Tax Court & Board of Tax Appeals Reported Decisions
James H. Swanson, et ux. v. Commissioner, 106 TC 76, Code Sec(s) 4975; 7430.
Code Sec(s): 4975; 7430 [pg. 76]
Docket: Tax Ct. Dkt. No. 21203-92.
Date Issued: 2/14/1996.
Judge: Opinion by Dean, J.
Tax Year(s): Years 1986, 1988, 1989, 1990.
Disposition: Decision for Taxpayers in part and for Commissioner in
part.106 TC 76106 TC No. 3
1. Litigation costs-substantial justification for IRS position-IRAs; prohibited
and sham transactions.
Taxpayers were awarded litigation costs because IRS wasn’t substantially
justified in arguing transfer of 100% of DISC’s original issue stock and DISC’s
dividend payment to taxpayer’s 1st IRA, and transfer of 100% of FSC’s original
issue stock to taxpayer’s 2d IRA, were Code Sec. 4975 prohibited transactions:
DISC couldn’t be disqualified person prior to its initial stock issuance;
taxpayer- fiduciary didn’t deal with IRA’s assets in his own interest and
only realized benefits from the payments as IRA participant; and IRS didn’t
promptly concede its position. But, costs were denied where IRS was substantially
justified in arguing sale of taxpayers’ home to trust was sham: taxpayers
and daughter lived on property, paid expenses and made repairs before it
was sold to 3d party; and business purpose for trust’s purchase was questionable.
Reference(s): 74,305.01(25); 49,755.01(35) Code Sec. 4975; 7430
2. Litigation costs-prevailing party-net worth calculation; exhaustion of
administrative remedies; reasonable costs. Taxpayers properly calculated net
worth by measuring their asset acquisition costs by amounts paid, against
FMV, for litigation cost award purposes; didn’t unreasonably protract proceedings;
and exhausted administrative remedies per se, even though they didn’t request
Appeals Conference, because IRS hadn’t issued 30 day letter before mailing
deficiency notice. Court computed cost of living adjustment from Oct. 1, 1981,
and adjusted award to reflect amount of attorney time and miscellaneous costs
allocable to each issue.
Reference(s): 74,305.01(50); 74,305.01(10); 74,536.23151(10) Code Sec. 7430
Official Tax Court Syllabus
Ps filed a motion for reasonable litigation costs pursuant to Rule 231,
Tax Court Rules of Practice and Procedure, and sec. 7430, I.R.C., claiming
that R was not substantially justified in determining that: (1) Prohibited
transactions had occurred under sec. 4975, I.R.C., with respect to a domestic
international sales corporation, a foreign sales corporation, and two individual
retirement accounts; and (2) the sale of Ps’ Illinois residence to P’s closely
held corporation was a sham transaction.
 Held: R was not substantially justified with respect to the first issue,
but was substantially justified with respect to the second issue.
 Held, further, net worth, for purposes of the Equal Access to Justice
Act, 28 U.S.C. sec. 2412(d)(2)(B) (1994), as incorporated by sec. 7430(c)(4)(A)(iii),
is determined based upon the cost of acquisition rather than the fair market
value of assets, and was less than $2 million each with respect to Ps on the
date their petition was filed.
 Held, further, Ps’ failure to request an Appeals Office conference did
not constitute a “[refusal] *** to participate in an Appeals office conference”
within the meaning of sec. 301.7430-1(e)(2)(ii), Proced. & Admin. Regs.,
and, because no 30-day letter was issued to Ps prior to the mailing of their
notice of deficiency, Ps are deemed to have per se exhausted their administrative
remedies for purposes of sec. 7430(b)(1).
 Held, further, Ps have not unreasonably protracted the proceedings within
the meaning of sec. 7430(b)(4).
 Held, further, the amount sought by Ps for litigation costs in this
matter is not reasonable and must be adjusted to comport with the record.
Neal J. Block and Maura Ann McBreen, for petitioners.
Gregory J. Stull, for respondent.
This case was assigned to Special Trial Judge John F. Dean pursuant to the
provisions of section 7443A(b)(4) and Rules 180, 181, and 183 1 The Court
agrees [pg. 77] with and adopts the Special Trial Judge’s opinion, which is
set forth below.
OPINION OF THE SPECIAL TRIAL JUDGE
DEAN, Special Trial Judge: This matter is before the Court pursuant to petitioners’
motion for award of reasonable litigation costs under section 7430 and Rule
References to petitioner are to James H. Swanson.
The matter before us involves petitioners’ combined use of a domestic international
sales corporation, a foreign sales corporation, and two separate individual
retirement accounts as a means of deferring the recognition of income. Respondent
zealously strove to characterize this arrangement, as well as an unrelated
sale by petitioners of their Illinois residence, as tax avoidance schemes.
A protracted period of entrenchment ensued, during which the parties firmly
established their respective positions, neither side wavering from its conviction
that it was in the right. Ultimately, however, these issues were resolved
by respondent’s notice of no objection to petitioners’ motion for partial
summary judgment as well as the entry of an agreed decision document, which
was later set aside and filed as a stipulation of settlement. As a consequence,
petitioners now seek redress for what they claim were unreasonable positions
taken by respondent.
A. Factual Background
Petitioners resided in Florida at the time the petition was filed. At all
times relevant to the following discussion, petitioner was the sole shareholder
of H & S Swansons’ Tool Company (hereinafter, Swansons’ Tool), which has
operated as a Florida corporation since 1983 2 Swansons’ Tool elected to
be taxed as a subchapter S corporation effective in 1987.
Swansons’ Tool is in the business of building and painting component parts
for various equipment manufacturers. As a part of these activities, Swansons’
Tool manufactures and exports property for use outside the United States.
1. The DISC and IRA #1
Following the advice of experienced counsel, petitioner arranged in the
early part of January 1985 for the organization of Swansons’ Worldwide, Inc.,
a domestic international sales corporation (hereinafter the DISC or Worldwide).
During this period, petitioner also arranged for the formation of an individual
retirement account (hereinafter IRA #1).
The articles of incorporation for Worldwide were filed on January 9, 1985,
and under the terms thereof petitioner was named the corporation’s initial
director. Shortly thereafter, Worldwide filed a Form 4876A, Election to be
Treated as an Interest Charge DISC.
A Form 5305, Individual Retirement Trust Account, was filed on January 28,
1985, establishing Florida National Bank (hereinafter Florida National) as
trustee of IRA #1, and petitioner as the grantor for whose benefit the IRA
was established. Under the terms of the IRA agreement, petitioner retained
the power to direct IRA #1’s investments.
On the same day that the Form 5305 was filed, petitioner directed Florida
National to execute a subscription agreement for 2,500 shares of Worldwide
original issue stock. The shares were subsequently issued to IRA #1, which
became the sole shareholder of Worldwide.
For the taxable years 1985 to 1988, Swansons’ Tool paid commissions to Worldwide
with respect to the sale by Swansons’ Tool of export property, as defined
by section 993(c). In those same years, petitioner, who had been named president
of Worldwide, directed, with Florida National’s consent, that Worldwide pay
dividends to IRA #1 3 Commissions paid to Worldwide received preferential
treatment, 4 and the dividends paid to IRA #1 were tax deferred pursuant to
section 408. Thus, the net effect of these transactions was to defer [pg.
79] recognition of dividend income that otherwise would have flowed through
to any shareholders of the DISC.
In 1988, IRA #1 was transferred from Florida National Bank to First Florida
Bank, N.A. (hereinafter First Florida), as custodian. Swansons’ Tool stopped
paying commissions to Worldwide after December 31, 1988, as petitioners no
longer considered such payments to be advantageous from a tax planning perspective.
2. The FSC and IRA #2
In January 1989, petitioner directed First Florida to transfer $5,000 from
IRA #1 to a new individual retirement custodial account (hereinafter IRA #2).
Under the terms of the IRA agreement, First Florida was named custodian of
IRA #2, and petitioner was named as the grantor for whose benefit the IRA
was established. Under the terms of the IRA agreement, petitioner reserved
the right to serve as the “Investment Manager” of IRA #2.
Contemporaneous with the formation of IRA #2, petitioner incorporated H
& $ Swansons’ Trading Company (hereinafter Swansons’ Trading or the FSC).
Petitioner directed First Florida to execute a subscription agreement for
2,500 newly issued shares of Swansons’ Trading stock. The shares were subsequently
issued to IRA #2, which became the corporation’s sole shareholder. Swansons’
Trading filed a Form 8279, Election To Be Treated as a FSC or as a Small
FSC, on March 31, 1989, and paid a dividend to IRA #2 in the amount of $28,000
during the taxable year 1990.
3. The Algonquin Property
In anticipation of Swansons’ Tool’s transferring its operations to Florida,
petitioners moved during 1981 from their Algonquin, Illinois, residence (hereinafter,
the Algonquin property or the property) to a condominium in St. Petersburg,
Florida. The Algonquin property was not advertised for sale until sometime
Conscious of a change in the Internal Revenue Code which would eliminate
preferential treatment of capital gain recognized on the sale of their home,
petitioners sought to sell the [pg. 80] Algonquin property prior to December
31, 1986. 5 As time was clearly a factor, petitioners arranged to sell the
property to a trust of which Swansons’ Tool was the beneficiary. Accordingly,
on December 19, 1986, petitioners conveyed the Algonquin property to “Trust
No. 234, Barry D. Elman, trustee,” (hereinafter Trust No. 234) under a Deed
in Trust, which was received and filed by the Recorder for the city of McHenry,
Illinois. As a consequence of this transaction, petitioners reported a long-term
capital gain of $141,120.78 on Schedule D, Capital Gains and Losses, of their
1986 Federal income tax return, reflecting a $225,000 sale price and an $83,879
Petitioners continued paying the electric bills, heating, exterior maintenance,
and house sitting expenses of the Algonquin property through May or June of
1987. In March of 1988, Swansons’ Tool reimbursed petitioners for maintenance
and repair expenses incurred during the time period December 1986 through
May 1987, as well as the expense of moving petitioners’ personal belongings
in September 1987. Swansons’ Tool capitalized these expenditures as part of
its basis in the Algonquin property. Subsequent to the signing of a “Real
Estate Sales Contract” during March of 1988, the Algonquin property was sold
by Swansons’ Tool to an unrelated third party on June 23, 1988.
Petitioners’ daughter, Jill, resided at the Algonquin residence from May
of 1987 through June of 1988. Although the record is not clear as to the extent
of usage, it appears that petitioners also periodically stayed at the residence
subsequent to its sale on December 19, 1986.
4. The Notice of Deficiency
Despite petitioners’ agreement to extend the period of limitations in their
case until June 30, 1992, petitioners did not receive a 30-day letter prior
to the notice of deficiency. Petitioners agreed to the extension in the hope
of resolving the case at the administrative level.
In the notice of deficiency, dated June 29, 1992, respondent set forth one
primary and three alternative positions for determining deficiencies in petitioners’
Federal income taxes [pg. 81] and additions to tax for negligence with respect
to petitioners’ 1986, 1988, 1989, and 1990 taxable years. Of relevance to
the present matter were respondent’s determinations that: (1) “prohibited
transactions” had occurred which resulted in the termination of IRA’s #1 and
#2; and (2) the sale of the Algonquin property to a trust in 1986 was a “sham”
transaction which could not be recognized for tax purposes.
a. “Prohibited Transactions”
Because the notice of deficiency failed to adequately explain respondent’s
bases for determining deficiencies and additions to tax with respect to the
years at issue, petitioners requested and received the revenue agent’s report
in their case. As demonstrated by the revenue agent’s report, respondent identified,
as alternative positions, two “prohibited transactions” which resulted in
the loss of IRA #1’s status as a trust under section 408. First, respondent
Mr. Swanson is a disqualified person within the meaning of section 4975(e)(2)(A)
of the Code as a fiduciary because he has the express authority to control
the investments of *** [IRA #1].
Mr. Swanson is also an Officer and Director of Swansons’ Worldwide. Therefore,
direct or indirect transactions described by section 4975(c)(1) between Swansons’
Worldwide and *** [IRA #1] constitute prohibited transactions.
Mr. Swanson, as an Officer and Director of Worldwide directed the payment
of dividends from Worldwide to *** [IRA #1] *** The payment of dividends is
a prohibited transaction within the meaning of section 4975(c)(1)(E) of the
Code as an act of self-dealing where a disqualified person who is a fiduciary
deals with the assets of the plan in his own interest. The dividend paid to
*** [IRA #1] December 30, 1988 will cause the IRA to cease to be an IRA effective
January 1, 1988 by reason of section 408(e)(1). Therefore, by operation of
section 408(d)(1), the fair market value of the IRA is deemed distributed
January 1, 1988. [Emphasis added.]
As further demonstrated by the revenue agent’s report, respondent’s second
basis for disqualifying IRA #1 under section 408 was that:
In his capacity as fiduciary of *** [IRA #1], Mr. Swanson directed the bank
custodian, Florida National Bank, to purchase all of the stock of Swansons’
Worldwide. At the time of the purchase, Mr. Swanson was the sole director
of Swansons’ Worldwide.
The sale of stock by Swansons’ Worldwide to Mr. Swanson’s Individual Retirement
Account constitutes a [pg. 82] prohibited transaction within the meaning of
section 4975(c)(1)(A) of the Code. The sale occurred February 15, 1985. By
operation of section 408(e)(2)(A) of the Code, the Individual Retirement Account
ceases to be an Individual Retirement Account effective January 1, 1985.
Effective January 1, 1985 the Individual Retirement Account is not exempt
from tax under section 408(e)(1) of the Code. The fair market value of the
account, including the 2500 shares of Swansons’ Worldwide, is deemed to have
been distributed to Mr. Swanson in accordance with section 408(e)(2)(B) of
the Code. Therefore, Mr. Swanson effectively became the sole shareholder of
Swansons’ Worldwide, Inc. with the loss of the IRA’s tax exemption. [Emphasis
Although the record is not entirely clear on the matter, it appears that
respondent imputed to IRA #2 the prohibited transactions found with respect
to IRA #1 and used similar reasoning to disqualify IRA #2 as a valid trust
under section 408(a).
b. “Sham Transaction”
With respect to the Algonquin property, respondent concluded in the notice
of deficiency that:
the purported sale of your personal residence located in Algonquin, Illinois
by you in 1986 to Trust #234, Barry D. Elman, Trustee, of which your corporation,
H & S Swansons’ Tool Company, Inc. is the beneficiary, can not be recognized
for tax purposes. The purported sale in 1986 was no more than a sham transaction
which was entered into for tax avoidance purposes. it is determined that the
purported sale served no other purpose than to enable you to obtain the tax
benefit of a long term capital gain deduction of 60 percent that would not
have been available had the sale occurred in tax years subsequent to 1986.
*** [Emphasis added. 6 ]
5. The Petition, Answer, Motion for Summary Judgment, and Settlement Agreement
In their petition, filed September 21, 1992, petitioners stated with respect
to respondent’s determination of “prohibited transactions” that:
At all pertinent times IRA #1 was the sole shareholder of Worldwide;
since the 2,500 shares of Worldwide issued to IRA #1 were original issue,
no sale or exchange of the stock occurred;
from and after the dates of his appointment as director and president of
Worldwide, Mr. Swanson engaged in no activities on behalf of Worldwide [pg.
83] which benefited him other than as a beneficiary of IRA #1;
IRA #1 was not maintained, sponsored, or contributed to by Worldwide during
the years at issue;
at no time did Worldwide have any active employees; and
Mr. Swanson engaged in no activities on behalf of Swansons’ Trading which
benefited him other than as a beneficiary of IRA #2.
With respect to the Algonquin residence, petitioners stated, in pertinent
part, that: (1) On December 19, 1986, petitioners conveyed the Algonquin property
by a Deed in Trust to a trust of which Swansons’ Tool was the beneficiary;
(2) the transfer documents conveyed full legal and beneficial ownership from
petitioners to this trust; (3) at no time did petitioners act in any manner
that was inconsistent with their transfer of all their right, title, and interest
in the Algonquin property; and (4) subsequent to the sale, petitioners had
no rights as tenants of the property other than as tenants at will.
Respondent filed an answer on November 13, 1992, denying, or denying for
lack of knowledge, each of the allegations listed above.
Petitioners filed a motion for partial summary judgment on March 22, 1993.
In their motion, petitioners restated their position, as set forth in their
petition, that no prohibited transactions had occurred with respect to IRA’s
#1 and #2.
On July 12, 1993, respondent filed a notice of no objection to petitioners’
motion for partial summary judgment, thereby ending the controversy on the
DISC and FSC issues.
Respondent conceded the Algonquin property issue in a settlement agreement
entered into on January 24, 1994. The parties agreed at that time to a total
deficiency of $11,372.40, which reflected an amount conceded by petitioners
in their petition as capital gain inadvertently omitted from their 1988 Federal
income tax. A stipulated decision (hereinafter the decision) was submitted
by the parties and entered on February 9, 1994.
6. Motion for Award of Reasonable Litigation Costs On March 14, 1994, this
Court received petitioner Josephine Swanson’s motion for award of reasonable
litigation costs (hereinafter also referred to as the motion). Finding that
it was not petitioner Josephine Swanson’s intent that the decision entered
on February 9, 1994, be conclusive [pg. 84] as to the issue of attorney’s
fees, the Court ordered on April 29, 1994, that the decision be vacated and
set aside. The Court further ordered that the decision of February 9, 1994,
be filed as a stipulation of settlement, that petitioner Josephine Swanson’s
motion for award of reasonable litigation costs be filed, and that respondent
file a response to petitioner Josephine Swanson’s motion in accordance with
Rule 232(c). Respondent’s objection to petitioner Josephine Swanson’s motion
for award of reasonable litigation costs was filed on June 29, 1994. Petitioners
sought leave to file a response to respondent’s objection by a motion filed
August 3, 1994, which was granted. Petitioners filed an amendment to the motion
for award of reasonable litigation costs (hereinafter amendment to motion)
on August 1, 1994, pursuant to which petitioner James Swanson joined petitioner
Josephine Swanson as a party to the motion. Petitioners filed their response
to respondent’s objection to petitioners’ motion for award of reasonable
litigation costs on September 15, 1994. Following a conference call with
the parties on March 20, 1995, the parties were ordered to file a stipulation
of facts with respect to items of net worth reported by petitioners on attachment
II of their amendment to motion. They were further ordered to file a stipulation
of facts regarding the issue of attorney’s fees paid or incurred by petitioners.
If the parties could not stipulate facts with respect to either issue, they
were ordered to file a status report with the Court on or before May 1, 1995.
On May 1, 1995, the parties participated in a conference call, during which
they agreed to stipulate certain items of net worth reported on attachment
II of petitioners’ amendment to motion. The parties also agreed to stipulate
that petitioners paid or incurred fees in this matter. The parties disagreed,
however, as to the proper method for determining the acquisition cost of
specific items on attachment II of petitioners’ amendment to motion. With
respect to these items, the parties were ordered to file, on or before June
1, 1995, simultaneous memoranda of law, and, on or before July 3, 1995, answering
memoranda of law. [pg. 85]
As an initial matter, we reject respondent’s argument that it was improper
for us to have vacated the decision of February 9, 1994, thereby allowing
petitioners to file their motion for award of reasonable litigation costs.
This Court may, in its sound discretion, set aside a decision that has not
yet become final. See, e.g., Cassuto v. Commissioner, 93 T.C. 256, 260 (1989),
affd. in part, revd. in part, and remanded on another issue 936 F.2d 736 [68
AFTR 2d 91-5096] (2d. Cir. 1991). Having so held, we turn to the merits of
Section 7430 provides that, in any court proceeding brought by or against
the United States, the “prevailing party” may be awarded reasonable litigation
costs. Sec. 7430(a). To qualify as a “prevailing party” for purposes of section
7430, petitioners must establish that: (1) The position of the United States
in the proceeding was not substantially justified; (2) they substantially
prevailed with respect to the amount in controversy, or with respect to the
most significant issue presented; and (3) they met the net worth requirements
of 28 U.S.C. sec. 2412(d)(2)(B) (1994), on the date the petition was filed.
Sec. 7430(c)(4)(A). Petitioners must also establish that they exhausted the
administrative remedies available to them within the Internal Revenue Service
and that they did not unreasonably protract the proceedings. Sec. 7430(b)(1),
(4). Petitioners bear the burden of proof with respect to each of the preceding
requirements. Rule 232(e).
Although it is conceded that petitioners substantially prevailed in this
case, respondent does not agree that her litigation position was not substantially
justified. 7 Furthermore, respondent asserts that petitioners: (1) Have not
satisfied the net worth requirements, (2) failed to exhaust the administrative
remedies available to them within the Internal Revenue Service, (3) unreasonably
protracted the proceedings, and (4) [pg. 86] have not shown that the costs
they have claimed are reasonable. We will address each contested point in
1. Whether Respondent’s Litigation Position Was Substantially Justified
In 1986, Congress amended section 7430 to conform that provision more closely
to the Equal Access to Justice Act (EAJA). Tax Reform Act of 1986, Pub. L.
99-514, sec. 1551, 100 Stat. 2085, 2752. Where the prior statute required
taxpayers to prove that the Government’s position in a proceeding was “unreasonable,”
the statute as amended now requires a showing that the position of the United
States was “not substantially justified.” Sec. 7430(c)(4)(A)(i). This Court
has concluded that the substantially justified standard is essentially a continuation
of the prior law’s reasonableness standard. Sher v. Commissioner, 89 T.C.
79, 84 (1987), affd. 861 F.2d 131 [63 AFTR 2d 89-422] (5th Cir. 1988). Thus,
a position that is “substantially justified” is one that is “justified to
a degree that could satisfy a reasonable person” or that has a “reasonable
basis both in law and fact.” Pierce v. Underwood, 487 U.S. 552, 565 (1988)
(internal quote marks omitted) (defining “substantially justified” in the
context of the EAJA).
Petitioners have not sought an award of administrative costs in this matter.
Accordingly, we need only examine the question of whether respondent’s litigation
position was substantially justified. 8
Respondent argues that we may not consider positions she took prior to the
filing of the answer in determining whether her litigation position was substantially
justified. In support, respondent cites, among other cases, 9 Huffman v. Commissioner,
978 F.2d 1139 [70 AFTR 2d 92-6016] (9th Cir. 1992), affg. in part and revg.
in part T.C. Memo. 1991-144 [91,144 PH Memo TC].
Respondent is correct in stating that Huffman approves of a bifurcated analysis
under section 7430, pursuant to which the two stages of a case, the administrative
proceeding and the court proceeding, are considered separately. This bifurcated
analysis: [pg. 87]
not only ensures that the prevailing taxpayer is reimbursed for pre-litigation
and litigation costs, but also supports Congress’s intent that before an award
of attorney’s fees is made, the taxpayer must meet the burden of proving that
the Government’s position was not substantially justified. It affords another
opportunity for the United States to reconsider an inappropriate position.
[Id. at 1146.]
Respondent’s arguments on this point appear moot, however, as we find no
discernible difference between the administrative and litigation positions
she took in this matter. 10 See Lennox v. Commissioner, 998 F.2d 244, 247-249
[72 AFTR 2d 93- 5710] (5th Cir. 1993) (holding that the Government’s position
must be analyzed in the context of the circumstances that caused it to take
that position), revg. in part and remanding T.C. Memo. 1992-382 [1992 RIA
TC Memo 92,382].
a. The DISC Issue
Petitioners contend that respondent was not substantially justified in maintaining
throughout the proceedings that prohibited transactions had occurred with
respect to IRA #1, and by implication, IRA #2. We agree.
As stated previously, respondent based her determination of prohibited transactions
on section 4975(c)(1)(A) and (E). Section 4975(c)(1)(A) defines a prohibited
transaction as including any “sale or exchange, or leasing, of any property
between a plan 11 and a disqualified person”. 12 Section [pg. 88] 4975(c)(1)(E)
further defines a prohibited transaction as including any “act by a disqualified
person who is a fiduciary 13 whereby he deals with the income or assets of
a plan in his own interest or for his own account”.
We find that it was unreasonable for respondent to maintain that a prohibited
transaction occurred when Worldwide’s stock was acquired by IRA #1. The stock
acquired in that transaction was newly issued – prior to that point in time,
Worldwide had no shares or shareholders. A corporation without shares or shareholders
does not fit within the definition of a disqualified person under section
4975(e)(2)(G). 14 It was only after Worldwide issued its stock to IRA #1
that petitioner held a beneficial interest in Worldwide’s stock, thereby
causing Worldwide to become a disqualified person under section 4975(e)(2)(G).
15 Accordingly, the issuance of stock to [pg. 89] IRA #1 did not, within the
plain meaning of section 4975(c)(1)(A), qualify as a “sale or exchange, or
leasing, of any property between a plan and a disqualified person”. 16 Therefore,
respondent’s litigation position with respect to this issue was unreasonable
as a matter of both law and fact.
We also find that respondent was not substantially justified in maintaining
that the payments of dividends by Worldwide to IRA #1 qualified as prohibited
transactions under section 4975(c)(1)(E). There is no support in that section
for respondent’s contention that such payments constituted acts of self-dealing,
whereby petitioner, a “fiduciary”, was dealing with the assets of IRA #1 in
his own interest. Section 4975(c)(1)(E) addresses itself only to acts of
disqualified persons who, as fiduciaries, deal directly or indirectly with
the income or assets of a plan for their own benefit or account. Here, there
was no such direct or indirect dealing with the income or assets of a plan,
as the dividends paid by Worldwide did not become income of IRA #1 until
unqualifiedly made subject to the demand of IRA #1. Sec. 1.301-1(b), Income
Tax Regs. Furthermore, respondent has never suggested that petitioner, acting
as a “fiduciary” or otherwise, ever dealt with the corpus of IRA #1 for his
Based on the record, the only direct or indirect benefit that petitioner
realized from the payments of dividends by Worldwide related solely to his
status as a participant of IRA #1. In this regard, petitioner benefited only
insofar as IRA #1 [pg. 90] accumulated assets for future distribution. Section
4975(d)(9) states that section 4975(c) shall not apply to:
receipt by a disqualified person of any benefit to which he may be entitled
as a participant or beneficiary in the plan, so long as the benefit is computed
and paid on a basis which is consistent with the terms of the plan as applied
to all other participants and beneficiaries.
Thus, we find that under the plain meaning 17 of section 4975(c)(1)(E),
respondent was not substantially justified in maintaining that the payments
of dividends to IRA #1 constituted prohibited transactions. Respondent’s
litigation position with respect to this issue was unreasonable as a matter
of both law and fact. 18 Respondent would have us believe that the delay
in settling the DISC issue was due to a statement in petitioners’ motion
for partial summary judgment that IRA #1 was exempt from tax at all times.
In her memorandum in objection to petitioners’ motion for litigation costs,
respondent contends that this was a “new and overriding issue” that required
her to determine whether “any other” prohibited transactions had occurred
during the period covered by the notice of deficiency. We disagree.
We need look no further than respondent’s own memorandum to divine that
the true reason for her delay in conceding the DISC issue was her desire
to discover new facts with which to resuscitate her meritless litigation
position. The following statements from respondent’s memorandum are illuminating
in this regard:
due to the complexity of the prohibited transaction rules and the many ways
in which disqualified person status can be achieved through specific relationships
described in I.R.C. section 4975(e)(2), it was imperative that [pg. 91] respondent
explore other possible violations before conceding that the facts (as represented
by petitioner’s counsel) demonstrated no violation.
Petitioner husband established the IRA and created a DISC inside of his
IRA to shelter from current income inclusion dividend payments made by an
international trading company in which he was the sole shareholder. But for
the existence of the IRA, such dividends would be currently taxable to him.
If he had created the DISC outside of the IRA, and then sold some or all
of the stock in the DISC to the IRA, the sale of stock in the DISC to his
IRA would clearly violate the prohibited transactions rules under I.R.C.
section 4975. Similarly, the payment of any dividends from his wholly owned
corporation to his IRA that effectively allows him to avoid current income
inclusion because he assigned his interest in the DISC to his IRA arguably
represents an indirect benefit to him personally.
For example, both petitioner husband and petitioner wife indirectly received
a significant current tax benefit derived from the payment of DISC dividends
into his IRA, rather than to the husband as a direct shareholder. But for
the creation and maintenance of the IRA, petitioner husband (and, by virtue
of her election to file a joint return, the petitioner wife) would have current
income inclusion for payments from the trading corporation to the DISC. Accordingly,
the transactions between his wholly- owned trading corporation to such entity
are arguably indirect prohibited transactions between disqualified persons
and the IRA. Also, since one slight variation in the structure or operation
of the petitioner’s transactions could have resulted in noncompliance with
the prohibited transactions rules, it was clearly reasonable for respondent
not to concede her position on answer and to analyze thoroughly all positions
presented by petitioner’s counsel during the litigation stage of the case.
We read the preceding statements as an acknowledgment by respondent that
her litigation position, as developed in the administrative proceedings and
adopted in her answer, was without a foundation in fact or law. This case
is distinguishable from those in which respondent promptly conceded an unreasonable
position taken in her answer, thereby avoiding an award of litigation costs.
Nothing occurred between the filing of respondent’s answer and her notice
of no objection to alter the fact that she had misapplied the prohibited transaction
rules of section 4975 to petitioners’ case. Accordingly, we find that respondent’s
litigation position with respect to IRA #1 was not substantially justified.
Petitioners are therefore entitled to an award of litigation costs under
As respondent’s determination of deficiencies with respect to IRA #2 was
inexorably linked to the fate of IRA #1, the [pg. 92] award of litigation
costs is also intended to cover respondent’s litigation position with respect
to IRA #2. 19
b. The House Issue
Petitioners contend that respondent was not substantially justified in determining
that the sale of the Algonquin property to Trust No. 234 was a sham transaction.
Respondent, on the other hand, argues that such a determination was reasonable,
particularly in light of the postsale use by petitioners and their daughter.
A “sham” transaction is one which, though it may be proper in form, lacks
economic substance beyond the creation of tax benefits. Karr v. Commissioner,
924 F.2d 1018, 1022-1023 [67 AFTR 2d 91- 653] (11th Cir. 1991), affg. Smith
v. Commissioner, 91 T.C. 733 (1988). In the context of a sale transaction,
as here, the inquiry is whether the parties have in fact done what the form
of their agreement purports to do. Grodt & McKay Realty, Inc. v. Commissioner,
77 T.C. 1221, 1237 (1981).
The term “sale” is given its ordinary meaning for Federal income tax purposes
and is generally defined as a transfer of property for money or a promise
to pay money. Commissioner v. Brown, 380 U.S. 563, 570-571 [15 AFTR 2d 790]
(1965). In deciding whether a particular transaction constitutes a sale, the
question of whether the benefits and burdens of ownership have passed from
seller to buyer must be answered. This is a question of fact which is to
be ascertained from the intention of the parties, as evidenced by the written
agreements read in light of the attendant facts and circumstances. Haggard
v. Commissioner, 24 T.C. 1124, 1129 (1955), affd. 241 F.2d 288 [50 AFTR 1035]
(9th Cir. 1956).
Various factors to consider in making a determination as to whether a sale
has occurred were summarized in Grodt & McKay Realty, Inc. v. Commissioner,
supra at 1237-1238, as follows:
(1) Whether legal title passes; (2) how the parties treat the transaction;
(3) whether equity was acquired in the property; (4) whether the contract
creates a present obligation on the seller to execute and deliver a deed and
a present obligation on the purchaser to make payments; (5) whether the right
of possession is vested in the purchaser; (6) which party pays the property
taxes; (7) which party bears the risk of loss or damage to the [pg. 93] property;
and (8) which party receives the profits from the operation and sale of the
property. *** [Citations omitted.]
An additional factor to be weighed is the presence or absence of arm’s-length
dealing. Falsetti v. Commissioner, 85 T.C. 332, 348 (1985) (citing Estate
of Franklin v. Commissioner, 64 T.C. 752 (1975), affd. 544 F.2d 1045 [38 AFTR
2d 76-6164] (9th Cir. 1976)).
We recognize that a number of the factors listed above favor petitioners’
contention that the sale of the Algonquin property was not a “sham” transaction.
Nevertheless, the fact remains that petitioners continued paying the heating,
electricity, security, and maintenance expenses incurred for the property
until sometime in June 1987; i.e., over 5 months after their sale of the property
to Trust No. 234. Petitioners also paid for a number of repairs to the property
prior to its sale to a third party in 1988. Although petitioners were ultimately
reimbursed for all or part of these expenses, it appears that such reimbursement
did not occur until proximate to the time a contract of sale was signed between
Trust No. 234 and the third party. Finally, we cannot discount the fact that
petitioners and their daughter occupied the property at various times between
the time of its sale to the trust and its ultimate sale to a third party.
In the case of the daughter, this period of occupancy lasted just over 1
year and ended shortly before the property was sold to the third party in
June of 1988. The foregoing takes on added significance in light of the fact
that petitioner was on “both sides” of the initial sale – both as owner of
the property and as the sole shareholder of Swansons’ Tool. Combined with
the questionable business purpose behind a manufacturing corporation’s purchase
of a personal residence, we do not find it unreasonable that respondent would
challenge the sale as not being at arm’s-length.
Based on the record as a whole, we cannot say that respondent’s position
with respect to the house issue was unreasonable, as a matter of either law
or fact. We recognize that petitioners have cited a number of cases supporting
the proposition that sales to close corporations by shareholders are not “sham”
transactions per se. We further note that petitioners cited cases supporting
the permissible occupancy of a residence subsequent to its sale. A careful
reading of each, however, does not persuade us that, based on the facts [pg.
94] of this case, respondent’s litigation position was not substantially justified.
Accordingly, we find that petitioners have failed to meet their burden of
proof on this issue. 20
Our conclusion is not diminished by the fact that respondent ultimately
conceded this matter in petitioners’ favor prior to trial. The determination
of whether respondent’s position was substantially justified is based on
all the facts and circumstances surrounding a proceeding; the fact that respondent
ultimately concedes or loses a case is not determinative. See Wasie v. Commissioner,
86 T.C. 962, 968-969 (1986); DeVenney v. Commissioner, 85 T.C. 927, 930 (1985).
2. Net Worth
Respondent contends that petitioners have failed to demonstrate that they
satisfied the net worth requirement of section 7430(c)(4)(A)(iii).
To qualify as a prevailing party eligible for an award of litigation costs,
a taxpayer must establish that he or she has a net worth that did not exceed
$2 million “at the time the civil action was filed”. 21 In the case of a husband
and wife seeking an award of litigation costs, the net worth test is applied
to each separately. Hong v. Commissioner, 100 T.C. 88, 91 (1993).
Although the term “net worth” is not statutorily defined, the legislative
history to the EAJA states: “In determining the value of assets, the cost
of acquisition rather than fair market value should be used.” H. Rept. 96-1418,
at 15 (1980); see also United States v. 88.88 Acres of Land, 907 F.2d 106,
107 (9th Cir. 1990); American Pacific Concrete Pipe Co., Inc. v. [pg. 95]
NLRB, 788 F.2d 586, 590 (9th Cir. 1986); Continental Web Press, Inc. v. NLRB,
767 F.2d 321, 322-323 (7th Cir. 1985).
To demonstrate that they each had a net worth of less than $2,000,000 on
the date their petition was filed, petitioners submitted, on August 1, 1994,
a “STATEMENT OF NET WORTH AT ACQUISITION COST AS OF SEPTEMBER 21, 1992”. 22
Petitioners’ separate net worths were reported on this statement as follows:
Asset Acq. Cost James Josephine
Cash/Checking $48,375 $24,188 $24,188
Money Fund 188,657 188,657 –
Repo Account 184,155 184,155 –
Mortgage 76,225 38,113 38,113
Mortgage 40,000 40,000 –
Contract 34,433 34,433 –
Note-1 26,815 26,815 –
Note-2 2,300 2,300 –
Note-3 80,000 80,000 –
Note-4 17,500 17,500 –
IRA-Kemper 9,000 9,000 –
IRA-Kemper 8,250 – 8,250
IRA-1st Fla. 2,500 2,500 –
IRA-1st Fla. 5,000 5,000 –
401-K Plan 45,000 45,000 –
Condo 185,000 – 185,000
Industrial Bldg. 107,500 – 107,500
Industrial Bldg. 260,000 – 260,000
Industrial Vacant 65,000 65,000 –
Stock – HSSTC 59,200 59,200 –
Prestige 23,500 – 23,500
Breck 25,000 25,000 –
West Coast 25,000 25,000 –
Sunshine 20,910 20,910 –
FSCC 5,000 5,000 –
Sailboat 85,000 85,000 –
Motorboat 8,000 8,000 –
Auto 17,000 – 20,000 [sic]
Art, etc. 40,000 20,000 20,000
_________ _________ _______
Totals 1,694,322 [sic] 1,010,771 683,551
With an exception for the four IRA’s, the 401(k) plan, and the stock of
the six listed corporations, the parties stipulated on May 16, 1995, to the
accuracy of the preceding statement. 23 [pg. 96]
Pursuant to our Order of May 1, 1995, the parties submitted simultaneous
and answering memoranda of law, addressing the proper method for determining
the acquisition cost of those assets for which there had been no stipulation.
As set forth in these memoranda, petitioners argue for an approach whereby
the amount paid for an asset, adjusted for depreciation, establishes the acquisition
cost of an asset for purposes of the net worth computation. Respondent, on
the other hand, argues that the acquisition cost of an asset should constantly
be adjusted to reflect realized (if not recognized) income. To quote respondent:
In summary, acquisition costs of an asset are generated not only from external
contributions but also from realized gains, the internal reinvestment of which
acquires an increase, improvement, or enhancement in such asset.
Having carefully considered the parties’ respective arguments, we accept
petitioners’ computation of their net worth under section 7430(c)(4)(A)(iii).
We find no basis in this case for disregarding the separate legal status of
entities in which petitioners hold beneficial or legal interests. See, e.g.,
Moline Properties, Inc. v. Commissioner, 319 U.S. 436, 438-439 [30 AFTR 1291]
(1943); Webb v. United States, 15 F.3d 203, 207 [73 AFTR 2d 94-1019] (1st
Cir. 1994); Bertoli v. Commissioner, 103 T.C. 501, 511-512 (1994); Allen v.
Commissioner, T.C. Memo. 1988-166 [88,166 PH Memo TC].
Respondent argues that even if Congress originally intended acquisition
cost as the proper measure of net worth, relatively recent trends in generally
accepted accounting principles (GAAP) require that such a measure be abandoned.
We have considered respondent’s arguments on this point and find them off
the mark. While there has been a change in the rules regarding the method
by which individuals prepare their financial statements, there has been no
change in the definition of acquisition cost under GAAP, and as that was the
standard set forth in the legislative history, it is the measure of net worth
we apply to this case. 24 [pg. 97]
After careful review of the record, we find that petitioners have adequately
set forth a statement of their net worth pursuant to Rule 231(b)(5) and have
met the burden of proving that their separate net worths did not exceed $2
million on the date they filed their petition.
We have considered all other arguments raised by respondent regarding the
net worth requirement and, to the extent not discussed above, find them to
be without merit. Before continuing, however, we find it necessary to comment
on some of the arguments raised by respondent in her memoranda.
While there was colorable merit to some of the contentions raised by respondent
in her memoranda regarding the question of net worth, others border on being
frivolous and vexatious. As an illustration, respondent set forth the following
proposition in arguing that additional amounts should be added to petitioner
Josephine Swanson’s calculation of net worth:
Florida provides for the equitable distribution of property between spouses
upon divorce. Fla. Stat. ch. 61.075 (1994). ***
Respondent notes that the record provides no indication of marital disharmony
between the petitioners and presumes that Florida’s equitable distribution
statute does not expressly apply to this case. However, this significant expectancy
to receive an equitable distribution in the event of divorce may itself constitute
an asset of a spouse entitled to recognition for purposes of the net worth
Such transparent sophistry speaks for itself and comes perilously close
to meriting an award of fees to petitioners under section 6673(a)(2).
3. Exhaustion of Administrative Remedies
Notwithstanding our conclusion that respondent was not substantially justified
with respect to the DISC issue, petitioners are not entitled to an award of
litigation costs if it is found that they failed to exhaust their administrative
No “30-day letter” was issued to petitioners prior to the issuance of the
statutory notice of deficiency. Respondent contends, however, that petitioners
failed to exhaust their administrative remedies by not seeking an Appeals
Office [pg. 98] conference prior to the filing of their motion for summary
judgment. In support, respondent maintains that:
After commencing litigation, *** [petitioners’] attorneys forged quickly
ahead by filing a motion for partial summary judgment without attempting to
confer with either Appeals or District Counsel to seek a possible settlement
– a conference which likely would have eliminated the need for the parties
to prepare a prosecution and defense of the motion and its extensive exhibits
and attachments, perhaps resulting in reduced litigation activities, saving
time for the parties and the Court.
In opposition, petitioners state that, pursuant to section 301.7430-1(e)(2),
Proced. & Admin. Regs., they have per se exhausted their administrative
In pertinent part, section 301.7430-1(e), Proced. & Admin. Regs., sets
forth the following exception to the general rule that a party must participate
25 in an Appeals Office conference in order to exhaust its administrative
(e) Exception to requirement that party pursue administrative remedies.
If the conditions set forth in paragraphs (e)(1), (e)(2), (e)(3), or (e)(4)
of this section are satisfied, a party’s administrative remedies within the
Internal Revenue Service shall be deemed to have been exhausted for purposes
of section 7430. ***
(2) In the case of a petition in the Tax Court –
(i) The party did not receive a notice of proposed deficiency (30-
day letter) prior to the issuance of the statutory notice and the failure
to receive such notice was not due to actions of the party (such as failure
to supply requested information or a current mailing address to the district
director or service center having jurisdiction over the tax matter); and
(ii) The party does not refuse to participate in an-Appeals
office conference while the case is in docketed status. [Emphasis added.]
Section 301.7430-1, Proced. & Admin. Regs., fails to define the phrase
“does not refuse to participate&. Respondent’s arguments suggest that
section 301.7430-1(e)(2), Proced. & Admin. Regs., is to be interpreted
as requiring an affirmative act by petitioners; i.e., a request for an Appeals
Office conference. Petitioners, on the other hand, [pg. 99] contend that the
proper interpretation is one that puts the burden on respondent, requiring
that she act affirmatively. Petitioners reason that they cannot “refuse to
participate” in an Appeals Office conference unless and until respondent makes
an offer of such a conference. 26
We conclude that petitioners’ reading of section 301.7430-1(e)(2), Proced.
& Admin. Regs., is correct. Section 601.106(d)(3), Statement of Procedural
Rules, states that with respect to cases docketed in the Tax Court:
(iii)If the deficiency notice in a case docketed in the Tax Court was not
issued by the Appeals office and no recommendation for criminal prosecution
is pending, the case will be referred by the district counsel to the Appeals
office for settlement as soon as it is at issue in the Tax Court. The settlement
procedure shall be governed by the following rules:
(a) The Appeals office will have exclusive settlement jurisdiction for a
period of 4 months over certain cases docketed in the Tax Court. The 4 month
period will commence at the time Appeals receives the case from Counsel, which
will be after the case is at issue. Appeals will arrange settlement conferences
in such cases within 45 days of receipt of the case. *** [Emphasis added.]
The notice of deficiency in this matter was issued by the District Director
for Jacksonville, Florida. There is no suggestion that a recommendation for
criminal prosecution was ever pending against petitioners. Accordingly, pursuant
to the procedural rules, respondent’s Appeals Office gained settlement jurisdiction
over petitioners’ case after it was docketed in this Court and maintained
such jurisdiction for a period of 4 months. Contrary to the language of section
601.106(d)(3)(iii)(a), Statement of Procedural Rules, however, Appeals in
this case did not arrange a settlement conference within 45 days of receipt
of petitioners’ case. Petitioners could not, therefore, have refused to participate
in an Appeals Office conference, as none was ever offered.
We note that when a 30-day letter has been issued, the procedural rules
provide that, in general, the taxpayer is entitled, as a matter of right,
to an Appeals Office conference. See sec. 601.106(b), Statement of Procedural
Rules. No such right exists, however, once the taxpayer’s case is docketed
in the Tax Court. Furthermore, once the case is [pg. 100] docketed, there
is no provision in the procedural rules for a taxpayer request for an Appeals
Based on the foregoing, we find that petitioners have exhausted their administrative
remedies within the meaning of section 7430 and the regulations thereunder.
4. Whether Petitioners Unreasonably Protracted the Proceedings
Based upon the record, we find that petitioners did not protract the proceedings.
5. Whether the Fees Sought in This Matter Are Reasonable
As discussed below, we find that the amount sought by petitioners in this
matter for litigation costs is not reasonable and must be adjusted to comport
with the record.
C. Award of Litigation Costs
As an initial matter, we note that the parties disagree as to whether the
cost of living adjustment (COLA), which applies to an award of attorney’s
fees under section 7430, should be computed from October 1, 1981, or from
January 1, 1986. 27 Respectively, these are the two dates on which COLA’s
were first provided under the EAJA and section 7430.
Our position on this issue was addressed in Bayer v. Commissioner, 98 T.C.
19 (1992), where we concluded that Congress, in providing for cost of living
adjustments in section 7430, intended the computation to start on the same
date the COLA’s were started under the EAJA; i.e., October 1, 1981. Id. at
23. Citing Lawrence v. Commissioner, 27 T.C. 713 (1957), revd. on other grounds
258 F.2d 562 [2 AFTR 2d 5073] (9th Cir. 1958), we stated that we would continue
to use 1981 as the correct year for making the COLA calculation, unless, of
course, the Court of Appeals to which appeal lay had held otherwise. Golsen
v. Commissioner, 54 T.C. 742, 756- 757 (1970), affd. 445 F.2d 985 [27 AFTR
2d 71-1583] (10th Cir. 1971).
This case is appealable to the Court of Appeals for the 11th Circuit, which
has not addressed the question of whether 1981 or 1986 is the correct date
for purposes of computing [pg. 101] the COLA adjustment under section 7430.
Accordingly, we will follow our holding in Bayer, and we find October 1, 1981,
to be the applicable date from which to make the adjustment.
1. Amount of Litigation Costs
Petitioners seek an award of litigation fees and expenses in the total amount
of $140,580.46. Petitioners have also asked that they be awarded any additional
costs incurred since March 1, 1994, to recover such fees and expenses. However,
as explained in the affidavit of petitioners’ counsel filed as a supplement
to motion for litigation costs:
with counsel’s acquiescence, Petitioners have paid to date only $56,588
of the fees incurred on their behalf. As a result of Baker & McKenzie’s
advisory role with regard to the DISC Issue, Petitioners agreed after Respondent
fully conceded the case to pay only $40,000 of the unbilled fees incurred
from December 1992 on their behalf. The $40,000 amount was paid by the Swansons
from their Joint checking account. H.& S. Swansons’ Tool Co., Mr. Swanson’s
closely held corporation and the client of record for bookkeeping purposes,
had previously paid $16,588 for services rendered on petitioners’ behalf between
September and November, 1992.
Petitioners agreed to allow Baker & McKenzie to recover any remaining
unbilled fees in excess of the $56,588 Petitioners have paid to date to the
extent that Petitioners prevail on *** [their Motion for Reasonable Litigation
Costs.] [Emphasis added.]
Thus, beyond the $40,000 agreed to, there is no legal obligation of petitioners
to pay fees incurred on their behalf in the judicial proceeding. 28 Furthermore,
based on the agreement detailed in the affidavits of petitioners’ counsel,
they incurred no fees with respect to the preparation of their motion. Petitioners
did not, therefore, incur fees in this matter in an amount greater than $40,000.
See Marre v. United States, 38 F.3d 823, 828-829 [74 AFTR 2d 94-7050] (5th
Cir. 1994); United States v. 122.00 Acres of Land, 856 F.2d 56 (8th Cir. 1988)
(applying sec. 304(a)(2) of the Uniform Relocation Assistance and Real Property
Acquisition Policies Act of 1970, 42 U.S.C. sec. 4654(a); fees were not actually
“incurred” because the taxpayer had no legal obligation to pay his attorney’s
fees); [pg. 102] accord SEC v. Comserv Corp., 908 F.2d 1407, 1414 (8th Cir.
1990) (construing the EAJA, which language the Court did not find to be significantly
different from that in United States v. 122.00 Acres of Land, supra); see
also Frisch v. Commissioner, 87 T.C. 838, 846 (1986) (lawyer representing
himself pro se was not entitled to fees for his own services because such
fees were not paid or incurred).
Because there is no mention in the affidavits of counsel regarding the liability
of petitioners for costs other than fees incurred after December 1992, we
find that petitioners are not similarly restricted with respect to an award
of “reasonable court costs” under section 7430(c)(1)(A) or those items listed
in section 7430(c)(1)(B)(i) and (ii).
We must apportion the award of fees sought by petitioners between the DISC
issue, for which respondent was not substantially justified, and the Algonquin
property issue, for which respondent was substantially justified. Based on
the record, we find that for the period December 1992 until September 1993,
29 a total of 312.9 hours was spent by counsel in connection with the Court
proceedings. Of this amount, 158.8 hours were devoted to the DISC issue, 139.8
hours to the Algonquin property issue, and 14.3 hours to general case management.
Based upon the $75-per- hour statutory rate, as adjusted by the COLA computed
from 1981, we find that petitioners are entitled to an award for 166.4 hours
of fees paid to counsel. 30
As for expenses other than fees, petitioners have asked for total miscellaneous
litigation costs in the amount of $6,512.33. Based upon our evaluation of
the total time spent on the DISC issue, and our need to exclude miscellaneous
expenses incurred with respect to the Algonquin property issue, we find that
petitioners are entitled to an award of miscellaneous expenses in the amount
of $3,300. [pg. 103]
To reflect the foregoing,
An appropriate order will be issued and decision will be entered pursuant
to Rule 155.
1 Unless otherwise indicated, all section references are to the Internal
Revenue Code. All Rule references are to the Tax Court Rules of Practice and
2 Initially organized as a corporation in the State of Illinois, Swansons’
Tool was subsequently merged into a newly formed Florida corporation of the
same name on Dec. 30, 1983.
3 The following dividends were paid by Worldwide to IRA #1 during the taxable
years 1986 through 1988:
Paid Date Fiscal Year Amount
4/8/86 12/31/86 $244,576
2/10/87 12/31/87 126,155
12/29/87 12/31/87 100,519
12/30/88 12/31/88 122,352
No distributions were made to petitioners from the trust during the years
4 Under sec. 991, except for the taxes imposed by ch. 5, a DISC is not subject
to income tax.
5 The Tax Reform Act of 1986 (TRA), Pub. L. 99-514, sec. 301(a), 100 Stat.
2085, 2216, eliminated the deduction under sec. 1202 for 60 percent of net
long-term capital gains. The repeal was effective for tax years beginning
after Dec. 31, 1986.
6 Respondent used substantially similar language in setting forth one primary
and two alternative positions on this issue.
7 Respondent argues that our consideration of whether she was substantially
justified in this matter should be based, in part, on the outcome of a related
case involving IRA #1. In docket No. 21109-92, respondent determined, and
IRA #1 ultimately conceded, that IRA #1 had unrelated business income for
the taxable year 1988. IRA #1’s concession in docket No. 21109-92, however,
appears to have been a direct result of respondent’s filing her notice of
no objection to petitioners’ motion for summary judgment in this case. In
any event, we give no weight to the outcome of docket No. 21109-92 because
it resulted from an agreement between the parties to that docket rather than
a judicial determination.
8 Respondent’s litigation position for purposes of this matter is that taken
on Nov. 13, 1992, the date the answer was filed. See Han v. Commissioner,
T.C. Memo. 1993-386 [1993 RIA TC Memo 93,386].
9 To the extent respondent has cited for support cases which discuss sec.
7430 prior to its amendment in 1986 by TRA sec. 1551, 100 Stat. 2085, 2752,
and in 1988 by the Technical and Miscellaneous Revenue Act of 1988, Pub. L.
100-647, sec. 6239, 102 Stat. 3342, 3743, we find them to be inapposite. See
Sansom v. United States, 703 F. Supp. 1505 [62 AFTR 2d 88-5304] (N.D. Fla.
10 Respondent’s administrative position for purposes of this matter is that
taken on June 29, 1992, the date of the notice of deficiency. Sec. 7430(c)(2).
11 A “plan” is defined by sec. 4975(e)(1) to encompass an individual retirement
account as described under sec. 408.
12 As applicable to the following discussion, sec. 4975(e)(2) defines a
disqualified person as:
(C) an employer any of whose employees are covered by the plan;
(D) an employee organization, any of whose members are covered by the plan;
(G) a corporation, partnership, or trust or estate of which (or in which)
50 percent or more of –
(i)the combined voting power of all classes of stock entitled to vote or
the total value of shares of all classes of stock of such corporation,
(ii) the capital interest or profits interest of such partnership, or
(iii) the beneficial interest of such trust or estate, is owned directly
or indirectly, or held by persons described in subparagraph (A), (B), (C),
(D), or (E);
(H) an officer, director (or an individual having powers or responsibilities
similar to those of officers or directors), a 10 percent or more shareholder,
or a highly compensated employee (earning 10 percent or more of the yearly
wages of an employer) of a person described in subpargraph (C), (D), (E),
or (G) *** [Emphasis added.]
13 In pertinent part, a “fiduciary” is defined by sec. 4975(e)(3) as any
(A) exercises any discretionary authority or discretionary control respecting
management of such plan or exercises any authority or control respecting management
or disposition of its assets, [or]
(C) has any discretionary authority or discretionary responsibility in the
administration of such plan. At all relevant times, petitioner maintained
and exercised the right to direct IRA #1’s investments. Petitioner, therefore,
was clearly a “fiduciary” with respect to IRA #1 and thereby a “disqualified
person” as defined under sec. 4975(e)(2)(A). Furthermore, as petitioner was
the sole individual for whose benefit IRA #1 was established, IRA #1 itself
was a disqualified person pursuant to sec. 4975(e)(2)(G)(iii).
14 Furthermore, we find that at the time of the stock issuance, Worldwide
was not, within the meaning of sec. 4975(e)(2)(C), an “employer”, any of whose
employees were beneficiaries of IRA #1. Although sec. 4975 does not define
the term “employer”, we find guidance in sec. 3(5) of the Employee Retirement
Income Security Act of 1974 (ERISA), Pub. L. 93-406, 88 Stat. 829, 834. In
pertinent part, ERISA sec. 3(5) provides that, for plans such as an IRA,
an “’employer’ means any person acting directly as an employer, or indirectly
in the interest of an employer, in relation to an employee benefit plan ***
.” Because Worldwide did not maintain, sponsor, or directly contribute to
IRA #1, we find that Worldwide was not acting as an “employer” in relation
to an employee plan, and was not, therefore, a disqualified person under
sec. 4975(e)(2)(C). As there is no evidence that Worldwide was an “employee
organization”, any of whose members were participants in IRA #1, we also find
that Worldwide was not a disqualified person under sec. 4975(e)(2)(D).
15 Sec. 4975(e)(4) incorporates the constructive ownership rule of sec.
267(c)(1), which states that: Stock owned, directly or indirectly, by or
for a corporation, partnership, estate, or trust shall be considered as being
owned proportionately by or for its shareholders, partners, or beneficiaries
*** Petitioner, as the sole individual for whose benefit IRA #1 was established,
was therefore beneficial owner of all the outstanding shares of Worldwide
after they were issued. Because petitioner, as the sole beneficial shareholder
of Worldwide, was also a “fiduciary” with respect to IRA #1, Worldwide thus
met the definition of a disqualified person under sec. 4975(e)(2)(G). Contrary
to respondent’s representations, petitioner was not a “disqualified person”
as president and director of Worldwide until after the stock was issued to
IRA #1. Sec. 4975(e)(2)(H). Furthermore, petitioner was not a disqualified
person under sec. 4975(e)(2)(H) solely due to his “shareholding” in Worldwide
as the constructive attribution rules provided under sec. 267 are applicable
only to sec. 4975(e)(2)(E)(i) and (G)(i). Sec. 4975(e)(4).
16 Ordinarily, controlling effect will be given to the plain language of
a statute unless to do so would produce absurd or futile results. Rath v.
Commissioner, 101 T.C. 196, 200 (1993) (citing United States v. American Trucking
Associations, 310 U.S. 534, 543-544 (1940)). As the Supreme Court has stated:
in the absence of a clearly expressed legislative intention to the contrary,
the language of the statute itself must ordinarily be regarded as conclusive.
Unless exceptional circumstances dictate otherwise, when we find the terms
of a statute unambiguous, judicial inquiry is complete. [Burlington No. R.
v. Oklahoma Tax Commn., 481 U.S. 454, 461 (1987); citations and internal quotation
Accordingly, when, as here, a statute is clear on its face, we require unequivocal
evidence of a contrary purpose before construing it in a manner that overrides
the plain meaning of the statutory words. Rath v. Commissioner, supra at 200-201
(citing Halpern v. Commissioner, 96 T.C. 895, 899 (1991); Huntsberry v. Commissioner,
83 T.C. 742, 747-748 (1984)).
17 See the discussion supra note 16 regarding application of a statute’s
18 In a letter accompanying the revenue agent’s report, respondent stated
that: We believe the statutory Notice of Deficiency adequately describes the
adjustments asserted therein. Moreover, during the course of the examination
your client became fully cognizant of the transactions under scrutiny. However,
as a convenience to you, enclosed is a copy of the revenue agent’s report.
Naturally, it is not the Service’s intent by this letter to in any way limit
the general language of the statutory notice. The Commissioner will stand
on any ground fairly raised by the statutory notice as a basis for her determination.
In finding that respondent was not substantially justified with respect
to the DISC issue, we have considered all grounds upon which respondent could
fairly raise a question of prohibited transactions under sec. 4975.
19 See discussion of IRA #2 supra p. 82.
20 For similar reasons, we find that it was not unreasonable as a matter
of fact or law for respondent to contend in alternative positions that the
proceeds from the sale of the Algonquin property should be adjusted between
petitioners and Swansons’ Tool. Having carefully considered petitioners’ arguments,
we find that they have not met their burden of proving that respondent was
not substantially justified on this point.
21 This requirement is set forth by implication in sec. 7430(c)(4), which
states in pertinent part that: (A) In general. – The term “prevailing party”
means any party in any proceeding to which subsection (a) applies
(iii) which meets the requirements of *** section 2412(d)(2)(B) of title
28, United States Code (as in effect on October 22, 1986) *** .
As applicable to this case, 28 U.S.C. sec. 2412(d)(2)(B) provides that a
“party” means “an individual whose net worth did not exceed $2,000,000 at
the time the civil action was filed.”
22 This statement of net worth was submitted as “attachment II” to petitioners’
amendment to motion for award of reasonable litigation costs. As noted by
petitioners, the figures presented therein are unadjusted for depreciation.
23 We note that petitioners omitted the asset identified as “Florida Bonds”
from their Aug. 1, 1994, statement of net worth in the amount of $60,000 to
be allocated half to each petitioner. Petitioners have explained, and we
accept, that this was an accidental omission. The stipulation of facts contains
other nonmaterial modifications and corrections.
24 As noted by the Courts of Appeals for the Ninth and Seventh Circuits,
“the cost of acquisition” under GAAP is arrived at by subtracting accumulated
depreciation from the original cost of an asset. American Pacific Concrete
Pipe Co., Inc. v. NLRB, 788 F.2d 586, 590- 591 (9th Cir. 1986); Continental
Web Press, Inc. v. NLRB, 767 F.2d 321, 322-323 (7th Cir. 1985). We do not
here decide whether depreciation should be used in determining net worth for
purposes of sec. 7430(c)(4)(A), as petitioners’ separate net worths, whether
computed using depreciation or not, do not exceed $2 million.
25 Sec. 301.7430-1(b)(2), Proced. & Admin. Regs., provides that: a party
or qualified representative of the party *** participates in an Appeals office
conference if the party or qualified representative discloses to the Appeals
office all relevant information regarding the party’s tax matter to the extent
such information and its relevance were known or should have been known to
the party or qualified representative at the time of such conference.
26 As we have not found any prior cases addressing this issue, it appears
that the correct interpretation of the meaning of the regulation is one of
27 Petitioners are seeking an award of fees based solely upon the statutorily
provided rate of $75 an hour, as adjusted by the COLA. Sec. 7430(c)(1)(B)(iii).
Petitioners have not argued that there are “special factors” which would justify
a higher rate in this case. Id.
28 We find that to the extent of the $16,588 paid by Swansons’ Tool, petitioners
did not “pay or incur” fees within the meaning of sec. 7430. Although the
nature of the agreement under which such payment was made is unclear, the
ultimate effect was to diminish the deterrent effect of the expense involved
in seeking review of, or defending against, unreasonable Government action.
See, e.g., SEC v. Comserv Corp., 908 F.2d 1407, 1413-1415 (8th Cir. 1990).
29 Pursuant to petitioners’ agreement with counsel, December 1992 was the
month from which they agreed to pay $40,000 of unbilled fees incurred on their
behalf. According to the affidavits of counsel, September 1993 was the last
month in which fees were incurred to defend the DISC issue. Thus, this is
the only period for which petitioners may recover fees in this matter.
30 We reach this figure based upon 158.8 hours devoted to the DISC issue
and 7.6 of general case management apportioned to the DISC issue ((158.8 /
(158.8 + 139.8) x 14.3 = 7.6).