                       T.C. Memo. 2005-73



                     UNITED STATES TAX COURT



    MICHAEL J. DOWNING AND SANDRA M. DOWNING, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent*



     Docket No. 12108-98.             Filed April 6, 2005.



          R determined that (1) substantial amounts of income
     from P-H’s plumbing business had not been reported on Ps’
     separate income tax returns; (2) Ps’ marriage contract did
     not have the effect of stopping application of Louisiana’s
     usual community property laws for Federal income tax
     purposes; and (3) each P is liable for the fraud penalty
     (alternatively, the negligence penalty) for both years in
     issue. In Downing v. Commissioner, T.C. Memo. 2003-347 we
     held that (1) the marriage contract did prevent income-
     splitting, and so P-W had no deficiency and no fraud (or
     negligence) penalty; (2) substantial amounts of income were
     omitted from P-H’s tax return; and (3) P-H is liable for
     civil fraud.

          P-W moves for an award of costs.


     *
       This opinion supplements our previously filed opinion in
Downing v. Commissioner, T.C. Memo. 2003-347, hereinafter
sometimes referred to as Downing I.
                                 - 2 -

          1. Held: R’s position on income-splitting was
     substantially justified; P-W was not prevailing party on
     that issue. Sec. 7430(c)(4)(B)(i), I.R.C. 1986.

          2. Held, further, R’s position on P-W’s civil fraud
     penalties was not substantially justified, but R’s
     alternative position on P-W’s negligence penalties was
     substantially justified; P-W was prevailing party on that
     issue to extent of excess of fraud penalties over negligence
     penalties. Sec. 7430(c)(4)(A), I.R.C. 1986.

          3. Held, further, Under the circumstances of the
     instant case, Ps’ motion to reopen the record did not
     unreasonably protract the proceedings. Sec. 7430(b)(3),
     I.R.C. 1986.

          4. Held, further, Amounts of costs apportioned,
     generally in accordance with ratio of (a) excess of P-W’s
     determined fraud penalties over P-W’s determined negligence
     penalties, to (b) other determined amounts.

          5. Held, further, Ps’ settlement offer was not a
     “qualified offer” because it failed statutory designation
     requirement. Sec. 7430(g)(1)(C), I.R.C. 1986.



     John S. Ponseti, for petitioners.

     Susan S. Canavello, for respondent.



                 SUPPLEMENTAL MEMORANDUM OPINION


     CHABOT, Judge:   This matter is before us on the motion of

petitioner Sandra M. Downing1 (hereinafter sometimes referred to

as Sandra) for an award of reasonable litigation and



     1
       Petitioner Michael J. Downing (hereinafter sometimes
referred to as Michael) is not a party to this motion, but he
nevertheless remains a party in the case. See DeLucia v.
Commissioner, 87 T.C. 804, 811 (1986).
                                  - 3 -

administrative costs pursuant to section 74302 and Rule 231.3

     The issues for decision are:

          (1) Whether Sandra is the “prevailing party” for

     purposes of section 7430--in particular:

                  (A)   Whether respondent established that

          respondent’s position was “substantially

          justified”, within the meaning of section

          7430(c)(4)(B)(i), or

                  (B)   Whether Sandra submitted a “qualified offer”

          withing the meaning of section 7430(g);

          (2) Whether Sandra unreasonably protracted the

     proceedings; and

          (3) Whether Sandra’s claimed costs are unreasonable or

     excessive.

     We reach issues (2) and (3) only if Sandra prevails, in

whole or in part, on issue (1).

     In her amendment to the motion, Sandra requested that we

“schedule an evidentiary hearing on this motion if deemed

necessary or if the Respondent and the Petitioners are unable to


     2
       Unless indicated otherwise, all section references are to
sections of the Internal Revenue Code of 1986 as in effect for
proceedings commenced at the time the petition in the instant
case was filed.
     3
       Unless indicated otherwise, all Rule references are to the
Tax Court Rules of Practice and Procedure.
                                - 4 -

come to an agreement”.    Respondent has not requested a hearing.

The Court ordered the parties to confer in accordance with Rule

232(c) and to thereafter file status reports.     The parties’

separate status reports did not indicate a need for a hearing.

Neither side’s motion papers stated reasons why the motion cannot

be disposed of without a hearing.    See Rules 231(b)(8), 232(b)

(final flush language).    We conclude that this motion may

properly be resolved without an evidentiary hearing.     See Rule

232(a)(2).

                             Background

     The underlying facts of this case are set out in detail in

Downing v. Commissioner, T.C. Memo. 2003-347.     We summarize the

factual and procedural background briefly here, as required for

our ruling on the instant motion.

     At all relevant times, petitioners resided in Louisiana, a

community property State.    Before their marriage, petitioners

entered into a marriage contract, agreeing to be separate in

property.    They properly filed the marriage contract in St.

Tammany Parish, where they resided at the time.     When they filed

the petition in the instant case and during all years in issue,

petitioners resided in Jefferson Parish.

     In the years in issue Michael ran a plumbing business, for

which Sandra did all the bookkeeping.     As the business’s

bookkeeper, Sandra took care of its banking and billing, and
                                 - 5 -

maintained records for use in tax return preparation.

Petitioners filed separate tax returns for the years in issue, on

which they reported only their respective incomes, without regard

to Louisiana’s usual community property laws.

     Respondent determined, among other things, that petitioners’

marriage contract did not stop the application of Louisiana’s

usual community property laws for Federal income tax purposes.

Respondent determined deficiencies and additions to tax (fraud)

against Sandra as a result of charging her with one-half of the

omitted income from Michael’s business.

     In the notices of deficiency, respondent’s determinations

against Michael totaled (deficiencies plus fraud penalties)

almost $65,000, and against Sandra totaled (deficiencies plus

fraud penalties) more than $40,000.      In the notices of

deficiency, respondent determined that, if the fraud penalty was

not sustained, then the accuracy-related penalty of section

6662(a) applied.   In the answer, respondent narrowed this

alternative to the 20-percent negligence accuracy-related

penalty.

     Respondent conceded at trial and on brief that, if we held

petitioners’ marriage contract was effective to take petitioners

out of Louisiana’s usual community property matrimonial regime,

then Sandra would have no deficiency and no addition to tax or

penalty for any year in issue.    In this event, respondent
                               - 6 -

asserted alternatively, Michael would be liable for all

deficiencies and additions to tax or penalties attributable to

the omitted income from his business.   Under this alternative

(which took into account some concessions respondent had already

made), respondent asserted deficiencies and penalties against

Michael totaling almost $70,000.

     About 1 month before the trial, petitioners submitted to

respondent an offer to settle for $5,750 both petitioners’

deficiencies, interest, and penalties for both years in issue.

Respondent rejected this offer 1 week after it was submitted.

     In Downing I, we concluded that petitioners’ marriage

contract was effective during the years in issue.     Accordingly,

we held that Sandra was not liable for any deficiency, addition

to tax, or penalty for any year in issue.    We also held that

respondent succeeded in proving by clear and convincing evidence

that Michael’s business produced substantially more income than

Michael reported for the years in issue, resulting in

deficiencies, and that these deficiencies were due to Michael’s

fraud.   Our determination on the marriage contract issue mooted

respondent’s determinations of penalties against Sandra, and so

we did not make any finding as to whether Sandra’s actions were

fraudulent or negligent.

                     _____________________
                               - 7 -

     Respondent’s position as to the applicability of Louisiana’s

usual community property laws was substantially justified in both

the court proceeding and the administrative proceeding.

     Respondent’s position as to Sandra’s liability for fraud

penalties was substantially justified in neither the court

proceeding nor the administrative proceeding.    However,

respondent’s alternative position as to Sandra’s liability for

negligence penalties was substantially justified in both the

court proceeding and the administrative proceeding.

     Sandra did not unreasonably protract the proceeding.

     In general, one-eighth of petitioners’ administrative costs

is attributable to the issue of Sandra’s liabilities for fraud

penalties in excess of negligence penalties.    In general, one-

eighth of petitioners’ litigation costs that were incurred before

Sandra’s motion for award of costs is attributable to the issue

of Sandra’s liabilities for fraud penalties in excess of

negligence penalties.   In general, one-third of Sandra’s costs

for Sandra’s motion for award of costs is attributable to the

issue of Sandra’s liabilities for fraud penalties in excess of

negligence penalties.   No part of petitioners’ costs for Rule 155

computations (other than to reflect our ruling on Sandra’s

motion for costs) is attributable to the issue of Sandra’s

liabilities for fraud penalties.
                                   - 8 -

                                Discussion

A.   In General

     The Congress has provided for the awarding of litigation and

administrative costs to a taxpayer who satisfies a series of

requirements.     Sec. 7430.4

     4
         Section 7430 provides, in pertinent part, as follows:

     SEC. 7430.     AWARDING OF COSTS AND CERTAIN FEES.

           (a) In General.–-In any administrative or court
     proceeding which is brought by or against the United States
     in connection with the determination, collection, or refund
     of any tax, interest, or penalty under this title, the
     prevailing party may be awarded a judgment or a settlement
     for–-

                 (1) reasonable administrative costs incurred in
            connection with such administrative proceeding within
            the Internal Revenue Service, and

                 (2) reasonable litigation costs incurred in
            connection with such court proceeding.

            (b)   Limitations.--

            *      *      *      *      *      *      *
                 (3) Costs denied where party prevailing
            protracts proceedings.--No award for reasonable
            litigation and administrative costs may be made
            under subsection (a) with respect to any portion
            of the administrative or court proceeding during
            which the prevailing party has unreasonably
            protracted such proceeding.

            *       *      *       *         *   *     *

            (c)   Definitions.--For purposes of this section--

            *       *      *       *         *   *     *


                                                      (continued...)
                             - 9 -



4
 (...continued)
          (2) Reasonable administrative costs.--The term
     “reasonable administrative costs” means–

               (A) any administrative fees or similar
          charges imposed by the Internal Revenue Service,
          and

               (B) expenses, costs, and fees described
          in paragraph (1)(B), except that any determination
          made by the court under clause (ii) or (iii)
          thereof shall be made by the Internal Revenue
          Service in cases where the determination under
          paragraph (4)(C) of the awarding of reasonable
          administrative costs is made by the Internal
          Revenue Service.

     Such term shall only include costs incurred on or after
     whichever of the following is the earliest: (i) the
     date of the receipt by the taxpayer of the notice of
     the decision of the Internal Revenue Service Office of
     Appeals; (ii) the date of the notice of deficiency; or
     (iii) the date on which the first letter of proposed
     deficiency which allows the taxpayer an opportunity for
     administrative review in the Internal Revenue Service
     Office of Appeals is sent.

          *       *      *           *   *    *      *

          (4)   Prevailing party.--

               (A) In general.–-The term “prevailing
          party” means any party in any proceeding to
          which subsection (a) applies * * *--

                      (i) which–-

                         (I) has substantially prevailed with
                respect to the amount in controversy, or

                         (II) has substantially prevailed
                with respect to the most significant issue or
                set of issues presented, and

                      (ii) which meets the requirements
                                                (continued...)
                           - 10 -



4
 (...continued)
                  of the 1st sentence of section
                  2412(d)(1)(B) of title 28, United States
                  Code * * *

               (B) Exception if United States establishes
          that its position was substantially justified.--

                       (i) General rule.–-A party shall
                  not be treated as the prevailing party
                  in a proceeding to which subsection (a)
                  applies if the United States establishes
                  that the position of the United States
                  in the proceeding was substantially
                  justified.

          *        *      *         *   *      *        *

               (C) Determination as to prevailing party.–-
          Any determination under this paragraph as to
          whether a party is a prevailing party shall be
          made by agreement of the parties or–-

          *        *      *         *   *      *        *

                       (ii) in the case where such final
                  determination is made by a court, the court.

          *        *      *         *   *      *        *

               (E) Special rules where judgment less than
          taxpayer’s offer.--

                       (i) In general.–-A party to a court
                  proceeding * * * shall be treated as the
                  prevailing party if the liability of the
                  taxpayer pursuant to the judgment in the
                  proceeding (determined without regard to
                  interest) is equal to or less than the
                  liability of the taxpayer which would have
                  been so determined if the United States had
                  accepted a qualified offer of the party under
                  subsection (g).

          *        *      *         *   *      *         *
                                                   (continued...)
                           - 11 -



4
 (...continued)
                       (iii) Special rules.-–If this
                  subparagraph applies to any court proceeding–

          *        *      *         *   *      *        *

                            (II) reasonable administrative and
                       litigation costs shall only include
                       costs incurred on and after the date of
                       such offer.

                       (iv) Coordination.--This subparagraph
                  shall not apply to a party which is a
                  prevailing party under any other provision of
                  this paragraph.

          *        *      *         *   *      *        *

          (5) Administrative proceedings.–-The term
     “administrative proceeding” means any procedure or
     other action before the Internal Revenue Service.

          (6) Court proceedings.–-The term “court
     proceeding” means any civil action brought in a court
     of the United States (including the Tax Court * * *).

          (7) Position of the United States.–-The term
     “position of the United States” means–-

               (A) the position taken by the United States
          in a judicial proceeding to which subsection (a)
          applies, and

               (B) the position taken in an administrative
          proceeding to which subsection (a) applies as of
          the earlier of--

                       (i) the date of the receipt by the
                  taxpayer of the notice of the decision of the
                  Internal Revenue Service Office of Appeals,
                  or

                       (ii) the date of the notice of
                  deficiency.

                                                   (continued...)
                              - 12 -

     In general, the requirements of section 7430 are in the

conjunctive; i.e., the taxpayer must satisfy each of them in

order to succeed.   See Corson v. Commissioner, 123 T.C. 202, 205-

206 (2004); Minahan v. Commissioner, 88 T.C. 492, 497 (1987).

Respondent concedes that Sandra (1) “substantially prevailed”

(sec. 7430(c)(4)(A)(i)), (2) exhausted available administrative

remedies (sec. 7430(b)(1)), and (3) met the net worth



     4
      (...continued)
          *      *       *      *      *     *       *

          (g)   Qualified Offer.--For purposes of subsection
     (c)(4)--

               (1) In general.–-The term “qualified offer” means
          a written offer which--

                     (A) is made by the taxpayer to the
                United States during the qualified offer
                period

                     (B) specifies the offered amount of the
                taxpayer’s liability (determined without
                regard to interest);

                     (C) is designated at the time it is made
                as a qualified offer for purposes of
                this section; and

                     (D) remains open during the period
                beginning on the date it is made and ending
                on the earliest of the date the offer is
                rejected, the date the trial begins, or the
                90th day after the date the offer is made.

The “qualified offer” alternative (secs. 7430(c)(4)(E) and (g))
was enacted after the petition in the instant case was filed; it
applies to costs incurred after January 18, 1999. Secs. 3101(e)
and (g) of the Internal Revenue Service Restructuring and Reform
Act of 1998, Pub. L. 105-206, 112 Stat. 685, 728, 729.
                               - 13 -

requirements (subpars. (A)(ii) and (D)(ii) of sec. 7430(c)(4)).

Respondent contends that (1) Sandra is not “the prevailing party”

because respondent’s position “was substantially justified” (sec.

7430(c)(4)(B)(i)), (2) the amount of costs Sandra claims is not

reasonable (pars. (1) and (2) of sec. 7430(c)), and (3) Sandra

“unreasonably protracted” the proceedings (sec. 7430(b)(3)).

     We consider first whether respondent’s position was

substantially justified, then whether Sandra unreasonably

protracted the proceedings, and then the proper allocation of

allowable costs.   Finally, we consider whether Sandra is allowed

a recovery of any amount under the “qualified offer” provisions.

B.   Substantially Justified

     To recover costs from respondent, Sandra must establish she

is the “prevailing party” within the meaning of section

7430(c)(4).   (As we noted in Downing I note 31, section 7491,

which shifts the burden of proof to the Commissioner if the

taxpayer meets certain conditions, does not apply in the instant

case because the examination of petitioners’ tax returns began

before the effective date of section 7491.)   Under section

7430(c)(4)(B)(i), Sandra shall not be treated as having satisfied

the prevailing party requirement if respondent “establishes that

the position of the United States in the proceeding was

substantially justified.”   (Although the overall burden of proof

as to “prevailing party” is on Sandra, the burden of proof on the

“substantially justified” element is on respondent, as a result
                                - 14 -

of section 701 of Pub.L. 104-168, 110 Stat. 1452, 1463 (1996),

Taxpayer Bill of Rights 2.)

     Respondent contends:    the Commissioner’s position was

substantially justified.    In particular, respondent contends:

(1) It was reasonable to take the position that petitioners “did

not have a valid matrimonial agreement under Louisiana law”; (2)

it was reasonable “to take whipsaw or inconsistent positions to

protect the revenue”; and (3) it was reasonable to charge Sandra

(as well as Michael) with civil tax fraud.

     Sandra contends that “Respondent had no reasonable basis in

fact or law to conclude [(1)] that the Marital Agreement did not

exist, was invalid, or was not timely filed in St. Tammany

Parish”; (2) that Louisiana law required a second filing; (3)

that a 1991 Jefferson Parish filing would not satisfy any second

filing requirement that there might be under Louisiana law; and

(4) “that any fraud penalty existed on Petitioner’s [Sandra’s]

tax return for either year in question.”

     The justification for each of respondent’s positions must be

separately determined.     Foothill Ranch Co. Partnership v.

Commissioner, 110 T.C. 94, 97 (1998).

     We agree with respondent as to income-splitting.    We agree

with Sandra as to civil fraud penalties, to the extent they

exceeded negligence penalties.
                               - 15 -

       The parties focus almost entirely on the requirements as to

litigation costs; we consider litigation costs first, and then

administrative costs.

       1.   Litigation Costs--Deficiency

       Ordinarily, we identify the point at which the United States

is first considered to have taken a position, and then decide

whether the position, taken from that point forward, was or was

not substantially justified.    Maggie Management Co. v.

Commissioner, 108 T.C. 430, 442 (1997).    For purposes of the

court proceedings in the instant case, the position of the United

States is the position respondent took in the answer.      Id. at

442.

       “Substantially justified” is defined as “justified to a

degree that could satisfy a reasonable person” and having a

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

487 U.S. 552, 565 (1988) (internal quotation marks omitted);5

Nalle v. Commissioner, 55 F.3d 189, 191 (5th Cir. 1995), affg.


       5
       Although the dispute in Pierce v. Underwood, 487 U.S. 552
(1988), arose under the provisions of the Equal Access to Justice
Act (EAJA), 28 U.S.C. sec. 2412(d), the relevant provisions of
the EAJA are almost identical to the language of sec. 7430.
Cozean v. Commissioner, 109 T.C. 227, 232 n.9 (1997).
Accordingly, we consider the holding in Pierce v. Underwood,
supra, to be applicable to the case before us.

     Also, the “substantially justified” standard is not a
departure from the reasonableness standard of pre-l986 law. Sher
v. Commissioner, 89 T.C. 79, 84 (1987), affd. 861 F.2d 131 (5th
Cir. 1988). Accordingly, we consider the holdings of pre-1986
law on reasonableness to be applicable to the case before us.
                                - 16 -

T.C. Memo. 1994-182.    Respondent’s position may be incorrect and

yet be substantially justified “if a reasonable person could

think it correct”.     Pierce v Underwood, 487 U.S. at 566 n.2.

     Whether respondent acted reasonably in the instant case

ultimately turns on the available information which formed the

basis for respondent’s position, as well as on the law relevant

to the instant case.     Nalle v. Commissioner, 55 F.3d at 191-192;

Coastal Petroleum Refiners v. Commissioner, 94 T.C. 685, 688-690

(1990).

     The fact that respondent eventually loses or concedes a case

does not by itself establish that respondent’s position is

unreasonable.     Estate of Perry v. Commissioner, 931 F.2d 1044,

1046 (5th Cir. 1991)(award of litigation costs in Court of

Appeals), affg. T.C. Memo. 1990-123; Swanson v. Commissioner, 106

T.C. 76, 94 (1996).    However, it is a factor that may be

considered.     Nalle v. Commissioner, 55 F.3d at 192 n.7; Estate of

Perry v. Commissioner, 931 F.2d at 1046.

     In determining whether respondent’s position was not

substantially justified, the question is whether respondent knew

or should have known that the Government’s position was invalid

at the time that respondent took the position in the litigation.

Nalle v. Commissioner, 55 F.3d at 191; Coastal Petroleum Refiners

v. Commissioner, 94 T.C. at 689.
                              - 17 -

     In the instant case, petitioners’ pleadings did not

challenge respondent’s determinations that Louisiana’s community

property laws required Michael’s omitted business income to be

split with Sandra.6   The parties do not consider whether events

described supra note 6 have any impact on whether we should judge

the reasonableness of respondent’s position as of respondent’s

answer.

     Also, the parties do not focus on what respondent knew of

the facts when the answer was filed, but accept the relevant

matters of fact as we found them in Downing I.   Thus, as to the


     6
       In the notices of deficiency, respondent determined that
Louisiana’s usual community property laws applied so as to
require the “splitting” of petitioners’ income, including the
substantial amounts that respondent determined as unreported
income from Michael’s business. In their joint petition,
petitioners did not assign error to this community property
determination. Instead, they contended that they filed amended
tax returns to change their status from “Married Filing Separate”
to “Married Filing Joint”. In the answer, respondent admitted
receiving the amended tax returns electing joint return status,
but stated that those documents had not been processed because
they were “received after the statutory notices of deficiency
were mailed to each of the petitioners.” In the reply,
petitioners repeated their assertions that their amended tax
returns changed their filing status.

      Finally, at the trial session, petitioners conceded that
their filing status is “married filing separate” and dropped
their joint return contentions. Downing I note 4. At that
point, the applicability of Louisiana’s usual community property
laws became potentially material to the results in the case. See
Downing I note 12 for a discussion of the conflict-of-interest
problems that arose from the introduction of this issue at such
a late date in the proceedings.
                                 - 18 -

instant motion, the parties focus on whether, in light of our

findings of fact, the Commissioner’s position had a reasonable

basis in law.

     As a result of the parties’ limited arguments, we do not

attempt to explore what respondent knew of the facts at any

specific date and the consequences of knowing or not knowing any

specific fact; we thereby avoid entering what might have turned

out to be a Serbonian bog.7

     In Downing I, we described the parties’ dispute as to the

requirements of Louisiana law, which both sides contended to be

controlling in the instant case, as follows:

               We consider first whether a marriage
          contract, which was properly filed for
          registry in the parish in which petitioners
          were domiciled at the time of this filing,
          must also be filed for registry in a
          different parish for the marriage contract to
          be effective toward third persons as to
          movables,13 if petitioners have in the
          meanwhile become domiciled in that different
          parish. [Fn. 14 reference omitted.]
              13
                 Both sides treat the matter before us as being
          controlled entirely by the rules as to movables; under
          the circumstances, we limit our determinations to the
          dispute that the parties present.

     We noted in Downing I that both sides agreed that there were

no Louisiana court opinions resolving this matter.          Both sides

directed our attention to a treatise on Louisiana community



     7
       For a recent review of “Serbonian bog” references in
American judicial opinions, see Potter, “Surveying the Serbonian
Bog: A Brief History of a Judicial Metaphor”, 28 Tul. Mar. L.J.
519 (2004).
                              - 19 -

property law; that treatise noted the uncertainty as to whether

refiling was required under the statute establishing the marital

contract filing system.   16 Spaht & Hargrave, Louisiana Civil Law

Treatise, Matrimonial Regimes sec. 8.5. (West 2d ed. 1997).

     In general, the Commissioner’s position is held to be

substantially justified when the underlying issue is one of first

impression.   TKB Intern., Inc. v. United States, 995 F.2d 1460,

1468 (9th Cir. 1993); Estate of Wall v. Commissioner, 102 T.C.

391, 394 (1994).   This is not a per se rule.   See cases collected

in Nalle v. Commissioner, 55 F.3d at 192-193.    However, the

instant case is not like any of the situations in the cases

collected in Nalle; rather, the instant case falls well into the

mainstream of first impression cases.   The controlling statute is

not clear on its face, and the treatise that both sides cited

describes the statute as “ambiguous” on the issue that both sides

regarded as central.   We conclude that a reasonable person could

regard the Commissioner’s position as a correct interpretation of

the Louisiana statute, and so we conclude that the Commissioner’s

position on this issue was substantially justified.

     Sandra contends in her motion papers that

          c). Even if a second filing had been required,
     the Respondent still had no reasonable basis in fact or
     in law to conclude that the “second filing” of the
     Matrimonial Agreement in Jefferson Parish in 1991 was
     not effective as to third parties. Hence, Petitioner’s
     income is still her separate property.
                             - 20 -

     In Downing I we found that the marriage contract had been

dealt with in parish records four times, as follows:

          (1) On July 14, 1989, petitioners filed the marriage
     contract “for registry” in the conveyance records of
     St. Tammany Parish, where petitioners then resided.

          (2) On October 8, 1991, Michael, who bought a house in
     Jefferson Parish 5 days earlier, filed the act of sale
     for this house in the conveyance records of Jefferson
     Parish. He attached a copy of the marriage contract to
     this filed act of sale.

          (3) On March 28, 1995, Michael, who bought another
     house in Jefferson Parish 4 days earlier, filed the act
     of sale for this house in the conveyance records of
     Jefferson Parish. He did not attach a copy of the
     marriage contract to this act of sale, but this act of
     sale refers to “a marriage contract dated July 12,
     1989, and annexed to act recorded as Act No. 91-44488,
     in the Parish of Jefferson”.

          (4) On February 2, 2000, the marriage contract was
     “filed for registry” in the conveyance records of
     Jefferson Parish.

     In their posttrial opening brief, petitioners focused on the

effect of the 1989 St. Tammany Parish filing for registry.     They

then stated as follows:

          Nevertheless, and in order to quash any possible
     lingering doubts, Petitioners have filed separately
     their marriage contract in the registry of Jefferson
     Parish. If by some chance the first filing in
     Jefferson Parish was only good as to the Newman
     property because it was only attached to the sale of
     that property and was not separately filed, the second
     filing (and at least the third such filing overall) of
     this marriage contract by itself should remove all
     lingering doubts as to any other immovable (or movable)
     property located in Jefferson Parish.

In their posttrial answering brief, petitioners took the position

that “the filings in Jefferson Parish were only needed to protect
                                - 21 -

the immovable property of Mr. Downing [i.e., the house

Michael bought in 1991 and the house he bought in 1995] that was

located in Jefferson Parish.”

     We believe petitioners got it right in their posttrial

answering brief--the 1991 and 1995 filings protected Michael’s

immovables.   However, if respondent’s position as to the effect

on movables of the 1989 filing was reasonable (and we have

concluded that it was), then nothing in the record causes us to

conclude that the 1991 filing or 1995 filing--each of which was

only an immovables filing--would settle the matter so that

respondent’s overall position would become unreasonable.      The

statute in question--La. Civ. Code Ann. art. 2332 (West 1985)--

does not state whether an immovables filing can serve also as a

movables filing.   The parties have not led us to any caselaw or

treatise discussion of the matter.       Whatever the answer may turn

out to be under Louisiana law, we are satisfied that on this

record the Commissioner’s position in the litigation as to

marriage contract filings was substantially justified.

     We hold for respondent on this issue.8


     8
       Under these circumstances, we do not rule on respondent’s
contention that respondent’s position was reasonable in order to
avoid a possible “whipsaw”. We note that the instant case does
not fit into the usual whipsaw setting, in which the Commissioner
takes inconsistent positions because the taxpayers involved in
the same transaction take inconsistent positions, or the
Commissioner reasonably foresees that the taxpayers may take
inconsistent positions. See, e.g., Sherbo v. Commissioner, 255
F.3d 650 (8th Cir. 2001), affg. T.C. Memo. 1999-367; Maggie
                                                   (continued...)
                              - 22 -

     2.   Litigation Costs--Fraud, Negligence

     In order to prevail on the fraud aspect of Sandra’s motion,

respondent must demonstrate that respondent had a reasonable

basis for believing respondent could prove Sandra’s fraud by

clear and convincing evidence.   See Rutana v. Commissioner, 88

T.C. 1329, 1331, 1337-1338 (1987).

     In Downing I, we held that respondent proved by clear and

convincing evidence that Michael understated his plumbing

business’s Schedule C, Profit or Loss From Business, gross

receipts by substantial amounts and that these understatements of

receipts resulted in understatements of income, which in turn

resulted in underpayments of Michael’s income tax.   We then held

that respondent proved by clear and convincing evidence that some

or all of these underpayments were due to Michael’s fraud.

Because we held in Downing I, that Sandra did not have a

deficiency (for purposes of the instant case, “underpayments” and

“deficiency” are equivalent terms; compare sec. 6211(a) with sec.

6664(a)), Sandra could not have any civil fraud penalty

liability, and so we did not consider in Downing I whether Sandra

had committed civil tax fraud.




     8
      (...continued)
Management Co. v. Commissioner, 108 T.C. 430, 446-448 (1997). In
the instant case, respondent took one position, and (at least by
the time of the trial) petitioners united in taking the opposite
position.
                              - 23 -

        We have held, supra, that the Commissioner’s position as

to the marriage contract filings was substantially justified even

though we ultimately ruled against respondent in Downing I.     If

in Downing I we had upheld respondent’s position, then presumably

Sandra would have had to report on her separate tax return one-

half of the omitted income from Michael’s plumbing business.    The

question we face now is whether there was substantial

justification for the Commissioner’s position that Sandra should

be liable for the civil fraud penalty for her failure to report

that income on her separate tax return.

     In order for Sandra to be liable for civil tax fraud,

respondent would have had to show that Sandra intended to evade

taxes which Sandra knew or believed she owed.   See, e.g., Powell

v. Granquist, 252 F.2d 56, 60 (9th Cir. 1958); Frazier v.

Commissioner, 91 T.C. 1, 12 (1988); Danenberg v. Commissioner, 73

T.C. 370, 393-394 (1979).   Sandra would not be liable if she

merely intended to help Michael evade taxes that Sandra knew or

believed Michael owed.   In order to show that Sandra knew or

believed that she was taxable on the omitted income from

Michael’s plumbing business, respondent would have to show that

Sandra did not believe that the marriage contract and its filing

prevented application of Louisiana’s usual community property

laws.
                              - 24 -

     The very uncertainty as to Louisiana law that leads us to

conclude that the Commissioner’s position on income-splitting was

substantially justified, also leads us to conclude that

respondent would have had to present an extraordinarily strong

case to persuade us by clear and convincing evidence that Sandra

believed her marriage contract filing was ineffective under

Louisiana law.   See Danenberg v. Commissioner, supra at 393-394.

     We have not found any evidence in the record, nor any

evidence that respondent offered or otherwise contended was

admissible, that would suggest that it was reasonable for

respondent to believe that respondent could prove this essential

element of a fraud case against Sandra.   Indeed, respondent’s

discussion in the memorandum on Sandra’s motion for costs deals

only with Sandra’s involvement in the record-keeping and

reporting regarding Michael’s business; it does not suggest, even

by way of a conclusory comment, that respondent expected to prove

by clear and convincing evidence that Sandra knew or believed

that Sandra had to report any omitted income from Michael’s

business.

     We conclude that respondent failed to establish that

respondent’s position as to Sandra’s civil fraud penalty was

substantially justified.

     However, respondent’s failure to carry the heavy burden of

proof as to the 75-percent civil fraud penalty would have left in
                                 - 25 -

place the notice of deficiency alternative determination of the

20-percent negligence penalty.     That is an issue that would be

decided by a preponderance of the evidence, and the burden would

have been on Sandra to prove that the negligence penalty did not

apply.9   The position of respondent, that Sandra would have been

liable for the negligence penalty if respondent had not succeeded

in establishing her liability for the civil fraud penalty, was

substantially justified.

     Accordingly, we hold for Sandra on this issue, but only to

the extent that the 75-percent civil fraud penalty would have

exceeded the 20-percent negligence penalty.

     3.   Administrative Costs

     For purposes of the administrative proceedings in this case,

the position of the United States is the position taken by

respondent in the notice of deficiency.     Sec. 7430(c)(7)(B);

Maggie Management Co. v. Commissioner, 108 T.C. at 442.

     Neither side has stated that any element of the

administrative costs dispute as to substantial justification is

different from the elements discussed supra regarding litigation

costs.    See Maggie Management Co. v. Commissioner, 108 T.C. at

442-443; Swanson v. Commissioner, 106 T.C. at 86-87.


     9
       As noted supra, sec. 7491 does not affect the instant
case. But, even if sec. 7491(c) had applied, the burden of
persuasion would have remained on Sandra. Higbee v.
Commissioner, 116 T.C. 438, 446-449 (2001).
                              - 26 -

Accordingly, we reach the same conclusions under this heading as

we do under the litigation costs heading.

      We hold, for respondent, that respondent has established

that the position of the United States in the administrative

proceeding, that Sandra was required to apply the usual Louisiana

community property laws, was substantially justified.

      We hold, for Sandra, that respondent failed to establish

that the position of the United States in the administrative

proceeding, that Sandra was liable for the fraud penalty, was

substantially justified, but only to the extent that the 75-

percent civil fraud penalty would have exceeded the 20-percent

negligence penalty.

C.   Protracted Proceedings

      Respondent asserts that Sandra “unreasonably protracted” the

litigation of this case by filing an unfounded and unnecessary

motion.   Section 7430(b)(3) provides that a prevailing party is

not entitled to recover costs for periods during which the party

has “unreasonably protracted” the administrative or court

proceedings.   Sandra contends that she has not unreasonably

protracted the proceedings.   Respondent argues that Sandra

unreasonably protracted the proceedings and is not entitled to

costs for a period of approximately 10 months, beginning with the

filing of petitioners’ Motion to Reopen the Record or in the

Alternative for a New Trial because, respondent asserts, the
                               - 27 -

motion was made to add evidence to the record which should have

been introduced or stipulated at an earlier time.

     We granted petitioners’ motion to reopen the record but only

to the extent of certain concessions made by respondent; we

denied that motion in all other respects.    The record then was

closed, and our opinion in Downing I was later issued.

     Respondent states that petitioners had in their possession

before the trial all the evidence which they sought to have

admitted into the record by their motion, and respondent argues:

“They cannot be heard to complain at this late date that they

were unfairly disadvantaged by having to check their own records

against schedules prepared by respondent.”    Even so, respondent

made numerous concessions on matters raised in petitioners’

motion.   See Downing I, nn. 24-27.

     Some of respondent’s concessions reflect errors that had

been earlier made by respondent, which respondent both implicitly

and expressly acknowledges.    Each of the error corrections was in

petitioners’ favor.   The net effects of respondent’s concessions

were to reduce unreported income for 1994 by almost $500, and for

1995 by more than $8,000.   These amounts are not trivial in the

context of the instant case.

     Petitioners should have noticed and corrected errors in the

stipulation document before signing it, and they should have

offered all evidence by the end of the trial.    However, given the
                                - 28 -

overall situation, where respondent made errors in drafting the

stipulation document and where concessions resulting from

petitioner’ motion significantly decreased the deficiencies, we

are satisfied that any protraction of the proceedings caused by

petitioners’ motion was not “unreasonable” in the context of the

instant case.     Sandra’s litigation costs recovery will not be

reduced on the basis of unreasonable protraction of the

proceeding.

      We hold for Sandra on this issue.

D.   Allocation

      Sandra’s motion claims about $55,000 of combined litigation

and administration costs.

      Respondent maintains that Sandra should take nothing because

she is not the prevailing party.     We hold that Sandra is the

prevailing party with respect to the determination of the fraud

penalty (to the extent that the fraud penalty exceeds the

negligence penalty) against her and she is not otherwise

disqualified.     Accordingly, respondent’s broad contention falls.

      Sandra, on the other hand, contends that she and Michael

decided on combined representation to avoid the duplication of

expense that separate representation would have entailed.

Accordingly, she contends, every expense is no more than she

would have incurred from separate representation and so every

expense is part of the costs that should be awarded to her.
                               - 29 -

Sandra charges that “Respondent continues to commingle the two

cases and issues despite this Court’s ruling that the Petitioners

are separate in property.”   Firstly, we have concluded (supra

Parts B.1, 3) that Sandra was not the prevailing party with

respect to the community property issue.   Secondly, we shall not

ignore the fact that it was petitioners who chose “to commingle

the two cases”.    The costs were incurred by both petitioners and

not only Sandra.   Accordingly, Sandra’s broad contention falls.

     We proceed to consider the other contentions that have been

raised as to this issue and conclude that, as to some of these

contentions, respondent’s arrows have hit their targets.   Cf.

Estate of Fusz v. Commissioner, 46 T.C. 214, 215 (1966).

     We agree with respondent’s contentions that any award of

costs must take account of the facts that the costs were incurred

(1) to represent Michael as well as Sandra, and (2) to deal with

all the issues in the case, including those where respondent’s

position was substantially justified.   For the most part it is

not practical to assign a pigeonhole for every item.

     In the notices of deficiency, respondent’s determinations of

civil fraud penalties against Sandra (to the extent the civil

fraud penalties exceeded the negligence penalties) totaled about

one-eighth of the aggregate determinations against both Sandra

and Michael.   Because petitioners had to prepare as though

everything that affected either of them also affected the other,
                              - 30 -

it was reasonable for them to incur costs without incurring

additional costs to calculate how much of any item primarily

benefited Sandra rather than Michael.     Also, everything that

affected the amount of the deficiency might have affected the

amount of the civil fraud penalty.     See sec. 6663(a).

Accordingly, we reject respondent’s contention that we should

reject petitioners’ costs that “pertain to the bank deposits

method”.   Accordingly, we conclude that one-eighth of the

administrative costs and the litigation costs (except as to

litigation costs incurred in connection with the instant motion

for costs) is properly allowable to Sandra in connection with the

fraud issue.

     Respondent contends that none of the costs incurred before

April 3, 1998, are awardable, relying on the last sentence of

section 7430(c)(2).   See supra note 4.    Sandra does not appear to

dispute respondent’s factual predicates or statutory

interpretation.   Accordingly, none of the costs incurred before

April 3, 1998, are to be taken into account in determining the

total to which the one-eighth allocation is to be applied.

     Respondent also contends that Sandra is not entitled to

litigation costs in connection with petitioners’ motion to

restrain assessment and collection.     It appears that, in

violation of section 6213(a), respondent assessed the determined

deficiencies and penalties after petitioners filed their
                              - 31 -

petition.   Petitioners’ counsel persuaded respondent to abate the

assessments.   After all the illegal assessments had been abated,

petitioners filed a motion under Rule 55 to restrain assessment

and collection.   The origin and purpose of Rule 55 is described

in the Court’s explanatory Note.   93 T.C. 821, 876-877.

Petitioners’ counsel’s actions leading to the abatements are in

furtherance of the instant litigation; the costs thereof are

proper litigation costs.   However, the Rule 55 motion, which was

filed after all the moved-for abatements had already been

accomplished, was moot at its inception.   The costs of the Rule

55 motion shall be borne by petitioners and are not proper

litigation costs for our purposes.

     We disagree with respondent’s contention that Sandra

unreasonably protracted the proceedings.   Supra, Part C.    The

costs incurred in connection with the actions respondent

identifies in this contention are includable in the base for the

one-eighth allocation.

     The costs that have been incurred, and those that will be

incurred, in connection with the computations under Rule 155

(except those that relate to the award under section 7430) are

allocable entirely to Michael and so are not includable in the

base for the one-eighth allocation.

     Sandra is the prevailing party but only with respect to the

excess of the civil fraud penalties over the negligence
                              - 32 -

penalties, and not with respect to the deficiencies.   The excess

of the civil fraud penalties over the negligence penalties is

about one-third of the total of the civil fraud penalties and the

deficiencies determined against Sandra.   We conclude that one-

third of the costs incurred in connection with the instant motion

is properly allowable to Sandra in connection with the penalties

issue.

     The parties are to calculate the amounts so awardable in

connection with the computations under Rule 155.   They are

cautioned to avoid “penny-wise and pound-foolish” disputes on

this matter.   See, e.g., Dang v. Commissioner, 259 F.3d 204, 206

(4th Cir. 2001), affg. an unreported order and decision of this

Court entered July 21, 2000; Goettee v. Commissioner, T.C. Memo.

2003-43 (issue II, B. 1, relating to a dispute, in an interest

abatement case, as to whether $2.44 had been paid on May 19,

1985, or May 19, 1986).

E.   Qualified Offer

      Sandra contends that, because she submitted a qualified

offer within the meaning of section 7430(g) and the judgment as

to her was less than the amount of the offer, she is the

prevailing party under section 7430(c)(4)(E).   See supra note 4.

Respondent contends that “Petitioner’s letter * * * was not a

qualified offer, because it was not designated at the time it was

made as a qualified offer for purposes of section 7430(g).”
                               - 33 -

Sandra responds that “Petitioners did not label their settlement

offer as a qualified offer, but an offer to settle the case is an

offer to settle the case.”

     We agree with respondent.

     The settlement offer on which Sandra relies, sent by

petitioners’ counsel to respondent’s counsel, states as follows:

     RE:    Michael Downing and Sandra Downing
            Tax Years 1994 and 1995

     Dear Mrs. Canavello:

          In view of the upcoming trial date and the
     forthcoming expenses associated with the final
     preparations for trial, I have been authorized to make
     you a settlement offer. This settlement offer is
     intended to cover both years (1994 and 1995) and all of
     their liability including tax, interest, and penalties
     for those years. This amount is $5,750.00. If you
     decide to reject this offer, please do so in writing so
     that I may forward such letter to my clients. If you
     accept this offer, please call me.

          Thank you for your cooperation and assistance in
     this matter.

     Section 7430(g)(1) defines “qualified offer”.    Subparagraph

(C) specifically requires a qualified offer to be “designated at

the time it is made as a qualified offer for purposes of this

section”.    Nothing in petitioners’ settlement offer even remotely

satisfies the subparagraph (C) requirement.10    The requirements

     10
       Compare petitioners’ settlement offer with the qualified
offer set forth in Johnston v. Commissioner, 122 T.C. 124, 126
(2004). We do not mean to suggest that the Johnston offer is the
only way to comply with the requirement of sec. 7430(g)(1)(C),
but there must be something in a putative qualified offer that
                                                   (continued...)
                              - 34 -

of the "qualified offer" definition are conjunctive.

Petitioners' settlement offer fails to meet the subparagraph (C)

requirement, and so it is not a qualified offer.

     We hold for respondent on this issue.11

     To reflect the foregoing,


                                      An appropriate order will be

                                 issued granting petitioner’s motion

                                 to the extent indicated herein and

                                 denying petitioner’s motion in all

                                 other respects.


     10
      (...continued)
might fairly qualify as a designation required by the statute.
As the Court of Appeals for the Third Circuit stated in another
Internal Revenue Code setting, “Congress has drafted the statute,
and we are not free to rewrite it.” Hildebrand v. Commissioner,
683 F.2d 57, 59 (3d Cir. 1982), affg. T.C. Memo. 1980-532.
     11
       Under these circumstances, we do not consider
respondent’s additional contention that the settlement offer does
not qualify under sec. 7430(g)(1)(B) because it “does not specify
what portion of the offered amount, if any, pertains to
[Sandra’s] liability as distinguished from that of” Michael.
Respondent has not contended, and so we do not consider, whether
sec. 7430(c)(4)(E)(i) (supra note 4 relating to requirement that
liability determined pursuant to the judgment be equal to or less
than liability under the offer) precludes Sandra from “qualified
offer” relief because the $5,750 offered amount is less than the
finally redetermined liabilities of Sandra and Michael combined.
Also, we do not consider whether sec. 7430(c)(4)(E)(iv) (supra
note 4 relating to coordination) precludes Sandra from “qualified
offer” relief because of the limited relief we have granted to
Sandra with regard to part of the civil fraud penalties.
Finally, it is not necessary to determine how much of the claimed
costs were incurred after Jan. 18, 1999. See supra note 4 last
paragraph.
