Foothill Ranch Company Partnership, Buck Equities, Ltd., Tax Matters Partner v. Commissioner ( 1998 )

110 T.C. No. 8
UNITED STATES TAX COURT
FOOTHILL RANCH COMPANY PARTNERSHIP,
BUCK EQUITIES, LTD., TAX MATTERS PARTNER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 26341-95. Filed February 9, 1998.
P is the tax matters partner of a partnership
comprised of four other partners. Two of the
partnership's partners are partnerships. P filed a
motion for reasonable litigation costs pursuant to sec.
7430, I.R.C., and contended that R was not
substantially justified in determining that petitioner
was not entitled, pursuant to sec. 460, I.R.C., to use
the percentage of completion method of accounting.
1. Held: R's position, relating to whether P was
entitled to use PCM, was not substantially justified.
2. Held, further, first-tier partners that meet
the net worth requirements of sec. 7430, I.R.C., are
eligible to receive an award.
3. Held, further, a partner in a TEFRA
partnership proceeding may receive an award for
litigation costs that are paid or incurred by the
partnership only to the extent such fees are allocable
to that partner.
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4. Held, further, the amount sought by P for
litigation costs is not reasonable and is adjusted
accordingly.
Michael S. Harms and McGee Grigsby, for petitioner.
William H. Quealy, Jr. and Paul B. Burns, for respondent.
OPINION
FOLEY, Judge: This matter is before the Court on
petitioner's motion for an award of litigation costs pursuant to
section 7430 and Rule 231. Unless otherwise indicated, all
section references are to the Internal Revenue Code in effect for
the year in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
Background
In early 1987, Laguna Niguel Properties, a Delaware
corporation, purchased the Whiting Ranch, a parcel of
approximately 2,743 acres of undeveloped land. Laguna
subsequently exchanged the Whiting Ranch for an interest in
Foothill Ranch Company Partnership (FRC), a California limited
partnership.
In March of 1988, FRC and Orange County, California,
executed an agreement that provided: (1) FRC would be allowed to
build housing units on the Whiting Ranch; (2) FRC would construct
a library, a school, roads, water and sewer lines, and other
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improvements; and (3) the county would incrementally issue FRC
permits to construct housing units as FRC fulfilled its
obligation to construct the aforementioned buildings and
improvements.
In May of 1988, FRC executed separate agreements, with Lyon
Communities, Inc. (Lyon), and P.B. Partners (Partners), to sell
each of them a large parcel of the Whiting Ranch. Lyon and
Partners entered into their respective agreements with the
intention to develop each of their parcels. To ensure that the
county would issue the construction permits necessary for such
development, each sales agreement provided that FRC would fulfill
its construction obligations to the county. The sales agreements
also imposed on FRC construction obligations that were unrelated
to its obligations to the county (e.g., the construction of
affordable housing units). In addition, the sales agreements
provided that Lyon and Partners would perform some of the
construction required pursuant to FRC's obligations to the
county.
By the end of FRC's 1988 tax year, FRC had not completed its
construction obligations. On its 1988 Form 1065 (U.S.
Partnership Return of Income), which was filed on October 16,
1989, FRC used the percentage of completion method of accounting
(PCM) to calculate the income attributable to its property
transactions with Lyon and Partners. On September 28, 1995,
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respondent mailed FRC a Notice of Final Partnership
Administrative Adjustment (FPAA). In the notice, respondent
determined that FRC could not use PCM to calculate the income
attributable to the aforementioned property transactions and that
FRC underreported its gross receipts by $90,801,873.
On December 18, 1995, Hon Property Investments, Inc., on
behalf of FRC, filed a petition. On the date the petition was
filed, FRC was comprised of Hon Property Investments, Inc., Hon
Family Trust, Hon Family Ventures, Ltd., Hon Irrevocable Income
Trust, and Buck Equities, Ltd. On February 16, 1996, respondent,
contending that Hon Property Investments, Inc., was not FRC's tax
matters partner, filed a motion to dismiss for lack of
jurisdiction. FRC subsequently amended the petition to list Buck
Equities, Ltd., as the tax matters partner, and on September 17,
1996, we denied respondent's motion. On November 4, 1996,
respondent filed his answer.
Petitioner on January 30, 1997, filed a motion for summary
judgment contending that, pursuant to section 6229(a), the 3-year
period of limitations on assessment was applicable and this
period had expired before respondent issued the FPAA. The
parties subsequently settled the case and filed a stipulation,
which made no adjustments to FRC's reported income. Petitioner,
on June 10, 1997, filed its motion for litigation costs.
Discussion
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Pursuant to section 7430, we may award reasonable litigation
and administrative costs to a prevailing party in any tax
proceeding with the United States. Litigation costs will not be
awarded unless the prevailing party establishes that it exhausted
its administrative remedies. Sec. 7430(b)(1). In addition, the
prevailing party may not receive an award relating to any portion
of the proceedings that such party unreasonably protracted. Sec.
7430(b)(4). Respondent concedes that petitioner has exhausted
its administrative remedies, but contends that petitioner has
failed to establish: (1) It was a prevailing party; (2) it did
not unreasonably protract this proceeding; and (3) its litigation
costs were reasonable.
I. Prevailing Party
To be a "prevailing party", a party in the proceeding must:
(1) Establish that the position of the United States was not
substantially justified; (2) substantially prevail in the
controversy; and (3) meet the net worth and number of employees
requirements (net worth requirements) of the Equal Access to
Justice Act (EAJA), 28 U.S.C. sec. 2412(d)(2)(B) (1994). Sec.
7430(c)(4)(A). Respondent concedes that petitioner has
substantially prevailed in this controversy, but contends that
petitioner has failed to satisfy the remaining requirements.
A. Substantial Justification
Respondent's positions are substantially justified only if
they have a reasonable basis in law and fact. Norgaard v.
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Commissioner, 939 F.2d 874, 881 (9th Cir. 1991), affg. in part
and revg. in part T.C. Memo. 1989-390. The justification for
each of respondent's positions must be independently determined.
See, e.g., Powers v. Commissioner, 51 F.3d 34, 35 (5th Cir.
1995); Swanson v. Commissioner, 106 T.C. 76, 92, 97 (1996).
During the course of this proceeding, respondent contended:
(1) The petition was defective because it did not designate the
proper tax matters partner; (2) the period of limitations on
assessment had not expired; and (3) petitioner was not entitled
to use PCM to report its income. Petitioner does not challenge
respondent's position relating to the tax matters partner and
period of limitations issues. As a result, petitioner is not
entitled to fees relating to those issues. Petitioner contends,
however, that respondent's position, regarding the PCM issue, was
not substantially justified.
Section 460(a) requires taxpayers to use PCM to report
income from any long-term contract. A long-term contract is "any
contract for the manufacture, building, installation, or
construction of property if such contract is not completed within
the taxable year in which such contract is entered into." Sec.
460(f)(1). Notice 89-15, 1989-1 C.B. 634, provides additional
guidance regarding the definition of a long-term contract. The
notice provides, in pertinent part, that a long-term contract
includes "any contract for the production or installation of real
property or any improvements to real property", if the contract
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is not completed within the taxable year in which it is entered
into. Notice 89-15, Q&A-2, 1989-1 C.B. 634. The notice further
provides that a contract for the sale of property may be a long-
term contract if the "building, installation, or construction of
the subject matter of the contract is necessary in order for the
taxpayer's contractual obligations to be fulfilled". Notice 89-
15, Q&A-4, 1989-1 C.B. 634.
Petitioner's sales agreements required the construction of
buildings and improvements to real property. Nevertheless,
respondent, relying on Notice 89-15, Q&A-4, 1989-1 C.B. 634,
contended that the agreements were not long-term contracts
because the sale of the parcels, rather than construction of
buildings and improvements, was the "primary subject matter" of
the agreements.
Contrary to respondent's contention, the construction of
buildings or improvements to real property need not be the
primary subject matter of the contract. Rather, such
construction need only be necessary to fulfill the taxpayer's
contractual obligation. Pursuant to the sales agreements, FRC
was obligated to construct buildings and improvements relating to
the Whiting Ranch. Moreover, Lyon's and Partners' rights to
develop their land were limited until these obligations were
fulfilled (i.e., the county would incrementally issue
construction permits as the obligations were fulfilled). In
addition, the sales agreements imposed on FRC construction
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obligations that were unrelated to its obligations to the county
(e.g., the construction of affordable housing units). As a
result, the construction of buildings and improvements to real
property was necessary to fulfill FRC's obligations under the
sales agreements, and these obligations were not completed within
the 1988 tax year. Accordingly, we conclude that respondent's
position relating to this issue was not substantially justified.
B. Net Worth
To be a "prevailing party", a party must meet EAJA's net
worth requirements. Sec. 7430(c)(4)(A)(iii). Specifically, a
party that is a corporation or partnership may not have a net
worth of more than $7,000,000 or more than 500 employees. EAJA,
28 U.S.C. sec. 2412(d)(2)(B) (1994). Petitioner and respondent
have differing views regarding who must meet the net worth
requirements. We reject both parties' contentions.
Petitioner contends that we must look to the partnership
entity, FRC, to determine whether the net worth requirements are
met. This partnership proceeding, however, is governed by the
procedural rules of the Tax Equity and Fiscal Responsibility Act
of 1982 (TEFRA), Pub. L. 97-248, sec. 402(a), 96 Stat. 324, 648,
codified as secs. 6221-6233. The partners, rather than the
partnership entity, are the parties in a TEFRA proceeding. See
secs. 6226(c), 6228(a)(4); Rule 247; Chef's Choice Produce, Ltd.
v. Commissioner, 95 T.C. 388, 395 (1990); see also Southwest
Marine, Inc. v. United States, 43 F.3d 420 (9th Cir. 1994)
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(holding that a nonparty could not be a "prevailing party" under
EAJA).
Respondent contends that only those persons or entities
whose tax liabilities are affected by the outcome of the
proceeding are eligible to receive an award. Because petitioner
and Hon Family Ventures, Ltd., are pass-through entities,
respondent contends that the Court should require petitioner's
and Hon Family Ventures, Ltd.'s partners to establish that they
meet the net worth requirements. Respondent further contends
that if petitioner's and Hon Family Ventures, Ltd.'s partners are
pass-through entities, the "look-through" process must continue
until it reaches a person or entity whose tax liability is
affected by the outcome of the proceeding. Respondent's proposed
"look-through rule", however, contradicts the congressional
determination that a partnership may receive litigation costs.
EAJA, 28 U.S.C. sec. 2412(d)(2)(B) (1994) (stating that a party
includes "any partnership" that meets the net worth and number of
employee requirements).
Pursuant to EAJA and the TEFRA partnership rules, we hold
that first-tier partners that meet the net worth requirements are
eligible to receive an award. Petitioner, Hon Family Ventures,
Ltd., and Hon Property Investments, Inc., have established that
they meet the net worth requirements. Accordingly, they are
prevailing parties. No evidence has been submitted relating to
the net worth of either Hon Family Trust or Hon Irrevocable
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Income Trust and, as a result, they have not met the net worth
requirements. We note that the presence of ineligible partners
does not preclude the eligible partners, petitioner, Hon Family
Ventures, Ltd., and Hon Property Investments Inc., from receiving
an award. See, e.g., Sierra Club v. United States Army Corps. of
Engrs., 776 F.2d 383, 393-394 (2d Cir. 1985) (concluding that the
presence of 1 ineligible party did not prevent 11 eligible
parties from receiving an award).
II. Unreasonable Protraction of Proceeding
Costs may not be awarded for any portion of the proceeding
which the prevailing party "unreasonably protracted". Sec.
7430(b)(4). Respondent contends that petitioner unreasonably
protracted this proceeding by failing to select properly a tax
matters partner and, therefore, the costs relating to the
preparation of petitioner's objection to respondent's motion to
dismiss should be denied. Respondent's contention is moot
because we have already concluded that petitioner may not recover
costs relating to the tax matters partner issue.
III. Determination of Reasonable Costs
Petitioner claims litigation costs totaling $224,816.
Petitioner is only entitled to these costs, however, if such
costs were both incurred and reasonable. Sec. 7430(a)(2).
A. Costs Incurred
A party's award for litigation costs is limited to the costs
that the party actually paid or incurred. Frisch v.
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Commissioner, 87 T.C. 838, 846 (1986); Thompson v. Commissioner,
T.C. Memo. 1996-468. FRC paid all the litigation costs in issue.
We conclude that a first-tier partner of FRC may receive an award
for such costs only to the extent they were allocated (e.g.,
under the partnership agreement) to that partner. The costs paid
by FRC were allocated to petitioner, Hon Family Ventures, Ltd.,
and Hon Property Investments, Inc., as follows:
1995 1996 1997
Petitioner 25.00% 19.88% 1%
Hon Family Ventures, Ltd. 23.08 25.36 3
Hon Property Investments, Inc. .52 .35 --
Therefore, petitioner, Hon Family Ventures, Ltd., and Hon
Property Investments, Inc., are eligible to receive an award for
costs to the extent of their allocable share in FRC during the
year in which the costs were paid.
B. Reasonable Costs
1. Services of an Attorney
Section 7430(c)(1) defines reasonable litigation costs as
reasonable fees paid or incurred for the services of attorneys in
connection with the court proceeding. Section 7430(c)(3)
provides that fees for the services of an individual (whether or
not an attorney) who is authorized to practice before the Court
or IRS shall be treated as fees for the services of an attorney
for purposes of section 7430(c)(1). See Cozean v. Commissioner,
109 T.C. 227, 234 (1997) (allowing litigation costs attributable
to services performed by accountants). We have also allowed
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costs attributable to services performed by individuals (e.g.,
paralegals and law clerks) under the supervision of someone who
was authorized to practice before the Court or IRS. See, e.g.,
Powers v. Commissioner, 100 T.C. 457, 492-493 (1993), affd. in
part, revd. in part and remanded 43 F.3d 172 (5th Cir. 1995).
The costs claimed by petitioner are attributable to services
performed by individuals who meet these requirements.
Accordingly, petitioner is eligible to receive an award for such
costs.
2. Reasonable Fees
Section 7430(c)(1)(B)(iii) limits the hourly rate for
attorney's fees to $75, with allowance for a higher rate for
increases in the cost of living and other special factors (e.g.,
the limited availability of qualified attorneys).
a. Special Factors
Petitioner contends that it is entitled to fees in excess of
the statutory rate because (1) petitioner's advisers had special
expertise in real estate and tax law, and (2) the prevailing rate
in the Los Angeles area exceeds $75. To qualify for a higher
statutory rate, the attorney must have tax expertise that is
necessary for the litigation in question. Pierce v. Underwood,
487 U.S. 552, 572 (1988); Huffman v. Commissioner, 978 F.2d 1139,
1149-1150 (9th Cir. 1992), affg. in part and revg. in part T.C.
Memo. 1991-144; Powers v. Commissioner, 100 T.C. at 489.
Petitioner has failed to meet this standard. In addition, the
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prevailing hourly rates in the relevant area are not a special
factor. Pierce v. Underwood, supra at 571-572; Powers v.
Commissioner, 100 T.C. at 489. Therefore, we conclude that
petitioner is not entitled to fees in excess of the statutory
rate (i.e., as adjusted by increases in the cost of living) and
award petitioner attorney's fees at an hourly rate of $104.29 for
1995, $107.37 for 1996, and $109.83 for 1997. See Huffman v.
Commissioner, supra at 1151 (stating that 1986 is the appropriate
base year for calculating cost of living increases); Galedrige
Constr., Inc. v. Commissioner, T.C. Memo. 1997-485 (providing the
rates for 1995, 1996, and 1997).
b. Apportioning and Awarding the Fees and Costs
Petitioner requests an award for 848.5 hours in fees and
$4,844.65 in costs. Because petitioner failed to challenge
respondent's position relating to the tax matters partner or the
period of assessment, petitioner may not receive an award for the
231.2 hours that are attributable to those issues. Therefore,
petitioner is eligible to receive an award of fees based on 617.3
hours (i.e., 95.6 hours in 1995, 225.2 hours in 1996, and 296.5
hours in 1997) and $4,844.65 (paid in 1997) in costs.
Accordingly, petitioner is entitled to an award of $7,674;
Hon Family Ventures, Ltd., is entitled to an award of $9,555; and
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Hon Property Investments, Inc., is entitled to an award of $137
for litigation costs.1
All other arguments made by the parties are either
irrelevant or without merit.
To reflect the foregoing,
An appropriate order and
decision will be entered.
1
The awards are determined pursuant to the following
formula: (1995 partnership allocation x (1995 hours x 1995
rate)) + (1996 partnership allocation x (1996 hours x 1996 rate))
+ (1997 partnership allocation x (1997 hours x 1997 rate) + (1997
allocation x costs) = total award. Thus, the parties' awards
were as follows: (1) Petitioner = (.25 x (95.6 x 104.29)) +
(.1988 x (225.2 x 107.37)) + (.01 x (296.5 x 109.83)) + (.01 x
4,844.65)); (2) Hon Family Ventures, Ltd. = (.2308 x (95.6 x
104.29)) + (.2536 x (225.2 x 107.37)) + (.03 x (296.5 x 109.83))
+ (.03 x 4,844.65)); and (3) Hon Property Investments, Inc. =
(.0052 x (95.6 x 104.29)) + (.0035 x (225.2 x 107.37)). All
totals are rounded to the nearest dollar.