On February 2, 2015, the United States Tax Court issued an opinion in the case of Estate of Roderigo F. Fenta v. Commissioner. Mr. Fenta, the taxpayer, on the Lakeside Lounge for over 30 years until he sold it in November 2010. He was audited and the IRS proposed a deficiency of $13,180 and an accuracy related penalty of $2636. The taxpayer filed a petition in Tax Court. Eventually, Fenta got the the tax liability was reduced to $1655 with no penalty. At that point, the taxpayer sought to recover his legal fees under Section 7430. The Tax Court said, “No.” The big lesson in this case is that if you get audited by the IRS, you need to get an experienced tax attorney involved who knows what you will need to prove your case so that you can put all the of the necessary facts, including documentary evidence, that will win your case in front of the IRS examiner before the agent assesses a deficiency and any penalties. What happened to Fenta?
Roderigo F. Fenta v. Commissioner
Mr. Fenta’s business was a cash-intensive business. He was audited by the IRS after he had sold the Lakeside Lounge. He produced some handwritten daily statements purporting to summarize the cash register tape, but did not produce the originals of his receipts, the original of the cash register tape or other documentation that would substantiate what he claimed to be losses from spillage and theft. Based on what the IRS had to work with, and after having to go to third parties to get records, the revenue agent proposed the deficiency and accuracy related penalty.
In Tax Court, after the IRS filed its answer, Fenta, for the first time, provided the IRS with the information and documentation needed to resolve most of the issues. Ultimately, the tax liability was reduced to $1655 with no penalty. It was only then that Fenta sought to recover his legal fees.
The court said that legal fees against the IRS can be awarded if the taxpayer: (1) is the prevailing party; (2) has exhausted his or her administrative remedies with the IRS (with respect to litigation costs only); and (3) did not unreasonably protract the administrative or court proceedings.
On issue (1), the taxpayer must: (a) have substantially prevailed with respect to either the amount in controversy or the most significant issue or set of issues presented; and (b) satisfy the applicable “net worth requirement.” The taxpayer will nevertheless fail to qualify as the prevailing party if the IRS can establish that its position was substantially justified. In this case, the IRS and the taxpayer agreed that the taxpayer had substantially prevailed with respect to the amount in controversy and that he satisfied the net worth requirement. So, the pivotal issue was whether the position of the IRS was substantially justified.
The Court said that the IRS’s position is substantially justified if, on the basis of all of the facts and circumstances and the legal precedents related to the case, the IRS acted reasonably. The facts and circumstances part of that test is based on what the IRS had available at the time of the assessment of tax. In other words, the IRS may later be proven wrong based on more and better facts, but nevertheless the IRS may be substantially justified if a reasonable person could think it’s position was correct. In this case, the IRS issued the notice of deficiency on March 11, 2013, at which time Fenta had not provided the IRS with the receipts, cash register tape or other original documentation that would support Fenta’s handwritten daily summaries or adequately substantiate Fenta’s claims regarding spillage and theft. Because of that, the Tax Court held that the IRS was substantially justified in its position when the matter first came before the Court and, as a result, Fenta was unable to recover his legal fees.
If Mr. Fenta had gotten a competent, experienced tax attorney before or during the audit itself, the results could have been very different.