UNITED STATES COURT OF APPEALS 

FOR THE FIFTH CIRCUIT

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No. 92-4826 

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MICHAEL L. LENNOX AND

GLENDA J. LENNOX,

Petitioners,

VERSUS

COMMISSIONER OF

INTERNAL REVENUE,

Respondent.

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Appeal from the Decision of the

United States Tax Court

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(August 4, 1993)

Before POLITZ, Chief Judge, REAVLEY, and BARKSDALE, Circuit Judges.

BARKSDALE, Circuit Judge:

In reviewing the Tax Court's denial of costs to the Lennoxes,

after the government conceded their challenge to its notice of

deficiency, we consider for the first time the definition of the

"position of the United States" on "the date of the notice" as

contained in 26 U.S.C. § 7430(c)(7)(B)(ii), as amended by the

Technical and Miscellaneous Revenue Act of 1988, Pub. L. No. 100-

647, § 6239(a), 102 Stat. 3342, 3743. Concluding that a

determination of the reasonableness of that position must include

a review of the actions leading to its establishment, we hold that

the government's position was not substantially justified.
1 Piperi later came under criminal investigation because this

loan, which he arranged in 1983, was a construction loan.

Construction had been completed in 1982.

2

Therefore, we REVERSE the denial of costs and REMAND to the Tax

Court for their determination. 

I.

The Internal Revenue Service began to question the Lennoxes'

tax returns during the course of its investigation of Ron Piperi,

an attorney who had represented Glenda Lennox's family since the

early 1970's. Michael Lennox first met Piperi in 1981, when Piperi

handled the probate of Glenda's mother's estate, from which Glenda

Lennox and her children inherited property worth approximately $1

million. Piperi advised the Lennoxes that they needed a tax

shelter and recommended investing some of the inheritance in

apartment projects. 

The first project was the Quail Creek Apartments (the

apartments) in Killeen, Texas, which Piperi was already developing,

and in which he offered to sell the Lennoxes an interest. In 1983,

he sold his interest to Michael Lennox, making him the sole owner.

At the closing, Lennox executed, among other documents, a $6.25

million note on which he was personally liable. The loan was

arranged by Piperi through a savings and loan for which he served

as chairman of the board.1 Title was recorded in the county

records. 

After experiencing some difficulty with the company managing

the apartments, Lennox contracted with Asset Plus, a management

company in which Piperi held an interest. Lennox visited the
2 In February 1983, Lennox had borrowed an additional $660,000

to use for interest payments on the larger note. He put up 120

acres of land from his mother-in-law's estate as collateral. That,

too, was lost in the foreclosure.

3

property regularly and handled the insurance and major repairs, but

Asset Plus was to provide him with monthly reports, collect rents,

and administer all expenditures, including making interest payments

on the $6.25 million note. At the hearing on costs, Lennox

testified that, as far as he knew, those payments were made.

Within the first two years, Lennox realized that the apartments

were not going to generate enough income to service the interest on

the note. Piperi then approached him with an offer: his savings

and loan would refinance the loan at a lower rate, but the existing

loan must first be placed in default. Lennox testified that he

understood Asset Plus was taking the amount it had been paying

toward the interest and placing it in escrow. However, Lennox

began to have difficulty obtaining an accounting or other records

from Asset Plus. The new financing did not go through, the savings

and loan foreclosed on the apartments,2 and Lennox filed

bankruptcy.

Meanwhile, IRS agent George Gilbert, in El Paso, was

investigating Piperi. During the course of that investigation, he

discovered that Piperi was receiving the rental income from the

apartments and using it for personal expenses, that no principal or

interest payments had been made on Lennox's $6.25 million note, and

that Piperi had arranged other similar loans, assuring the

"borrowers" that they would never have to pay, and in some cases,
4

paying them $20,000 for signing the notes. This information caused

Gilbert to suspect that Lennox was only a nominee owner of the

apartments, and he concluded that Lennox should be investigated to

determine the true ownership. On August 10, 1990, Gilbert sent a

memorandum to his branch chief, alerting him to these concerns and

suggesting that the Lennoxes' tax returns be examined.

On August 22, having received a copy of Gilbert's memorandum,

IRS agent Phelps Brookshire, in Waco, began an examination of the

Lennoxes' returns for 1983, 1984 and 1985. For each of those

years, the Lennoxes had claimed deductions related to the

apartments, including large net operating losses. Brookshire

examined those returns and spoke with Gilbert, but did not conduct

an investigation of his own. When Brookshire realized, in late

August, that the limitations period would expire that October 27,

he determined that he would "have to do something fast".

On September 11, Brookshire telephoned Lennox and explained

that all losses associated with the apartments would be disallowed.

Lennox and Brookshire spoke again the following day, and Brookshire

stated that he would have to issue a notice of deficiency unless

Lennox agreed to extend the limitations period. Several days

later, Lennox's accountant called Brookshire, advised him that the

tax rolls listed Lennox as the owner of the apartments and that

Lennox had filed bankruptcy because of his debt on them, and

offered, on behalf of Lennox, to sign a limited extension,

extending the period only as to questions related to the

apartments. Brookshire refused. He later testified that his
5

manager said that there was not enough time (in the approximately

35 days remaining in the limitations period) to get approval for

the specific language for a limited extension.

Not having received an extension, Brookshire issued a

statutory notice of deficiency on October 2, disallowing the losses

claimed on the apartments due to questions of actual ownership. On

January 3, 1991, the Lennoxes petitioned the Tax Court for a

redetermination of the deficiencies. The Commissioner of Internal

Revenue answered on March 5, denying all facts of ownership as

alleged in the petition. On April 10, the Lennoxes' attorney, John

D. Copeland, had a one-hour telephone conversation with an IRS

appeals officer and discussed evidence that Michael Lennox was the

true owner. (Nothing in the record, however, describes that

evidence.)

Eight months later, Copeland received settlement documents

from the IRS. He testified that, after the April telephone

conversation, he intended to send the appeals officer copies of

documents showing ownership but "never got around to sending them

to him, but [the IRS] went ahead and dropped the case, even without

my sending those documents".

On March 16, 1992, the day this matter was set for trial, the

parties filed a stipulation of settled issues, stating that there

were no deficiencies or additions due from, nor overpayments due

to, the Lennoxes for 1983, 1984 or 1985. The Lennoxes filed a

motion for administrative and litigation costs that same day, and

the Tax Court heard evidence on the motion on March 19. On June
6

25, the Lennoxes supplemented their motion, adding additional

costs. The Tax Court filed an opinion on July 8, concluding that

the government's position, beginning with the date of issuance of

the notice of deficiency, was substantially justified.

Accordingly, costs were denied. 

II.

Internal Revenue Code § 7430 allows the "prevailing party" in

tax proceedings to recoup reasonable costs, including attorney's

fees. Determining a "prevailing party" includes several factors,

only one of which is at issue here: whether "the position of the

United States in the proceeding was not substantially justified".

26 U.S.C. § 7430(c)(4)(A)(i). This determination requires us to

resolve two subissues. Because our court has not interpreted the

applicable definition of "position of the United States", we must

first determine when that position becomes fixed and what actions

can be considered for purposes of this analysis. Then, against

that backdrop, we must determine whether the position was

substantially justified.

A.

When § 7430 was first enacted in 1982, the term "position of

the United States" was not defined. 26 U.S.C. § 7430 (1982). It

was first defined when the section was amended in 1986, and that

definition was amended in 1988. Applicable to all proceedings

commenced after November 10, 1988, that version is at issue here,

and reads in pertinent part:
3 Subsection (a) provides:

In any administrative or court proceeding

which is brought by or against the United States in

connection with the determination, collection, or

refund of any tax, interest, or penalty under this

title, the prevailing party may be awarded a

judgment or a settlement for --

(1) reasonable administrative costs

incurred in connection with such administrative proceeding within the Internal Revenue

Service, and

(2) reasonable litigation costs incurred

in connection with such court proceeding.

26 U.S.C. § 7430(a) (1988).

7

The term "position of the United States" means --

(A) the position taken by the United States

in a judicial proceeding to which subsection (a)

applies, [as quoted in note 3, infra,] and

(B) the position taken in an administrative

proceeding to which subsection (a) applies as of

the earlier of --

(i) the date of the receipt by the

taxpayer of the notice of the decision of the

Internal Revenue Service Office of Appeals, or

(ii) the date of the notice of

deficiency.

26 U.S.C. § 7430(c)(7) (1988).3

The Lennoxes contend that the position of the United States on

October 2, 1990, the date of the notice of deficiency, was not

substantially justified. There is no question that it is the

position taken by the United States on that day which we must

consider. The question, however, is what actions the Tax Court can

look to in determining the justification for that position. This

issue of statutory interpretation is, of course, one of law, which
8

we review de novo. E.g., Dresser Industries v. C.I.R., 911 F.2d

1128, 1132 (5th Cir. 1990); Sliwa v. C.I.R., 839 F.2d 602, 605 (9th

Cir. 1988). 

Although the Tax Court found that there had been sufficient

time to have the limited extension prepared and executed, it

nevertheless refused to consider any actions which took place

before October 2, summarily holding: "[I]t is clear from section

7430(c)(7)(B) that the only position taken by the United States in

an administrative proceeding which is to be considered in this case

in determining whether [the Lennoxes] are the prevailing part[ies]

is the position taken by [the United States] beginning with the

date of the deficiency notice. ... Therefore the reasonableness

of the actions of the revenue agent in not accepting the restricted

[limitations] waiver are not relevant since those actions were

taken prior to October 2, 1990."

The Lennoxes challenge this interpretation of § 7430, and

contend that such a rule will require courts to decide cases in a

vacuum. We agree. Although we have not previously interpreted the

amended subsection of § 7430 in issue (§ 7430(c)(7)(B)(ii)), at

least one prior opinion by our court foreshadows this result. In

Hanson v. C.I.R., 975 F.2d 1150 (5th Cir. 1992), in considering the

United States' position in a judicial proceeding, § 7430(c)(7)(A),

our court did so "against the backdrop of the administrative

actions that have gone before", concluding that such a backdrop "is

relevant to a determination whether the government's position in

litigation is substantially justified". Id. at 1153 n.2 (emphasis
4 Pierce v. Underwood, concerning the Equal Access to Justice

Act (EAJA), 28 U.S.C. § 2412(d), interprets the same words at issue

here. Where the language is the same, "courts read the EAJA and §

7430 in harmony". Kenagy v. United States, 942 F.2d 459, 464 (8th

Cir. 1991).

9

in original). In sum, our court declined to construe §

7430(c)(7)(A) (judicial proceeding) as strictly as the Tax Court

here construed § 7430(c)(7)(B)(ii) (administrative proceeding).

Instead, our court interpreted the government's position at a

particular time in the context of what led to the formulation of

that position.

We agree with the Hanson analysis, and apply the same

interpretation to § 7430(c)(7)(B)(ii). We hold that the government's position on "the date of the notice of deficiency" must be

analyzed in the context of what caused it to take that position.

The IRS would not have issued the notice on October 2 (forcing the

Lennoxes to file suit) if the Lennoxes had extended the limitations

period. They declined to do so, offering a limited extension

instead. Because the IRS refused the limited extension, it issued

the notice which set this proceeding in motion. Certainly we must

consider the reasonableness of that refusal, among other factors,

in determining whether the issuance of the notice was substantially

justified.

B.

The position of the United States is substantially justified

if it is "justified to a degree that could satisfy a reasonable

person". Pierce v. Underwood, 487 U.S. 552, 565 (1988).4 It is

not enough that a position simply possesses enough merit to avoid
10

sanctions for frivolousness; it must have a "`reasonable basis both

in law and fact'". Id.; see, e.g., Hanson, 975 F.2d at 1153. The

burden of proving no substantial justification is with the

taxpayers. Estate of Johnson v. C.I.R., 985 F.2d 1315, 1318 (5th

Cir. 1993). We review the Tax Court's ruling on substantial

justification for abuse of discretion, id., and will reverse only

if we have a definite and firm conviction that an error of judgment

was committed. See TKB International, Inc. v. United States, __

F.2d __, 1993 WL 184021 (9th Cir. June 3, 1993). 

Of course, the ultimate failure of the government's legal

position does not necessarily mean that it was not substantially

justified. It is, however, a factor to be considered. Estate of

Perry v. C.I.R., 931 F.2d 1044, 1046 (5th Cir. 1991). In this

case, the Tax Court was not swayed by the government's concession,

because it concluded that, after the notice was filed, the

government "ascertained the facts and conceded the case as

expeditiously as might be expected".

To the extent that this is a finding of fact that the IRS

obtained new evidence between notice and concession, we hold that

it is clearly erroneous. When the notice was issued, the IRS knew

that the tax rolls showed Michael Lennox as the owner of the

apartments and that he had filed for bankruptcy because of his debt

on them. There is nothing in the record to reveal what information

was later obtained, or how it might have persuaded the IRS to

concede. It is undisputed that the Lennoxes' attorney spoke to an

IRS appeals officer for one hour on April 10, 1991; but, obviously,
5 Indeed, at oral argument before us, government counsel

conceded that the "record is scant" regarding any new information

which could have come to light between notice and concession. Also

at oral argument, the Lennoxes' counsel explained that the only

evidence discussed in the telephone conversation was documents from

the public record which would show Michael Lennox's ownership of

the apartments. It is clear that the IRS knew, before issuance of

notice, that title had been transferred to Lennox and that the tax

records reflected such ownership. Moreover, because the IRS has

never contested Lennox's record ownership, it seems unlikely that

it would find such evidence persuasive. Of course, statements made

before us could not have been considered by the Tax Court in

reaching a factual finding. The statements only reinforce the

conclusion we reached from our review of the record.

6 The Commissioner cites Harrison v. C.I.R., 854 F.2d 263 (7th

Cir. 1988), cert. denied, 489 U.S. 1053 (1989) (concerned pre-1988

version of § 7430) as authority for its position that it is

reasonable to issue a notice of deficiency in order to toll the

statute of limitations. Harrison, however, is distinguishable, and

entirely consistent with our holding today. In Harrison, the IRS

sent the taxpayers a consent form for extension of the limitations

period. The taxpayers signed the form and returned it, but it

never reached the IRS. Faced with imminent expiration of the

period, the IRS issued the notice. Today we conclude that issuance

11

the mere length of that conversation is not evidence of its

contents.5 

In the face of the rapidly expiring limitations period, the

government staked its position on October 2, and then, given no

additional information, surrendered that position more than a year

later. The Lennoxes concede, and we agree, that the IRS had a

basis for suspicion regarding ownership of the apartments. But, on

this record, that suspicion was not a sufficient basis for issuance

of the notice, in light of the opportunity for further, and much

needed, investigation. The restricted extension of the limitations

period, offered by the Lennoxes, would have afforded the government

that opportunity; and, as the Tax Court found, there was sufficient

time to formulate and execute that extension.6 In sum, we conclude
of notice to the Lennoxes was unreasonable, partially because the

IRS had, but declined, the opportunity to extend the period as to

the matter in question. We need not decide whether, absent the

Lennoxes' counter-offer, the position of the United States would

have been substantially justified. 

12

that the Tax Court abused its discretion in finding the

government's position substantially justified on issuance of the

notice. 

III.

Accordingly, that part of the Tax Court's Order and Decision

denying costs is REVERSED, and this proceeding is REMANDED for

their determination.

REVERSED in part and REMANDED.