T.C. Memo. 1999-118
UNITED STATES TAX COURT
PHILLIP LEE ALLEN AND CAROLYN F. ALLEN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 243-97. Filed April 6, 1999.
Jeri Gartside and Joseph Mudd, for petitioners.
Andrew Lee, for respondent.
MEMORANDUM OPINION
GERBER, Judge: Petitioners, by motion under section 7430
and Rule 231,1 seek the award of litigation costs incurred in
this controversy where they have shown that respondent’s
1 Unless otherwise stated, all section references are to the Internal Revenue Code in effect for the taxable years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. - 2 -
determination was in error. In Allen v. Commissioner, T.C. Memo.
1998-406, filed November 13, 1998, we found that a settlement
paid to petitioners by their homeowners’ insurance company was
for compensatory, and not punitive, damages. Accordingly, the
settlement payment was not taxable, and no deficiency resulted.
Our findings of fact in Allen v. Commissioner, supra, are
incorporated by this reference.
A tax litigant may recover the reasonable litigation fees
and costs incurred in connection with the litigation only if the
four elements of section 7430 are present. See sec. 7430. Those
elements are: (1) The fees or costs requested were incurred in
an administrative or court proceeding in connection with the
determination, collection, or refund of a tax; (2) administrative
remedies have been exhausted; (3) the proceedings have not been
unreasonably protracted by the taxpayer; and (4) the taxpayer was
the prevailing party in the action. See id. The taxpayer will
not be treated as the prevailing party if respondent establishes
that respondent’s position was substantially justified.2 To be
2 Taxpayer Bill of Rights 2, Pub. L. 104-168, 110 Stat. 1463, 1464, modified sec. 7430(c)(4) by striking the requirement that the party seeking an award must prove that the United States’ position was “not substantially justified” in order to recover. The 1996 amendment, for purposes of this case, provides that “A party shall not be treated as the prevailing party in a proceeding to which subsection (a) applies if the United States establishes that the position of the United States in the proceeding was substantially justified.” Thus, the 1996 amendment effectively shifted the burden of proof on the issue of (continued...) - 3 -
treated as the prevailing party, the taxpayer must show that the
taxpayer substantially prevailed with respect to the amount in
controversy or the main issues and has met the net worth limits.
See sec. 7430(c)(4)(B)(i). If respondent’s position was
substantially justified, the taxpayer cannot be considered a
prevailing party and therefore cannot meet the requirements of
section 7430.
The Supreme Court has interpreted “substantially justified”
to mean “justified to a degree that could satisfy a reasonable
person.” Pierce v. Underwood, 487 U.S. 552, 565 (1988). The
United States’ position need not be correct to be “substantially
justified”; it need only have “a reasonable basis in law and
fact.” Id. at 566 n.2. The determination of reasonableness is
made on the basis of all the facts and circumstances, and the
fact that the Government eventually loses the case is not
determinative. See Baker v. Commissioner, 83 T.C. 822, 828
(1984), vacated and remanded on another issue 787 F.2d 637 (D.C.
Cir. 1986).
In their motion for fees, petitioners contend that they have
met all elements for an award under section 7430. Conversely,
2 (...continued) the Government’s “substantial justification” from the party seeking the award to the Government. The amendment applies to proceedings commenced after July 30, 1996. The petition was filed after July 30, 1996, making the amended sec. 7430 applicable. - 4 -
respondent argues that, although petitioners substantially
prevailed with respect to the issues and amounts in controversy,
petitioners are not the prevailing party because respondent was
substantially justified in maintaining his position. Respondent
also argues that all administrative remedies were not exhausted,
that petitioners unreasonably protracted the proceedings, and
that the fees requested are unreasonable. If we determine that
respondent was substantially justified, we need not address the
other aspects raised by respondent.
Respondent contends that the evidence that was available
prior to trial substantially justified the position that
petitioners’ settlement included payment for punitive damages.
Petitioners counter that the evidence they provided to respondent
regarding the expenses of rehabilitating their home rendered
respondent’s position on the taxability of the settlement
unreasonable and without justification.
In seeking to recover from their insurance company,
petitioners made a series of demands for reimbursement as the
repairs progressed and the amount of damage grew due to
subsequent discoveries of damage. After a few payments to
petitioners, the insurance company disputed petitioners’
estimates and refused to honor petitioners’ demands. Petitioners
brought suit over this refusal and alleged delay by the insurance
company. In their complaint, petitioners set forth several - 5 -
grounds for relief and/or damages, including bad faith and
punitive damages.
In the settlement of the suit, petitioners released any
rights they may have had for all claims stated and for possible
future claims arising from their relationship with the insurance
company on this matter. The terms of the settlement did not
specify any particular grounds for which the payment was made.
In pursuing the question of whether the settlement was
taxable, petitioners seemed to focus on the fact that the cost of
repair approximated the total recovery from all sources. When
respondent questioned whether the amount received was for
punitive damages, petitioners presented the Appeals officer with
repair receipts in an effort to demonstrate that they had spent
the funds received for repairs to the home. Petitioners have
continued this approach in disputing the deficiency and emphasize
this aspect in their present motion. Conversely, respondent has
focused on the fact that petitioners’ claims and settlement with
their insurance company may have been for punitive damages.3 The
parties’ arguments have gone off on different tangents.
3 Respondent did argue about the expenditures as a secondary matter. Respondent questioned whether some of the expenditures by petitioners were improvements, rather than replacement and repairs. In the Court’s analysis, we found that there were some improvements, as respondent contended, but we found them to be de minimis. For example, petitioners added air conditioning to their replacement heating unit. This aspect adds some justification for respondent’s position. - 6 -
Petitioners attribute their success to their evidence that
the settlement funds were spent on repairs. This evidence,
however, does not address the threshold element of the two
section 1033 prerequisites to nonrecognition treatment. To
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T.C. Memo. 1999-118
UNITED STATES TAX COURT
PHILLIP LEE ALLEN AND CAROLYN F. ALLEN, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 243-97. Filed April 6, 1999.
Jeri Gartside and Joseph Mudd, for petitioners.
Andrew Lee, for respondent.
MEMORANDUM OPINION
GERBER, Judge: Petitioners, by motion under section 7430
and Rule 231,1 seek the award of litigation costs incurred in
this controversy where they have shown that respondent’s
1 Unless otherwise stated, all section references are to the Internal Revenue Code in effect for the taxable years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. - 2 -
determination was in error. In Allen v. Commissioner, T.C. Memo.
1998-406, filed November 13, 1998, we found that a settlement
paid to petitioners by their homeowners’ insurance company was
for compensatory, and not punitive, damages. Accordingly, the
settlement payment was not taxable, and no deficiency resulted.
Our findings of fact in Allen v. Commissioner, supra, are
incorporated by this reference.
A tax litigant may recover the reasonable litigation fees
and costs incurred in connection with the litigation only if the
four elements of section 7430 are present. See sec. 7430. Those
elements are: (1) The fees or costs requested were incurred in
an administrative or court proceeding in connection with the
determination, collection, or refund of a tax; (2) administrative
remedies have been exhausted; (3) the proceedings have not been
unreasonably protracted by the taxpayer; and (4) the taxpayer was
the prevailing party in the action. See id. The taxpayer will
not be treated as the prevailing party if respondent establishes
that respondent’s position was substantially justified.2 To be
2 Taxpayer Bill of Rights 2, Pub. L. 104-168, 110 Stat. 1463, 1464, modified sec. 7430(c)(4) by striking the requirement that the party seeking an award must prove that the United States’ position was “not substantially justified” in order to recover. The 1996 amendment, for purposes of this case, provides that “A party shall not be treated as the prevailing party in a proceeding to which subsection (a) applies if the United States establishes that the position of the United States in the proceeding was substantially justified.” Thus, the 1996 amendment effectively shifted the burden of proof on the issue of (continued...) - 3 -
treated as the prevailing party, the taxpayer must show that the
taxpayer substantially prevailed with respect to the amount in
controversy or the main issues and has met the net worth limits.
See sec. 7430(c)(4)(B)(i). If respondent’s position was
substantially justified, the taxpayer cannot be considered a
prevailing party and therefore cannot meet the requirements of
section 7430.
The Supreme Court has interpreted “substantially justified”
to mean “justified to a degree that could satisfy a reasonable
person.” Pierce v. Underwood, 487 U.S. 552, 565 (1988). The
United States’ position need not be correct to be “substantially
justified”; it need only have “a reasonable basis in law and
fact.” Id. at 566 n.2. The determination of reasonableness is
made on the basis of all the facts and circumstances, and the
fact that the Government eventually loses the case is not
determinative. See Baker v. Commissioner, 83 T.C. 822, 828
(1984), vacated and remanded on another issue 787 F.2d 637 (D.C.
Cir. 1986).
In their motion for fees, petitioners contend that they have
met all elements for an award under section 7430. Conversely,
2 (...continued) the Government’s “substantial justification” from the party seeking the award to the Government. The amendment applies to proceedings commenced after July 30, 1996. The petition was filed after July 30, 1996, making the amended sec. 7430 applicable. - 4 -
respondent argues that, although petitioners substantially
prevailed with respect to the issues and amounts in controversy,
petitioners are not the prevailing party because respondent was
substantially justified in maintaining his position. Respondent
also argues that all administrative remedies were not exhausted,
that petitioners unreasonably protracted the proceedings, and
that the fees requested are unreasonable. If we determine that
respondent was substantially justified, we need not address the
other aspects raised by respondent.
Respondent contends that the evidence that was available
prior to trial substantially justified the position that
petitioners’ settlement included payment for punitive damages.
Petitioners counter that the evidence they provided to respondent
regarding the expenses of rehabilitating their home rendered
respondent’s position on the taxability of the settlement
unreasonable and without justification.
In seeking to recover from their insurance company,
petitioners made a series of demands for reimbursement as the
repairs progressed and the amount of damage grew due to
subsequent discoveries of damage. After a few payments to
petitioners, the insurance company disputed petitioners’
estimates and refused to honor petitioners’ demands. Petitioners
brought suit over this refusal and alleged delay by the insurance
company. In their complaint, petitioners set forth several - 5 -
grounds for relief and/or damages, including bad faith and
punitive damages.
In the settlement of the suit, petitioners released any
rights they may have had for all claims stated and for possible
future claims arising from their relationship with the insurance
company on this matter. The terms of the settlement did not
specify any particular grounds for which the payment was made.
In pursuing the question of whether the settlement was
taxable, petitioners seemed to focus on the fact that the cost of
repair approximated the total recovery from all sources. When
respondent questioned whether the amount received was for
punitive damages, petitioners presented the Appeals officer with
repair receipts in an effort to demonstrate that they had spent
the funds received for repairs to the home. Petitioners have
continued this approach in disputing the deficiency and emphasize
this aspect in their present motion. Conversely, respondent has
focused on the fact that petitioners’ claims and settlement with
their insurance company may have been for punitive damages.3 The
parties’ arguments have gone off on different tangents.
3 Respondent did argue about the expenditures as a secondary matter. Respondent questioned whether some of the expenditures by petitioners were improvements, rather than replacement and repairs. In the Court’s analysis, we found that there were some improvements, as respondent contended, but we found them to be de minimis. For example, petitioners added air conditioning to their replacement heating unit. This aspect adds some justification for respondent’s position. - 6 -
Petitioners attribute their success to their evidence that
the settlement funds were spent on repairs. This evidence,
however, does not address the threshold element of the two
section 1033 prerequisites to nonrecognition treatment. To
qualify under section 1033, the payment must have been received
as compensation for an involuntary conversion of the taxpayer’s
property. See sec. 1033(a). Having established that, then it
must be shown that the money was expended within a specified
period of time for the replacement of the converted property with
similar property. See sec. 1033(a)(2)(A) and (B). Only after
the threshold question, whether the amount received was
compensatory, has been answered is it necessary to consider the
issue of how the funds were spent. Although an explanation of
both prongs of section 1033 was given in our opinion, petitioners
have persisted in their single-minded focus on the repair and
replacement aspect.
If the character is not clear on the face of a settlement,
the characterization of settlement proceeds becomes a factual
inquiry, dependent on the payor’s intent when the proceeds were
paid. See Hentzel v. Commissioner, T.C. Memo. 1991-277. “[W]hen
respondent receives conflicting evidence of the payor’s intent,
* * * respondent does not act unreasonably by insisting upon an
explanation to clear up the conflict.” Id. Where unexplained
facts support respondent’s position and the Court must consider - 7 -
the credibility of witnesses and probative value of evidence,
respondent’s position may be “substantially justified”. See
Creske v. Commissioner, T.C. Memo. 1990-318, affd. 946 F.2d 43
(7th Cir. 1991). In the case before us, the taxability of
petitioners’ settlement was dependent on the weight of the
evidence presented and our subsequent interpretation of the
settlement agreement.
Throughout the pretrial process and up to the March 24,
1998, trial, respondent possessed conflicting information about
the purpose of the settlement. Even though Allstate Insurance
Co.’s (Allstate) counsel, Charles Siegal, advised respondent’s
counsel on March 10, 1998, that Allstate did not pay punitive
damages, respondent possessed evidence supporting the position
that the payment was made in settlement of multiple claims,
including bad faith and/or punitive damages. That evidence
included the complaint against Allstate, the settlement
documents, and two letters from petitioners’ prior
representative. All referenced recovery for personal injury
and/or punitive damages.
Respondent also points out that the Allstate underwriter
involved in petitioners’ claim had advised that the settlement
was made for punitive or bad faith damages. It was only 4 days
before trial when the underwriter called respondent’s counsel to
advise that she could not testify to her prior statement because - 8 -
she had not attended the settlement conference and may not have
remembered the situation correctly.
Petitioners’ amended return and attachment, the complaint
against the insurance company, and settlement agreement and
accompanying memorandum were sufficient to create substantial
doubt regarding whether petitioners’ settlement included punitive
damages. Even though respondent had the opportunity to consider
the credibility of the witnesses, a witness’ testimony is not
necessarily conclusive as to the outcome of a factual issue. See
Williams v. United States, 26 Cl. Ct. 1031, 1032 (1992). That is
especially so where, as here, there is contradictory evidence.
Respondent could have reasonably decided to go to trial in the
hope that the Court would have found the documentary evidence
supporting respondent’s view more persuasive than the contrary
oral testimony supporting petitioners’ view.
Additionally, there is no indication that the evidence
relied on by respondent was “unusually scanty or unworthy of
belief” or that “respondent had taken his position for any
purpose other than to prevail in the litigation.” VanderPol v.
Commissioner, 91 T.C. 367, 370 (1988). Nor did respondent “offer
a novel or unsupported interpretation of the law or unreasonably
rely upon a statutory interpretation that already had been
rejected by this or another court.” Williams v. United States,
supra at 1031-1032. Respondent’s position was substantially - 9 -
justified in light of the facts and circumstances presented in
this case.
An appropriate order and
decision will be entered.