Owens v. CIR ( 2003 )

United States Court of Appeals
Fifth Circuit
F I L E D
IN THE UNITED STATES COURT OF APPEALS May 15, 2003
FOR THE FIFTH CIRCUIT Charles R. Fulbruge III
_____________________ Clerk
No. 02-61057
Summary Calendar
_____________________
CHARLES B. OWENS; SALLY L. OWENS,
Petitioners-Appellants,
versus
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.
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Appeal from the United States Tax Court
(672-01)
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BEFORE DAVIS, WIENER, and EMILIO M. GARZA, Circuit Judges.
PER CURIAM:*
Petitioners-Appellants Charles B. Owens (“Owens”) and Sally L.
Owens, husband and wife, (collectively, “Petitioners”) filed a
motion in the United States Tax Court under § 7430 of the Internal
Revenue Code (“IRC”) of 19861 to recover from Respondent-Appellee
Commissioner of Internal Revenue (“Commissioner”) the
administrative and litigations costs that they had incurred.
Petitioners had successfully sued the Commissioner in that court
*
Pursuant to 5TH CIR. R. 47.5, the court has determined that
this opinion should not be published and is not precedent except
under the limited circumstances set forth in 5TH CIR. R. 47.5.4.
1
References to “Section” or “§” shall be to the IRC.
for a redetermination of an income tax deficiency asserted by the
Internal Revenue Service (“IRS”) in connection with 1994 income
taxes. Petitioners now appeal the Tax Court’s judgment to the
extent it denied recovery of a portion of their claim under § 7430.
We affirm the uncontested portion of the Tax Court’s judgment
awarding Petitioners $1,449.58 on the issue of penalties
improvidently sought by the Commissioner, but we reverse the Tax
Court’s judgment to the extent that it rejected the balance of
Petitioners’ total claim, viz., the portion that the Tax Court
attributed to the issue of discharge-of-indebtedness income. We
therefore remand the case to the Tax Court with instructions to
modify its judgment to include the amount of $8,697.49 as
calculated but rejected by the court, plus additional sums,
pursuant to § 7430, for recoverable costs incurred by Petitioners
in this appeal and those that they will incur in proceedings in the
Tax Court on remand.
I. Facts and Proceedings
The Tax Court noted, and none dispute on appeal, that there is
no disagreement on the operative facts underlying this case. Thus,
the following facts come either from stipulations or uncontested
evidence.
Owens obtained a loan (“the Owens loan”) from a bank that
subsequently failed. The Owens loan was one of a number that the
FDIC acquired from that failed bank, which loan was one that was
managed for the FDIC by AMRESCO. In 1994, the FDIC issued Owens a
2
Form 1099-C, Cancellation of Debt 1994. This form specified
October 6, 1994 as the date of cancellation of the Owens loan and
listed the total amount for which the loan was canceled, including
interest. Certain that the 1099-C had been issued in error,
Petitioners dutifully reported the amount set forth on that form as
debt cancellation income on their tax return for 1994 but “zeroed-
out” that figure with an offsetting entry labeled “ERRONEOUS 1099-C
—— DEBT NOT DISCHARGED” (Petitioners eventually reported income
from their discharge of this indebtedness for the later year in
which the statute of limitations for collection expired).
In the course of its examination of Petitioners’ 1994 income
tax return, the IRS issued a summons to the FDIC for documentation
relating to the Owens loan. The data received by the IRS in
response included a copy of a “Dormant Account Status Approval
Form” regarding that loan, effective October 6, 1994, bearing the
statement, “This memorandum is a request for Authorization to write
off the remaining balance” of the Owens loan (emphasis added).
This form also bears the statement “Not Economic to Pursue and
Unsaleable,” together with a narrative of the loan’s history,
collection efforts, and unavailability of assets, as well as the
conclusion that “[i]t does not appear to be cost effective to
pursue a collection lawsuit against the obligor.” This dormant
account form had apparently been prepared by an agent of AMRESCO
and is stamped “REQUEST APPROVED BY OVERSIGHT COMMITTEE SPECIAL
ASSET BANK” on October 20, 1994. The documentation furnished to
3
the IRS by the FDIC also included copies of two letters exchanged
between Owens and the principal of AMRESCO, one dated November 1,
1994 and the other dated November 7, 1994. Neither these letters
nor any other instrument obtained by the IRS expressly states that
the Owens loan was canceled; and there is no evidence that the FDIC
or AMRESCO contacted Petitioners after November 7, 1994.
Significantly, the record is also devoid of evidence that the Owens
loan was ever actually canceled by or on behalf of the FDIC.
Even more to the point of this § 7430 case is the absence of
any testimony or documentary evidence whatsoever that the IRS ever
attempted to contact representatives of AMRESCO or the FDIC, either
to confirm or refute the contention, continually advanced by
Petitioners to the IRS, that the FDIC had issued the subject Form
1099-C in error, and that, in fact, the Owens loan had never been
canceled. Without making any effort to run that key question to
ground, and instead apparently relying solely on the contested Form
1099-C and on erroneous inferences that it drew from one or more of
the instruments obtained from the FDIC, the IRS stuck to its
conclusional position that the Owens loan had been canceled in
1994, producing discharge-of-indebtedness income to Petitioners in
that year, and resulting in a deficiency in the amount of income
taxes reported on their return for 1994.
After extensive administrative practice failed to resolve this
controversy, the IRS issued a deficiency letter in November, 2000,
asserting that Petitioners owed additional income tax plus a 20%
4
accuracy-related penalty under § 6662 for negligence or disregard
of rules or regulations. In January, 2001, Petitioners filed a
petition in Tax Court seeking redetermination of the deficiency
asserted by the IRS. The Commissioner answered in March of that
year, denying error. The Tax Court scheduled the trial of the
matter for early December, 2001, but shortly before the trial date
the Commissioner completely changed his position and advised
Petitioners that he would concede the entire case, stipulating to
that effect in the Tax Court. With Petitioners reserving their
right to file for relief under § 7430, the Tax Court dismissed
their suit on the basis of the Commissioner’s concession.
On motion of Petitioners for relief under § 7430, the Tax
Court awarded them $1,449.58, which it attributed to costs they
incurred in connection with penalties improvidently sought by the
Commissioner under § 6662. After adjusting the $9,529.16 balance
of Petitioners’ claim to $8,697.49, however, the Tax Court rejected
this entire balance of Petitioners’ claim in connection with the
discharge-of-indebtedness issue, reasoning that, despite having
prevailed in their deficiency redetermination litigation and having
correctly asserted that the Commissioner’s position with respect to
the penalty issue was not “substantially justified” within the
meaning of § 7430(c)(4)(B)(i), the Commissioner was nevertheless
substantially justified with respect to the discharge-of-
indebtedness issue.
5
Petitioners appealed the denial of the portion of their § 7430
claim that is based on the discharge-of-indebtedness issue. As the
Commissioner did not cross-appeal the Tax Court’s award to
Petitioners in connection with the penalty issue, however, that
part of the court’s judgment stands.
II. Analysis
A. Standard of Review
When a taxpayer’s entitlement to recover costs under § 7430
turns on a trial court’s determination that the position of the
Commissioner in the underlying litigation was or was not
“substantially justified” for purposes of § 7430(c)(4)(B)(i), we
review such determination for abuse of discretion.2 One way that
a trial court can abuse its discretion is to ground its exercise
thereof either in errors of law or clearly erroneous facts.3 More
specifically, the Commissioner bears the burden of proving by a
preponderance of the evidence that a deficiency notice is grounded
in fact and law; if such a notice is not thus grounded, it is
“clearly erroneous” as a matter of law, making reliance on such a
notice unjustified, substantially or otherwise, and in turn making
2
Hanson v. Commissioner, 975 F.2d 1150, 1152-53 (5th Cir.
1992).
3
See, e.g., United States v. Marolf, 277 F.3d 1156, 1160 (9th
Cir. 2002)(citation omitted).
6
a court’s refusal to grant an award of § 7430 costs an abuse of
discretion.4
B. The Position of the Commissioner Was Not Substantially
Justified.
To recover reasonable administrative and litigation costs
under § 7430, a taxpayer must be the “prevailing party.”5 In
addition to showing that he has exhausted his administrative
remedies —— not an issue in the instant case —— a taxpayer must
show that he substantially prevailed either on the “amount in
controversy” or “the most significant issue or set of issues
presented.”6 A taxpayer is not a “prevailing party”if the United
States establishes that the Commissioner’s position was
“substantially justified.”7 Here, given the Commissioner’s total
capitulation shortly before trial, there can be no question that
Petitioners substantially prevailed on both the amount in
controversy and the most significant set of issues presented, i.e.,
that the FDIC did not cancel the Owens loan in 1994 (or any other
year for that matter) and that the assertion of a negligence
penalty against Petitioners was baseless. Thus, the only question
remaining is whether the Commissioner was nevertheless
4
See Portillo v. Commissioner (“Portillo II”), 988 F.2d 27,
28-29 (5th Cir. 1993).
5
26 U.S.C.§ 7430(c)(4)(A)(i).
6
26 U.S.C. § 7430(c)(4)(A)(i)(I)-(II).
7
Id. § 7430(c)(4)(B); see also Sherbo v. Commissioner, 255
F.3d 650, 653 (8th Cir. 2001).
7
substantially justified in the position taken relative to
discharge-of-indebtedness income in 1994.
For purposes of determining whether the Commissioner’s
position was substantially justified, the fact that he lost the
case —— here, conceded it —— is not alone sufficient.8 It is,
however, a factor for consideration. As instructed by the Supreme
Court in Pierce v. Underwood, the position of the Commissioner is
substantially justified if it has a reasonable basis both in fact
and in law.9 As this standard is conjunctive, a position is not
substantially justified if it lacks a reasonable basis in either
fact or law.
In concluding that the Commissioner was substantially
justified in maintaining that Petitioners had discharge-of-
indebtedness income in 1994, the Tax Court observed that the issue
is “extremely fact specific, often turning on the subjective intent
of the creditor as manifested by an objectively identifiable
event,” citing Friedman v. Commissioner,10 and Cozzi v.
Commissioner.11 The Tax Court pointed to the FDIC’s issuance and
filing of the 1099-C with respect to the Owens loan as an
identifiable (albeit non-dispositive) event, because, to the court,
8
Maggie Mgmt. Co. v. Commissioner, 108 T.C. 430, 443 (1997).
9
487 U.S. 552, 565, 108 S.Ct. 2541, 2550 (1988).
10
75 T.C.M. (CCH) 2383 (1998), aff’d, 216 F.3d 257 (6th Cir.
2000).
11
88 T.C. 435, 445-448 (1987).
8
it evidenced “an intention to cancel the loan” —— not, we must
point out, actual cancellation of the loan. Indeed, the Tax Court
recognized inconsistent evidence of cancellation in the November 7,
1994 letter from the principal of AMRESCO to Owens, observing in a
footnote, that “[w]hile the term ‘dormant’ does not necessarily
signify an intent on the part of the FDIC to cancel the loan, the
language of the FDIC’s ‘Dormant Account Status Approval Form’ for
the [Owens] loan in some respects evidences such an intent (e.g.,
‘This memorandum is a request for Authorization to write off the
remaining balance’)” (emphasis added). In light of all the
operative facts, especially those just mentioned, we conclude that
the Tax Court clearly erred in finding the 1099-C and related
documentation from the FDIC to be an “identifiable event”
sufficient to credit the Commissioner’s position with a reasonable
basis in both law and fact.
First, the Tax Court equates the intention to act in the
future with the actual performance of the act: AMRESCO’s
recommendation to cancel the Owens loan and even the FDIC’s intent
to cancel it are not synonymous with the FDIC’s actually canceling
that debt. Second, and more significant, the record confirms that
no agent of the IRS bothered to follow up on the intention —— the
evidence of which postdated the 1099-C —— to verify actual
cancellation. Whether this failure resulted from overwork,
deliberate indifference, inability to distinguish intention to do
something in the future from doing something in the present, or any
9
other reason, cause, or excuse, the fact remains that the IRS
dropped the ball. Given the consistent insistence of Petitioners
that the Owens loan had never been canceled, the failure of the IRS
to take the last logical step and verify cancellation vel non is
antithetical to the conclusion that the Commissioner had a
reasonable basis in fact to issue the deficiency notice and
tenaciously cling to it throughout the administrative process and
the responsive pleadings phase of the lawsuit, recanting only
shortly before trial by conceding the case.
The parties in their briefs and the Tax Court in its opinion
discuss at length the pair of cases from this court that are
directly on point and controlling: Portillo I,12 and Portillo II.13
Briefly, Portillo I involved a deficiency assessed against a
taxpayer who, as a painting subcontractor, had received a Form 1099
from a general contractor for whom the taxpayer performed painting
services. The taxpayer insisted that the 1099 erroneously stated
an inflated quantum of payments from the contractor during the tax
year in question. Agents of the IRS contacted the contractor who
had issued the 1099 and were told by him that the larger figure was
correct, claiming that, in addition to paying the taxpayer with
checks (the total amount of which equaled exactly the lesser amount
of income claimed by the taxpayer on his tax return), he had made
12
Portillo v. Commissioner, 932 F.2d 1128 (5th Cir. 1991).
13
Portillo v. Commissioner, 988 F.2d 27 (5th Cir. 1993).
10
cash payments as well. Instead of proceeding to verify which
version of the relevant facts was correct, the IRS agent took it
upon himself to make a credibility call, electing to believe the
contractor rather than the taxpayer.
In the ensuing litigation over the deficiency assessed to the
subcontractor as taxpayer, we reversed judgment for the
Commissioner and held that the subject 1099, unverified except by
the agent’s impermissible credibility call, was insufficient.
Subsequently, when the taxpayer sought to recover costs from the
Commissioner under § 7430, the Tax Court determined that, despite
having lost the case, the Commissioner had nevertheless taken a
substantially justified position in reliance on the contested 1099
and the testimony of its issuer. In Portillo II, we again
reversed, holding that the Tax Court had abused its discretion in
denying § 7450 litigation costs to the Taxpayer on the facts of the
case. Noting that the panel in Portillo I had characterized the
deficiency notice based on the unsubstantiated and unreliable 1099
as “clearly erroneous,” we stated in Portillo II that “[t]here can
be no clearer indication from this Court that the government’s
position in relying on such an unsupported notice of deficiency was
not justified.”14 We went on to conclude that “[t]he
unsubstantiated and unreliable 1099 Form submitted to the IRS by
[the contractor] was insufficient to form a rational foundation for
14
Portillo II, 988 F.2d at 29.
11
the tax assessment against the Portillos” making the assessment
arbitrary and erroneous.15
In the instant case, the Tax Court viewed Portillo II as
distinguishable, relying on the difference between the
investigation and ensuing credibility call by the IRS agent in
Portillo, on the one hand, and the IRS agent’s reliance on the
documentation obtained from the FDIC in this case, on the other
hand. Given the facts that (1) Petitioners here repeatedly
insisted from the outset that the 1099-C was issued in error by the
FDIC because the loan was never canceled, (2) the documentation
obtained from the FDIC supports no conclusion other than an
intention to cancel the loan rather than its actual cancellation,
and (3) the utter failure of the IRS to contact the FDIC and obtain
a simple, factual determination whether the loan had in fact been
canceled in 1994, there is no distinguishable difference in fact or
in law from the situation in the Portillo cases: issuance of a
taxpayer-contested 1099 followed by a deficiency assessment
grounded in nothing more than the agent’s credibility call in a
swearing match between the issuer and the recipient of that
document. Indeed, the Commissioner might have been on even
slightly more solid ground in Portillo because there the agent at
least contacted the issuer of the 1099 and obtained a statement;
here, the agent failed to contact the FDIC at all. This is not the
15
Id.12
stuff of which a reasonable basis both in law and in fact is made,
absent which, as a matter of law, the position of the Commissioner
cannot be “substantially justified.”
III. Conclusion
The Commissioner’s reliance on the contested 1099-C and
documentation from the issuer reflecting nothing more than an
intention to cancel the Owens loan at some future time fails to
provide a reasonable basis in either fact or law. Absent that, the
deficiency assessment, and the litigating position of the
Commissioner, was not substantially justified. Consequently,
Petitioners were prevailing parties in the underlying litigation
and are entitled to recover their administrative and litigation
costs from the Commissioner on both the penalty issue and the
cancellation-of-indebtedness issue, pursuant to the provisions of
§ 7430. The ruling of the Tax Court to the contrary constitutes
abuse of discretion and must, therefore, be reversed.16
Although we affirm the judgment of the Tax Court to the extent
it awarded Petitioners $1,449.58 in connection with the penalty
issue, we reverse the court’s denial of eligible costs of
$8,697.49. We therefore remand this case with instructions to the
Tax Court to modify its judgment by increasing the amount of the
16
See United States v. Logan, 861 F.2d 859, 866 n.5 (5th Cir.
1988)(“Of course, ‘abuse of discretion’ is a phrase which ‘sounds
worse than it really is’; it is simply a legal term of art which
carries no pejorative connotations of a professional or personal
nature.”)(citation omitted).
13
award to Petitioners by $8,697.49, plus reasonable amounts,
consistent with the provisions of § 7430, for additional litigation
costs incurred in this appeal and in the Tax Court on remand.
AFFIRMED in part, REVERSED in part, and REMANDED WITH INSTRUCTIONS.
14