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Litigation Costs Denied Where IRS had Substantially Justifiable Position.
(Parker Tax Publishing October 7, 2014)

Taxpayers were not entitled to approximately $13,000 in administrative or litigation costs, even though they prevailed in their appeal of an IRS deficiency assessment, because they did not timely provide the IRS with information supporting their return position. Bussen v. Comm'r, T.C. Memo. 2014-185 (9/11/2014).

Brian and Apryl Bussen filed their 2009 tax return, listing their address at a U.S. military base in Germany. The return reported wages received by Brian, who at the time served with U.S. Air Force, but did not report wages earned by Apryl. The IRS sent the Bussens a notice proposing to increase their taxable income because of approximately $14,000 in unreported wages paid to Apryl in 2009. The Bussens did not dispute that Apryl received the compensation but did dispute, without including any supporting documentation, the proposed increase, arguing that Apryl earned the wages while physically present in Germany and was thus entitled to the foreign earned income exclusion under Code Sec. 911. In July 2012, the IRS mailed a notice of deficiency on the basis that Apryl's compensation was includable in the Bussen's income for 2009. In response, the couple filed a petition for redetermination arguing that the IRS erred in its determination because their 2009 tax home was in Germany and thus the exclusion was proper.

Upon referral to IRS Appeals, the IRS again requested support for the Bussens' position. The couple provided no evidence of Apryl's German residency and made a qualified offer of $0 for 2009, which the IRS rejected. Subsequently, the Bussens sent a copy of Brian's military orders to the Appeals office showing he was stationed in Germany during all of 2009, but the documents did not indicate whether Apryl had accompanied him. After a trial date was set, the Bussens submitted documentation including copies of Apryl's passport, their children's school records, and bank records reflecting transactions in Germany throughout 2009. The IRS conceded the case and sent settlement documents showing no deficiency due, which the Bussens accepted. The Bussens then moved for reasonable litigation or administrative costs of approximately $13,000.

An award of litigation or administrative costs under Code Sec. 7430(a) will be granted if the taxpayer is the prevailing party, has exhausted all administrative remedies with the IRS, and did not unreasonably protract the administrative or court proceedings. To be a prevailing party, the taxpayer must substantially prevail with respect to either the amount in controversy or the most significant issue or set of issues presented, and satisfy the applicable net worth requirements. However, the taxpayer will not succeed as the prevailing party if the IRS can establish that its position was substantially justified. As the Supreme Court held in Pierce v. Underwood, 487 U.S. 522 (1988), to be substantially justified, the position must be justified to a degree that could satisfy a reasonable person. Under Code Sec. 7430(c)4(e)(ii)(I), the qualified offer rule does not apply to any judgment issued pursuant to a settlement.

The Bussens argued that they should be considered the prevailing party because the IRS's position was not substantially justified. The IRS argued that, based on the evidence available to it at the time it took its position in the proceedings, it was substantially justified andacted reasonably.

The Tax Court held that the Bussens were not entitled to an award for litigation or administrative costs because the IRS's position was substantially justified. The court explained that the IRS's position was substantially justified because of its knowledge of the facts and circumstances both when the deficiency was issued and when the petition was filed. The court reasoned that because the Bussens' tax return did not report Apryl's wages and, at the time the notice of deficiency was issued the IRS had not received any documentation to support the Bussens' position that Apryl's income was excludible, the IRS was substantially justified in issuing a notice of deficiency.

For a discussion of the criteria taxpayers must meet to recover litigation or administrative costs, see Parker Tax ¶263,540. For information on the foreign earned income exclusion, see Parker Tax ¶78,620. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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