                         T.C. Memo. 1999-29



                       UNITED STATES TAX COURT


                  JOHN BOWDEN, INC., Petitioner v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket No. 11148-95.               Filed February 1, 1999.


     David P. Leeper, for petitioner.

     Gerald L. Brantley, for respondent.


                         MEMORANDUM OPINION

         DEAN, Special Trial Judge:   This case was assigned to

Special Trial Judge John F. Dean pursuant to sections 7430, 7443A

and Rules 180, 181, and 1821 for the purpose of disposing of

petitioner's Motion for Litigation Costs pursuant to Rules 230



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


through 233.   Neither party requested a hearing.   Rule 232(a).

Accordingly, we rule on petitioner's motion for litigation costs

on the basis of the parties' submissions and the record in this

case.   The underlying issues raised in the petition were settled,

and the Court entered a stipulated decision.   Upon petitioner's

subsequent filing of the motion, the decision was vacated and set

aside by order.   It was decreed in this order that the stipulated

decision document was to be filed as the Second Settlement

Stipulation.

     For taxable years ending June 30, 1992 and 1993, respondent

determined deficiencies in John Bowden, Inc.'s Federal income

taxes in the amounts of $8,539, and $5,195, respectively.    John

Bowden, Inc., was a Texas corporation with a principal place of

business in El Paso, Texas, at the time the petition was filed.

                            Background

     John Bowden, Inc. (petitioner or corporation) was

incorporated by John Bowden in June 1991 to perform services in

the insurance industry.   Prior to its incorporation, Mr. Bowden

operated the business as a sole proprietorship, working under

contract as a district manager for a group of insurance
                               - 3 -


companies2 in the El Paso, Texas, area.   Pursuant to the

contract, Mr. Bowden recruited and trained insurance agents to

sell insurance exclusively for the insurance companies with which

he had contracted.   After incorporation of his business,

Mr. Bowden continued to perform substantially the same services

for the insurance companies that he had performed prior to

incorporation, but he worked as an employee of the corporation.3

     Mr. Bowden served as the sole director of the corporation,

and his wife, Karol Bowden, served as secretary.4   The corporate

minutes reflect that B. Kent Straughan was appointed as corporate

accountant and was instructed to handle the tax preparation and

accounting requirements associated with the incorporation.

E.P. "Bud" Kirk was appointed as corporate attorney.

     In a transaction to which section 351 is applicable,

Mr. Bowden transferred property to the corporation in 1991

consisting of $10,000 cash, an airplane with a zero basis, a Ford

van with a stated basis of $21,139, a computer system with a

     2
      The insurance companies are Farmers Insurance Exchange,
Truck Insurance Exchange, Fire Insurance Exchange, Mid-Century
Insurance Co., Farmers Texas County Mutual Insurance Co., and
Farmers New World Life Insurance Co.
     3
      Because Mr. Bowden no longer operated the business as a
sole proprietorship, the insurance companies renewed their
service contract with the corporation, with Mr. Bowden personally
performing the services.
     4
      The corporate minutes reflect that Karol Bowden served as
temporary secretary for purposes of the corporate meetings.
                                - 4 -


stated basis of $97, office furniture and equipment with a stated

basis of $241, and insurance premium renewals with a stated basis

of $245,000.

     In return, the corporation issued 1,000 shares of stock to

Mr. Bowden.    The corporation also assumed a $220,468 liability,

evidenced by a note, that Mr. Bowden had incurred to acquire his

ex-wife's community property interest in the sole proprietorship.

Assumption of the debt by the corporation did not relieve

Mr. Bowden of his primary liability on the note.

     Upon incorporation, an account payable of $60,009 was

created on the books of the corporation to pay cash to Mr. Bowden

or pay other personal expenses on his behalf in the amounts of

$15,768, $21,540, and $23,951, for calendar years 1991, 1992, and

1993, respectively.5

     Respondent determined deficiencies in the Bowdens' Federal

income taxes for 1991, 1992, and 1993.   Respondent determined

that in 1991 the Bowdens had recognized $280,477 in net capital

gain upon incorporation of their business.   This gain was

calculated by characterizing as boot the $60,009 account payable




     5
      Although the parties stipulate the yearly amounts paid to
Mr. Bowden, the Court notes that the sum of these three payments
exceeds the $60,009 account payable recorded on the books of the
corporation. It is unclear to what source the additional funds
paid to Mr. Bowden were attributable.
                               - 5 -


in cash and the $220,468 note payable assumed by the corporation

for Mr. Bowden's liability to his ex-wife.

     Respondent's notice of deficiency to the corporation for FYE

June 30, 1992 and 1993, determined that expenses shown as

management fees should be reclassified as officers' compensation.

Respondent reduced the corporation's deductions for rent,

depreciation, meals and entertaining, insurance, business

promotions, and travel expenses on the basis that they were not

ordinary and necessary business expenses.    Respondent also made

corresponding increases in the allowable deductions for salaries

and auto expenses.

     The corporation filed a petition with the Court, alleging

error in each of the determinations contained in the notice of

deficiency.   Respondent filed an answer denying each allegation

contained in the petition.

     In response to a motion, the Court granted the corporation

leave to amend its petition.   In the amendment, the corporation

alleged that respondent failed to make the required section

362(a) adjustment, which would increase the basis of assets held

by the corporation by the amount of gain recognized by the

Bowdens upon transfer of their assets to the corporation.    The

corporation further alleged that it was entitled to a refund.      In

his answer to the amendment, respondent admitted that if the

Bowdens were to recognize a net capital gain by virtue of the
                               - 6 -


section 351 transaction, the corporation would be entitled to an

upward basis adjustment in the property received in the

transaction in the same amount as the gain recognized.    The

answer to amendment did not, however, specify the assets eligible

for the basis adjustment or the amount of any such adjustment.

     The corporation filed a motion for a more definite

statement, requesting that respondent identify the assets as to

which the corporation would receive a section 362(a) adjustment,

in what proportion, and over what period of time that adjustment

would be depreciable.   The motion was granted in part, and

respondent was ordered to file a statement indicating

respondent's position as to the appropriate amount and allocation

of the section 362(a) adjustment.

     Respondent subsequently filed an amended answer to the

corporation's amendment to petition, responding that the

appropriate amount of the section 362 adjustment was either

$280,477 or the actual amount of net capital gain ultimately

recognized by the Bowdens on the transfer of assets to the

corporation.   Respondent also determined that the section 362

basis adjustment should be allocated to Mr. Bowden's rights under

the contract with Farmer's Insurance Group.   The Bowdens had

stated the basis of this asset as $245,000 in their 1991 tax

return, but respondent subsequently determined the basis to be

zero.
                                - 7 -


     This case was later settled, and it was stipulated that the

corporation had made an overpayment in income tax of $4,377 for

taxable year ending June 30, 1992, and had a deficiency in the

amount of $199 for taxable year ending June 30, 1993.    The

corporation subsequently filed a motion for an award of

reasonable litigation costs.

                            Discussion

     Taxpayers may be awarded an amount for reasonable litigation

costs if they meet the requirements of section 7430.     In order to

qualify for such an award, a party must:    (1) Qualify as a

prevailing party; (2) have exhausted available administrative

remedies; (3) not have unreasonably protracted the court

proceeding; and (4) show that the costs claimed are reasonable

litigation costs incurred in connection with the court

proceeding.   Sec. 7430(c)(4), (b)(1), (b)(4), (a)(2).   The

taxpayers have the burden of establishing that all the foregoing

criteria have been satisfied.   See Rule 232(e); Maggie Management

Co. v. Commissioner, 108 T.C. 430 (1997).

     Both petitioner and respondent agree that all the

administrative remedies available within the Internal Revenue

Service have been exhausted.    There is some dispute, however, as

to the other requirements of section 7430.

     Prevailing Party

     To be a "prevailing party", a taxpayer must establish:
                                 - 8 -


(1) The position of the United States was not substantially

justified; (2) the taxpayer substantially prevailed with respect

to either the amount in controversy or the most significant issue

or set of issues presented; and (3) the taxpayer met the net

worth requirements of 28 U.S.C. section 2412(d)(2)(B) (1994) at

the time the petition was filed.    Sec. 7430(c)(4).

      Respondent concedes that petitioner meets the net worth

requirements and that petitioner substantially prevailed with

respect to the amount in controversy.    Therefore, we need only

examine the question of whether the Government's litigation

position was substantially justified.    See Swanson v.

Commissioner, 106 T.C. 76, 86 (1996).

Substantially Justified

      Whether the Government'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 the case.     Pierce v. Underwood, 487 U.S. 552, 565

(1988).   A position is substantially justified if the position is

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

Id.   Determining the reasonableness of the Government's position

and conduct requires considering what the Government knew at the

time.   See Rutana v. Commissioner, 88 T.C. 1329, 1334 (1987);

DeVenney v. Commissioner, 85 T.C. 927, 930 (1985).
                               - 9 -


     In deciding this issue, we must identify the point at which

the United States is first considered to have taken a position,

and then decide whether the position taken was or was not

substantially justified.   The position taken by the United

States, for purposes of litigation costs, is the position of the

United States in the judicial proceeding.     Sec. 7430(c)(7)(A).

The first opportunity for the United States to take a position in

the judicial proceeding is in the answer filed.     See Huffman v.

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

revg. in part T.C. Memo. 1991-144.     Therefore, in deciding

whether the Government's position was substantially justified, we

must review the actions of the IRS District Counsel in answering

the petition and the actions of the IRS Appeals officers who

considered petitioner's case after the answer was filed.

     When the answer was filed in this case, respondent denied

that there was error contained in the notice of deficiency.

Respondent denied error even though the notice of deficiency did

not contain a section 362 basis adjustment.     Respondent argues

that no basis adjustment was allowed because the Government was

caught in a potential whipsaw situation, and was trying to

prevent the possibility that income could go untaxed.     The

Bowdens had filed a petition in their case, alleging that they

should recognize no gain upon transfer of their assets to the

corporation.   Respondent contends the corporation was originally
                              - 10 -


not allowed a section 362 basis adjustment in order to protect

the revenue should the Bowdens prevail on their issue.

     In its motion, however, petitioner does not address whether

respondent's position with respect to the adjustments contained

in the notice of deficiency was substantially justified.

Petitioner argues that because respondent failed to acknowledge

the section 362 basis adjustment until the amended answer to the

amendment to petition was filed, respondent's position was

unreasonable and petitioner is entitled to litigation costs.       We

disagree.   Petitioner does not explain, nor does the record

suggest, how the section 362 basis adjustment relates to the

deficiency amounts contained in the notice of deficiency.     We

therefore find that respondent's position regarding the basis

adjustments to be irrelevant to petitioner's motion.

     Even if we were to consider respondent's position with

respect to the section 362 basis adjustments, we have recognized

that the Government may, at times, take alternative or

inconsistent positions with respect to different taxpayers.     Rule

31(c); Dixson Intl. Serv. Corp. v. Commissioner, 94 T.C. 708, 717

(1990); Barkley Co. v. Commissioner, 89 T.C. 66, 68 (1987).

There are limits, however, to the propriety of taking

inconsistent positions.   If a so-called inconsistent position has

no possible chance of success, it has been held to be

unreasonable.   Dixson Intl. Serv. Corp. v. Commissioner, supra.
                               - 11 -


     Petitioner has not shown that this is a situation where

respondent's position had no possible chance of success at the

time the position was taken.   The Bowdens had alleged in their

petition to the Court that they were not liable for any

additional tax.   Therefore, respondent's initial failure to state

that the corporation was entitled to a section 362 basis

adjustment was not unreasonable given the possibility that the

Bowdens might prevail in their case.    In the end, the Bowdens

conceded gain recognition under section 357.    Nevertheless,

respondent's initial failure to compute a section 362 basis

adjustment for the corporation was proper given the unknown

ultimate outcome of the Bowdens' case.

     Respondent filed an answer to the amended petition, and an

amended answer to the amended petition.    In those pleadings,

respondent agreed that the corporation was entitled to the

corresponding section 362 adjustment should the Bowdens recognize

gain from the section 351 transaction.    We find the Government's

position reasonable given the facts and circumstances of this

case.

     The Court has previously indicated that it is preferable for

the Government to clearly indicate that alternative positions are

being taken and to state that there is no intention to tax the

same income twice.   See Dixson Intl. Serv. Corp. v. Commissioner,

supra at 715; Doggett v. Commissioner, 66 T.C. 101, 104 (1976).
                              - 12 -


In some instances, an unexplained alternative and theoretically

inconsistent position could be totally misleading and cause an

unsophisticated taxpayer to spend needless time and effort trying

to comprehend the Government's position.    This case, however,

does not present such a problem.

     The issue of the Bowdens' gain from the section 351

transaction and the corresponding section 362 adjustments was the

subject of much correspondence and discussion between respondent

and petitioner.   The Government's position was also outlined in

the revenue agent's report disclosed to petitioner on

September 5, 1995.   The record reflects that the petitioner was

familiar with the issues as well as with the Government's

position on these issues from early on in the proceeding.

Accordingly, we find that petitioner has not established that

respondent's position was not substantially justified.

     Because petitioner has not proven that respondent's position

was not substantially justified, we need not decide whether

petitioner's litigation costs are reasonable and whether

petitioner unreasonably protracted the court proceedings.

Petitioner's motion for litigation costs will be denied.

     To reflect the foregoing,

                                           An appropriate Order

                                    and Decision will be entered.
