The opinion
T.C. Memo. 2012-74
UNITED STATES TAX COURT
MARITZA FURIATTI NEWMAN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
ROBERT MECK COMFORT AND OSCARLINA CAMPOS COMFORT,
Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 25028-09, 1124-10. Filed March 19, 2012.
Ps were foreign citizens who worked in the United States at foreign
embassies whose countries had not been certified by the U.S. State
Department under I.R.C. sec. 893(b). Claiming tax exemption for those
wages pursuant to I.R.C. sec. 893(a), Ps did not report their embassy wages
as income. R issued notices of deficiency including the embassy wages as
income, and Ps filed petitions. Before trial of these cases, this Court issued
its Opinion in Abdel-Fattah v. Commissioner, 134 T.C. 190 (2010), holding
against the IRS’s interpretation of I.R.C. sec. 893(b). As to Ps, the IRS later
conceded the I.R.C. sec. 893(b) issue and eventually conceded their cases
altogether. Ps moved for administrative and litigation costs under I.R.C.
sec. 7430.
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Held: Notwithstanding our Opinion in Abdel-Fattah, R’s position in
these cases, though incorrect, was “substantially justified” under I.R.C.
sec. 7430(c)(4)(B)(i), so that Ps may not recover costs.
A. Duane Webber and Kathleen A. Agbayani, for petitioners.
Karen Lynne Baker and William J. Gregg, for respondent.
MEMORANDUM OPINION
GUSTAFSON, Judge: These cases are now before the Court on motions for
costs filed pursuant to Rule 231 and section 7430.1 The procedural predicate for
those motions is as follows: On the dates given in the table below, respondent, the
Internal Revenue Service (“IRS”), issued a notice of deficiency (“NOD”) to Maritza
Furiatti Newman and an NOD to Robert Meck Comfort and Oscarlina Campos
Comfort; petitioners filed petitions in this Court; the IRS filed its answers; after the
cases were calendared for trial, but before trial, the parties filed
1
Unless otherwise indicated, all Rule references are to the Tax Court Rules of
Practice and Procedure, and all section references are to sections of the Internal
Revenue Code of 1986 (codified in 26 U.S.C., and referred to herein as “I.R.C.” or
“the Code”), as amended, in effect for the years at issue.
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stipulations of settled issues; and petitioners filed their motions for costs. The dates
of these actions were as follows:
Newman Comfort
Action No. 25028-09 No. 1124-10
NOD Aug. 6, 2009 Oct. 20, 2009
Petition Oct. 20, 2009 Jan. 13, 2010
Answer Dec. 16, 2009 Mar. 1, 2010
Stipulation of
settled issues Dec. 14, 2010 Nov. 23, 2010
Motion for costs Jan. 28, 2011 Jan. 31, 2011
The issue for decision is whether the IRS’s position in these cases was
“substantially justified” for purposes of section 7430(c)(4)(B)(i). We hold in favor
of the IRS.
Background
Petitioners’ employment and tax reporting
Throughout the years at issue (i.e., 2002 through 2007 for Ms. Newman and
2003 through 2007 for the Comforts), Mrs. Comfort and Ms. Newman were
Brazilian citizens and were employed at the Brazilian Aeronautical Commission (the
“Commission”), which was a part of the Brazilian Embassy. Both Mrs. Comfort
and Ms. Newman lived in the United States pursuant to diplomatic A-2 immigrant
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visas that were renewed every two years on the basis of their continued employment
at the Commission. They both worked as bilingual technical assistants at the
Commission under annual renewable employment contracts.
For the years at issue petitioners did not report the wages paid by the
Commission (“Commission wages”) on their Federal income tax returns, instead
taking the position that the Commission wages were exempt from tax under section
893(a) and, therefore, that petitioners had no income tax liabilities associated with
those wages.
The IRS’s initiative concerning employees of foreign embassies
In 2006 the IRS conducted an initiative in connection with the employees of
foreign embassies, including the Embassy of Brazil. (Also included were employees
of the Embassy of the United Arab Emirates. See Abdel-Fattah v. Commissioner,
134 T.C. 190 (2010).) The IRS investigated several issues, including the exclusion
of embassy wages pursuant to section 893(a). Section 893(b) requires the U.S.
Secretary of State to certify to the Secretary of the Treasury the names of the foreign
countries that grant to employees of the U.S. Government an exemption that is
equivalent to the exemption under section 893(a), and the IRS took the position that
this certification was a prerequisite for exemption under section 893(a).
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Engagement of counsel
In July 2008 petitioners’ counsel agreed to represent the Commission’s A-2
visa holders with respect to the section 893 income tax exemption issues that had
begun to arise for the Commission’s employees. Since the Commission and
petitioners could not afford to pay counsel’s customary fee for this work, counsel
agreed to represent petitioners and other A-2 visa holders during the administrative
phase for a limited fee (to be paid by the Commission) and thereafter on a pro bono
basis.
Administrative proceedings
The IRS issued to Ms. Newman (on June 30, 2008) and to the Comforts (on
December 2, 2008) notices of proposed adjustment for their taxable years at issue.
The proposed adjustments included petitioners’ Commission wages as taxable
income because the IRS’s position at the time was that the Commission wages did
not qualify for exemption under section 893(a).
In response to the notices of proposed adjustment, petitioners’ counsel
submitted to the IRS Office of Appeals protests to the notices of proposed
adjustment. The protests argued that petitioners’ Commission wages were exempt
under section 893(a) because, they contended, section 893(a) stands alone, and
petitioners’ situations satisfied all of the conditions in section 893(a).
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On February 27, 2009, in accordance with section 893(b), the U.S.
Department of State certified to the Secretary of Treasury that Brazil does not tax
the wages, fees, or salaries of non-Brazilian employees of the U.S. Mission to Brazil
and that such employees perform services of a character similar to those performed
by employees of the Embassy and Consulates of Brazil in the United States. The
IRS maintained, however, that the Secretary of State’s certification applied only
prospectively, i.e., from the date of the certification, and therefore the certification
was not effective for petitioners’ tax years at issue.
The IRS, in August 2009 (for Ms. Newman) and October 2009 (for the
Comforts), brought an end to petitioners’ administrative proceedings by issuing
notices of deficiency to petitioners for the taxable years at issue. In the notices of
deficiency the IRS determined that since Ms. Newman and Mrs. Comfort were
residents of the United States, their personal service wages from the Brazilian
Embassy (i.e., the Commission wages) were taxable by the United States.
Accordingly, the IRS determined that their Commission wages were taxable by the
United States and that petitioners had resulting deficiencies.2
2
The IRS determined in the notices of deficiency that Ms. Newman owed a
balance of $40,039 in tax, $9,009 in sec. 6651(a)(1) additions to tax, and at least
$4,978 in sec. 6651(a)(2) additions to tax, and that the Comforts owed a balance of
$81,060 in tax and $16,212 in sec. 6662(a)(2) penalties.
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Commencement of litigation
Petitioners filed timely petitions for redetermination--Ms. Newman on
October 20, 2009, and the Comforts on January 13, 2010--asserting that their
Commission wages were exempt from tax. Petitioners resided in Maryland when
they filed their petitions. Petitioners were self-represented when they filed their
petitions, because counsel had evidently withdrawn from the representation by that
time.
The IRS answered Ms. Newman’s petition on December 16, 2009, and the
Comforts’ petition on March 1, 2010. In its answers the IRS continued to deny that
the Commission wages were exempt from tax. The Court set Ms. Newman’s case
for trial to begin in Washington, D.C., during the week of June 21, 2010, but on
June 9, 2010, the Court granted the IRS’s motion to continue generally Ms.
Newman’s case. The Court set the Comforts’ case for trial during the Court’s trial
session beginning on November 29, 2010, in Washington, D.C. No trial ever
occurred in either of the cases.
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Proceedings in Abdel-Fattah
As we have noted, the IRS had raised the section 893 exemption issue with
employees of multiple embassies. The issue was before this Court in a case brought
by an employee of an embassy of the United Arab Emirates--Abdel-Fattah v.
Commissioner, 134 T.C. 190 (2010)--in which the parties cross-moved for summary
judgment. (The taxpayer’s counsel in Abdel-Fattah was not the same counsel who
represents petitioners in these cases.) We held oral argument on the cross-motions
in Abdel-Fattah on March 18, 2010; and in that argument the Court did not suggest
to the IRS that its position regarding section 893 was unreasonable. On the
contrary, we said to the taxpayer’s counsel:
[T]he support for saying that [section 893(b) is] a condition * * * is that it
follows on immediately, which is not nothing, and addresses the same subject
matter as the first part, the conditions, two of the conditions anyway, and says
that those things shall be certified by the Secretary * * *. [I]f we want to do a
plain meaning analysis we have to make sure that we give meaning to all of
the words and all the sentences and all the subsections, but one criticism of
[petitioner’s] position would be that it reads [subsection (b)] almost out of the
statute. [Tr. at 16-17.]
Nonetheless, the IRS’s position did not prevail. On April 27, 2010, this
Court issued an Opinion in Abdel-Fattah v. Commissioner, 134 T.C. 190, holding
that income of an employee working for a foreign embassy in the United States is
exempt from U.S. tax if the requirements of section 893(a) are satisfied, and that
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certification from the Secretary of State under section 893(b) is not a prerequisite
for exemption under section 893(a).
The decision in Abdel-Fattah became final on October 11, 2010, when the
IRS did not file a notice of appeal.3
Re-entry of counsel
On December 1, 2009, Ms. Newman re-engaged as counsel the same lawyers
who had assisted her in her administrative proceedings but had not filed her petition
in this litigation. On April 30, 2010, three days after the issuance of the Abdel-
Fattah Opinion, petitioners’ counsel filed their entry of appearance in Newman. On
August 26, 2010, the IRS informed petitioners’ counsel that it intended to concede
in Newman.
Less than a month later, on September 20, 2010, Mr. and Mrs. Comfort re-
engaged as counsel those same lawyers. Counsel filed their entry of appearance in
Comfort three days later on September 23, 2010.
The record does not show the reason for petitioners’ counsel’s exit from and
re-entry into these pro bono cases.
3
Although the Opinion in Abdel-Fattah v. Commissioner, 134 T.C. 190
(2010), was issued on April 27, 2010, it was necessary for the parties to make
computations under Rule 155. The Court did not enter its decision until July 12,
2010.
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IRS concessions
Consistent with a later-announced action on decision (“AOD”) discussed
below, IRS counsel in the present cases began investigating whether petitioners met
the requirements of section 893(a). The IRS requested documents in both Newman
(in March 2010) and Comfort (in September 2010).
On July 9, 2010, counsel for the parties met to discuss a stipulation of facts in
Newman, at which time petitioners’ counsel gave to the IRS information that was
relevant to the disputed issues in Newman. As is noted above, on August 26, 2010,
the IRS’s counsel advised petitioners’ counsel that the IRS was conceding the
Newman case.
Similarly, petitioners’ counsel gave to the IRS information that was relevant
to the disputed issues in Comfort on October 28, 2010. Four days later, on
November 1, the IRS’s counsel informed the Comforts that the IRS intended to
concede its case in Comfort.
On November 22, 2010, the Chief Counsel of the IRS published an AOD
with respect to Abdel-Fattah, advising that “the Service will no longer take the
position that the certification required by the Secretary of State in I.R.C. § 893(b)
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is a prerequisite for the tax exemption provided for in I.R.C. § 893(a).”4 Action on
Decision 2010-04 (Nov. 22, 2010).
The next day--November 23, 2010--the parties in Comfort filed a stipulation
of settled issues, and the parties in Newman filed such a stipulation on
December 14, 2010.
Motions for costs
In late January 2011, petitioners filed motions for awards of reasonable
litigation and administrative costs. The motions request costs for the services their
counsel performed during the administrative and litigation proceedings in their
respective cases.
Petitioners argue that they are entitled to awards of costs under section 7430
because they were prevailing parties and the IRS lacked substantial justification to
4
The AOD also stated:
However, the employee has the burden of proof to establish the
enumerated conditions of I.R.C. § 893(a) are met. In disposing of
cases where the State Department has issued an I.R.C. § 893(b)
certification, the Service will apply the certification to all taxable years
for which the facts and law are the same as those upon which the
certification was based. In cases where the State Department has not
issued an I.R.C. § 893(b) certification, the Service will continue to
challenge a non-U.S.-citizen embassy employee’s claim of exemption
if the employee fails to establish to the Service that the conditions of
I.R.C. § 893(a)(2) and (3) are met as to that employee. [Action on
Decision 2010-04 (Nov. 22, 2010).]
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deviate from the plain language of section 893. Petitioners rely on our Opinion in
Abdel-Fattah v. Commissioner, 134 T.C. 190 (2010), to support their contention. In
addition petitioners cite the fact that the IRS did not appeal the decision in Abdel-
Fattah and that the IRS eventually conceded its position in petitioners’ cases as well
as several other similar cases.
The IRS responds by arguing first that petitioners did not incur any costs
associated with their proceedings and, therefore, are not entitled to an award under
section 7430. Alternatively, the IRS argues that petitioners were not prevailing
parties as required by section 7430 because the IRS’s position that section 893(b)
was a prerequisite for exemption under section 893(a)--although ultimately held
incorrect--was substantially justified.
Discussion
I. Operative legal principles
A. Section 7430 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, the “prevailing party” may be awarded reasonable administrative and
litigation costs incurred in connection with the proceeding. Sec. 7430(a). Costs
incurred include fees paid or incurred for the services of an attorney in connection
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with the proceeding. See sec. 7430(c)(1)(B)(iii); 26 C.F.R. sec. 301.7430-
4(b)(1)(iv), Proced. & Admin. Regs. The Court may award reasonable attorney’s
fees for pro bono legal services, even though a taxpayer does not “incur” those fees.
Sec. 7430(c)(3)(B).
To recover incurred costs, the taxpayer: (1) must be the “prevailing party”,
sec. 7430(a); (2) must have exhausted administrative remedies, sec. 7430(b)(1); and
(3) must not have protracted the proceedings unreasonably, sec. 7430(b)(3). To
qualify as a “prevailing party”, the taxpayer: (1) must substantially prevail with
respect to the amount in controversy or the most significant issue or set of issues
presented, sec. 7430(c)(4)(A)(i); and (2) must meet the timing and net worth
requirements of the first sentence of 28 U.S.C. section 2412(d)(1)(B), incorporated
by reference in section 7430(c)(4)(A)(ii).
Most notably however, a taxpayer will nevertheless fail to qualify as the
“prevailing party” if the IRS can establish that its position in the proceedings,
though unsuccessful, was “substantially justified”. Sec. 7430(c)(4)(B)(i). By
denying costs where the IRS’s unsuccessful position was“substantially justified”,
section 7430 resembles 28U.S.C. section2412(d)(1)(A)5 and distinguishes itself
5
The Equal Access to Justice Act (“EAJA”) provides for awards of fees and
costs against the United States, in cases other than tax cases covered by
(continued...)
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from some other fee-shifting statutes, in comparison with which section7430 is not
at all generous. By contrast, Rule54(d)(1) of the Federal Rules of Civil Procedure
as a general rule allows costs other than attorney’s fees to the prevailing party as a
matter of course.6 As to awards of attorney’s fees, section 7430 does not, like the
Fair Labor Standards Act, provide that “[t]he court in such action shall, in addition
to any judgment awarded to the plaintiff or plaintiffs, allow a reasonable attorney’s
fee to be paid by the defendant, and costs of the action”, 29 U.S.C. sec. 216(b)
(emphasis added); nor does section 7430, like the Employee Retirement Income
Security Act (“ERISA”), provide that “the court in its discretion may allow a
reasonable attorney’s fee and costs of action to either party”), 29 U.S.C.
5
(...continued)
section 7430. See 28 U.S.C. sec. 2412(e) (2006) (“The provisions of this section
shall not apply to any costs, fees, and other expenses in connection with any
proceeding to which section 7430 of the Internal Revenue Code of 1986 applies”).
Like section 7430, the EAJA denies attorney’s fees if “the court finds that the
position of the United States was substantially justified”. 28 U.S.C.
sec. 2412(d)(1)(A).
6
See United States ex rel. Ritchie v. Lockheed Martin Corp., 558 F.3d 1161,
1172 (10th Cir. 2009). This general rule of Fed. R. Civ. P. 54(d)(1)--that “costs
* * * should be allowed to the prevailing party” (emphasis added)--applies “[u]nless
a federal statute * * * provides otherwise”, so that the limits of section 7430 apply
not only in the Tax Court but also in Federal tax litigation in the district courts.
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sec. 1132(g)(1) (emphasis added).7 Rather, Congress has directed that no costs
(including attorney’s fees), however reasonably and necessarily incurred, will be
awarded to a winning taxpayer if the IRS’s position was “substantially justified”.
Sec. 7430(c)(4)(B)(i).
The IRS agrees that petitioners (1) have substantially prevailed with respect
to the amount in controversy and with respect to the most significant issue in the
action, (2) meet the net worth requirements of 28 U.S.C. section 2412(d)(2)(B),
(3) exhausted the administrative remedies that were available to them, and (4) did
not unreasonably protract the administrative or judicial proceedings. Accordingly,
the only issue remaining with regard to petitioners’ eligibility for reasonable fee
awards is whether the IRS’s position in the proceeding was substantially justified.
B. Substantial justification in particular
The IRS’s position is substantially justified if, based on all the facts and
circumstances of the case, it acted reasonably, that is, if the IRS’s position had a
reasonable basis in both law and fact. Pierce v. Underwood, 487 U.S. 552, 563
(1988); Sher v. Commissioner, 89 T.C. 79, 84 (1987), aff’d, 861 F.2d 131 (5th Cir.
1988). The relevant inquiry is whether the IRS knew or should have known that its
7
See also 42 U.S.C. sec. 2000e-5(k) (Title VII; “In any action or proceeding
under this subchapter the court, in its discretion, may allow the prevailing party * * *
a reasonable attorney’s fee (including expert fees) as part of the costs”).
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position was invalid when adopted, given the facts available and any legal precedent
related to the case. Nalle v. Commissioner, 55 F.3d 189, 191 (5th Cir. 1995), aff’g
T.C. Memo. 1994-182; Maggie Mgmt. Co. v. Commissioner, 108 T.C. 430, 443
(1987); Prouty v. Commissioner, T.C. Memo. 2002-175. The Supreme Court has
warned that courts must “resist the understandable temptation to engage in post hoc
reasoning by concluding that, because a plaintiff did not ultimately prevail, his
action must have been unreasonable or without foundation.” Christiansburg
Garment Co. v. EEOC, 434 U.S. 412, 421-422 (1978). Or, as the Court of Appeals
for the D.C. Circuit put it, “courts need to guard against being ‘subtly influenced by
the familiar shortcomings of hindsight judgment.’” Taucher v. Brown-Hruska, 396
F.3d 1168, 1173 (D.C. Cir. 2005) (quoting Beck v. Ohio, 379 U.S. 89, 96 (1964)).
The IRS’s position may be incorrect but nevertheless substantially justified
“‘if a reasonable person could think it correct’.” Maggie Mgmt. Co. v.
Commissioner, 108 T.C. at 443 (quoting Pierce, 487 U.S. at 566 n.2). The IRS’s
eventually conceding or even losing a case does not establish that its position was
unreasonable, but its concession does remain a factor to be considered. Sokol v.
Commissioner, 92 T.C. 760, 767 (1989).
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As to matters of fact, in order for a position to be substantially justified,
“substantial evidence” must exist to support it. Pierce, 487 U.S. at 564.
“‘[Substantial evidence] does not mean a large or considerable amount of evidence,
but rather such relevant evidence as a reasonable mind might accept as adequate to
support a conclusion.’” Id. at 564-565 (quoting Consol. Edison Co. v. NLRB, 305
U.S. 197, 229 (1938)). The IRS is not obliged to concede adjustments whose
resolution requires factual determinations until it has received and had a reasonable
period of time to verify adequate substantiation for the matters in issue. See Nguyen
v. Commissioner, T.C. Memo. 2003-313; Huynh v. Commissioner, T.C. Memo.
2002-110.
As to matters of law, “[g]enerally, the Commissioner’s position is considered
substantially justified when an issue is one of first impression.” Vines v.
Commissioner, T.C. Memo. 2006-258 (citing TKB Int’l, Inc. v. United States, 995
F.2d 1460, 1468 (9th Cir. 1993)). In particular, a position is substantially justified
when it is “a case of first impression,” it is “not contrary to any published decision”,
and a “reasonable person [could not] say that it lacked colorable justification.”
Estate of Wall v. Commissioner, 102 T.C. 391, 394 (1994).
The mere fact that a case is one of first impression will not establish
substantial justification when the IRS’s position is in conflict with the “clear and
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unequivocal” language of the statute such that the IRS’s interpretation of that statute
is clearly unreasonable. Nalle v. Commissioner, 55 F.3d at 193. For instance, if the
IRS’s interpretation of a statute “‘lacked any ligaments of fact’ and was ‘clearly
erroneous’ as a matter of law”, Portillo v. Commissioner, 988 F.2d 27, 29 (5th Cir.
1993) (quoting Portillo v. Commissioner, 932 F.2d 1128, 1133 (5th Cir. 1991)),
rev’g T.C. Memo. 1992-99, or if “[n]one of the arguments offered by the IRS during
the various stages of the litigation had even a chance of succeeding”, Beaty v.
United States, 937 F.2d 288, 292-293 (6th Cir. 1991), such an interpretation would
violate the “clear and unequivocal” language of the statute and would not be
substantially justified.
However, the courts have not held that a Government position that is later
determined to be contrary to the plain meaning of a statute necessarily fails, for that
reason, to be substantially justified. Rather, if on a question of first impression the
Government takes a position that fails to give effect to the plain meaning of the
statute but that is still colorable, its position, though unavailing, may be substantially
justified and may not warrant an award of fees to its opponent. In Nalle v.
Commissioner, 55 F.3d at 190-191, for example, the Court of Appeals for the Fifth
Circuit had held that the regulation whose validity the IRS defended and on which
the IRS relied “contradicted the plain meaning of [I.R.C.] § 48”; but the court also
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held, id. at 194, that, for purposes of section 7430, the IRS’s position was
nonetheless substantially justified.8 Similarly, after the Supreme Court held
that a “literal reading of the” statutory language supported the conclusion adverse to
the Government and that “[t]he text of [18 U.S.C.] § 209(a) thus indicates that
employment status is an element of the offense”, Crandon v. United States, 494
U.S. 152, 159 (1990), the Court of Appeals for the Fourth Circuit (to which an
appeal would lie in either Newman or Comfort) nonetheless held, for purposes
of the Equal Access to Justice Act, see supra note 5, that before the Supreme Court
had so announced, the Government’s contrary position was nonetheless
“substantially justified”, see United States v. Paisley, 957 F.2d 1161, 1170 (4th Cir.
1992). A “plain meaning” analysis may be a very important consideration in
8
The Court of Appeals in Nalle addressed the question “whether the
Commissioner * * * knew or should have known that her position was invalid at the
onset of the litigation”, 55 F.3d at 191 (emphasis added), i.e., at a time when the
circumstances were equivalent to those in these cases now before us: At “the onset
of the litigation” in Nalle, when the petition was filed in the Tax Court, there was no
opinion of any court addressing the issue, and the IRS’s regulation and its litigating
position contradicted the plain meaning of the statute. The Tax Court later issued an
Opinion upholding the regulation and the IRS’s position, which the Court of
Appeals reversed, see Nalle v. Commissioner, 99 T.C. 187 (1992), rev’d, 997 F.2d
1134 (5th Cir. 1993); but that pro-IRS Tax Court Opinion did not exist as of “the
onset of the litigation” and therefore could not be cited as an authority giving rise to
substantial justification.
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determining whether the Government’s position is substantially justified, but it is not
always the only consideration.
The foregoing principles must be applied to the IRS’s position on
section 893(a).
C. Section 893
The primary substantive issue in petitioners’ administrative and judicial
proceedings was whether petitioners’ Commission wages were exempt from
taxation under section 893. Section 893(a) and (b) provides:
SEC. 893(a). Rule for Exclusion.--Wages, fees, or salary of any
employee of a foreign government or of an international organization
(including a consular or other officer, or a nondiplomatic
representative), received as compensation for official services to such
government or international organization shall not be included in gross
income and shall be exempt from taxation under this subtitle if--
(1) such employee is not a citizen of the United States, or
is a citizen of the Republic of the Philippines (whether or not a
citizen of the United States); and
(2) in the case of an employee of a foreign government,
the services are of a character similar to those performed by
employees of the Government of the United States in foreign
countries; and
(3) in the case of an employee of a foreign government,
the foreign government grants an equivalent exemption to
employees of the Government of the United States performing
similar services in such foreign country.
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(b) Certificate by Secretary of State.--The Secretary of State
shall certify to the Secretary of the Treasury the names of the foreign
countries which grant an equivalent exemption to the employees of the
Government of the United States performing services in such foreign
countries, and the character of the services performed by employees of
the Government of the United States in foreign countries.
That is, section 893(a) provides an exclusion on three conditions, and section 893(b)
provides that the Secretary of State shall certify two of the conditions.
Before this Court’s Opinion in Abdel-Fattah v. Commissioner, 134 T.C. 190
(2010), there had been no published opinions precluding the IRS’s position that
section 893(b) certification was a prerequisite to an exemption under section 893(a).
However, in Abdel-Fattah we concluded “that under the plain language of the
statute, certification [by the Secretary of State] is not a condition or prerequisite of
the exemption”. Id. at 204.
Under section 893 as we interpret it (and as petitioners have always
contended it should be interpreted), deciding whether a taxpayer is entitled to
exemption from income tax under section 893 still requires a factual inquiry--i.e., to
determine whether the conditions in section 893(a) have been met.
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II. Analysis
A. The two phases of these cases
To determine “substantial justification”, we must identify the point at which
the IRS first took the position that petitioners’ Commission wages were not exempt
from income tax under section 893, and we must then decide whether this position
from that point forward was substantially justified. Maggie Mgmt. Co. v.
Commissioner, 108 T.C. at 442. When determining whether the IRS’s position was
substantially justified as of a given date, a significant factor is whether the taxpayer
had presented all relevant information and legal arguments supporting the taxpayer’s
position. 26 C.F.R. sec. 301.7430-5(c), Proced. & Admin. Regs.
In these cases the IRS maintained from the start that petitioners’
Commission wages were not exempt under section 893, and the IRS did not
deviate from this position until the parties settled. As proceedings in petitioners’
cases were taking place, this Court issued an Opinion and decided Abdel-Fattah,
which clarified the Tax Court’s interpretation of section 893 and provided
petitioners with new legal authority to support their position. Before the issuance
of Abdel-Fattah, there was no legal authority interpreting section 893. Given
petitioners’ reliance on Abdel-Fattah as new legal authority, it is appropriate to
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analyze the reasonableness of the IRS’s position in two phases--i.e., before the
Abdel-Fattah Opinion and after.
B. Substantial justification for the IRS’s pre-Abdel-Fattah position
Since the legal issues in Abdel-Fattah and petitioners’ cases were the same
(i.e., whether section 893(b) is a prerequisite for exemption under section 893(a)),
the position that the IRS took in Abdel-Fattah is indicative of its position in
petitioners’ cases. Accordingly, if the IRS’s arguments in Abdel-Fattah were
reasonable, then its position in petitioners’ cases was also reasonable, at least until
the time that we issued our Opinion in Abdel-Fattah. That case raised an issue of
first impression. Although we did not ultimately agree with the IRS’s position, that
position had a colorable justification, based on its arguments as to (i) policy
objectives and (ii) the proximity of subsections (a) and (b) of section 893.
1. Policy objectives
The IRS considered section 893 as a whole and argued that the purpose of
including subsection (b) in section 893 was to require the U.S. State Department’s
certification as a prerequisite for the income tax exemption under subsection (a).
We noted that the Code includes other provisions that do make a Government
official’s certification a prerequisite to a tax benefit; and we observed that these
provisions reflect a legislative choice not to “assign[] to the tax collector the task
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of making, in the first instance, difficult determinations that may be well outside his
knowledge or expertise” but instead to “commit[] the determination to the agency
with the relevant subject-matter expertise.” Abdel-Fattah v. Commissioner,
134 T.C. at 202-203. In that connection, we noted the IRS’s contention that
granting the section 893(a) tax benefit without the section 893(b) certification
“requires section 893 to be administered without the benefit of ‘State’s expertise in
the arena of international affairs’”, id. at 209; and we acknowledged that “[t]hese
issues of diplomacy and tax administration might be reasons to prefer a rule that
required State Department certification as a prerequisite to the income tax
exemption”, id. at 210.9 We ultimately determined that there is no basis to impute
such reasoning to the Congress that enacted section 893, but we cannot say that the
argument was unreasonable.
2. The proximity of subsections (a) and (b)
As we noted at oral argument, the criteria for exemption under section 893
are stated in subsection (a), and the requirement that the Secretary of State certify
9
In De Allende v. Baker, 891 F.2d 7, 12 (1st Cir. 1989), the Court of Appeals
for the First Circuit similarly noted the Government’s proffered policy
considerations in holding that the Government’s position, which was contrary to the
plain meaning of 8 U.S.C. section 1182(a)(27) and that therefore failed on the
merits, see De Allende v. Shultz, 845 F.2d 1111 (1st Cir. 1988), was nonetheless
substantially justified for purposes of the EAJA.
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two of those criteria follows immediately in subsection (b)--which originally was in
the same subsection. Thus, the IRS’s position did not invent a limitation out of
whole cloth but rather urged that the certification--which certainly is provided for in
section 893(b)--is a prerequisite to the benefit in section 893(a)--to which the
certification certainly relates. The IRS’s position exaggerated the significance of
this arrangement in interpreting the statute, but it was not wrong to urge that this
arrangement be taken into account. The plain meaning of statutory language is not
determined without regard to its context; rather, “[t]he plain meaning of the statute’s
words, enlightened by their context”, Edwards v. Aguillard, 482 U.S. 578, 594
(1987) (emphasis added), governs our interpretation. We ultimately determined that
the proximity of subsections (a) and (b) did not vitiate the benefit conferred in
section 893(a) in the absence of the certification called for in section 893(b), so that
the arrangement of the statutory language does not overcome what is otherwise its
plain meaning; but the proximity of these provisions did help to justify the IRS’s
contrary argument.
Since the IRS’s position in Abdel-Fattah was colorable, it was also
substantially justified. See Estate of Wall v. Commissioner, 102 T.C. at 394; see
also Nalle v. Commissioner, 55 F.3d at 193-194. Since the IRS’s position in Abdel-
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Fattah and its position in petitioners’ cases were the same, the IRS’s pre-Abdel-
Fattah position in petitioners’ cases was substantially justified.
C. Substantial justification for the IRS’s post-Abdel-Fattah position
When Abdel-Fattah was issued, the situation changed. The issue was no
longer one of first impression, and the IRS’s position was now contrary to a
published Opinion, thus making the IRS’s position newly susceptible to the criticism
that it lacked substantial justification. It took several months (four months in Ms.
Newman’s case and six months in the Comforts’) after the decision in Abdel-Fattah
for the IRS to concede these cases, and petitioners argue that the IRS’s position was
not substantially justified during these periods. However, we find the IRS’s post-
Abdel-Fattah handling of these cases reasonable--and we therefore find its position
substantially justified--for two reasons:
1. Sufficient time to concede the section 893(b) issue
Just as the IRS must be given a reasonable amount of time to change its
position when it becomes aware of new pertinent facts in a case, see Nguyen v.
Commissioner, T.C. Memo. 2003-313; Huynh v. Commissioner, T.C. Memo.
2002-110, so the IRS must be given time to reassess its position in light of new legal
precedent. We expect the IRS to administer the tax laws not ad hoc but uniformly.
If it is to do so, then decisions about the positions it will take on legal issues must be
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resolved centrally and not by various Chief Counsel attorneys handling various
cases. These cases were among a group of cases arising from the IRS’s initiative in
connection with the employees of multiple foreign embassies. Coordinated
decision-making necessarily requires time to present the issues to authorized
officials and to let them make decisions.
Moreover, the decision whether to treat section 893(b) certification as a
prerequisite to section 893(a) exemption was necessarily bound up with the decision
whether to appeal Abdel-Fattah, but that appeal decision was not committed solely
to the IRS. Rather, under 28 U.S.C. section 519, that decision required the
involvement of the Department of Justice. We cannot criticize the IRS for allowing
this process to take its course in Abdel-Fattah before conceding Newman and
Comfort.
We issued our Opinion in Abdel-Fattah on April 27, 2010; and on August 26
and November 1, 2010--i.e., four and six months later--the IRS’s counsel informed
Ms. Newman and the Comforts that the IRS would concede the section 893(b)
issue. That was a reasonable amount of time for the Government to decide to revise
its position and concede this issue.
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2. Sufficient time to address the section 893(a) issue
Petitioners further criticize the IRS for taking several months after we issued
our Opinion in Abdel-Fattah to confirm that petitioners satisfied the requirements of
section 893(a). However, the IRS is not obliged to concede adjustments whose
resolution requires factual determinations until it has received and had a reasonable
period of time to verify adequate substantiation for the matters in issue. See Nguyen
v. Commissioner, T.C. Memo. 2003-313; Huynh v. Commissioner, T.C. Memo.
2002-110.
Even though section 893(b) certification is not a prerequisite to section 893(a)
exemption, petitioners still had the burden to prove that they satisfied the three
conditions for an exemption set forth in section 893(a). See Rule 142; see also New
Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). Ms. Newman did not
substantiate her citizenship or employment information until July 9, 2010. Similarly,
the Comforts did not substantiate Mrs. Comfort’s citizenship or employment
information until October 28, 2010.
Petitioners point out, however, that before the decision in Abdel-Fattah, the
IRS asserted to petitioners and their counsel that the requirements of section 893(a)
were not at issue. Consequently, the IRS did not seek confirmation that petitioners
met those requirements. Petitioners urge that the IRS could and should have asked
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for that information before it issued notices of deficiency or defended them in
litigation.
For us to hold that the IRS’s position was substantially justified is to hold that
the IRS was entitled to assume that position in conducting investigations and
determining deficiencies. Since we hold that the IRS was substantially justified in
taking the position that section 893(b) certification is a prerequisite to exemption,
the IRS was therefore not required to develop alternative positions before issuing
notices of deficiency or answering petitions.
It is evidently true that the IRS did not challenge Mrs. Comfort’s or
Ms. Newman’s citizenship or employment status before Abdel-Fattah, but this was
natural because the IRS’s position up to that point was that the Commission wages
did not qualify for exemption under section 893(a) because section 893(b) had not
been satisfied. Accordingly, under the IRS’s pre-Abdel-Fattah position, whether
petitioners satisfied the citizenship and employment requirements of section 893(a)
was immaterial. Although the IRS could have investigated Mrs. Comfort’s and Ms.
Newman’s citizenship or employment situation as additional or alternate grounds to
support its position before Adbel-Fattah, the IRS was not unreasonable in declining
to do so.
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Conclusion
Since we have determined that the IRS was substantially justified in both its
pre-Abdel-Fattah and post-Abdel-Fattah positions, petitioners were not prevailing
parties for purposes of section 7430(c)(4). Accordingly, petitioners are not entitled
to an award of costs under section 7430.
Appropriate orders and
decisions will be entered.