                        T.C. Memo. 1996-317



                      UNITED STATES TAX COURT



         SIMPSON FINANCIAL SERVICES, INC., Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

       RICHARD H. AND CHRISTINE R. SIMPSON, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket Nos. 4255-95, 4354-95.      Filed July 15, 1996.



     Robert D. Winston, Jr., for petitioners.

     Emile L. Hebert III, for respondent.



                        MEMORANDUM OPINION


     LARO, Judge:   Petitioners moved the Court on March 13, 1996,

to recover $19,126 of administrative and litigation costs under

section 7430 and Rule 231.   Petitioners petitioned the Court to

redetermine respondent's determination for their 1988 taxable
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year.      On December 20, 1994, respondent had issued petitioners

separate notices of deficiency reflecting her determination that

they were liable for the following deficiencies in Federal income

tax and additions thereto:

Simpson Financial Services, Inc., docket No. 4255-95

                                          Additions to Tax
                                  Sec.           Sec.           Sec.
Year          Deficiency       6651(a)(1)      6653(a)(1)       6661

1988           $28,225           $7,056          $1,411        $7,056


Richard H. and Christine R. Simpson, docket No. 4354-95

                                          Additions to Tax
                                  Sec.           Sec.           Sec.
Year          Deficiency       6651(a)(1)      6653(a)(1)       6661

1988           $13,083           $3,271            $778        $3,271

Prior to trial, the parties settled all issues raised in

respondent's notices of deficiency.         In their settlement

agreement, the parties agreed that there remained a deficiency

for Simpson Financial Services, Inc., for its 1988 taxable year

in the amount of $1,579, and a $395 addition thereto under

section 6651(a)(1).        Respondent conceded all adjustments with

respect to Richard H. and Christine R. Simpson.

       Following this agreement and concession, we must decide

whether respondent's position was substantially justified in fact

and law for purposes of section 7430(c)(4)(A)(i).1           We conclude

       1
       Respondent filed her answers on Apr. 20, 1995, generally
denying all material allegations of error contained in the
petitions. Respondent's position taken in her answers was the
                                 - 3 -

that it was.2    All section references are to the Internal Revenue

Code in effect for the year in issue, and all Rule references are

to the Tax Court Rules of Practice and Procedure.      Dollar amounts

are rounded to the nearest dollar.       Simpson Financial Services,

Inc., Richard H. Simpson, and Christine R. Simpson are separately

referred to as Simpson Financial, Mr. Simpson, and Mrs. Simpson,

respectively.     Mr. Simpson and Mrs. Simpson are collectively

referred to as the Simpsons.

                              Background

     We decide petitioners' motion for an award of administrative

and litigation costs on the record of the case, including

respondent's objection and the parties' affidavits and exhibits,

which are incorporated herein by this reference.      Neither party

requested a hearing, and we conclude that one is not necessary.

Rule 232(a)(3).     Simpson Financial's principal place of business

was Kenner, Louisiana, when it filed its petition.      The Simpsons

are husband and wife.     When they filed their petition, they

resided in Kenner, Louisiana.

         On February 24, 1993, respondent issued 30-day letters to

petitioners, proposing deficiencies in their income taxes.




same as that taken in her notices of deficiency.
     2
       Based on our holding, we do not decide the other issue in
dispute; namely, whether the litigation and administrative costs
claimed in petitioners' motion filed Mar. 13, 1996, are
reasonable.
                               - 4 -

Included with these letters were copies of the revenue agent's

examination reports (RAR) and waiver forms.

     With respect to Simpson Financial, the RAR contained

essentially four types of adjustments to its income tax return

for 1988.   First, the RAR increased Simpson Financial's gross

receipts and decreased its cost of goods sold.   These adjustments

stemmed from what the revenue agent perceived as a misapplication

by Simpson Financial of its method of accounting.   Second, the

RAR decreased, for lack of substantiation, Simpson Financial's

claimed expenses for its office, public relations, travel and

entertainment, insurance, and depreciation.   Third, the RAR

disallowed Simpson Financial's claimed net operating loss (NOL)

carryforward from its 1987 taxable year.   The revenue agent

disallowed this loss, due to the revenue agent's determination

that there were apparent discrepancies between Simpson

Financial's 1987 Federal income tax return and its books and

records for 1987.   Fourth, the RAR determined that Simpson

Financial paid constructive dividends to the Simpsons during the

subject year.   The RAR issued to the Simpsons reflected the

revenue agent's adjustment to their taxable income to reflect the

constructive dividends.   The RAR's also reflected additions to

tax for delinquent filing of returns, negligence, and substantial

understatement of tax.

     Petitioners did not protest the RAR with respondent's

Appeals Division (Appeals).   Petitioners requested review of the
                                - 5 -

RAR relating to Simpson Financial with respondent's examination

division.   A revised RAR for Simpson Financial was issued to

petitioners on June 28, 1993.    The revised RAR conceded portions

of the revenue agent's adjustments to Simpson Financial's gross

receipts and cost of goods sold.    The revised RAR stated that

Simpson Financial's proposed deficiency was $28,682, rather than

$55,844 as reflected on the previous RAR, and the additions to

Simpson Financial's tax were proportionately lowered.

     Respondent mailed notices of deficiency to petitioners on

December 20, 1994, taking into account the adjustments in the

revised RAR.    On March 20, 1995, petitioners filed their

respective petitions in this Court.     After respondent answered

these petitions on April 20, 1995, she transferred the cases to

Appeals for settlement consideration.

     On April 24, 1995, an Appeals officer mailed a letter to

petitioners' counsel suggesting that they discuss the cases on

May 17, 1995.    By letter dated May 2, 1995, petitioners' counsel

requested a later date.    The parties held a conference on

July 25, 1995, and petitioners provided documentation to the

Appeals officer, which was in addition to other documentation

provided earlier to the revenue agent during her examination.

Based upon this new documentation, the Appeals officer wrote

petitioners' counsel on July 27, 1995, to settle various issues.

     While the cases were still within Appeals, Appeals asked the

examination division to audit the NOL reported for Simpson
                                 - 6 -

Financial's 1987 taxable year.    Appeals made this request due to

the disallowed loss carryforward from 1987 to 1988.

     Settlement negotiations between the parties continued

through September 11, 1995, when it became apparent to the

parties that they would be unable to reach a mutually agreeable

settlement.    Petitioners' counsel sent the Appeals officer a

letter requesting the case be transferred back to District

Counsel, citing his objection to the Appeals officer's continued

demands for additional documentation.    On September 15, 1995,

Appeals referred the cases back to District Counsel for trial

preparation.

     Shortly thereafter, District Counsel was notified by the

examination division that Simpson Financial's 1987 Federal income

tax return would not be audited.    Petitioners and District

Counsel held a conference on December 14, 1995, to discuss the

cases in preparation for trial.    At that conference, the parties

reviewed various documentation that petitioners provided in

response to District Counsel's informal discovery request.     While

some of this documentation had been provided earlier by

petitioners to respondent either at the audit level or later at

the Appeals level, petitioners furnished additional documentation

that had not previously been provided to respondent.    The parties

settled all issues raised by the notice of deficiency issued to

Simpson Financial, including the NOL carryforward, which

respondent conceded.    Respondent conceded the NOL issue after the
                               - 7 -

examination division decided not to audit Simpson Financial's

1987 taxable year.

     With respect to the Simpsons' individual return, respondent

fully conceded the constructive dividend issue.   Petitioners

established to the satisfaction of respondent's counsel that the

sums in question were repayments of the Simpsons' loans to

Simpson Financial, rather than constructive dividends.

Petitioners had not established this fact at the audit, nor at

the Appeals level.

1. Motion for Litigation and Administrative Costs:   Overview

     In order to recover reasonable administrative and litigation

costs under section 7430, petitioners must prove, inter alia,

that they were the "prevailing party" within the meaning of

section 7430(c)(4), which requires petitioners to establish:

(1) That respondent's position was not substantially justified in

fact or law, sec. 7430(c)(4)(A)(i); Pierce v. Underwood, 487 U.S.

552, 564-565 (1988); Wilkerson v. United States, 67 F.3d 112, 119

(5th Cir. 1995); Bouterie v. Commissioner, 36 F.3d 1361, 1373

(5th Cir. 1994), revg. T.C. Memo. 1993-510; Han v. Commissioner,

T.C. Memo. 1993-386; (2) that they substantially prevailed in the

proceeding with respect to the amount in controversy or the most

significant issues presented, sec. 7430(c)(4)(A)(ii); and

(3) that at the commencement of the proceeding, they met the net

worth requirement under section 7430(c)(4)(A)(iii) and 28 U.S.C.

sec. 2412(d)(2)(B) (1994).   In addition, petitioners must prove
                               - 8 -

that they exhausted their administrative remedies within the

meaning of section 7430(b)(1);3 that they did not unreasonably

protract the proceedings within the meaning of section

7430(b)(4); and that their claimed costs are reasonable, sec.

7430(c)(1) and (2).   These requirements are in the conjunctive.

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

must prove each and every requirement.   Rule 232(e); Welch v.

Helvering, 290 U.S. 111, 115 (1933); Nalle v. Commissioner, 55

F.3d 189, 191 (5th Cir. 1995), affg. T.C. Memo. 1994-182; Lennox

v. Commissioner, 998 F.2d 244, 248 (5th Cir. 1993), revg. in part

T.C. Memo. 1992-382; Gantner v. Commissioner, 92 T.C. 192, 197

(1989), affd. 905 F.2d 241 (8th Cir. 1990).

     Respondent agrees that petitioners have met all of the above

requirements except two.   Respondent disputes petitioners'

contention that her position was not substantially justified, and

respondent argues that some of petitioners' claimed costs are not

reasonable.

2. Whether Respondent's Position was Substantially Justified

     Whether respondent's position was substantially justified

turns on a finding of reasonableness, based on all the facts and

circumstances of the case, as well as any legal precedents which

may relate thereto.   Wilkerson v. United States, supra at 119;

Nalle v. Commissioner, supra at 191; Coastal Petroleum Refiners,

     3
       This requirement only applies to an award of reasonable
litigation costs. Sec. 7430(b)(1).
                                - 9 -

Inc. v. Commissioner, 94 T.C. 685, 688-696 (1990).    We ask

ourselves, "whether * * * [respondent] knew or should have known

that her position was indefensible at the onset".    See Nalle v.

Commissioner, supra at 191.    Respondent first took a position in

these cases when she issued the subject notices of deficiency.4

Sec. 7430(c)(7)(B)(ii); see, e.g., Han v. Commissioner, T.C.

Memo. 1993-386.

     Petitioners allege that respondent's positions were

unreasonable as evidenced by the fact that she conceded a large

percentage of the deficiencies reflected in the subject notice of

deficiencies.   We disagree.   The Government's position can be

justified even if ultimately rejected by the Court.    Wilfong v.

Commissioner, 991 F.2d 359, 364 (7th Cir. 1993).    The fact that

respondent eventually loses or has made substantial concessions

is not dispositive in establishing that the positions taken by

respondent were unreasonable, Nalle v. Commissioner, supra at

191; Bouterie v. Commissioner, supra at 1367, but is merely one

factor to consider; Heasley v. Commissioner, 967 F.2d 116, 120

(5th Cir. 1992), affg. in part and revg. in part T.C. Memo.

1991-189; Estate of Perry v. Commissioner, 931 F.2d 1044, 1046

(5th Cir. 1991); Sher v. Commissioner, 89 T.C. 79, 84 (1987),

     4
       A 30-day letter is not the equivalent of a notice of the
decision from the IRS Office of Appeals or a notice of
deficiency. Consequently, a 30-day letter does not constitute a
position of the United States, for purposes of claiming an award
of administrative costs under sec. 7430. See Estate of Gillespie
v. Commissioner, 103 T.C. 395 (1994).
                               - 10 -

affd. 861 F.2d 131 (5th Cir. 1988).     For petitioners to prevail,

respondent's position, as a matter of both fact and law, must not

have been "justified to a degree that could satisfy a reasonable

person."   Pierce v. Underwood, supra at 565; Wilkerson v. United

States, supra at 119.    Whether respondent's position has a

reasonable basis in fact and law turns in part on whether there

is "substantial evidence" to support it.     Pierce v. Underwood,

supra at 564-565; Powers v. Commissioner, 100 T.C. 457, 473

(1993).    Respondent must have at least some relevant evidence

sufficient to support her position.

      Respondent developed her position in the instant case based

on her examination and investigation of petitioners' returns.

Cf.   Powers v. Commissioner, supra.    In the notices of

deficiency, respondent premised the adjustments primarily on

petitioners' failure to substantiate items on their returns.

Deductions are a matter of legislative grace, and petitioners

bore the burden of establishing their entitlement thereto.

New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).      In

addition, section 6001 imposed on petitioners an affirmative duty

to maintain books and records sufficient to establish items

reported on their returns.    It was reasonable for respondent not

to concede the adjustments until she had received and verified

adequate substantiation for the items in question.     Harrison v.

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

1987-52; Sokol v. Commissioner, 92 T.C. 760, 765 (1989).
                              - 11 -

     Shortly after respondent answered petitioners' petitions,

she transferred the cases to Appeals.   The Appeals officer met

with petitioners' counsel in an effort to settle these cases.

The Appeals officer reviewed petitioners' documentation for their

claimed deductions and other items and requested additional

substantiation from petitioners in order to determine their

correct tax liability.   Respondent, through her Appeals officer,

made changes to her positions and offered settlements regarding

those changes based on the documentation petitioners furnished at

the Appeals conference; however, the parties could not then reach

a mutually acceptable settlement.   After these cases were

transferred back to District Counsel, respondent's counsel

requested additional documentation through informal discovery.

Upon review of this additional documentation and a conference

between the parties, respondent was able to settle these cases

shortly over 1 year after issuing her notices of deficiency and

within 11 months of answering petitioners' petition.

     Petitioners argue that respondent did not have a reasonable

basis in either fact or law primarily because her revenue agent

"employed poor audit procedures, made substantial erroneous

conclusions of fact and law, made arbitrary adjustments and

concocted corruptions of fact and law."   Petitioners also argue

that respondent's agents did not contact petitioners at various

times during the review of their audit or during the interval

between the issuance of the revised RAR on June 28, 1993, and the
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issuance of the notices of deficiency approximately 1-1/2 years

later.    Petitioners state that respondent unjustly denied them

the opportunity to seek an administrative appeal by not issuing a

second 30-day letter after issuing the revised examination

report.    Petitioners charge that there existed a pattern of

harassment against petitioners by respondent's agents, which

unreasonably increased the asserted deficiencies and made

petitioners' substantiation efforts unduly difficult.

     We are not persuaded by petitioners' arguments.    Based on

our review of the record before us, we find nothing to support

petitioners' claims of overreaching and abusive tactics by

respondent's agents.    To the contrary, our review of the record

indicates that respondent expeditiously conceded several issues

when petitioners provided convincing evidence concerning the

matters in dispute.    Although petitioners attempt in their motion

to articulate the abuse and overreaching of respondent's agents,

such statements are not proof.    Rule 143(b); See Niedringhaus v.

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

Commissioner, 90 T.C. 1248, 1255 (1988); Evans v. Commissioner,

48 T.C. 704, 709 (1967), affd. 413 F.2d 1047 (9th Cir. 1969).

     We hold that respondent's positions had a reasonable basis

in law and fact.    Accordingly, petitioners are not entitled to

administrative and litigation costs under section 7430.

     To reflect the foregoing,
- 13 -

          An appropriate order will

     be issued denying

     petitioners' motion for an

     award of administrative and

     litigation costs, and

     decisions will be entered.
