is entitled to reasonable litigation and administrative

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

       We first consider whether respondent's position during the

administrative            proceeding         was         substantially         justified.

Respondent's position in the administrative proceeding was first

established with the issuance of the notice of deficiency, dated

February 15, 1996.           The notice stated that petitioner's taxable

income was being increased by the amount of bank deposits at City
                                 - 12 -


National Bank due to "the absence of adequate records".        It is not

clear what information respondent possessed at the time the notice

was issued. However, it is evident that such information was

limited to information obtained from third party sources and

witness   statements    (particularly   those   of   petitioner's   former

husband John Williams and Mr. Kazanjian). Moreover, petitioner had

yet to provide any information to respondent to corroborate the

information given by others.

     Furthermore, petitioner has not proven that the information

possessed by respondent at the time the notice was issued would

satisfy the hypothetical reasonable person that the bank deposits

came from nontaxable sources.      Although, as petitioner contends,

respondent may have known about petitioner's divorce and the

subsequent nontaxable property settlement and child care payments,

there is no evidence that respondent had successfully matched the

bank deposits with those sources. Additionally, there were many

deposits that required explanation, and a determination of the

amount of income (if any) petitioner received from rendering

interior decorating services had to be made.

     To be sure, it is not unreasonable for the Commissioner to

require a taxpayer to corroborate his or her claims regarding

dispositive and unresolved facts.       Baker v. Commissioner, 83 T.C.

822, 830 (1984), vacated and remanded on another issue 787 F.2d 637

(D.C. Cir. 1986).      The Commissioner is not required to concede a
                                    - 13 -


case until petitioner provides the necessary documentation to prove

petitioner's contentions.      See Brice v. Commissioner, supra.

     In   sum,   we   find   that   respondent's    position    during   the

administrative proceeding was substantially justified.

     We now turn our attention to whether respondent's position in

the judicial proceeding was substantially justified.           Respondent's

position in the judicial proceeding first occurred with the filing

of an answer to petitioner's petition on or about June 24, 1996.

The position taken in respondent's answer was the same as in the

notice of deficiency; i.e., respondent sought verification and

corroboration of petitioner's bank deposit sources.

     Because no new information was received between the time the

notice of deficiency was issued (February 15, 1996) and the time

the answer was filed (June 24, 1996), respondent's position in the

answer was reasonable.       See Brantley v. Commissioner, T.C. Memo.

1995-564.     Moreover, respondent made diligent efforts to resolve

this case, contacting petitioner regarding settlement discussions

within 1 month of filing the answer.         One reason why settlement may

not have been reached sooner than it was (in April 1997) was

because of petitioner's request for additional time to complete her

own bank deposit analysis and to gather more information from the

Government.

     After the notice of deficiency is issued, respondent may

through district counsel independently verify a taxpayer's claims
                                       - 14 -


before   conceding       issues    and    settling      a     case.    Sliwa       v.

Commissioner,      839   F.2d   602,     609    (9th   Cir.   1988).   Respondent

attempted   this    through     both     telephone     conversations       with   Mr.

Guterman and the Branerton letter.              Petitioner has not suggested

that respondent's actions after the issuance of the notice of

deficiency were improper or in an effort to delay the proceedings.

In fact, only 1-1/2 months after receiving petitioner's responses

to respondent's Branerton letter and petitioner's own bank deposit

analysis, respondent made a request to settle the case, and shortly

thereafter respondent did in fact concede the majority of it.                     Cf.

Brantley v. Commissioner, supra, and cases cited therein.

     Although petitioner may have believed that the third party

information obtained by the Government was sufficient to resolve

this case, it was not enough to satisfy respondent in the exercise

of reasonable judgment.         We find that respondent's position during

the judicial proceeding was substantially justified.

     Because we hold that respondent's position was substantially

justified   in   this     case,   we     do    not   need   to   address    whether

petitioner exhausted her administrative remedies or whether the

costs sought are reasonable.
                              - 15 -


     To reflect the foregoing and the stipulation of settled issues

filed June 20, 1997,



                                          An appropriate order and

                                    decision will be entered.
