Morreale v. Commissioner
T.C. Memo. 2021-90

On July 15, 2021, the Tax Court issued a Memorandum Opinion in the case of Morreale v. Commissioner (T.C. Memo. 2021-90). The primary issue presented in Morreale v. Commissioner was whether the petitioner was entitled for reasonable litigation fees from the IRS.

Background to Morreale v. Commissioner

The petitioner filed a Tax Court petition in November 2017 disputing certain adjustments to his return. The petitioner and the IRS settled in January 2019, with the IRS agreeing to two adjustments and conceding all penalties.  In February 2019, the petitioner filed a motion for reasonable litigation or administrative costs pursuant to IRC § 7430.

When Costs are Reasonable

IRC § 7430(a) authorizes an award for “reasonable administrative costs [and] reasonable litigation costs” to the “prevailing party” in a Tax Court dispute. A party that otherwise qualifies as a “prevailing party” will not be entitled to an award if the IRS can prove that “the position of the United States in the proceeding was substantially justified.” IRC § 7430(c)(4)(B)(i). In applying this standard, the Tax Court recognizes that the IRC § 7430 is a limited waiver of sovereign immunity and therefore is “construed narrowly in favor of the Government.” United States v. Johnson, 920 F.3d 639, 650 (10th Cir. 2019) (citing Ardestani v. INS, 502 U.S. 129, 137 (1991)).

Ordinarily, the Tax Court considers the position taken in an administrative proceeding separately from the position taken by the IRS in his answer in subsequent litigation. See Maggie Mgmt. Co. v. Commissioner, 108 T.C. 430, 442 (1997). In this case, however, the IRS has conceded that the position taken in the administrative proceeding resulting from petitioner’s bankruptcy proceeding is “essentially the same” as the position taken in the IRS’s answer in this proceeding.

If the position of the United States in the administrative proceeding and in its answer was not substantially justified, the petitioner bears the burden of proving the reasonableness of his claimed costs. See Tax Court Rule 232(a); Powers v. Commissioner, 100 T.C. 457, 491 (1993), aff’d in part, rev’d in part and remanded, 43 F.3d 172 (5th Cir. 1995). However, the IRS bears the burden of proof as to whether its position was substantially justified. See IRC § 7430(c)(4)(B)(i).

Substantial Justification

For a position to be “substantially justified” it must have a “reasonable basis both in law and fact.” Pierce v. Underwood, 487 U.S. 552, 565-566 (1988). If the IRS “did not follow applicable published guidance,” then “the position of the United States shall be presumed not to be substantially justified.” IRC § 7430(c)(4)(B)(ii). “Applicable published guidance” means regulations, revenue rulings, revenue procedures, information releases, notices, and announcements, as well as private letter rulings, technical advice memoranda and determination letters issued to the taxpayer. IRC § 7430(c)(4)(B)(iv).

To determine when the United States took a position, the Tax Court applies IRC § 7430(c)(7)(B), which provides that United States takes a “position” at the earlier of: (1) the date a taxpayer receives a notice of decision of the Appeals Office, or (2) the date of a notice of deficiency. As we have elsewhere explained, this provision identifies when the United States takes a position for purposes of IRC § 7430. See, e.g., Rathbun v. Commissioner, 125 T.C. 7, 13 (2005).

To determine whether the United States’ position was substantially justified, the Tax Court must also identify the nature of the position. Ordinarily, this Court applies an item-by-item analysis, whereby “[t]he justification for each of respondent’s positions must be independently determined.” Foothill Ranch Co. P’ship v. Commissioner, 110 T.C. 94, 97 (1998).

After the petitioner filed his motion but before the IRS filed his response, however, the U.S. Court of Appeals for the Tenth Circuit issued its opinion in Johnson, 920 F.3d at 649. While that case arose under different facts, the Tax Court concluded that its holding with regard to the proper analysis of an IRC § 7430 claim is “squarely in point.” Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971). Accordingly, the Tax Court applied the Johnson analysis.

In Johnson, the Court of Appeals addressed the proper scope of inquiry with regard to whether the “position of the United States” was substantially justified under IRC § 7430. In its analysis, the Court of Appeals drew heavily on caselaw interpreting the Equal Access to Justice Act (EAJA), 28 U.S.C. § 2412. The EAJA, using wording similar, though not identical, to that found in IRC § 7430, provides that a court shall award fees and other expenses to a prevailing party in any case brought by or against the United States, unless the court finds that the position of the United States was substantially justified.” 28 U.S.C. § 2412(d)(1)(A).

Given this linguistic similarity, the Court of Appeals looked to caselaw interpreting the meaning of the “position of the United States” under the EAJA to guide its analysis under IRC § 7430. To start, the Court of Appeals relied on the Supreme Court’s statements in Commissioner, INS v. Jean, 496 U.S. 154, 161-162 (1990), that the structure of the EAJA—like other fee-shifting statutes—favors treating a case as an inclusive whole when defining the word “position.”

The Court of Appeals also relied heavily on the analysis in Roanoke River Basin Ass’n v. Hudson (Roanoke), 991 F.2d 132, 139 (4th Cir. 1993), where the U.S. Court of Appeals for the Fourth Circuit first held that the “position of the United States” should be understood as a singular, holistic position rather than multiple itemized contentions. The Court of Appeals in Johnson, 920 F.3d at 649, considered Roanoke’s “in-depth analysis of the issue to be persuasive” and adopted its approach.

The IRS’s Argument and the Petitioner’s “Hyperbole”

The IRS argued that because Johnson “stands for the proposition that substantial justification shouldn’t turn on whether the Government was substantially justified on any one thing, but whether looking at the case as a whole, the Government was substantially justified”, respondent’s entire position was justified. The petitioner, by contrast, contends that “applying the holistic approach of Johnson to this case is simply not appropriate and would create an absurd result.”

Namely, the petitioner contended that because the IRS always has the right under IRC § 7602 to examine tax returns, the Government is always substantially justified from the moment it decides to examine any tax return—and no taxpayer can recover under IRC § 7430. The petitioner further argued that applying Johnson would preclude an award of fees even in cases with egregious misconduct in the examination.

“While [the Tax Court] share[d] some of petitioner’s concerns with regard to the interplay of the Johnson standard and the unique provisions of IRC § 7430, [it] believe that petitioner’s hyperbole is misplaced.” The Tax Court found that a trial court “should focus not on the government’s success or failure [on a particular issue], but on the reasonableness of its position in bringing about or continuing the litigation.” Johnson, 920 F.3d at 650 (quoting Roanoke, 991 F.2d at 139).

While the statutory language of IRC § 7430 does not use the terms “issue” and “position” interchangeably, a trial court may consider the various contentions taken on individual issues as part of its overall analysis of the holistic position of the United States. Id. at 649-50.

This is because, under the Johnson standard, the Tax Court must consider the totality of the circumstances, including the possibility that “a more egregious example of [governmental] misconduct might, even if confined to a narrow but important issue, taint the government’s ‘position’ in the entire case as unreasonable.”[1]

The IRS’s Position

The Tax Court concluded that the IRS took a position when it issued the notice of deficiency in September 2017, which it repeated when it filed its answer. See IRC § 7430(c)(7); see also Fla. Country Clubs, Inc. v. Commissioner, 122 T.C. 73, 86 (2004), aff’d, 404 F.3d 1291 (11th Cir. 2005). Under the Johnson standard, the Tax Court opined that it must consider the position taken by the IRS “holistically, with an eye to all facts and circumstances.” That is to say, the Tax Court must examine the “building blocks of the position of the United States” to determine whether that position was, on the whole, substantially justified.

With regard to the basis dispute, the Appeals Office concluded that petitioner had “provided a basis computation along with prior year workpapers, schedules, and books that was sufficient to substantiate basis.”  Because the notice of determination ignored this conclusion, the IRS’s basis argument “lacked a reasonable basis in fact.” With regard to the method of accounting dispute, the Tax Court could find no reasonable legal or factual basis for the IRS’s determination relating to the proposed change in method of accounting determined in the notice and adopted in the answer. Moreover, the Tax Court concluded that the IRS did not follow applicable published guidance, specifically Treas. Reg. § 1.446-1(c)(2)(i). See IRC § 7430(c)(4)(B)(ii), (iv)(I).

Analysis under the Johnson Standard

Under the Johnson standard, the Tax Court does not look granularly at the basis of each dispute to attempt to identify a saving basis for the IRS. Although it acknowledged that IRC § 7430 represents a limited waiver of sovereign immunity, it must also be a viable path for fee awards in proper circumstances. To identify those circumstances, the Tax Court looks at the overall reasonableness of the IRS’s position in bringing about or continuing the litigation. Johnson, 920 F.3d at 650 (quoting Roanoke, 991 F.2d at 139).

Although conceding a case—even in full—does not, on its own, mean that the position of the United States was not substantially justified, Maggie Mgmt. Co. v. Commissioner, 108 T.C. at 443, this case does not involve a mere concession in the IRS’s answer. Instead, the IRS’s concessions here came after filing his answer and were made because the Appeals Office concluded that the determination reflected in his answer lacked a basis in fact and law—a conclusion with which the Tax Court agreed wholeheartedly.

In the light of all the facts of this examination and litigation, the Tax Court “[could] not say that the position of the United States was justified in the main.” Underwood, 487 U.S. at 565. Rather, these determinations were contrary to applicable guidance and were lacking in a factual basis, and they tainted the Government’s position in the entire case. See Roanoke, 991 F.2d at 139.

Victory to the Petitioner

Ultimately, the Tax Court concluded that the IRS failed to prove that its position was substantially justified under the Johnson standard. Because the IRS has otherwise conceded that petitioner is a prevailing party, we further conclude that petitioner is entitled to an award under IRS § 7430.

Morreale v. Commissioner

(T.C. Memo. 2021-90) Morreale v. Commissioner


[1] Roanoke, 991 F.2d at [*16] 139 (emphasis added); see also EEOC v. Memphis Health Ctr., Inc., 526 F. App’x 607, 614-615 (6th Cir. 2013) (citing Roanoke); Gatimi v. Holder, 606 F.3d 344, 349-350 (7th Cir. 2010) (citing Roanoke); United States v. Jones, 125 F.3d 1418, 1429-1431 (11th Cir. 1997); Hanover Potato Prods., Inc. v. Shalala, 989 F.2d 123, 131 (3d Cir. 1993).

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