James H. & Josephine A. Swanson v. Commissioner, 106 T.C. No. 3

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U.S. Tax Court

James H. & Josephine A. Swanson v. Commissioner

106 T.C. No. 3 · Docket 21203-92 · Decided Feb 14, 1996 · Dawson · T.C. Opinion

Rule 155 computation

Source ↗

Addresses I.R.C. § 4975, 28 U.S.C. § 2412, I.R.C. § 408, Treas. Reg. § 301.7430-1

106 T.C. No. 3 UNITED STATES TAX COURT JAMES H. SWANSON AND JOSEPHINE A. SWANSON, Petitioners v .

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 21203-92. Filed February 14, 1996.

Ps filed a motion for reasonable litigation costs pursuant to Rule 231, Tax Court Rules of Practice and Procedure, and sec. 7430, I.R.C., claiming that R was not substantially justified in determining that: (1) Prohibited transactions had occurred under sec. 4975, I.R.C., with respect to a domestic international sales corporation, a foreign sales corporation, and two individual retirement accounts; and (2) the sale of Ps' Illinois residence to P's closely held corporation was a sham transaction.

1. Held

: R was not substantially justified with respect to the first issue, but was substantially justified with respect to the second issue.

2. Held

, further , net worth, for purposes of the Equal Access to Justice Act, 28 U.S.C. sec.

2412(d)(2)(B) (1994), as incorporated by sec.

7430(c)(4)(A)(iii), is determined based upon the cost of acquisition rather than the fair market value of OPINION OF THE SPECIAL TRIAL JUDGE DEAN, Special Trial Judge : This matter is before the Court pursuant to petitioners' motion for award of reasonable litigation costs under section 7430 and Rule 231. References to petitioner are to James H. Swanson. The matter before us involves petitioners' combined use of a domestic international sales corporation, a foreign sales corporation, and two separate individual retirement accounts as a means of deferring the recognition of income. Respondent zealously strove to characterize this arrangement, as well as an unrelated sale by petitioners of their Illinois residence, as tax avoidance schemes. A protracted period of entrenchment ensued, during which the parties firmly established their respective positions, neither side wavering from its conviction that it was in the right. Ultimately, however, these issues were resolved by respondent's notice of no objection to petitioners' motion for partial summary judgment as well as the entry of an agreed decision document, which was later set aside and filed as a stipulation of settlement. As a consequence, petitioners now seek redress for what they claim were unreasonable positions taken by respondent.

Petitioners' daughter, Jill, resided at the Algonquin residence from May of 1987 through June of 1988. Although the record is not clear as to the extent of usage, it appears that petitioners also periodically stayed at the residence subsequent to its sale on December 19, 1986.

4. The Notice of Deficiency

Despite petitioners' agreement to extend the period of limitations in their case until June 30, 1992, petitioners did not receive a 30-day letter prior to the notice of deficiency. Petitioners agreed to the extension in the hope of resolving the case at the administrative level.

In the notice of deficiency, dated June 29, 1992, respondent set forth one primary and three alternative positions for determining deficiencies in petitioners' Federal income taxes and additions to tax for negligence with respect to petitioners' 1986, 1988, 1989, and 1990 taxable years. Of relevance to the present matter were respondent's determinations that: (1) "Prohibited transactions" had occurred which resulted in the termination of IRA's #1 and #2; and (2) the sale of the Algonquin property to a trust in 1986 was a "sham" transaction which could not be recognized for tax purposes.

a. "Prohibited Transactions"

Because the notice of deficiency failed to adequately explain respondent's bases for determining deficiencies and additions to tax with respect to the years at issue, petitioners requested and received the revenue agent's report in their case. As demonstrated by the revenue agent's report, respondent identified, as alternative positions, two "prohibited transactions" which resulted in the loss of IRA #1's status as a trust under section 408. First, respondent concluded that: Mr. Swanson is a disqualified person within the meaning of section 4975(e)(2)(A) of the Code as a fiduciary because he has the express authority to control the investments of * * * [IRA #1].

Mr. Swanson is also an Officer and Director of

Swansons' Worldwide. Therefore, direct or indirect transactions described by section 4975(c)(1) between Swansons' Worldwide and * * * [IRA #1] constitute prohibited transactions.

Mr. Swanson, as an Officer and Director of Worldwide directed the payment of dividends from Worldwide to * * * [IRA #1] * * * * The payment of dividends is a prohibited transaction within the meaning of section 4975(c)(1)(E) of the Code as an act of self-dealing where a disqualified person who is a fiduciary deals with the assets of the plan in his own interest . The dividend paid to * * * [IRA #1] December 30, 1988 will cause the IRA to cease to be an IRA effective January 1, 1988 by reason of section 408(e)(1). Therefore, by operation of section 408(d)(1), the fair market value of the IRA is deemed distributed January 1, 1988. [Emphasis added.]

As further demonstrated by the revenue agent's report, respondent's second basis for disqualifying IRA #1 under section 408 was that:

In his capacity as fiduciary of * * * [IRA #1], Mr. Swanson directed the bank custodian, Florida National Bank, to purchase all of the stock of Swansons' Worldwide. At the time of the purchase, Mr. Swanson was the sole director of Swansons' Worldwide.

The sale of stock by Swansons' Worldwide to

Mr. Swanson's Individual Retirement Account constitutes a prohibited transaction within the meaning of section 4975(c)(1)(A) of the Code . The sale occurred February 15, 1985. By operation of section 408(e)(2)(A) of the Code, the Individual Retirement Account ceases to be an Individual Retirement Account effective January 1, 1985.

Effective January 1, 1985 the Individual Retirement

Account is not exempt from tax under section 408(e)(1) of the Code. The fair market value of the account, including the 2500 shares of Swansons' Worldwide, is deemed to have been distributed to Mr. Swanson in accordance with section 408(e)(2)(B) of the Code. Therefore, Mr. Swanson effectively became the sole shareholder of Swansons' Worldwide, Inc. with the loss of the IRA's tax exemption. [Emphasis added.]

Although the record is not entirely clear on the matter, it appears that respondent imputed to IRA #2 the prohibited transactions found with respect to IRA #1 and used similar reasoning to disqualify IRA #2 as a valid trust under section 408(a).

b. "Sham Transaction"

With respect to the Algonquin property, respondent concluded in the notice of deficiency that:

the purported sale of your personal residence located in Algonquin, Illinois by you in 1986 to Trust #234, Barry D. Elman, Trustee, of which your corporation, H & S Swansons' Tool Company, Inc. is the beneficiary, can not be recognized for tax purposes. The purported sale in 1986 was no more than a sham transaction which was entered into for tax avoidance purposes. It is determined that the purported sale served no other which Swansons' Tool was the beneficiary; (2) the transfer documents conveyed full legal and beneficial ownership from petitioners to this trust; (3) at no time did petitioners act in any manner that was inconsistent with their transfer of all their right, title, and interest in the Algonquin property; and (4) subsequent to the sale, petitioners had no rights as tenants of the property other than as tenants at will.

Respondent filed an answer on November 13, 1992, denying, or denying for lack of knowledge, each of the allegations listed above.

Petitioners filed a motion for partial summary judgment on

March 22, 1993. In their motion, petitioners restated their position, as set forth in their petition, that no prohibited transactions had occurred with respect to IRA's #1 and #2. On July 12, 1993, respondent filed a notice of no objection to petitioners' motion for partial summary judgment, thereby ending the controversy on the DISC and FSC issues. Respondent conceded the Algonquin property issue in a settlement agreement entered into on January 24, 1994. The parties agreed at that time to a total deficiency of $11,372.40, which reflected an amount conceded by petitioners in their petition as capital gain inadvertently omitted from their 1988 Federal income tax. A stipulated decision (hereinafter the decision) was submitted by the parties and entered on February 9, 1994.

6. Motion for Award of Reasonable Litigation Costs

On March 14, 1994, this Court received petitioner Josephine

Swanson's motion for award of reasonable litigation costs

(hereinafter also referred to as the motion). Finding that it was not petitioner Josephine Swanson's intent that the decision entered on February 9, 1994, be conclusive as to the issue of attorney's fees, the Court ordered on April 29, 1994, that the decision be vacated and set aside. The Court further ordered that the decision of February 9, 1994, be filed as a stipulation of settlement, that petitioner Josephine Swanson's motion for award of reasonable litigation costs be filed, and that respondent file a response to petitioner Josephine Swanson's motion in accordance with Rule 232(c).

Respondent's objection to petitioner Josephine Swanson's motion for award of reasonable litigation costs was filed on June 29, 1994. Petitioners sought leave to file a response to respondent's objection by a motion filed August 3, 1994, which was granted.

Petitioners filed an amendment to the motion for award of reasonable litigation costs (hereinafter amendment to motion) on August 1, 1994, pursuant to which petitioner James Swanson joined petitioner Josephine Swanson as a party to the motion. Petitioners filed their response to respondent's objection to petitioners' motion for award of reasonable litigation costs on September 15, 1994.

Following a conference call with the parties on March 20, 1995, the parties were ordered to file a stipulation of facts with respect to items of net worth reported by petitioners on attachment II of their amendment to motion. They were further ordered to file a stipulation of facts regarding the issue of attorney's fees paid or incurred by petitioners. If the parties could not stipulate facts with respect to either issue, they were ordered to file a status report with the Court on or before May 1, 1995.

On May 1, 1995, the parties participated in a conference call, during which they agreed to stipulate certain items of net worth reported on attachment II of petitioners' amendment to motion. The parties also agreed to stipulate that petitioners paid or incurred fees in this matter. The parties disagreed, however, as to the proper method for determining the acquisition cost of specific items on attachment II of petitioners' amendment to motion. With respect to these items, the parties were ordered to file, on or before June 1, 1995, simultaneous memoranda of law, and, on or before July 3, 1995, answering memoranda of law. B. Discussion As an initial matter, we reject respondent's argument that it was improper for us to have vacated the decision of February 9, 1994, thereby allowing petitioners to file their motion for award of reasonable litigation costs. This Court may, in its sound discretion, set aside a decision that has not yet issue was her desire to discover new facts with which to resuscitate her meritless litigation position. The following statements from respondent's memorandum are illuminating in this regard:

due to the complexity of the prohibited transaction rules and the many ways in which disqualified person status can be achieved through specific relationships described in I.R.C. § 4975(e)(2), it was imperative that respondent explore other possible violations before conceding that the facts (as represented by petitioner's counsel) demonstrated no violation. * * * * * * * Petitioner husband established the IRA and created a DISC inside of his IRA to shelter from current income inclusion dividend payments made by an international trading company in which he was the sole shareholder. But for the existence of the IRA , such dividends would be currently taxable to him. If he had created the DISC outside of the IRA , and then sold some or all of the stock in the DISC to the IRA, the sale of stock in the DISC to his IRA would clearly violate the prohibited transactions rules under I.R.C. § 4975. Similarly, the payment of any dividends from his wholly owned corporation to his IRA that effectively allows him to avoid current income inclusion because he assigned his interest in the DISC to his IRA arguably represents an indirect benefit to him personally. For example, both petitioner husband and petitioner wife indirectly received a significant current tax benefit derived from the payment of DISC dividends into his IRA, rather than to the husband as a direct shareholder. But for the creation and maintenance of the IRA , petitioner husband (and, by virtue of her election to file a joint return, the petitioner wife) would have current income inclusion for payments from the trading corporation to the DISC. Accordingly, the transactions between his wholly-owned trading corporation to such entity are arguably indirect prohibited transactions between disqualified persons and the IRA. Also, since one slight variation in the structure or operation of the petitioner's transactions could have resulted in noncompliance with to Trust No. 234 was a sham transaction. Respondent, on the other hand, argues that such a determination was reasonable, particularly in light of the postsale use by petitioners and their daughter.

A "sham" transaction is one which, though it may be proper in form, lacks economic substance beyond the creation of tax benefits. Karr v. Commissioner , 924 F.2d 1018, 1022-1023 (11th Cir. 1991), affg. Smith v. Commissioner , 91 T.C. 733 (1988). In the context of a sale transaction, as here, the inquiry is whether the parties have in fact done what the form of their agreement purports to do. Grodt & McKay Realty, Inc. v. Commissioner , 77 T.C. 1221, 1237 (1981).

The term "sale" is given its ordinary meaning for Federal income tax purposes and is generally defined as a transfer of property for money or a promise to pay money. Commissioner v. Brown , 380 U.S. 563, 570-571 (1965). In deciding whether a particular transaction constitutes a sale, the question of whether the benefits and burdens of ownership have passed from seller to buyer must be answered. This is a question of fact which is to be ascertained from the intention of the parties, as evidenced by the written agreements read in light of the attendant facts and circumstances. Haggard v. Commissioner , 24 T.C. 1124, 1129 (1955), affd. 241 F.2d 288 (9th Cir. 1956).

Various factors to consider in making a determination as to whether a sale has occurred were summarized in Grodt & McKay Realty, Inc. v. Commissioner , supra at 1237-1238, as follows:

(1) Whether legal title passes; (2) how the parties treat the transaction; (3) whether equity was acquired in the property; (4) whether the contract creates a present obligation on the seller to execute and deliver a deed and a present obligation on the purchaser to make payments; (5) whether the right of possession is vested in the purchaser; (6) which party pays the property taxes; (7) which party bears the risk of loss or damage to the property; and (8) which party receives the profits from the operation and sale of the property. * * * [Citations omitted.]

An additional factor to be weighed is the presence or absence of arm's-length dealing. Falsetti v. Commissioner , 85 T.C. 332, 348 (1985) (citing Estate of Franklin v. Commissioner , 64 T.C. 752 (1975), affd. 544 F.2d 1045 (9th Cir. 1976)).

We recognize that a number of the factors listed above favor petitioners' contention that the sale of the Algonquin property was not a "sham" transaction. Nevertheless, the fact remains that petitioners continued paying the heating, electricity, security, and maintenance expenses incurred for the property until sometime in June 1987; i.e., over 5 months after their sale of the property to Trust No. 234. Petitioners also paid for a number of repairs to the property prior to its sale to a third party in 1988. Although petitioners were ultimately reimbursed for all or part of these expenses, it appears that such reimbursement did not occur until proximate to the time a contract of sale was signed between Trust No. 234 and the third party. Finally, we cannot discount the fact that petitioners and their daughter occupied the property at various times between the time of its sale to the trust and its ultimate sale to a third party. In the case of the daughter, this period of occupancy lasted just over 1 year and ended shortly before the property was sold to the third party in June of 1988. The foregoing takes on added significance in light of the fact that petitioner was on "both sides" of the initial sale--both as owner of the property and as the sole shareholder of Swansons' Tool. Combined with the questionable business purpose behind a manufacturing corporation's purchase of a personal residence, we do not find it unreasonable that respondent would challenge the sale as not being at arm's-length.

Based on the record as a whole, we cannot say that respondent's position with respect to the house issue was unreasonable, as a matter of either law or fact. We recognize that petitioners have cited a number of cases supporting the proposition that sales to close corporations by shareholders are not "sham" transactions per se. We further note that petitioners cited cases supporting the permissible occupancy of a residence subsequent to its sale. A careful reading of each, however, does not persuade us that, based on the facts of this case, respondent's litigation position was not substantially justified.

discussed above, find them to be without merit. Before continuing, however, we find it necessary to comment on some of the arguments raised by respondent in her memoranda. While there was colorable merit to some of the contentions raised by respondent in her memoranda regarding the question of net worth, others border on being frivolous and vexatious. As an illustration, respondent set forth the following proposition in arguing that additional amounts should be added to petitioner Josephine Swanson's calculation of net worth:

Florida provides for the equitable distribution of property between spouses upon divorce. Fla. Stat. ch. 61.075 (1994). * * * Respondent notes that the record provides no indication of marital disharmony between the petitioners and presumes that Florida's equitable distribution statute does not expressly apply to this case. However, this significant expectancy to receive an equitable distribution in the event of divorce may itself constitute an asset of a spouse entitled to recognition for purposes of the net worth computation.

Such transparent sophistry speaks for itself and comes perilously close to meriting an award of fees to petitioners under section 6673(a)(2).

3. Exhaustion of Administrative Remedies

Notwithstanding our conclusion that respondent was not substantially justified with respect to the DISC issue, petitioners are not entitled to an award of litigation costs if it is found that they failed to exhaust their administrative remedies.

(e) Exception to requirement that party pursue administrative remedies. If the conditions set forth in paragraphs (e)(1), (e)(2), (e)(3), or (e)(4) of this section are satisfied, a party's administrative remedies within the Internal Revenue Service shall be deemed to have been exhausted for purposes of section 7430.

* * * * * * * (2) In the case of a petition in the Tax Court--(i) The party did not receive a notice of proposed deficiency (30-day letter) prior to the issuance of the statutory notice and the failure to receive such notice was not due to actions of the party (such as failure to supply requested information or a current mailing address to the district director or service center having jurisdiction over the tax matter); and (ii) The party does not refuse to participate in an Appeals office conference while the case is in docketed status .

[Emphasis added.]

Section 301.7430-1, Proced. & Admin. Regs., fails to define the phrase "does not refuse to participate".

Respondent's arguments suggest that section 301.74301(e)(2), Proced. & Admin. Regs., is to be interpreted as requiring an affirmative act by petitioners; i.e., a request for an Appeals Office conference. Petitioners, on the other hand, contend that the proper interpretation is one that puts the burden on respondent, requiring that she act affirmatively.

Petitioners reason that they cannot "refuse to participate" in an 4 months. Contrary to the language of section 601.106(d)(3)(iii)(a), Statement of Procedural Rules, however, Appeals in this case did not arrange a settlement conference within 45 days of receipt of petitioners' case. Petitioners could not, therefore, have refused to participate in an Appeals Office conference, as none was ever offered.

We note that when a 30-day letter has been issued, the procedural rules provide that, in general, the taxpayer is entitled, as a matter of right, to an Appeals Office conference. See sec. 601.106(b), Statement of Procedural Rules. No such right exists, however, once the taxpayer's case is docketed in the Tax Court. Furthermore, once the case is docketed, there is no provision in the procedural rules for a taxpayer request for an Appeals Office conference.

Based on the foregoing, we find that petitioners have exhausted their administrative remedies within the meaning of section 7430 and the regulations thereunder.

4. Whether Petitioners Unreasonably Protracted the

Proceedings

Based upon the record, we find that petitioners did not protract the proceedings.

5. Whether the Fees Sought in This Matter Are Reasonable

As discussed below, we find that the amount sought by petitioners in this matter for litigation costs is not reasonable and must be adjusted to comport with the record.

Respectively, these are the two dates on which COLA's were first provided under the EAJA and section 7430.

Our position on this issue was addressed in Bayer v. Commissioner , 98 T.C. 19 (1992), where we concluded that Congress, in providing for cost of living adjustments in section 7430, intended the computation to start on the same date the COLA's were started under the EAJA; i.e., October 1, 1981. Id. at 23. Citing Lawrence v. Commissioner , 27 T.C. 713 (1957), revd. on other grounds 258 F.2d 562 (9th Cir. 1958), we stated that we would continue to use 1981 as the correct year for making the COLA calculation, unless, of course, the Court of Appeals to which appeal lay had held otherwise. Golsen v. Commissioner , 54 T.C. 742, 756-757 (1970), affd. 445 F.2d 985 (10th Cir. 1971). This case is appealable to the Court of Appeals for the 11th Circuit, which has not addressed the question of whether 1981 or 1986 is the correct date for purposes of computing the COLA petitioners are entitled to an award of miscellaneous expenses in the amount of $3,300.

To reflect the foregoing, An appropriate order will be issued and decision will be entered pursuant to Rule 155 .

Footnotes

¹ The Court agrees with and adopts the Special Trial Judge's opinion, which is set forth below.

² Swansons' Tool elected to be taxed as a subchapter S corporation effective in 1987. Swansons' Tool is in the business of building and painting component parts for various equipment manufacturers. As a part of these activities, Swansons' Tool manufactures and exports property for use outside the United States. 1. The DISC and IRA #1 Following the advice of experienced counsel, petitioner arranged in the early part of January 1985 for the organization of Swansons' Worldwide, Inc., a domestic international sales corporation (hereinafter the DISC or Worldwide). During this period, petitioner also arranged for the formation of an individual retirement account (hereinafter IRA #1). The articles of incorporation for Worldwide were filed on January 9, 1985, and under the terms thereof petitioner was named the corporation's initial director. Shortly thereafter,

³ (...continued) 12/30/88 12/31 88 122,352 Total 593,602 No distributions were made to petitioners from the trust during the years at issue.

⁴ and the dividends paid to IRA #1 were tax deferred pursuant to section 408. Thus, the net effect of these transactions was to defer recognition of dividend income that otherwise would have flowed through to any shareholders of the DISC. In 1988, IRA #1 was transferred from Florida National Bank to First Florida Bank, N.A. (hereinafter First Florida), as custodian. Swansons' Tool stopped paying commissions to Worldwide after December 31, 1988, as petitioners no longer considered such payments to be advantageous from a tax planning perspective. 2. The FSC and IRA #2 In January 1989, petitioner directed First Florida to transfer $5,000 from IRA #1 to a new individual retirement custodial account (hereinafter IRA #2). Under the terms of the IRA agreement, First Florida was named custodian of IRA #2, and petitioner was named as the grantor for whose benefit the IRA was established. Under the terms of the IRA agreement, petitioner

⁵ (...continued) 1202 for 60 percent of net long-term capital gains. The repeal was effective for tax years beginning after Dec. 31, 1986. clearly a factor, petitioners arranged to sell the property to a trust of which Swansons' Tool was the beneficiary. Accordingly, on December 19, 1986, petitioners conveyed the Algonquin property to "Trust No. 234, Barry D. Elman, trustee," (hereinafter Trust No. 234) under a Deed in Trust, which was received and filed by the Recorder for the city of McHenry, Illinois. As a consequence of this transaction, petitioners reported a long-term capital gain of $141,120.78 on Schedule D, Capital Gains and Losses, of their 1986 Federal income tax return, reflecting a $225,000 sale price and an $83,879 basis. Petitioners continued paying the electric bills, heating, exterior maintenance, and house sitting expenses of the Algonquin property through May or June of 1987. In March of 1988, Swansons' Tool reimbursed petitioners for maintenance and repair expenses incurred during the time period December 1986 through May 1987, as well as the expense of moving petitioners' personal belongings in September 1987. Swansons' Tool capitalized these expenditures as part of its basis in the Algonquin property. Subsequent to the signing of a "Real Estate Sales Contract" during March of 1988, the Algonquin property was sold by Swansons' Tool to an unrelated third party on June 23, 1988.

⁶ ] 5. The Petition, Answer, Motion for Summary Judgment, and Settlement Agreement In their petition, filed September 21, 1992, petitioners stated with respect to respondent's determination of "prohibited transactions" that: (1) At all pertinent times IRA #1 was the sole shareholder of Worldwide; (2) since the 2,500 shares of Worldwide issued to IRA #1 were original issue, no sale or exchange of the stock occurred; (3) from and after the dates of his appointment as director and president of Worldwide, Mr. Swanson engaged in no activities on behalf of Worldwide which benefited him other than as a beneficiary of IRA #1; (4) IRA #1 was not maintained, sponsored, or contributed to by Worldwide during the years at issue; (5) at no time did Worldwide have any active employees; and (6) Mr. Swanson engaged in no activities on behalf of Swansons' Trading which benefited him other than as a beneficiary of IRA #2. With respect to the Algonquin residence, petitioners stated, in pertinent part, that: (1) On December 19, 1986, petitioners conveyed the Algonquin property by a Deed in Trust to a trust of

⁷ (...continued) substantially justified in this matter should be based, in part, on the outcome of a related case involving IRA #1. In docket No. 21109-92, respondent determined, and IRA #1 ultimately conceded, that IRA #1 had unrelated business income for the taxable year 1988. IRA #1's concession in docket No. 21109-92, however, appears to have been a direct result of respondent's filing her notice of no objection to petitioners' motion for summary judgment in this case. In any event, we give no weight to the outcome of docket No. 21109-92 because it resulted from an agreement between the parties to that docket rather than a judicial determination. Furthermore, respondent asserts that petitioners: (1) Have not satisfied the net worth requirements, (2) failed to exhaust the administrative remedies available to them within the Internal Revenue Service, (3) unreasonably protracted the proceedings, and (4) have not shown that the costs they have claimed are reasonable. We will address each contested point in turn. 1. Whether Respondent's Litigation Position Was Substantially Justified In 1986, Congress amended section 7430 to conform that provision more closely to the Equal Access to Justice Act (EAJA). Tax Reform Act of 1986, Pub. L. 99-514, sec. 1551, 100 Stat. 2085, 2752. Where the prior statute required taxpayers to prove that the Government's position in a proceeding was "unreasonable," the statute as amended now requires a showing that the position of the United States was "not substantially justified." Sec. 7430(c)(4)(A)(i). This Court has concluded that the substantially justified standard is essentially a continuation of the prior law's reasonableness standard. Sher v.

⁸ Respondent argues that we may not consider positions she took prior to the filing of the answer in determining whether her litigation position was substantially justified. In support, respondent cites, among other cases,

⁹ Huffman v. Commissioner , 978 F.2d 1139 (9th Cir. 1992), affg. in part and revg. in part T.C. Memo. 1991-144.

¹⁰ See Lennox v. Commissioner , 998 F.2d 244, 247-249 (5th Cir. 1993) (holding that the Government's position must be analyzed in the context of the circumstances that caused it to take that position), revg. in part and remanding T.C. Memo. 1992-382. a. The DISC Issue Petitioners contend that respondent was not substantially justified in maintaining throughout the proceedings that prohibited transactions had occurred with respect to IRA #1, and by implication, IRA #2. We agree.

¹¹ A "plan" is defined by sec. 4975(e)(1) to encompass an individual retirement account as described under sec. 408.

¹² (...continued) powers or responsibilities similar to those of officers or directors), a 10 percent or more shareholder , or a highly compensated employee (earning 10 percent or more of the yearly wages of an employer) of a person described in subparagraph (C), (D), (E), or (G) * * * [Emphasis added.]

¹³ In pertinent part, a "fiduciary" is defined by sec. 4975(e)(3) as any person who: (A) exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, [or] * * * * * * * (C) has any discretionary authority or discretionary responsibility in the administration of such plan. At all relevant times, petitioner maintained and exercised the right to direct IRA #1's investments. Petitioner, therefore, was clearly a "fiduciary" with respect to IRA #1 and thereby a "disqualified person" as defined under sec. 4975(e)(2)(A). Furthermore, as petitioner was the sole individual for whose benefit IRA #1 was established, IRA #1 itself was a disqualified person pursuant to sec. 4975(e)(2)(G)(iii). 4975(c)(1)(E) further defines a prohibited transaction as including any "act by a disqualified person who is a fiduciary [ 13 ] whereby he deals with the income or assets of a plan in his own interest or for his own account". We find that it was unreasonable for respondent to maintain that a prohibited transaction occurred when Worldwide's stock was acquired by IRA #1. The stock acquired in that transaction was newly issued--prior to that point in time, Worldwide had no shares or shareholders. A corporation without shares or

¹⁴ It was only after Worldwide issued its stock to IRA #1 that petitioner held a beneficial interest in Worldwide's stock, thereby causing Worldwide to become a disqualified person under section 4975(e)(2)(G).

¹⁵ (...continued) 4975(e)(2)(H) solely due to his "shareholding" in Worldwide as the constructive attribution rules provided under sec. 267 are applicable only to sec. 4975(e)(2)(E)(i) and (G)(i). Sec. 4975(e)(4).

¹⁶ Therefore, respondent's litigation position with respect to this issue was unreasonable as a matter of both law and fact. We also find that respondent was not substantially justified in maintaining that the payments of dividends by Worldwide to IRA #1 qualified as prohibited transactions under section 4975(c)(1)(E). There is no support in that section for respondent's contention that such payments constituted acts of self-dealing, whereby petitioner, a "fiduciary", was dealing with

¹⁷ of section 4975(c)(1)(E), respondent was not substantially justified in

¹⁸ Respondent would have us believe that the delay in settling the DISC issue was due to a statement in petitioners' motion for partial summary judgment that IRA #1 was exempt from tax at all times. In her memorandum in objection to petitioners' motion for litigation costs, respondent contends that this was a "new and overriding issue" that required her to determine whether "any other" prohibited transactions had occurred during the period covered by the notice of deficiency. We disagree. We need look no further than respondent's own memorandum to divine that the true reason for her delay in conceding the DISC

¹⁹ b. The House Issue Petitioners contend that respondent was not substantially justified in determining that the sale of the Algonquin property

²⁰ Our conclusion is not diminished by the fact that respondent ultimately conceded this matter in petitioners' favor prior to trial. The determination of whether respondent's position was substantially justified is based on all the facts and circumstances surrounding a proceeding; the fact that respondent ultimately concedes or loses a case is not determinative. See Wasie v. Commissioner , 86 T.C. 962, 968-969 (1986); DeVenney v. Commissioner , 85 T.C. 927, 930 (1985). 2. Net Worth Respondent contends that petitioners have failed to demonstrate that they satisfied the net worth requirement of section 7430(c)(4)(A)(iii). To qualify as a prevailing party eligible for an award of litigation costs, a taxpayer must establish that he or she has a net worth that did not exceed $2 million "at the time the civil action was filed".

²¹ (...continued) applies * * * * * * * (iii) which meets the requirements of * * * section 2412(d)(2)(B) of title 28, United States Code (as in effect on October 22, 1986) * * *. As applicable to this case, 28 U.S.C. sec. 2412(d)(2)(B) provides that a "party" means "an individual whose net worth did not exceed $2,000,000 at the time the civil action was filed."

²² Petitioners' separate net worths were reported on this statement as follows:

²³ (...continued) accidental omission. The stipulation of facts contains other nonmaterial modifications and corrections. Pursuant to our Order of May 1, 1995, the parties submitted simultaneous and answering memoranda of law, addressing the proper method for determining the acquisition cost of those assets for which there had been no stipulation. As set forth in these memoranda, petitioners argue for an approach whereby the amount paid for an asset, adjusted for depreciation, establishes the acquisition cost of an asset for purposes of the net worth computation. Respondent, on the other hand, argues that the acquisition cost of an asset should constantly be adjusted to reflect realized (if not recognized) income. To quote respondent: In summary, acquisition costs of an asset are generated not only from external contributions but also from realized gains, the internal reinvestment of which acquires an increase, improvement, or enhancement in such asset. Having carefully considered the parties' respective arguments, we accept petitioners' computation of their net worth under section 7430(c)(4)(A)(iii). We find no basis in this case for disregarding the separate legal status of entities in which petitioners hold beneficial or legal interests. See, e.g., Moline Properties, Inc. v. Commissioner , 319 U.S. 436, 438-439 (1943); Webb v. United States , 15 F.3d 203, 207 (1st Cir. 1994);

²⁴ After careful review of the record, we find that petitioners have adequately set forth a statement of their net worth pursuant to Rule 231(b)(5) and have met the burden of proving that their separate net worths did not exceed $2 million on the date they filed their petition. We have considered all other arguments raised by respondent regarding the net worth requirement and, to the extent not

²⁵ in an Appeals Office conference in order to exhaust its administrative remedies:

²⁶ We conclude that petitioners' reading of section 301.74301(e)(2), Proced. & Admin. Regs., is correct. Section 601.106(d)(3), Statement of Procedural Rules, states that with respect to cases docketed in the Tax Court: (iii) If the deficiency notice in a case docketed in the Tax Court was not issued by the Appeals office and no recommendation for criminal prosecution is pending, the case will be referred by the district counsel to the Appeals office for settlement as soon as it is at issue in the Tax Court. The settlement procedure shall be governed by the following rules: (a) The Appeals office will have exclusive settlement jurisdiction for a period of 4 months over certain cases docketed in the Tax Court. The 4 month period will commence at the time Appeals receives the case from Counsel, which will be after the case is at issue. Appeals will arrange settlement conferences in such cases within 45 days of receipt of the case . * * * [Emphasis added.] The notice of deficiency in this matter was issued by the District Director for Jacksonville, Florida. There is no suggestion that a recommendation for criminal prosecution was ever pending against petitioners. Accordingly, pursuant to the procedural rules, respondent's Appeals Office gained settlement jurisdiction over petitioners' case after it was docketed in this Court and maintained such jurisdiction for a period of

²⁷

²⁸ (...continued) such payment was made is unclear, the ultimate effect was to diminish the deterrent effect of the expense involved in seeking review of, or defending against, unreasonable Government action. See, e.g., SEC v. Comserv Corp. , 908 F.2d 1407, 1413-1415 (8th Cir. 1990). detailed in the affidavits of petitioners' counsel, they incurred no fees with respect to the preparation of their motion. Petitioners did not, therefore, incur fees in this matter in an amount greater than $40,000. See Marre v. United States , 38 F.3d 823, 828-829 (5th Cir. 1994); United States v. 122.00 Acres of Land , 856 F.2d 56 (8th Cir. 1988) (applying sec. 304(a)(2) of the Uniform Relocation Assistance and Real Property Acquisition Policies Act of 1970, 42 U.S.C. sec. 4654(a); fees were not actually "incurred" because the taxpayer had no legal obligation to pay his attorney's fees); accord SEC v. Comserv Corp. , 908 F.2d 1407, 1414 (8th Cir. 1990) (construing the EAJA, which language the Court did not find to be significantly different from that in United States v. 122.00 Acres of Land , supra ); see also Frisch v. Commissioner , 87 T.C. 858, 846 (1986) (lawyer representing himself pro se was not entitled to fees for his own services because such fees were not paid or incurred). Because there is no mention in the affidavits of counsel regarding the liability of petitioners for costs other than fees incurred after December 1992, we find that petitioners are not similarly restricted with respect to an award of "reasonable court costs" under section 7430(c)(1)(A) or those items listed in section 7430(c)(1)(B)(i) and (ii).

²⁹ a total of 312.9 hours was spent by counsel in connection with the Court proceedings. Of this amount, 158.8 hours were devoted to the DISC issue, 139.8 hours to the Algonquin property issue, and 14.3 hours to general case management. Based upon the $75-per-hour statutory rate, as adjusted by the COLA computed from 1981, we find that petitioners are entitled to an award for 166.4 hours of fees paid to counsel.

³⁰ As for expenses other than fees, petitioners have asked for total miscellaneous litigation costs in the amount of $6,512.33. Based upon our evaluation of the total time spent on the DISC issue, and our need to exclude miscellaneous expenses incurred with respect to the Algonquin property issue, we find that

Sections addressed

I.R.C. § 4975 Tax on prohibited transactions
(c) (c)(1) (c)(1)(A) (c)(1)(E) (d)(9) (e)(1) (e)(2) (e)(2)(A) (e)(2)(C) (e)(2)(D) (e)(2)(E)(i) (e)(2)(G) (e)(2)(G)(iii) (e)(2)(H) (e)(3) (e)(4)
28 U.S.C. § 2412
(d)(2)(B)
I.R.C. § 408 Individual retirement accounts
(a) (d)(1) (e)(1) (e)(2)(A) (e)(2)(B)
Treas. Reg. § 301.7430-1
(b)(2) (e) (e)(2) (e)(2)(ii)