Opinion
20981-18 15264-19
03-15-2023
TRACE T. WATKINS & LAUREE L. WATKINS, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER
David Gustafson Judge
These consolidated cases concern deficiencies in federal income tax for the 2015, 2016, and 2017 tax years of petitioners Trace and Lauree Watkins. The IRS determined deficiencies totaling more than $440,000 plus 20% penalties, but by a joint stipulation of settled issues, the parties agreed to deficiencies totaling about $22,000 (i.e., about 5% of the amounts as previously determined by the IRS) with no penalties. Now before the Court is petitioners' motion for litigation costs filed pursuant to section 7430 and Tax Court Rule 231. Because petitioners failed to exhaust their administrative remedies, we will deny their motion for costs.
Unless otherwise indicated, statutory references in this order are to the Internal Revenue Code, Title 26 U.S.C., as in effect at the relevant times; regulation references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), as in effect at the relevant times; and Rule references are to the Tax Court Rules of Practice and Procedure. References to "Doc." are to documents as numbered in the docket record of this case, and the page numbers cited in those references are according to the numbering in the portable document format ("PDF") of the digital file.
Background
Examination of petitioners' 2015 and 2016 returns and notice of deficiency
By letter dated September 21, 2017, an IRS Tax Compliance Officer ("TCO") notified petitioners that their 2015 and 2016 federal income tax returns had been selected for examination. (Doc. 312 at 44.) At the same time, the TCO sent to petitioners Form 4564, "Information Document Request" (IDR), to request documentation substantiating certain expense deductions that petitioners claimed on their Schedule C, "Profit or Loss From Business", for both years. (Doc 312 at 46.) Petitioners did not submit documents in response to the IDR. (Doc. 312 at 42.)
On December 6, 2017, the IRS mailed to petitioners a Letter 915, commonly called a "30-day letter", that included copies of a proposed examination report. (Doc. 312 at 54-55.) The 30-day letter stated:
IF YOU DON'T AGREE with the changes shown in the examination report, you should do one of the following by the response date.
• Mail us any additional information that you would like us to consider
• Discuss the report with the examiner
• Discuss your position with the examiner's supervisor
• Request a conference with an Appeals Officer, as explained in the enclosed Publication 3498, The Examination Process. . . . [Doc. 312 at 55-54.]The first page of the letter included the caption-
Last date to respond to this letter:
January 5, 2018
On July 1, 2019, the IRS Office of Appeals was renamed the "Internal Revenue Service Independent Office of Appeals". See Taxpayer First Act, Pub. L. No. 116-25, sec. 1001(a), 133 Stat. at 983 (2019). Some of the events in this case predate that renaming. We use the term "IRS Appeals" without distinction to refer to the office both before and after the name change.
We take notice of the fact that Publication 3498 (Rev. 11-2004), available online at irs.gov/pub/irs-pdf/p3498.pdf, includes at pages 6-7 a discussion entitled "How Do You Appeal a Decision?".
Petitioners allege (see Doc. 316 at 6), and we assume, that on December 19 and 20, 2017, Ms. Watkins contacted the TCO and submitted some documentation. It appears that this was the first time that petitioners submitted documents for 2015 and 2016. (Doc. 312 at 5, 25; Doc. 316 at 6.) The TCO indicated, however, that the provided documents were illegible, and that the IRS still needed additional information before allowing petitioners' deductions for Schedule C business expenses. (Doc. 312 at 42, 45.)
On December 21, 2017 (i.e., 15 days after the 30-day letter), the TCO mailed to petitioners a follow-up letter ("Letter 1912"). (Doc. 312 at 56-58.) The Letter 1912 stated that petitioners should contact the IRS representative designated on the letter within 15 days. The Letter 1912 also repeated the offer of a conference with IRS Appeals:
Also, you can request a conference with an appeals officer who will take a fresh look at your case. The appeals officer is independent of our office.The letter repeated that "[w]e will issue a notice of deficiency if you don't reply 15 days from this letter's date." Reaffirming the 30-day deadline of the Letter 915, the Letter 1912 included on its first page the same caption that had appeared on the Letter 915:
Last date to respond to this letter: January 5, 2018
Petitioners did not request a conference with IRS Appeals but instead continued to correspond with IRS examination personnel. They "drop[ped] off" a "box of documents", but on February 27, 2018, the TCO reported (Doc. 312 at 43):
My attempted review of the documentation determined many expenses that appear to be personal expenses and not business expenses. Mr. Watkins was notified of the findings and that the documents needed to be organized. All documents were given back to Mr. Watkins. Mr. Watkins' response was that they are in the business of property management as well. They manage a property for an individual who also resides out of the country. The taxpayer's have the responsibility of paying the utilities, HOA, maintenance fees, etc. on behalf of the individual. The taxpayers were requested to provide separately the income and related expenses for each individual business activity. Mr. Watkins stated that he would provide the documents as requested.However, on March 12, 2018, "Mrs. Watkins stated that her accountant determined there wasn't a need to fulfill the request." (Doc. 312 at 43.) Evidently petitioners provided no additional substantiation.
The TCO accordingly "closed case file to MGR [manager], on June 25, 2018, and the next day the manager "[c]losed [the case] to Tech Services" for the issuance of a notice of deficiency. (Doc. 312 at 43; see also Doc. 323 at 11.)
The closing entry is signed with the initials "CJ" (Doc. 312 at 43), and Carl Johnson was the Group Manager (see Doc. 312 at 55).
On August 27, 2018, the IRS issued a NOD disallowing the Schedule C business expenses that petitioners claimed for 2015 and 2016 and determining the resulting deficiencies in income tax. (Doc. 23 at 111.) The NOD was issued by Technical Services. (Doc. 23 at 114.)
On July 19, 2018-i.e., after the examination personnel had closed their case for 2015-2016, but before Technical Services had issued the NOD-Ms. Watkins sent a letter to the TCO who had handled the examination. Our record includes a certified mailing receipt with this date, and the return receipt was signed not by the TCO but by "G Barnes" on July 23, 2018. The letter itself does not appear in our record. Petitioners allege, and we assume, that this letter requested an Appeals conference regarding 2015 and 2016. (Doc. 323 at 2, 6-7, 11.) The letter is not reflected on the TCO's "Examining Officer's Activity Record" (Doc. 312 at 42); and, again, she had closed the case before the date of this letter. But petitioners allege, and we assume, that their representative reported to them that on July 27, 2018, the TCO "did acknowledge that she received the appeal but then commented it was too late".
Petitioners subsequently retained Attorney Abram Jack Fishman as counsel sometime in October 2018 (Doc. 319 at 2.) On October 23, 2018, in response to the NOD, petitioners timely filed their Tax Court petition seeking review of their notice of deficiency for 2015 and 2016. (Doc. 1 at 1.)
Post-petition Appeals conference for 2015 and 2016
After the Tax Court petition was docketed, on December 18, 2018, respondent referred the case for 2015 and 2016 (docket number 20981-18) to Appeals for settlement, and petitioners' case was assigned to Appeals Officer Teresa R. Jones ("AO Jones"). (Doc. 312 at 212.) According to her case activity report, AO Jones noted on April 3, 2019, that "no information has ever been provided" with respect to 2015 and 2016 case. (Doc. 312 at 216-17.) Rather, petitioners' counsel urged that the post-petition Appeals conference for 2015-2016 should be postponed until they could be combined with the year 2017 (which, he noted, was still in exam for which there had "just been issued a 30-day letter"). When IRS Appeals declined to delay 2015-2016, counsel "was wanting me to just close it to counsel". Appeals then referred the case back to the Area Counsel in April 2019. (Doc. 312 at 215, 217; see also Doc. 319, ¶¶ 8-10.)
Examination of petitioners' 2017 return and notice of deficiency.
In July 2018, the TCO began investigation of petitioners' 2017 federal income tax return and sent to petitioners another Form 4564 requesting documentation substantiating some of the 2017 Schedule C business expenses that petitioners claimed. (Doc. 312 at 60.) During the course of her investigation for 2017, the TCO reviewed several documents submitted by petitioners but ultimately determined that petitioners' documents were insufficient to substantiate several of their claimed Schedule C business expenses. (Doc. 23 at 166.) Consequently, on March 13, 2019, the IRS issued to petitioners a Letter 915 (i.e., a 30-day letter) for 2017, proposing to disallow those expenses and providing them opportunity to "[r]equest a conference with an Appeals Officer" (again explained in an enclosed Form 3498) in order to potentially resolve the matter before an NOD was issued for 2017. (Doc. 312 at 198-99). (The first page of the letter included a caption, "Last date to respond to this letter: April 12, 2019"). (Doc. 312 at 198.) Fifteen days later, on March 28, 2019, the TCO sent to petitioners and their counsel, Mr. Fishman, a follow-up letter (Letter 1912) requesting a response within 15 days and once again informing petitioners that they "can request a conference with an appeals officer" and bearing the caption, "Last date to respond to this letter: April 12, 2019". (Doc. 312 at 208.)
Petitioners did not request (and do not allege that they requested) a conference with IRS Appeals concerning their 2017 liability. (Doc. 316 at 5-6.)
On August 7, 2019, the IRS (through its Technical Services unit) issued to petitioners an NOD for 2017 determining a deficiency in federal income tax due to a disallowed portion of petitioner's claimed Schedule C expenses. (Doc. 23 at 4, 150; Doc. 312 at 208-09.) On August 19, 2019, petitioners filed another Tax Court Petition challenging respondent's determinations in the NOD that was issued to them for 2017. (Doc. 312 at 8.)
Post-petition Appeals conference for 2017
On May 25, 2019, respondent's counsel referred to IRS Appeals the case for 2017 (docket number 15264-19), so that petitioners and Appeals could attempt to settle the case. (Doc. 312 at 219.) Appeals Officer Pattrick W. Bahr ("AO Bahr") was assigned to petitioners' 2017 case. (Doc. 312 at 219.) AO Bahr's case activity report noted that on December 10, 2019, Appeals had received "nothing" and that Mr. Fishman indicated that "none of the 2015-2017 info had been prepared by [the taxpayers] for him to look at." (312 at 220.) On December 12, 2019, Mr. Fishman then "advised his clients to provide records" for 2017. (Doc. 319 at 3.)
Mr. Fishman insisted that both 2015-2016 and 2017 should be considered simultaneously by IRS Appeals; but IRS Appeals explained that "Counsel had control of 2015 & 2016 and [IRS Appeals] had control of 2017." (Doc. 312 at 220.) (As to 2015 and 2016, IRS Appeals' post-petition consideration had concluded in April 2019.) Mr. Fishman did not yield to this distinction. On February 6, 2020, AO Bahr noted the Mr. Fishman had delivered to Area Counsel the documentation for 2015, 2016, and 2017, but he had yet to provide Appeals with the 2017 documentation. (Doc. 312 at 221.) On March 3, 2020, AO Bahr also noted that Mr. Fishman had mailed the documentation for 2017 to "IRS Counsel instead of me." For IRS Appeals, the means for "consolidat[ing] the 2015-2017 years" was to "hav[e] me close 2017 to Counsel", leaving all three years within the responsibility of litigation counsel and none of the years before IRS Appeals. (Doc. 312 at 221.) When confronted with the choice of dividing the years between IRS Appeals and counsel or having Counsel be responsible for all three years, Mr. Fishman sent to IRS Appeals on March 18, 2020, a telefacsimile that stated:
IN RE: TRACE T. & LAUREE L. WATKINS
TAX YEARS 2015, 2016 & 2017
Appeals Officer Carey,
Please send all records for the above mentioned Taxpayers to the IRS, Office of Chief Counsel.That same day, IRS Appeals created an entry stating, "Left voicemail message with COR Fishman that I had his fax, and was closing 2017 to Counsel per his request." (Doc. 312 at 221.) Consequently, in the post-petition context, IRS Appeals did not consider petitioners' 2017 year.
Tax Court Proceedings
The Tax Court originally set petitioners 2015 and 2016 cases for trial on the Court's January 13, 2020, trial calendar. (Doc. 4 at 1.) Petitioners then moved for continuance, requesting that trial of their case for 2015 and 2016 be continued so that it could be consolidated with their 2017 deficiency case. (Doc. 7 at 1-2.) The Court granted petitioners' motion for continuance. (Doc. 9 at 1.)
On July 30, 2020, petitioners moved to consolidate these cases for trial, and the Court granted the motion and set the cases for trial in Atlanta, Georgia, on November 16, 2020. (Doc. 14 at 1-2; Doc. 15 at 1-2; Doc. 16: at 1-2.) On October 26, 2020, petitioners moved for another continuance, and the Court granted petitioner's motion and set the cases for trial on the Court's May 17, 2021, trial calendar in Atlanta. (Doc. 26 at 1-2; Doc. 28 at 1-2). On May 11, 2021, petitioners' counsel requested another continuance because of medical issues, which the Court granted. (Doc. 32 at 1-2.) The Court subsequently set the cases for trial on July 14, 2021. (Doc. 32 at 1-2.)
In anticipation of trial, petitioners filed proposed exhibits, which were subsequently stricken from the record because they did not comply with the Court's procedures. (Doc. 293 at 1-2.) Petitioners were accordingly ordered to file their proposed trial exhibits in compliance with the Court's procedures no later than July 12, 2021. (Doc. 293 at 1-2.) Petitioners complied and filed their proposed exhibits on July 9 and 10, 2021. (Doc. 312 at 16.) Thereafter, respondent apparently found within petitioners' proposed exhibits a "few new documents" that justified a revised settlement offer that proposed lower deficiencies, and the parties were then able to settle the cases. (Doc. 312 at 16.)
On July 13, 2021, the parties initiated a telephone conference with the Court reporting that they had reached a basis for settlement and that they expected to file a stipulation of settled issues no later than July 14, 2021. (Doc. 302 at 1.) During the conference, petitioners' counsel stated that petitioners intended to move for an award of costs. (Doc. 302 at 1.)
On September 13, 2021, after the filing of the parties' stipulation of settled issues, petitioners filed their motion for costs under section 7430. (Doc. 303 at 1-3; Doc. 306 at 1-4.) Respondent subsequently filed his response to the motion for costs in which he concedes that petitioners have substantially prevailed with respect to the issues and amounts in controversy for the 2015, 2016, and 2017 years. See § 7430(c)(4)(A)(i). (Doc. 312 at 2.) Nevertheless, respondent opposes petitioners' motion on grounds that (1) petitioners did not exhaust their administrative remedies; (2) respondent's position in this proceeding was substantially justified; (3) petitioners unreasonably protracted the litigation; and (4) in the alternative, that at least "some" of the costs claimed are unreasonable in amount. (Doc. 312 at 17.)
Discussion
I. General legal framework
Section 7430(a) authorizes an award of reasonable litigation costs incurred by the prevailing party in a court proceeding brought by or against the Unites States in connection with the determination of any income tax; but this provision is substantially restricted by requirements and limitations, several of which the Commissioner relies on here to oppose petitioners' motion for an award. We need not address all of the issues that the Commissioner raises, because this case is resolved by reference to the issue of exhaustion of administrative remedies. Section 7430(b)(1) provides:
(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. [Emphasis added.]
The regulations implementing section 7430 and defining the exhaustion requirement include these provisions in 26 C.F.R. § 301.7430-1(b)(1):
Section 301.7430-1(f) provides exceptions to the exhaustion requirement, but petitioners do not allege that they meet any of these exceptions, and we do not see in our record any warrant for any of those exceptions.
A party has not exhausted the administrative remedies available within the Internal Revenue Service with respect to any tax matter for which an Appeals office conference is available under §§ 601.105 and 601.106 of this chapter . . . unless-
(i) The party, prior to filing a petition in the Tax Court ... participates, either in person or through a qualified representative . . ., in an Appeals office conference; or
(ii) If no Appeals office conference is granted, the party, prior to the issuance of a statutory notice in the case of a petition in the Tax Court . . . --
(A) Requests an Appeals office conference in accordance with §§ 601.105 and 601.106 of this chapter or any successor published guidance . . . .The cross-referenced provisions from Part 601 provide as follows in the case of a correspondence examination (such as was conducted in this instance), in 26 C.F.R. § 601.105(c)(1)(i):
In a correspondence examination the taxpayer is furnished with a report of the examiner's findings by a form letter. The taxpayer is asked to sign and return an agreement if the taxpayer accepts the findings. The letter also provides a detailed explanation of the alternatives available if the taxpayer does not accept the findings, including consideration of the case by an Appeals office, and requests the taxpayer to inform the district director, within the specified period, of the choice of action. An Appeals office conference will be granted to the taxpayer upon request without submission of a written protest. [Emphasis added.]Under the regulation, a taxpayer "participates" in an Appeals conference "if the party . . . discloses to the Appeals office all relevant information regarding the party's tax matter to the extent such information and its relevance were know or should have been known to the party . . . at the time of such conference." Treas. Reg. § 301.7430-1(b)(2).
In the case of an "office exam", an equivalent provision is given in 26 C.F.R. § 601.105(c)(2)(i) ("the taxpayer will be sent a copy of the examination report under cover of a transmittal (30-day) letter, providing a detailed explanation of the alternatives available, including consideration of the case by an Appeals office, and requesting the taxpayer to inform the district director, within the specified period, of the choice of action" (emphasis added)).
II. Analysis
A. 2015 and 2016
1. 30-day letter opportunity
Petitioners allege that that they requested an Appeals conference for 2015 and 2016 by letter dated July 18, 2018. A copy of the letter does not appear in our record, but petitioners did present a certified mail receipt to corroborate their allegation that they sent a letter requesting an Appeals office conference. (Doc. 323 at 6-7.) Although petitioners' argument is not elaborated, petitioners seem to urge the Court to accept this as evidence that they were not provided an opportunity to participate in an Appeals conference before issuance of the NOD but that they did appropriately request an Appeals conference in accordance with sections 601.105 and 601.106. We assume that if a taxpayer duly requests a conference but IRS Appeals fails or refuses to grant it, then we would not hold that the taxpayer had failed to exhaust administrative remedies. But in this case, petitioners' argument widely misses the mark.
First, section 7430 requires that the taxpayer exhaust "the administrative remedies available to such party within the Internal Revenue Service", and section 301.7430-1(b)(1)(ii)(A) requires that that the taxpayer "[r]equest an Appeals office conference in accordance with §§ 601.105 and 601.106". According to section 601.105(c)(1)(i), an Appeals conference or other choice of action is to be requested "within the specified time period" in the 30-day letter (i.e., in this instance within 30 days after December 6, 2017). Second, and to the same effect, section 601.105(d)(1)(iv) states that if a taxpayer does not respond to the letter within 30 days, an NOD will be issued or other appropriate action will be taken. The remedy created by these provisions is an Appeals conference requested within 30 days of a 30-day letter, and the request must be timely in order to exhaust that remedy. Petitioners' purported request for an Appeals conference was therefore too late to satisfy this procedural requirement, given that petitioners allegedly requested an Appeals conference by letter dated July 18, 2018-i.e., more than 6 months after the stated and restated deadline of January 5, 2018.
2. Post-petition opportunity
In any event, even assuming that petitioners should be excused for failing to exhaust the remedy afforded by the 30-day letter, they could recover costs under section 7430 only if they exhausted all the remedies that they were granted. They did not do so, because they were offered an Appeals conference after they had filed their Tax Court petition, but they similarly failed to take advantage of that opportunity. Section 301.7430-1(b)(1)(i) limits a costs award to a taxpayer who "participates in an Appeals office conference" after filing his petition. See Rogers v. Commissioner, T.C. Memo.1987-374. But the record shows that petitioners did not participate in the Appeals conference-i.e., did not "disclose[] to the Appeals office all relevant information regarding the party's tax matter to the extent such information and its relevance were know or should have been known to the party . . . at the time of such conference." Treas. Reg. § 301.7430-1(b)(2). Rather, petitioners failed to furnish any available information at the post-petition Appeals conference, and petitioners' counsel asked IRS Appeals to close the case and let settlement responsibility devolve on Chief Counsel. Where petitioners select silence as their litigation strategy, they must bear the consequences. See, e.g., DeVenney v. Commissioner, 85 T.C. 927, 933 (1985); Rogers v. Commissioner, T.C. Memo.1987-374. Therefore, as to 2015 and 2016, petitioners failed to exhaust their administrative remedies as required by section 7430(b)(1).
B. 2017
1. 30-day letter opportunity
IRS examination personnel sent petitioners a 30-day letter for 2017, providing them the opportunity to request an Appeals conference to resolve the matter before the NOD was issued. Nonetheless, petitioners chose not to participate in or request an Appeals conference before they filed the petition. They therefore failed to exhaust the remedy afforded in the 30-day letter. See Treas. Reg. § 301.7430-1(g), Example (11).
2. Post-petition opportunity
Petitioners likewise failed to avail themselves of their post-petition opportunity before IRS Appeals because, as we set out above, they declined to provide documentation to Appeals after filing their petition for 2017. Given their failure to provide information after they filed their petition for 2017, petitioners failed to exhaust their available post-petition remedy, and they are not entitled an award of reasonable litigation costs as to 2017.
Because petitioners have failed to exhaust their administrative remedies, we need not address their other contentions. It is therefore
ORDERED that petitioners' motion for litigation costs is denied. In due course we will enter decision consistent with the parties' stipulation of settled issues.