Case — Prevailing Party Cost Recovery

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TL Case Summ

THE QUESTION

When can a taxpayer recover costs incurred in connection with an administrative dispute with the IRS?

THE DISPUTE

Taxpayer Says: The IRS should reimburse her for costs incurred in a dispute over her 2006 federal income tax return.

Internal Revenue Service Says: The taxpayer was not the prevailing party in the dispute, and the reimbursement should be denied.

THE LAW

From Internal Revenue Code Section 7430: A taxpayer who has prevailed in an administrative proceeding with the IRS may be entitled to the reasonable administrative costs incurred in connection with the proceeding. To be awarded administrative costs, the taxpayer must prove that she was the “prevailing party” in the administrative proceeding. The prevailing party” is the party who has “substantially prevailed with respect to the amount in controversy or * * * has substantially prevailed with respect to the most significant issue or set of issues presented”, and who meets other requirements.

From Treasury Regulation 301.7430-5(d) : The “amount in controversy shall include the amount in issue as of the administrative proceeding date.”

From Treasury Regulation 301.7430-5(e) : An issue or set of issues constitutes the most significant issue or set of issues presented if, despite involving a lesser dollar amount in the proceeding than the other issue or issues, it objectively represents the most significant issue or set of issues for the taxpayer or the Internal Revenue Service. This may occur because of the effect of the issue or set of issues on other transactions or other taxable years of the taxpayer or related parties.

THE CAUSE OF THE DISPUTE

If you are the “prevailing party” in a dispute with the IRS (and you meet other requirements), you can request reimbursement of reasonable costs and fees, such as attorney fees and court costs. You meet the definition of “prevailing party” when you substantially prevail with respect to the amount in controversy, or the most significant issue or set of issues presented.

In this case, the taxpayer received an IRS notice assessing tax of $11,076 instead of the liability of $3,249 she had reported on her 2006 tax return. She disputed the assessment, and eventually reached a compromise agreement with the IRS in 2010. She filed an amended return based on the compromise agreement, and the IRS abated $3,450 of the assessment, resulting in a net liability of $7,626.

The following table details the issues in the dispute and the related assessment and compromise.

McCauley Table

In April of 2010, the taxpayer requested a reimbursement of the costs she incurred during the dispute.

The IRS denied the request, saying the taxpayer had neither substantially prevailed in the dispute, nor substantially prevailed with respect to the most significant issue presented.

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Right answer!
For the IRS. The difference between the two party’s positions–$7,827–is “the amount in issue” or the “amount in controversy.” Of the $7,827 amount in controversy, the taxpayer prevailed as to $3,450 (i.e., the IRS’s $11,076 position minus the $7,626 reflected in the compromise agreement). Thus, of the $7,827 in controversy, the taxpayer prevailed as to only 44% (i.e., $3,450/$7,827). On the basis of that percentage, we hold that the taxpayer did not substantially prevail with respect to the amount in controversy.

We also hold that the taxpayer did not substantially prevail with respect to the most significant issue presented. The two issues presented in her dispute with the IRS were: (1) whether her taxable income should be reduced by $13,679.50 for the attorney’s fees for her employment-discrimination lawsuit and (2) whether her taxable income should include $20,116.50 in wages. We hold that the attorney’s fee issue was not the most significant issue. In dollar amount, the attorney’s-fee issue was worth less than the wage issue. The attorney’s-fee issue did not affect other tax years. The attorney’s-fee issue was not a threshold, or “primary”, issue relative to the wage issue. The two issues were unrelated. Although the taxpayer prevailed on the attorney’s-fee issue, this was not the most significant issue presented.

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