Litigation costs denied; IRS substantially justified in its position

Where a taxpayer’s Tax Court petition was filed after the 30-day deadline in Sec. 6330(d)(1), the court held the IRS was substantially justified in its litigation position that the petition was untimely and, consequently, the court lacked jurisdiction over the taxpayer’s case. The court found the IRS was substantially justified in this position because, when the petition was filed, the case law was clear that the Sec. 6330(d)(1) deadline was jurisdictional and, therefore, a Tax Court petition filed after the Sec. 6330(d)(1) deadline was untimely.

Background

The IRS issued Josefa Castillo a notice of deficiency for 2014 in November 2016. In the notice, the Service determined that Castillo owed a deficiency of $44,427 and was liable for accuracy-related penalties of $8,885 for an underpayment attributable to a substantial understatement of income tax. The notice was mailed to Castillo’s last known address, but she did not receive it, and it was returned to the IRS.

The IRS subsequently assessed the deficiency and issued a Notice of Federal Tax Lien (NFTL). Castillo requested and received a collection due process (CDP) hearing, at which she argued that the income attributed to her in the deficiency notice was instead attributable to Castillo Seafood, a business she allegedly sold in 2009.

The settlement officer informed Castillo that because her notice of deficiency was properly mailed but unclaimed, she could not dispute the underlying liability unless she could show she was out of the country during that time. She could not make this showing. Therefore, after the hearing, the IRS issued Castillo a notice of determination sustaining the collection action.

Based on the date of the notice of determination, the 30-day period specified in Sec. 6330(d)(1) for filing a petition with the Tax Court to review the CDP determination expired on Jan. 10, 2019. Castillo, however, filed a petition with the court for review on Oct. 8, 2019.

In 2020, the IRS moved to dismiss Castillo’s case for lack of jurisdiction, arguing that the Sec. 6330(d)(1) 30-day deadline was jurisdictional and, therefore, Castillo’s Tax Court petition was untimely. The court granted the motion.

Later in 2020, Castillo appealed the case to the Second Circuit. The court held the case in abeyance pending the Supreme Court’s decision in Boechler, P.C., 142 S. Ct. 1493 (2022), in which the Court was addressing whether the Sec. 6330(d)(1) deadline was jurisdictional or nonjurisdictional. If the Court held that the deadline was nonjurisdictional, it would be subject to equitable tolling, and the 30-day filing deadline could have been suspended in Castillo’s case. Consequently, Castillo’s petition would no longer be considered untimely, and the Tax Court would have jurisdiction over her case.

In 2022, the Supreme Court decided Boechler, holding that the Sec. 6330(d)(1) 30-day deadline to file a petition for review of a CDP determination is nonjurisdictional and subject to equitable tolling. In accordance with the Supreme Court’s decision, the Second Circuit vacated the Tax Court’s order dismissing Castillo’s case and remanded the case to the Tax Court for further proceedings. Back in the Tax Court, the IRS, forced to litigate the actual issues in the case, conceded that Castillo was not liable for the unreported income, penalty, or interest determined in the deficiency notice.

As a result, Castillo now owed no taxes for 2014. However, in her administrative appeal of the alleged 2014 deficiency, she claimed she had incurred $5,601 in administrative costs and in the subsequent litigation claimed she had incurred litigation costs of $129,750. She therefore made a motion requesting that the Tax Court order the IRS to pay her administrative and litigation costs per Sec. 7430(a).

The IRS conceded that it should pay her the administrative costs, so the Tax Court was only required to determine whether the IRS was required under Sec. 7430(a) to pay her litigation costs.

The Tax Court’s decision

The Tax Court held that the IRS was not required to pay Castillo’s litigation costs. The court found the Service was not required to do so because its position, that the court did not have jurisdiction because Castillo had filed an untimely petition, was substantially justified at the time she filed it.

Sec. 7430(a) provides that the prevailing party may be awarded reasonable administrative or litigation costs for any proceedings brought by or against the United States in connection with the determination, collection, or refund of any tax, interest, or penalty. To recover costs, the taxpayer must establish that (1) the taxpayer is the prevailing party, (2) he or she did not unreasonably protract the proceedings, (3) the amount of the costs requested is reasonable, and (4) he or she exhausted the administrative remedies available.

The taxpayer has the burden of proof, and the requirements are conjunctive, so all four must be met. Relevant to Castillo’s case, under Tax Court precedent, the fact that the IRS ultimately conceded the case in full is not determinative as to whether a taxpayer is entitled to an award of reasonable litigation costs.

The IRS conceded that Castillo had met all the Sec. 7430(a) requirements except the first, that she was the prevailing party in the case. Under Sec. 7430(c)(4)(A)(i), to be the prevailing party, the taxpayer must have substantially prevailed with respect to the amount in controversy or have substantially prevailed with respect to the most significant issue or set of issues presented. As the IRS had conceded that Castillo was not liable for the deficiency, interest, or penalty determined in the notice of deficiency, the Tax Court found that she had prevailed with respect to the amount in controversy and was the prevailing party.

However, as the Tax Court explained, an exception applies to this rule. Under 7430(c)(4)(B)(i), a party is not treated as the prevailing party if the IRS establishes that its position was “substantially justified.” The IRS claimed that this rule applied in Castillo’s case.

Under the applicable case law, the IRS’s litigation position is substantially justified when it is based on supportable interpretations of federal tax statutes and case law and it is generally established at the time the IRS files its answer in the judicial proceeding. To be substantially justified, the IRS’s position must have a reasonable basis in both fact and law.

The Tax Court found that, in Castillo’s case, the IRS’s litigation position, which was established in the IRS’s answer to her petition, was that the court lacked jurisdiction because Castillo had not timely filed her petition. It was undisputed that Castillo had not filed her petition within 30 days, as required by Sec. 6330(d)(1), and, at that time (prior to the Boechler decision), it was well established that the 30-day period to file a petition for review of a CDP determination was jurisdictional and therefore could not be extended. Because the law was clear at the time that a timely filing of a petition was necessary to establish Tax Court jurisdiction, the IRS was substantially justified in asserting that the court lacked jurisdiction.

The Tax Court noted that the Supreme Court’s decision in Boechler did not change this result. Before that decision, the Tax Court stated, neither it nor the federal courts of appeals had held the 30-day period in Sec. 6330(d)(1) to be nonjurisdictional. Under Tax Court precedent, the IRS generally is not subject to an award of litigation costs under Sec. 7430 where the underlying issue is one of first impression. Because the question of whether the Sec. 6330(d)(1) deadline was jurisdictional or nonjurisdictional was a matter of first impression for the Supreme Court in Boechler, the Tax Court found that the IRS’s position was substantially justified.

Castillo also argued that the IRS’s position should be presumed not to be substantially justified under Sec. 7430(c) (4)(B)(ii), which states that “the position of the United States shall be presumed not to be substantially justified if the Internal Revenue Service did not follow its applicable published guidance in the administrative proceeding.” Castillo contended that this rule applied because the IRS did not follow guidance provided in the Internal Revenue Manual (IRM).

However, the Tax Court determined that the presumption in Sec. 7430(c) (4)(B)(ii) did not arise in Castillo’s case because the IRM is not “applicable published guidance” within the meaning of the statute. Sec. 7430(c)(4)(B)(iv) defines “applicable published guidance” exhaustively as “regulations, revenue rulings, revenue procedures, information releases, notices, and announcements, and . . . any of the following which are issued to the taxpayer: private letter rulings, technical advice memoranda, and determination letters.” As the IRM is not in this list, the court found that the IRM is not applicable published guidance for purposes of Sec. 7430(c)(4)(B)(ii).

Reflections

Although the facts in Castillo’s case were unusual, the Tax Court’s determination that she was not entitled to a Sec. 7430(a) award of litigation costs because of the Sec. 7430(c)(4)(B)(i) substantial-justification exception was not. Whether the IRS was substantially justified in a position is a case-by-case, facts-and-circumstances determination, and the IRS’s position will frequently be found to be substantially justified where, as in Castillo’s case, the IRS loses the case and the taxpayer is vindicated. Even where an IRS determination is found to have been arbitrary, capricious, and without sound basis in fact, it may be held to be substantially justified (see, e.g., Mid-Del Therapeutic Center, Inc., T.C. Memo. 2000-383, aff ’d, 30 Fed. Appx. 889 (10th Cir. 2002)).

Thus, given the broad scope of when the IRS is considered to be substantially justified, while there is no harm in making a motion for reasonable litigation or administrative costs, the taxpayer generally should not expect a successful outcome to the motion.

Castillo, 160 T.C. No. 15 (2023)

Contributor

James A. Beavers, CPA, CGMA, J.D., LL.M., is The Tax Adviser’s tax technical content manager. For more information about this column, contact thetaxadviser@aicpa.org.