* This opinion supplements our prior Memorandum Opinion, Payne

v. Commissioner, T.C. Memo. 1998-227, revd. 224 F.3d 415 (5th

Cir. 2000).

T.C. Memo. 2001-231

UNITED STATES TAX COURT

JERRY S. PAYNE, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent*

Docket Nos. 980-95, 26812-95. Filed August 27, 2001.

Jerry S. Payne, pro se.

Richard T. Cummings, for respondent.

SUPPLEMENTAL MEMORANDUM OPINION

SWIFT, Judge: This matter is before us on petitioner’s

motion under Rule 231 for an award of $42,376 in litigation costs

under section 7430. 
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Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

After concessions, the primary issue for decision is whether

respondent’s position in Payne v. Commissioner, T.C. Memo. 1998-

227, revd. 224 F.3d 415 (5th Cir. 2000), as to the tax

deficiencies and the fraud additions to tax was substantially

justified.

Background

During 1987 and 1988, petitioner practiced law, and

petitioner owned and operated in Houston, Texas, a law firm under

the name of Payne & Associates. Petitioner provided extensive

legal representation to and eventually managed, controlled, and

owned the stock of 2618, Inc. (2618 Inc.), a corporation that

owned and operated a topless dance club in Houston, Texas, under

the name Caligula XXI (the Club). 

Petitioner received funds relating to various transactions

involving 2618 Inc., the Club, and other entities and activities. 

Those funds were generally deposited into petitioner’s bank

accounts. Portions of those funds were then disbursed from

petitioner’s bank accounts for and on behalf of 2618 Inc. and the

Club; other portions of the funds were used by petitioner for his

personal purposes.
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During 1987 and 1988, petitioner failed to maintain adequate

books and records for his law firm, and adequate books and

records were not maintained for 2618 Inc. and for the Club.

On audit, respondent determined that petitioner failed to

establish and to substantiate the nature and amount of

petitioner’s income and expenses claimed on his 1987 and 1988

Federal income tax returns. 

Due to the inadequacy of petitioner’s books and records,

respondent reconstructed petitioner’s taxable income for 1987 and

1988 using the specific item and the bank deposits methods of

proof. Respondent determined significant increases to

petitioner’s income over that reported on petitioner’s 1987 and

1988 Federal income tax returns, disallowed many claimed business

and itemized deductions, made other adjustments, and charged

petitioner with the fraud additions to tax for each year. 

In our prior Memorandum Opinion, Payne v. Commissioner, T.C.

Memo. 1998-227, we sustained in significant part respondent’s

deficiency determinations, and we concluded that petitioner was

liable for the fraud additions to tax for 1987 and 1988.

On appeal, in Payne v. Commissioner, 224 F.3d 415 (5th Cir.

2000), the Court of Appeals for the Fifth Circuit concluded that

respondent did not satisfy his clear and convincing burden of

proof applicable to the fraud additions to tax, and (because

absent fraud the period of limitations for assessment of the tax
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deficiencies against petitioner for 1987 and 1988 are expired)

the Court of Appeals reversed our holding as to the tax

deficiencies for 1987 and 1988 that respondent had determined. 

Sec. 6501(a), (c); Rule 142(b). 

On remand to this Court from the Court of Appeals for the

Fifth Circuit for entry of decisions in favor of petitioner,

respondent submitted proposed decision documents reflecting zero

tax deficiencies for petitioner and no fraud additions to tax for

1987 and 1988.

Petitioner in the instant motion has refused to agree to

respondent’s proposed decision documents, and petitioner requests

that, under section 7430 and Rule 231, an award in his favor of

$42,376 in litigation costs be included in the decision

documents.

Discussion

Section 7430(a) provides, among other things, that a

taxpayer who qualifies as a prevailing party in this Court may be

awarded reasonable litigation costs. 

Respondent acknowledges that petitioner exhausted all

administrative remedies, and (because of the reversal by the

Court of Appeals for the Fifth Circuit of our prior Memorandum

Opinion in Payne v. Commissioner, T.C. Memo. 1998-227) respondent

acknowledges that petitioner substantially prevailed in the
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underlying litigation with regard to respondent’s deficiency

determinations and fraud additions to tax. Sec. 7430(a), (b)(1), 

and (c)(4).

Respondent contends, however, that because his position was

substantially justified petitioner does not qualify as a

prevailing party, that petitioner unreasonably protracted the

proceedings, that petitioner does not satisfy the net worth

requirements of 28 U.S.C. sec. 2412(d)(2)(B), and that the

litigation costs petitioner seeks are not reasonable. Sec.

7430(a), (b), and (c)(4); Foothill Ranch Co. Pship. v.

Commissioner, 110 T.C. 94, 97 (1998).

Respondent correctly notes that petitioner’s success on

appeal does not establish that respondent’s position herein was

not substantially justified. E.g., Nalle v. Commissioner, 55

F.3d 189, 192 (5th Cir. 1995), affg. T.C. Memo. 1994-182; Lennox

v. Commissioner, 998 F.2d 244, 248 (5th Cir. 1993), revg. in part

and remanding T.C. Memo. 1992-382. 

The test of whether respondent’s position was substantially

justified is essentially one of reasonableness in law and fact.

E.g., Pierce v. Underwood, 487 U.S. 552, 563-564 (1988); Nalle v.

Commissioner, supra at 191. The term "substantially justified"

means justified to a degree that could satisfy a reasonable

person. E.g., Pierce v. Underwood, supra at 565; Nalle v.

Commissioner, supra.
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We agree with respondent that his position as to the

underlying tax deficiencies and the fraud additions to tax for

1987 and 1988 was substantially justified.

In reversing our Memorandum Opinion, the Court of Appeals

for the Fifth Circuit noted that in its opinion there existed a

lack of persuasive evidence in favor of petitioner or respondent

and based its reversal on respondent’s burden of proof. Payne v.

Commissioner, 224 F.3d at 420-424. The Court of Appeals stated

as follows: "Despite our painstaking review of the record, we

are unable to determine which of these competing positions more

closely comports with reality." Id. at 424. The Court of

Appeals continued --

The expansive record in this case certainly

demonstrates that Payne has no acumen for keeping

orderly records of his financial dealings; and we

sympathize with the government and the Tax Court for

the difficulty they faced in reconstructing Payne’s

financial affairs and then attempting to determine

their tax consequences. In addition, we are aware

that, in some cases, poor record keeping has been

deemed indicative of fraud. * * * 

* * * This evidentiary equipoise results in a

 draw * * * [Id.] 

We believe and so hold that the fact that we decided the

underlying issues in favor of respondent combined with the fact

that the Court of Appeals for the Fifth Circuit reversed on the

basis of a “draw” establishes that the position of respondent
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herein as to the tax deficiencies and the fraud additions to tax

was substantially justified. 

We are aware of the recent District Court opinions involving

petitioner and respondent. See Payne v. United States, 91 F.

Supp. 2d 1014 (S.D. Tex. 1999), on appeal (5th Cir., argued

Apr. 3, 2001), and Payne v. United States, 85 AFTR 2d 564, 2000-1

USTC par. 50,218 (S.D. Tex. 1999), on appeal (5th Cir., argued

Apr. 3, 2001), in which damages and litigation costs were awarded

to petitioner as a result of what was regarded by the District

Court as improper disclosure by respondent of tax return

information relating to petitioner’s 1987 and 1988 tax

liabilities, the same years involved herein. Secs. 6103,

7431(a)(1). At the District Court level, petitioner was awarded

$1,536,680 in actual damages, $1,000 in punitive damages, and

$105,361 in litigation costs. Payne v. United States, 91 F.

Supp. 2d at 1029; Payne v. United States, 85 AFTR 2d at 567,

2000-1 USTC par. 50,218 at 83,590. 

We emphasize, however, that the above District Court

opinions, now on appeal, involved the manner by which respondent

conducted the audit of petitioner’s 1987 and 1988 Federal income

tax returns. In contrast, the instant litigation pertains to

respondent’s substantive tax deficiencies and additions to tax

arising out of that audit. 
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The above District Court opinions and the award to

petitioner therein of damages and litigation costs do not

constitute a finding that respondent’s position with regard to

the underlying tax deficiencies and fraud additions to tax was

not substantially justified. 

In light of our conclusion that respondent’s position as to

the underlying tax deficiencies and the fraud additions to tax

was substantially justified, we need not decide whether

petitioner protracted the litigation, whether petitioner

satisfied the net worth limitations of 28 U.S.C. sec.

2412(d)(2)(B), or whether petitioner’s claimed litigation costs

were reasonable. 

For the reasons stated, petitioner’s motion for litigation

costs will be denied.

Appropriate orders and decisions

will be entered.