                  T.C. Memo. 1998-449



                UNITED STATES TAX COURT



   ROBERT M. AND PAULETTE G. MADDOX, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 20959-96.               Filed December 23, 1998.



     Respondent disallowed substantially all of petitioners’
claimed deductions. The parties settled, with respondent
conceding about 97 percent of the disallowed deductions for
1 year and about 91 percent for the other year, and
conceding that there were no deficiencies for either year.
Respondent’s position when filing the answer in the instant
case was based on respondent’s not yet having received
substantiation for the disallowed deductions.

     Held: On the facts, respondent was primarily
responsible for the substantiation not having been provided
by the time respondent filed the answer, and so respondent’s
position was not “substantially justified.” Sec.
7430(c)(4)(B)(i), I.R.C. 1986. Stipulated amount of
litigation costs awarded.


Daniel W. Schreimann, for petitioners.

James E. Archie, for respondent.
                                - 2 -

                         MEMORANDUM OPINION

     CHABOT, Judge:    This matter is before us on petitioners’

motion for an award of litigation costs1 pursuant to section

74302 and Rule 231.3

     The issue for decision is whether respondent’s position in

the instant case was substantially justified, within the meaning

of section 7430(c)(4)(B)(i).

     Neither side has requested a hearing, and we conclude that a

hearing is not necessary.   Rule 232(a).   Accordingly, we decide

petitioners’ motion on the basis of the parties’ stipulations,

stipulated exhibits, and briefs filed in connection with

petitioners’ motion, and the other documents in the Court’s

record in the instant case.



     1
          Although petitioners refer to “administrative” costs at
a few places in their brief, it is evident from the language in
their motion and from the exhibit describing their counsel’s work
that their motion does not deal with costs paid or incurred
before their counsel began to work on the petition herein. From
the foregoing, we conclude that petitioners’ references to
administrative costs are inadvertent and that our proceedings
relate only to litigation costs.
     2
          Unless indicated otherwise, all section references are
to sections of the Internal Revenue Code of 1986, as in effect
for the years in issue. References to sec. 7430 are to that
section as in effect for proceedings commenced at the time the
petition in the instant case was filed. Because the petition was
filed on Sept. 26, 1996, the amendments made by title VII of the
Taxpayer Bill of Rights 2, Pub. L. 104-168, sec. 701, 110 Stat.
1452, 1463 (1996), effective after July 30, 1996, apply to the
instant case. See Maggie Management Co. v. Commissioner, 108
T.C. 430, 438-441 (1997).
     3
          Unless indicated otherwise, all Rule references are to
the Tax Court Rules of Practice and Procedure.
                               - 3 -

     Respondent determined deficiencies in Federal individual

income tax and additions to tax under section 6662 (accuracy-

related) against petitioners as follows:

                                              Additions to Tax
           Year           Deficiency            Sec. 6662

           1991           $356,117                 $71,223
           1992            470,966                  94,193


                            Background

     When the petition was filed in the instant case, petitioners

Robert M. Maddox (hereinafter sometimes referred to as Robert)

and Paulette G. Maddox (hereinafter sometimes referred to as

Paulette), husband and wife, resided in El Paso, Texas.

Businesses

     Robert is an ophthalmologist with a medical practice in El

Paso, Texas.   In 1991, Robert opened another ophthalmology office

in Juarez, Mexico, which allowed him to perform a type of laser

eye surgery that was not permitted in the United States at that

time.

     Robert had extensive business interests in addition to his

medical practice.   He was the sole shareholder of several S

corporations, some of which related to his medical practice.

Others involved a restaurant, a farm, and real estate interests.

El Paso to Dallas

     Petitioners filed individual income tax returns for 1991 and

1992.   The tax returns were mailed, in accordance with extensions
                                - 4 -

for filing, on October 15, 1992, and October 15, 1993,

respectively, and were received at the Austin, Texas, Service

Center on October 19, 1992, and October 18, 1993, respectively.

     In October 1994, a revenue agent with the IRS office in El

Paso telephoned petitioners and indicated that there would be an

examination of petitioners’ 1991 and 1992 tax returns.

     On November 14, 1994, petitioners’ representative wrote to

the revenue agent, asking that the location of the examination be

transferred to Dallas, Texas.   Petitioners’ representative stated

that his office is in Dallas and that he “has all of the books,

records, and source documents that will be necessary to complete

a 1991 and 1992 examination.”   The revenue agent did not send

correspondence to petitioners identifying specific matters to be

addressed in the examination.

     In connection with the transfer of the examination and

related files to Dallas, the revenue agent asked petitioners to

consent to extending to June 30, 1996, the period of limitations

for assessment of 1991 income tax.      To accomplish this, a Form

872 was executed by petitioners’ representative on December 20,

1994, by petitioners on December 21, 1994, and by respondent on

January 5, 1995.   The period of limitations date for 1992

remained October 15, 1996.

     The IRS administrative files relating to 1991 and 1992 were

transferred from El Paso on January 20, 1995, and received in the

Dallas IRS office on February 10, 1995.      The responsibility for
                                 - 5 -

examining petitioners’ income tax returns was assigned to Dallas

IRS Examination Group 1432 on February 16, 1995.     There remained

16½ months before the limitations period for 1991 would expire.

     In mid-December 1995, a revenue agent in Dallas saw the

administrative files for petitioners’ case, together with those

for 16 other cases, in the bottom of an extra file cabinet

outside the acting manager’s office.     There remained 6½ months

before the limitations period for 1991 would expire.

     Finally, on April 17, 1996, petitioners’ case was assigned

by the acting manager to a revenue agent, Julie Ward, hereinafter

sometimes referred to as Ward.    Ward’s manager instructed her to

secure extensions of the limitations periods and, if she could

not do so, then she was to “write-up and disallow issues and send

to 90-Day.”   There remained 10½ weeks before the limitations

period for 1991 would expire.

The April 23, 1996, Meeting

     On April 18, 1996, Ward telephoned petitioners’

representative, and left a message in order to set up a meeting.

She called again on April 19.    Petitioners’ representative

returned the April 19 telephone call, but Ward was not available.

Ward left another message for petitioners’ representative that

afternoon.

     Ward finally reached petitioners’ representative by

telephone on April 22, and asked for extensions of the

limitations periods.   Petitioners’ representative expressed
                               - 6 -

reluctance, because he had already consented to one extension and

he believed the tax returns were “clean”.    Ward and petitioners’

representative arranged an appointment for the afternoon of April

23, 1996, at petitioners’ representative’s office.   This

telephone call was the first contact by IRS personnel with

petitioners or petitioners’ representative regarding petitioners’

tax returns since the time that the administrative files had been

transferred to Dallas.   During the April 23, 1996, meeting,

petitioners’ representative and Ward conducted the initial

examination and reviewed petitioners’ tax returns.   For 2 hours,

Ward asked petitioners’ representative numerous questions

relating to petitioners’ multiple business interests.

Petitioners’ representative’s responses to Ward’s questions were

as follows:

     Schedule E:   Curie Building, Galveston House

     The Curie Building is an office building owned by Paulette.

It was purchased in 1987 and petitioners are personally liable on

the note obtained to finance the purchase.

     Petitioners also owned a rental house in Galveston, Texas.

Paulette inherited the house and allowed her sister to live

there.

     Petitioners’ S Corporations

     Robert owned 100 percent of four S corporations, as follows:
                               - 7 -

        Eye Pharmacy, Inc.

        This business was established to distribute eye

medicines.    The business was operated out of the Curie

Building.    The last year of operations was 1991, for which

the corporation earned $2,000.         By the time of the April 23,

1996, meeting, there were no assets, the corporation’s

organization costs were written off, and the cash was

remitted to Robert Maddox, M.D., P.A.

        Casa Sabrosa, Inc.

        This corporation operated a Mexican restaurant in the

Curie Building.    It was operated by a restaurant manager

during the business hours of the Curie Building’s tenants.

The restaurant did not pay any rent to petitioners.         The

corporation’s operation of the Mexican restaurant ended in

1991.    As of the April 23, 1996, meeting that space in the

Curie Building was being used as an employee cafeteria for

Robert Maddox, M.D., P.A.

        Maddox Optical, Inc.

        This corporation was still active at the time of the

April 23, 1996, meeting.       Its primary purpose is the

production of eyeware, such as glasses and contact lenses.

The corporation leases 4,000 square feet of space in the

Curie Building.    It earns about $200,000 per year in gross

receipts.
                                 - 8 -

          Robert Maddox, M.D., P.A.

          Robert Maddox, M.D., P.A., operates the El Paso office

     of Robert’s medical practice.       The corporation employed a

     staff of about 75 people and at one time had 2 optometrists

     and 1 medical doctor on staff.       At the time of the April 23,

     1996, meeting, Robert was an employee of the corporation.

     This corporation also operates out of the Curie Building.



     Schedule C

     Robert Maddox, M.D., P.A., was Robert’s Schedule C laser

surgery practice, which had its office in Juarez, Mexico.       The

practice was started in 1990 in order to allow Robert to perform

laser eye surgery using a certain type of machine.       This

procedure was not then approved in the United States.       (It was

first approved in the United States in October 1995.)

     In order to determine whether this type of surgery was

warranted in a specific case, Robert examined patients in his El

Paso office, which was operated by Robert Maddox, M.D., P.A.        If

surgery was warranted, then Robert transported the patient across

the border to Juarez to perform the surgery.       Robert had one

surgical nurse, named Maria, assisting him with the operations.

Petitioners’ representative did not know Maria’s surname.

     While this particular surgical procedure had been approved

in Mexico, the Mexican Government imposed restrictions on the

procedure until December 1991.    Robert incurred legal fees
                                - 9 -

associated with these restrictions.     He was also required to make

payments to a Mexican corporation for the right to conduct this

business in Mexico.    The Mexican corporation, Excimer Laser,

Inc., is 49 percent owned by Robert and 51 percent owned by

Maria.    Robert Maddox, M.D., leased office space from Excimer

Laser, Inc.

     Pueblo Investment Partnership

     Robert was a 29-percent general partner in Pueblo Investment

Group, a TEFRA partnership.    Robert’s basis for this interest was

$150,000.    Pueblo Investment Group was involved in rental real

estate and in oil and gas.

     Farm Rental

     Petitioners had owned about 212 acres4 of land outside El

Paso.    Petitioners received a percentage of the cotton crops

which were raised by a tenant farmer on this land.    The land,

which was bought in 1984 or 1985, comprised three separate

tracts.    A 34-acre tract, which cost $415,000, was foreclosed on

in 1996.    A 35-acre tract, which cost $300,000, was foreclosed on

in 1992.    A 150-acre tract, which cost $1,200,000, was also

foreclosed on in 1992.    Each foreclosure resulted in an even

exchange of the deed for the balance of the debt owed.


     4
          The acreage is taken from Ward’s summary of her April
23, 1996, meeting with petitioners’ representative, a stipulated
exhibit. The sum of the listed areas of the three tracts is 219
acres, not the 212-acre listed total. Neither side has noted,
much less sought to explain, this discrepancy.
                               - 10 -

     Schedule A:   Charitable Contributions

     Petitioners had donated $343,000 worth of computer equipment

to El Paso in 1987.    The equipment was in the Curie Building when

it was bought, in 1987.

     Petitioners’ representative told Ward there was proper

documentation to verify all income and expense items shown on

petitioners’ 1991 and 1992 tax returns.    Ward asked for

petitioners’ consent to extend for 1 year the time to assess the

income tax for 1991.   Petitioners’ representative orally agreed

to a 6-month extension.    Ward said she would prepare the Form 872

to cover the 6-month period and deliver the Form 872 to

petitioners’ representative’s office on April 25, 1996.

Petitioners’ representative told Ward to call before she came to

his office.

     On April 22, 1996, Ward had prepared a Form 4564,

Information Document Request (hereinafter sometimes referred to

as an IDR) for petitioners’ 1991 and 1992 tax returns.      An IDR is

an informal written request for information or documents from a

taxpayer.   It serves as documentation that items have been

requested and provides to the taxpayer a list of items that the

taxpayer is to locate.    It is not uncommon for an agent to ask

for information or documents orally and follow up with a written

request.    Although this IDR had been prepared for the April 23,

1996, meeting, Ward did not leave it with petitioners’

representative, nor did Ward give to him any other writing
                               - 11 -

specifying for examination particular items shown on petitioners’

1991 or 1992 tax returns.

After The Meeting

      On April 25, 1996, Ward prepared the Form 872 and telephoned

petitioners’ representative.   She left a message at his office.

She also left messages on April 30, May 3, May 6, May 10, and May

13.   Petitioners’ representative did not return these calls.

      On June 20, 1996, petitioners’ representative spoke with the

chief of the 90-Day Review Section.     This section chief then

directed Ward to return to petitioners’ representative’s office

regarding the Form 872.

      On June 26, 1996, Ward went to petitioners’ representative’s

office with the Form 872.   Petitioner’s representative refused to

sign the Form 872, saying that he was willing to consent to a

period of limitations extension if Ward limited the scope of her

examination.   Ward refused to agree to a limited-scope extension,

without discussing this with her manager.     The parties did not

extend the limitations period for 1991 or 1992, apart from the

1991 extension that had previously been agreed to in order to get

the IRS to move the audit from El Paso to Dallas.     Petitioners’

representative also stated that he had never received an IDR for

these years.   Ward offered to give to him the IDR that she had

prepared for the April 23, 1996, meeting, but petitioners’

representative refused to accept it.

      The next day, June 27, 1996, respondent issued a notice of
                               - 12 -

deficiency relating to petitioners’ 1991 and 1992 income tax

returns.

     Petitioners filed a timely petition with this Court on

September 26, 1996.5    Respondent filed a timely answer on

November 21, 1996.

     After respondent filed the answer, an Appeals officer and a

revenue agent reviewed the substantiation documentation that

petitioners’ representative provided relating to the notice of

deficiency adjustments.    Petitioners’ representative’s first

meeting with the Appeals Officer was on January 23, 1997.     The

adjustments were ultimately settled as shown in table 1 for 1991,

and table 2 for 1992.




     5
          The postmark date is Sept. 24, 1996, the 89th day after
the notice of deficiency was issued. See sec. 7502.
                                             - 13 -

                                         Table 1    (1991)
                                                              Change To
                            Claimed On        Notice Def.     Adjustment      Net Stipulated
Item                        Tax Return        Adjustment     Per Settlement      Adjustment

Sched. C
Depreciation                 $11,676           $11,676        ($41,233)           ($29,557)
Interest                         646               646            (646)              -0-
Legal, other professional     27,422            27,422           -0-                27,422
Tax                           70,006            70,006           -0-                70,006
Other deductions                 461              -0-            -0-                 -0-

Sched. E
Depreciation                 373,772           373,772        (373,772)             -0-
Interest                     569,840           569,840        (569,840)             -0-
Casa Sabrosa                   7,971             7,971          (3,533)             4,438
Maddox, M.D., P.A.            56,248            56,248         (56,248)             -0-
Maddox Optical                15,249            15,249         (15,249)             -0-
Farm rental                   24,423            24,423         (24,423)             -0-
Other deductions             379,766              -0-            -0-                -0-

Sched. A
Contributions                 20,575               20,575      (55,844)           (35,269)
Real estate tax               11,141
Home mtg. int.                49,241
Limitation1                    -0-                 32,952      (32,550)               402

Exemptions1                    8,600                8,600       (8,600)             -0-

New issues
Loan amortization              -0-                   -0-           (68)               (68)

Other Loss                     1,100                -0-          -0-                -0-

  Totals                   1,628,137         1,219,380       (1,182,006)           37,374
____________
1
   Computational adjustments.
                                             - 14 -

                                         Table 2    (1992)
                                                               Change To
                            Claimed On        Notice Def.      Adjustment      Net Stipulated
Item                        Tax Return        Adjustment      Per Settlement      Adjustment

Sale of business            $203,973           $203,973        ($203,973)             -0-

Sched. C
Depreciation                   92,353              92,353        (82,611)          $9,742
Interest                       32,789              32,789        (32,789)            -0-
Legal, other professional      40,900              40,900        (40,900)            -0-
Mexican rights                 24,500              24,500        (24,500)            -0-
Other deductions               25,503                -0-           -0-               -0-

Sched. E
Depreciation                  353,714              353,714      (353,714)            -0-
Interest                      546,244              546,244      (546,244)            -0-
Maddox, M.D., P.A.             32,622               32,622       (32,622)            -0-
Maddox building rental        224,097              224,097      (134,453)          89,644
Farm rental                   613,781              613,781      (524,364)          89,417
Other deductions              144,094                 -0-          -0-               -0-

Sched. A
Real estate tax                6,998
Home mtg. int.                47,442
Investment int.                  312
Limitation1                     -0-                 43,536       (43,536)            -0-

Exemptions1                    9,200                 9,200        (9,200)            -0-
½ S.E. tax deduction1           -0-                 (2,462)        2,462             -0-

New issues
Gross receipts                 -0-                 -0-             3,440            3,440
Loan amortization              -0-                 -0-              (270)            (270)
 Totals                   2,398,522           2,215,247       (2,023,274)         191,973
______________
  1
    Computational adjustments.
                                - 15 -

     The deductions that petitioners claimed on their tax returns

exceeded the income they reported thereon by such large amounts

that, even after the parties’ agreements as to net adjustments

for 1991 ($37,374) and 1992 ($191,973), petitioners do not have

deficiencies for either year.

     Petitioners’ reasonable litigation costs in the instant

case, including their costs of litigating their motion for award

of litigation costs, are $15,000.

               _____________________________________

     Petitioners have exhausted the administrative remedies

available to them.   Petitioners have not unreasonably protracted

the proceeding in this Court.    Petitioners have substantially

prevailed with respect to the amount in controversy.    Petitioners

have satisfied the applicable net worth limitation.

     The position of respondent in the instant proceeding was not

substantially justified.

                            Discussion

     The Congress has provided for the awarding of litigation

costs to taxpayers in certain circumstances.    Under section

7430,6 a taxpayer who satisfies a series of requirements is


     6
         Sec. 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 penally under this title [the
     Internal Revenue Code of 1986], the prevailing party may be
     awarded a judgment or a settlement for--
                                                   (continued...)
                          - 16 -

6
 (...continued)
          (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.--

          (1) Requirement that administrative remedies be
     exhausted.--A judgment for reasonable litigation costs
     shall not be awarded under subsection (a) in any court
     proceeding unless the court determines that the
     prevailing party has exhausted the administrative
     remedies available to such party within the Internal
     Revenue Service. Any failure to agree to an extension
     of the time for the assessment of any tax shall not be
     taken into account for purposes of determining whether
     the prevailing party meets the requirements of the
     preceding sentence.

            *    *    *     *      *   *   *

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

            *    *    *     *      *   *   *

          (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

            *    *    *     *      *   *   *

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

                                               (continued...)
                            - 17 -




6
 (...continued)
                       (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--

                       (i) in the case where the final
                  determination with respect to the tax,
                  interest, or penalty is made at the
                  administrative level, by the Internal Revenue
                  Service, or

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

          (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 and the
     United States Claims Court).

          (7) Position of 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

                                                 (continued...)
                                - 18 -

entitled to recover reasonable litigation costs. These

requirements are in the conjunctive; i.e., a taxpayer must

overcome each of these hurdles in order to succeed as to

litigation costs.    Minahan v. Commissioner, 88 T.C. 492, 497

(1987).   Respondent concedes that petitioners have satisfied all

of the requirements except for the one established by section

7430(c)(4)(B)(i), relating to whether the position of the United

States was substantially justified.7     As to this requirement, the

statute provides, in effect, that respondent has the burden of

proof.    See, e.g., Maggie Management Co. v. Commissioner, 108

T.C. 430, 437-441 (1997).

     Respondent contends that, as of the time respondent filed

the answer, (1) it was reasonable for respondent to require

petitioners to substantiate their claimed deductions, (2)

petitioners had not yet provided this substantiation, and (3)

thus it was reasonable at that time for respondent to take the

position that petitioners were not entitled to their claimed

deductions.   Respondent contends--

     At the time of the Answer, respondent’s administrative file
     reflected that respondent’s Agent [Ward] was met with a set
     of circumstances which required prompt action and that she
     found herself confronted with an uncooperative
     representative for petitioners.3   * * *


     6
      (...continued)
                            (ii) the date of the notice of
                       deficiency.
     7
          To avoid disputes about minutiae and the potential of
ongoing costs in this Court, the parties have stipulated that if
we hold that petitioners are entitled to an award of litigation
costs, then the amount to be awarded, “exclusive of any
litigation costs that may be incurred with respect to an appeal
of this case and thereafter,” is $15,000.
                               - 19 -


                 *    *    *       *    *   *   *

          As a legal matter, the petitioners were required to
     substantiate the deductions claimed on their returns. As a
     factual matter, the information available to respondent at
     the time of Answer was that, although the representative
     prepared petitioners’ returns and was in possession of the
     records which he used to prepare the returns, the
     representative failed to communicate with the Agent in order
     for those records to be inspected.5 Respondent submits
     that, under these circumstances, it was reasonable for
     respondent to answer the case and require petitioners to
     submit their substantiation for review before respondent
     conceded the adjustments.

                 *    *    *       *    *   *   *

     ______________
          3
             Moreover, the file reflected that, considering the
          circumstances, the Agent had not been unreasonable in
          exploring the possibility of extending the statutes of
          limitations.

                 *    *    *       *    *   *   *
          5
             Respondent does not argue that it was unreasonable
          of petitioners’ representative to decline to extend the
          statute of limitations. Rather, it is respondent’s
          position that the substantiation could have been
          provided beginning April 23, 1996, allowing
          consideration prior to the issuance of the statutory
          notice. * * *

Petitioners maintain as follows:

     1.   Respondents [sic] denial of substantially all of
     Petitioners’ deductions on their 1991 and 1992 individual
     income tax returns was not substantially justified because
     Respondent did not have a basis in both fact and law for the
     disallowance at the time Respondent issued the notice of
     deficiency or during the litigation of this case.

     2.   Petitioners are entitled to an award for administrative
     and litigation costs [see supra note 1] under I.R.C. Section
     7430 since Respondent’s position was not substantially
     justified either when Respondent issued the notice of
     deficiency or during the litigation of this case.

                 *    *    *       *    *   *   *

     Respondent’s position did not have a reasonable basis in
     both fact and law because Respondent had no information
                               - 20 -

     about the case and had made no attempt to obtain information
     about the case prior to adopting the position at issue.
     Respondent failed to diligently investigate this case.

     We agree with petitioners’ conclusion.

     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 from that point forward was or was

not substantially justified.     Maggie Management Co. v.

Commissioner, 108 T.C. at 442.    The position of the United States

is the position taken by respondent in this proceeding.

  Sec. 7430 (c)(7)(A).   Respondent’s position is that which is

set forth in the answer filed with the Court on November 21,

1996.   Maggie Management Co. v. Commissioner, 108 T.C. 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); Nalle v. Commissioner, 55 F.3d 189, 191 (5th Cir.

1995), affg. 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 the position taken in the answer, as well as on any

legal precedents related to the case.     Nalle v. Commissioner, 55

F.3d at 191-192; Coastal Petroleum Refiners v. Commissioner, 94

T.C. 685, 688 (1990).
                                - 21 -

     The fact that the Commissioner eventually loses or concedes

a case does not by itself establish that the position the

Commissioner took 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).      It is only 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 it took the position in the litigation.      Nalle

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

Commissioner, 94 T.C. at 689.

     The instant case does not present questions as to validity

of Treasury regulations or disputed interpretations of the

statutes, as did, e.g., Nalle v. Commissioner, supra, and Minahan

v. Commissioner, 88 T.C. 492 (1987).      Rather, the instant case is

based on availability of factual substantiation of claimed

deductions.   As of November 21, 1996, the date the answer was

filed, respondent knew (1) the information that petitioners’

representative had given to Ward at the April 23, 1996, meeting,

(2) petitioners’ representative claimed at this meeting that

there was proper documentation to verify all the income and

expense items shown on petitioners’ tax returns for the years in

issue, and (3) petitioners’ representative had claimed from the
                                - 22 -

start that he had in his possession “all of the books, records,

and source documents that will be necessary to complete a 1991

and 1992 examination.”    However, as of November 21, 1996,

petitioners’ representative had not shown any of this

documentation to respondent.

     Both sides agree that respondent’s position is to be

evaluated in the context of what led to the formulation of that

position.    See Lennox v. Commissioner, 998 F.2d 244, 247-248 (5th

Cir. 1993), revg. T.C. Memo. 1992-382; Powers v. Commissioner,

100 T.C. 457, 473-474 (1993), affd. in part and revd. in part on

other issues 43 F.3d 172 (5th Cir. 1995); see also Coastal

Petroleum Refiners v. Commissioner, 94 T.C. at 687; Golsen v.

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

1971).

     In analyzing the situation on November 21, 1996, both sides

focus on the events preceding the issuance of the notice of

deficiency.     It may be helpful to briefly summarize the events.

In October 1994, about 2 years after petitioners filed their 1991

tax return and about 1 year after petitioners filed their 1992

tax return, respondent notified petitioners that both tax returns

would be examined.     The next month, petitioners’ representative

asked respondent to change the place of audit from El Paso to

Dallas.     Respondent thereupon asked petitioners to extend the

1991 tax return period of limitations to June 30, 1996.

Petitioners did so in late December 1994, respondent signed the

extension on January 5, 1995, and respondent thereupon
                              - 23 -

transferred the administrative files to Dallas.    The

administrative files were received by the Dallas IRS office on

February 10, 1995--3 weeks after they were sent by the El Paso

IRS office.   At this point, 16½ months remained before the

expiration of the 1991 tax return limitations period.

     About 10 months later, the administrative files were noticed

in the bottom of a file cabinet outside the office of the acting

manager of the examination group to which the matter had been

sent.   Four months later the acting manager assigned the case to

Ward.   At this point, less than 2½ months remained before the

expiration of the 1991 tax return limitations period.    Ward moved

relatively promptly.   Six days later she and petitioners’

representative met to discuss the case.   For 2 hours petitioners’

representative answered Ward’s questions.    Ward asked for a 1-

year extension of the limitations periods.    Petitioners’

representative and Ward orally agreed to a 6-month extension.

Ward had prepared an IDR, and had taken it to the April 23, 1996,

meeting, but did not give the IDR to petitioners’ representative.

Nor did Ward give to petitioners’ representative at this meeting

any other writing specifying for examination particular items

shown on the 1991 or 1992 tax returns.    For the next 3 weeks Ward

telephoned petitioners’ representative’s office, but the calls

were not returned.   Finally, on June 26, 1996, Ward went to

petitioners’ representative’s office, but he said he would agree

to only a restricted extension.   The next day, a notice of

deficiency was issued.
                              - 24 -

     When the case had been assigned to Ward, her manager

instructed her to secure extensions of the limitations periods

and, if she could not do so, then she was to “write-up and

disallow issues and send to 90-Day.”

     In the notice of deficiency respondent disallowed about 75

percent of petitioners’ claimed 1991 deductions, and then settled

by conceding about 97 percent of the disallowance.   Supra table

1.

     In the notice of deficiency respondent disallowed about 92

percent of petitioners’ claimed 1992 deductions, and then settled

by conceding about 91 percent of the disallowance.   Supra table

2.

     In the footnotes in the quoted excerpts from respondent’s

brief, supra, respondent recognizes the concerns about the

statute of limitations that led to our Court-reviewed opinion in

Minahan v. Commissioner, 88 T.C. at 501-508 (1987), and to the

congressional determination to embody those concerns in the last

sentence of section 7430(b)(1).   Yet, the record makes it plain

that Ward was instructed to get an extension of the limitations

period or to prepare a report disallowing deductions, leading to

a notice of deficiency.   That is exactly what Ward did.    Even

though petitioners’ representative had claimed to have the

substantiating documentation, Ward did not ask to see it.     Ward

prepared an IDR, but did not give the IDR to petitioners’

representative until the day before respondent issued the notice

of deficiency, and then only when prompted by petitioners’
                                - 25 -

representative.    Respondent’s counsel did not have anything

useful to work with when filing the answer herein.     But,

collectively, respondent’s employees were unreasonable in

creating the situation that led to respondent’s counsel not

having the substantiation when preparing the answer.     Thus,

respondent’s counsel may have been reasonable, but respondent was

not.

       Petitioners are not blameless.    Petitioners’ representative

could have asked for an IDR or other listing of documents that

respondent needed, but apparently failed to do so.     He should

have returned Ward’s telephone calls--but the only indication in

the record as to the purpose of these telephone calls is that

respondent wanted a limitations extension and not that respondent

wanted substantiation materials.

       Petitioners’ case is not as strong as that of the taxpayers

in Powers v. Commissioner, supra.

       The issue in Powers was whether the Commissioner’s position

was substantially justified where it was not based on any factual

information about the taxpayer and where the Commissioner had not

attempted to obtain information about the case before adopting

the position.     Powers v. Commissioner, 100 T.C. at 478.

Specifically, this Court noted that the Commissioner’s position

lacked a reasonable basis in fact and law because:     (1) The

Commissioner made no effort to contact the taxpayer during the 3

years allowed by section 6501 to assess tax or the 3 additional

years for which the taxpayer agreed to extend the period to
                              - 26 -

assess tax by signing Forms 872-A; (2) before asking the taxpayer

to consent to extending the limitations period, the Commissioner

had already decided to let the statute of limitations bar

assessment of tax against the taxpayer if the taxpayer did not

consent; (3) the Commissioner had also decided not to contact the

taxpayer or examine the taxpayer’s books and records; and (4) the

Commissioner’s counsel had prior familiarity with the taxpayer’s

tax returns for the years at issue which should have led him to

doubt that Commissioner’s position would prevail.   Powers v.

Commissioner, 100 T.C. at 473-474.

     Powers is distinguishable from the instant case because here

respondent did contact petitioners and attempt to obtain

information from them about the case.

     The instant case comes close to being a borderline

situation.   Respondent could and should have served the IDR or

otherwise started the process of requesting substantiation at the

April 23, 1996, meeting between Ward and petitioners’

representative.   Instead, Ward withheld the already-prepared IDR

and did not otherwise ask for any substantiation at this meeting.

Although the matter is not free from doubt, we conclude that it

is more likely than not that respondent’s fixation with obtaining

the second extension, after having frittered away the bulk of the

extension that petitioners already had granted, was the primary

cause of the position respondent took in the answer.    At the time

of the answer, respondent did not have the substantiation because

respondent had decided not to ask for the substantiation.   Thus,
                             - 27 -

respondent created the very problem that respondent seeks to use

as an excuse.

     We conclude, and we have found, that respondent’s position

in the instant proceeding was not substantially justified.

     To reflect the foregoing,

                                             An appropriate order

                                        will be issued, and

                                        decision will be entered

                                        for petitioners.
