The opinion
T.C. Memo. 1999-29
UNITED STATES TAX COURT
JOHN BOWDEN, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11148-95. Filed February 1, 1999.
David P. Leeper, for petitioner.
Gerald L. Brantley, for respondent.
MEMORANDUM OPINION
DEAN, Special Trial Judge: This case was assigned to
Special Trial Judge John F. Dean pursuant to sections 7430, 7443A
and Rules 180, 181, and 1821 for the purpose of disposing of
petitioner's Motion for Litigation Costs pursuant to Rules 230
1
All section references, unless otherwise noted, are to the
Internal Revenue Code. All Rule references are to the Tax Court
Rules of Practice and Procedure.
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through 233. Neither party requested a hearing. Rule 232(a).
Accordingly, we rule on petitioner's motion for litigation costs
on the basis of the parties' submissions and the record in this
case. The underlying issues raised in the petition were settled,
and the Court entered a stipulated decision. Upon petitioner's
subsequent filing of the motion, the decision was vacated and set
aside by order. It was decreed in this order that the stipulated
decision document was to be filed as the Second Settlement
Stipulation.
For taxable years ending June 30, 1992 and 1993, respondent
determined deficiencies in John Bowden, Inc.'s Federal income
taxes in the amounts of $8,539, and $5,195, respectively. John
Bowden, Inc., was a Texas corporation with a principal place of
business in El Paso, Texas, at the time the petition was filed.
Background
John Bowden, Inc. (petitioner or corporation) was
incorporated by John Bowden in June 1991 to perform services in
the insurance industry. Prior to its incorporation, Mr. Bowden
operated the business as a sole proprietorship, working under
contract as a district manager for a group of insurance
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companies2 in the El Paso, Texas, area. Pursuant to the
contract, Mr. Bowden recruited and trained insurance agents to
sell insurance exclusively for the insurance companies with which
he had contracted. After incorporation of his business,
Mr. Bowden continued to perform substantially the same services
for the insurance companies that he had performed prior to
incorporation, but he worked as an employee of the corporation.3
Mr. Bowden served as the sole director of the corporation,
and his wife, Karol Bowden, served as secretary.4 The corporate
minutes reflect that B. Kent Straughan was appointed as corporate
accountant and was instructed to handle the tax preparation and
accounting requirements associated with the incorporation.
E.P. "Bud" Kirk was appointed as corporate attorney.
In a transaction to which section 351 is applicable,
Mr. Bowden transferred property to the corporation in 1991
consisting of $10,000 cash, an airplane with a zero basis, a Ford
van with a stated basis of $21,139, a computer system with a
2
The insurance companies are Farmers Insurance Exchange,
Truck Insurance Exchange, Fire Insurance Exchange, Mid-Century
Insurance Co., Farmers Texas County Mutual Insurance Co., and
Farmers New World Life Insurance Co.
3
Because Mr. Bowden no longer operated the business as a
sole proprietorship, the insurance companies renewed their
service contract with the corporation, with Mr. Bowden personally
performing the services.
4
The corporate minutes reflect that Karol Bowden served as
temporary secretary for purposes of the corporate meetings.
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stated basis of $97, office furniture and equipment with a stated
basis of $241, and insurance premium renewals with a stated basis
of $245,000.
In return, the corporation issued 1,000 shares of stock to
Mr. Bowden. The corporation also assumed a $220,468 liability,
evidenced by a note, that Mr. Bowden had incurred to acquire his
ex-wife's community property interest in the sole proprietorship.
Assumption of the debt by the corporation did not relieve
Mr. Bowden of his primary liability on the note.
Upon incorporation, an account payable of $60,009 was
created on the books of the corporation to pay cash to Mr. Bowden
or pay other personal expenses on his behalf in the amounts of
$15,768, $21,540, and $23,951, for calendar years 1991, 1992, and
1993, respectively.5
Respondent determined deficiencies in the Bowdens' Federal
income taxes for 1991, 1992, and 1993. Respondent determined
that in 1991 the Bowdens had recognized $280,477 in net capital
gain upon incorporation of their business. This gain was
calculated by characterizing as boot the $60,009 account payable
5
Although the parties stipulate the yearly amounts paid to
Mr. Bowden, the Court notes that the sum of these three payments
exceeds the $60,009 account payable recorded on the books of the
corporation. It is unclear to what source the additional funds
paid to Mr. Bowden were attributable.
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in cash and the $220,468 note payable assumed by the corporation
for Mr. Bowden's liability to his ex-wife.
Respondent's notice of deficiency to the corporation for FYE
June 30, 1992 and 1993, determined that expenses shown as
management fees should be reclassified as officers' compensation.
Respondent reduced the corporation's deductions for rent,
depreciation, meals and entertaining, insurance, business
promotions, and travel expenses on the basis that they were not
ordinary and necessary business expenses. Respondent also made
corresponding increases in the allowable deductions for salaries
and auto expenses.
The corporation filed a petition with the Court, alleging
error in each of the determinations contained in the notice of
deficiency. Respondent filed an answer denying each allegation
contained in the petition.
In response to a motion, the Court granted the corporation
leave to amend its petition. In the amendment, the corporation
alleged that respondent failed to make the required section
362(a) adjustment, which would increase the basis of assets held
by the corporation by the amount of gain recognized by the
Bowdens upon transfer of their assets to the corporation. The
corporation further alleged that it was entitled to a refund. In
his answer to the amendment, respondent admitted that if the
Bowdens were to recognize a net capital gain by virtue of the
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section 351 transaction, the corporation would be entitled to an
upward basis adjustment in the property received in the
transaction in the same amount as the gain recognized. The
answer to amendment did not, however, specify the assets eligible
for the basis adjustment or the amount of any such adjustment.
The corporation filed a motion for a more definite
statement, requesting that respondent identify the assets as to
which the corporation would receive a section 362(a) adjustment,
in what proportion, and over what period of time that adjustment
would be depreciable. The motion was granted in part, and
respondent was ordered to file a statement indicating
respondent's position as to the appropriate amount and allocation
of the section 362(a) adjustment.
Respondent subsequently filed an amended answer to the
corporation's amendment to petition, responding that the
appropriate amount of the section 362 adjustment was either
$280,477 or the actual amount of net capital gain ultimately
recognized by the Bowdens on the transfer of assets to the
corporation. Respondent also determined that the section 362
basis adjustment should be allocated to Mr. Bowden's rights under
the contract with Farmer's Insurance Group. The Bowdens had
stated the basis of this asset as $245,000 in their 1991 tax
return, but respondent subsequently determined the basis to be
zero.
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This case was later settled, and it was stipulated that the
corporation had made an overpayment in income tax of $4,377 for
taxable year ending June 30, 1992, and had a deficiency in the
amount of $199 for taxable year ending June 30, 1993. The
corporation subsequently filed a motion for an award of
reasonable litigation costs.
Discussion
Taxpayers may be awarded an amount for reasonable litigation
costs if they meet the requirements of section 7430. In order to
qualify for such an award, a party must: (1) Qualify as a
prevailing party; (2) have exhausted available administrative
remedies; (3) not have unreasonably protracted the court
proceeding; and (4) show that the costs claimed are reasonable
litigation costs incurred in connection with the court
proceeding. Sec. 7430(c)(4), (b)(1), (b)(4), (a)(2). The
taxpayers have the burden of establishing that all the foregoing
criteria have been satisfied. See Rule 232(e); Maggie Management
Co. v. Commissioner, 108 T.C. 430 (1997).
Both petitioner and respondent agree that all the
administrative remedies available within the Internal Revenue
Service have been exhausted. There is some dispute, however, as
to the other requirements of section 7430.
Prevailing Party
To be a "prevailing party", a taxpayer must establish:
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(1) The position of the United States was not substantially
justified; (2) the taxpayer substantially prevailed with respect
to either the amount in controversy or the most significant issue
or set of issues presented; and (3) the taxpayer met the net
worth requirements of 28 U.S.C. section 2412(d)(2)(B) (1994) at
the time the petition was filed. Sec. 7430(c)(4).
Respondent concedes that petitioner meets the net worth
requirements and that petitioner substantially prevailed with
respect to the amount in controversy. Therefore, we need only
examine the question of whether the Government's litigation
position was substantially justified. See Swanson v.
Commissioner, 106 T.C. 76, 86 (1996).
Substantially Justified
Whether the Government's position was substantially
justified turns on a finding of reasonableness, based upon all
the facts and circumstances, as well as the legal precedents
relating to the case. Pierce v. Underwood, 487 U.S. 552, 565
(1988). A position is substantially justified if the position is
"justified to a degree that could satisfy a reasonable person."
Id. Determining the reasonableness of the Government's position
and conduct requires considering what the Government knew at the
time. See Rutana v. Commissioner, 88 T.C. 1329, 1334 (1987);
DeVenney v. Commissioner, 85 T.C. 927, 930 (1985).
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In deciding this issue, we must identify the point at which
the United States is first considered to have taken a position,
and then decide whether the position taken was or was not
substantially justified. The position taken by the United
States, for purposes of litigation costs, is the position of the
United States in the judicial proceeding. Sec. 7430(c)(7)(A).
The first opportunity for the United States to take a position in
the judicial proceeding is in the answer filed. See Huffman v.
Commissioner, 978 F.2d 1139, 1148 (9th Cir. 1992), affg. in part,
revg. in part T.C. Memo. 1991-144. Therefore, in deciding
whether the Government's position was substantially justified, we
must review the actions of the IRS District Counsel in answering
the petition and the actions of the IRS Appeals officers who
considered petitioner's case after the answer was filed.
When the answer was filed in this case, respondent denied
that there was error contained in the notice of deficiency.
Respondent denied error even though the notice of deficiency did
not contain a section 362 basis adjustment. Respondent argues
that no basis adjustment was allowed because the Government was
caught in a potential whipsaw situation, and was trying to
prevent the possibility that income could go untaxed. The
Bowdens had filed a petition in their case, alleging that they
should recognize no gain upon transfer of their assets to the
corporation. Respondent contends the corporation was originally
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not allowed a section 362 basis adjustment in order to protect
the revenue should the Bowdens prevail on their issue.
In its motion, however, petitioner does not address whether
respondent's position with respect to the adjustments contained
in the notice of deficiency was substantially justified.
Petitioner argues that because respondent failed to acknowledge
the section 362 basis adjustment until the amended answer to the
amendment to petition was filed, respondent's position was
unreasonable and petitioner is entitled to litigation costs. We
disagree. Petitioner does not explain, nor does the record
suggest, how the section 362 basis adjustment relates to the
deficiency amounts contained in the notice of deficiency. We
therefore find that respondent's position regarding the basis
adjustments to be irrelevant to petitioner's motion.
Even if we were to consider respondent's position with
respect to the section 362 basis adjustments, we have recognized
that the Government may, at times, take alternative or
inconsistent positions with respect to different taxpayers. Rule
31(c); Dixson Intl. Serv. Corp. v. Commissioner, 94 T.C. 708, 717
(1990); Barkley Co. v. Commissioner, 89 T.C. 66, 68 (1987).
There are limits, however, to the propriety of taking
inconsistent positions. If a so-called inconsistent position has
no possible chance of success, it has been held to be
unreasonable. Dixson Intl. Serv. Corp. v. Commissioner, supra.
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Petitioner has not shown that this is a situation where
respondent's position had no possible chance of success at the
time the position was taken. The Bowdens had alleged in their
petition to the Court that they were not liable for any
additional tax. Therefore, respondent's initial failure to state
that the corporation was entitled to a section 362 basis
adjustment was not unreasonable given the possibility that the
Bowdens might prevail in their case. In the end, the Bowdens
conceded gain recognition under section 357. Nevertheless,
respondent's initial failure to compute a section 362 basis
adjustment for the corporation was proper given the unknown
ultimate outcome of the Bowdens' case.
Respondent filed an answer to the amended petition, and an
amended answer to the amended petition. In those pleadings,
respondent agreed that the corporation was entitled to the
corresponding section 362 adjustment should the Bowdens recognize
gain from the section 351 transaction. We find the Government's
position reasonable given the facts and circumstances of this
case.
The Court has previously indicated that it is preferable for
the Government to clearly indicate that alternative positions are
being taken and to state that there is no intention to tax the
same income twice. See Dixson Intl. Serv. Corp. v. Commissioner,
supra at 715; Doggett v. Commissioner, 66 T.C. 101, 104 (1976).
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In some instances, an unexplained alternative and theoretically
inconsistent position could be totally misleading and cause an
unsophisticated taxpayer to spend needless time and effort trying
to comprehend the Government's position. This case, however,
does not present such a problem.
The issue of the Bowdens' gain from the section 351
transaction and the corresponding section 362 adjustments was the
subject of much correspondence and discussion between respondent
and petitioner. The Government's position was also outlined in
the revenue agent's report disclosed to petitioner on
September 5, 1995. The record reflects that the petitioner was
familiar with the issues as well as with the Government's
position on these issues from early on in the proceeding.
Accordingly, we find that petitioner has not established that
respondent's position was not substantially justified.
Because petitioner has not proven that respondent's position
was not substantially justified, we need not decide whether
petitioner's litigation costs are reasonable and whether
petitioner unreasonably protracted the court proceedings.
Petitioner's motion for litigation costs will be denied.
To reflect the foregoing,
An appropriate Order
and Decision will be entered.