Widow Can't Recover Litigation Costs After Prevailing on Innocent Spouse Issue

(Parker Tax Publishing June 2024)

Siding with the IRS, the Tax Court held that a widow, who had been granted innocent spouse relief, did not qualify under Code Sec. 7430 for an award of any of the legal or administrative costs she incurred in that litigation. According to the court, the IRS's position was substantially justified, and thus the widow could not prevail, because there were no statutes, regulations, or judicial decisions that either articulated or clearly dealt with an equity argument raised by the widow, making it an issue of first impression that was not clearly settled by existing law. O'Nan v. Comm'r, T.C. Memo. 2024-57.

Background

In O'Nan v. Comm'r, T.C. Memo. 2023-117, the Tax Court held that Sarah O'Nan, a widow to whom the IRS granted partial innocent spouse relief under Code Sec. 6015(f), was entitled to a refund of most of the proceeds from the sale of the home she owned with her late husband that had been paid to the IRS in satisfaction of a lien.

Prior to the Tax Court's decision, O'Nan's lawyer, Harlan Louis, had sent four settlement proposals to the IRS's counsel. The first three proposals were mailed in 2019, 2020, and January 11, 2021. The subject line of each letter read: "Settlement Proposal (CONFIDENTIAL UNDER RULE 408) Sarah S. O'Nan v. Commissioner, Tax Court Case No 5115-17." Louis sent the fourth proposal by mail on February 1, 2021, with substantially the same subject line. There was no evidence that the IRS's counsel accepted any of the proposals, none of which referenced Code Sec. 7430 or included the phrase "qualified offer."

After the Tax Court's decision in 2023, O'Nan requested an award under Code Sec. 7430 of almost $87,000 for attorney's fees and some miscellaneous filing fees. The attorney's fees related to work performed by Louis's firm, Bailey Cavalieri, LLC, between March 2015 and September 2023.

Code Sec. 7430 provides for the award of litigation or administrative costs to a taxpayer in a proceeding brought by or against the United States involving the determination, collection, or refund of any tax, interest, or penalty if the taxpayer can demonstrate that she (1) is the prevailing party; (2) exhausted administrative remedies within the IRS; (3) did not unreasonably protract the proceeding; and (4) has claimed reasonable costs. The requirements are conjunctive; failure to satisfy any one of them precludes an award. Even if the taxpayer meets all the requirements, the taxpayer is not treated as the prevailing party if the IRS establishes that its position in the proceeding was substantially justified.

The IRS conceded that O'Nan substantially prevailed in the case, that her net worth did not exceed the $2 million limit for filing for a Code Sec. 7430 award, and agreed that she exhausted her administrative remedies, and that she did not unreasonably protract the proceedings. Thus, under Code Sec. 7430(c)(4)(E)(i), if any of her settlement proposals constituted a "qualified offer," she was entitled to an award of her administrative and litigation costs even if the IRS's position was substantially justified. Under Code Sec. 7430(g)(1), a qualified offer is a written offer which: (1) is made by the taxpayer to the United States during the qualified offer period; (2) specifies the offered amount of the taxpayer's liability (determined without regard to interest); (3) is designated at the time it is made as a qualified offer; and (4) remains open during the period beginning on the date it is made and ending on the earliest of the date the offer is rejected, the date the trial begins, or the 90th day after the date the offer is made. However, the qualified offer provisions do not apply to any proceeding in which the amount of tax liability is not in issue.

Analysis

The Tax Court held that the IRS's position in the case was substantially justified and thus O'Nan did not qualify under Code Sec. 7430 for an award of any of the legal or administrative costs she incurred in her dispute with the IRS. The court noted that the case was instituted to dispute the IRS's refusal to provide a refund of amounts taken to satisfy an undisputed tax liability of a third party, O'Nan's deceased husband. O'Nan's tax liability, the court observed, was not in issue during the IRS or court proceedings and thus none of the settlement proposals made by her attorney constituted a qualified offer under Code Sec. 7430.

Because no qualified offer was made, the court went on to examine whether the IRS's position during the proceedings was substantially justified. The court noted that it was only after an earlier partial summary judgment ruling that O'Nan raised as an issue the fact that the equity in her late husband's former one-half interest in the family home was insufficient to account for the entire IRS lien payment. That equity argument, the court noted, presupposed that when a Code Sec. 6321 lien attaches to property jointly owned by two spouses and one spouse is subsequently granted innocent spouse relief for some or all of the tax liability secured by the lien, the lien then encumbers the relieved spouse's interest in the property only to the extent of the liability for which that spouse was not granted relief. The Tax Court said it was not aware of any statute, regulation, or judicial decision that either articulated or clearly implied this point of law before the court issued its original decision in this case. Nor could the court say that the IRS's response to the equity argument - viz, that an earlier-arising Code Sec. 6321 lien is unaffected by a grant of innocent spouse relief - was not justified to a degree that could satisfy a reasonable person.

The Tax Court observed that it and other courts have consistently held the IRS's position to be substantially justified for purposes of Code Sec. 7430(c)(4)(B)(i) when its position addressed a question of first impression that was not clearly settled by existing statutes or regulations. According to the court, the IRS's position was substantially justified, and thus the widow could not prevail, because there were no statutes, regulations, or judicial decisions that either articulated or clearly dealt with the equity argument raised by the widow, making it an issue of first impression that was not clearly settled by existing law.

For a discussion of the criteria for recovering legal and administrative fees after prevailing in litigation with the government, see Parker Tax ¶263,540.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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