TAX COURT OPINION

Case: Stephen J. Trollope
Docket Number: 25907-06
Judge: Haines
Opinion Type: memo
Filed: 07/30/2009
Pages: 13

T .C . Memo . 2009 17 7 UNITED STATES TAX COURT STEPHEN J . TROLLOPE, Petitioner v . COMMISSIONER OF INTERNAL REVENUE, Responden t Docket No . 25907-06 . Filed July 30, 2009 . David B . Porter , for petitioner . Trent D . Usitalo , for respondent . MEMORANDUM OPINIO N HAINES, Judge : This case is before the Court on petitioner' s motion for recovery of administrative and litigation costs brought under section 7430 and Rile 231 . 1 'Unless otherwise indicated , section references are to the Internal Revenue Code as amended , and all Rule references are to the Tax Court Rules of Practice and Procedure . Amounts are (continued . . . ) SERVED JUL 3 0 2009 -2- Respondent determined a deficiency of $1,042,674 i n petitioner's Federal income tax for 2001 . The deficiency arose from respondent's dividend income adjustment of $2,605,126 under sections 301 and 316 . Respondent subsequently conceded th e _de,ficiency as it related to the net income adjustment . Petitioner seeks to recover costs totaling $122,402 incurre d -.L.from,..,December 6, 2004, the date respondent confirmed that h e Two'uldi?ssue petitioner a 30-day letter, through February 11 , 2,0-0 8, _ the date of filing of this motion . - .1- TT- e issues for decision are : (1 ) Whether petitioner is w-----i-entitled to an award of reasonable administrative and litigation costs ;and (2 ) if .the answer on the first issue is "yes", th e amount of the awardable costs . , When the petition was filed, petitioner resided in Background California . Petitioner and John Larik were each 50-percent owners of Arrow Capital Associates, Inc . (Arrow) . Between March 200 1 and the beginning of August 2001 petitioner and Mr . Larik created several drafts of stock purchase agreements for Arrow to purchase ~Mr . Larik's 50-percent interest in Arrow . 1( . . .continued) rounded to the nearest dollar . -3- Arrow lent Mr . Larik $100 , 000 on March 1, 2001, and $ 600,00 0 on June 1, 2001 . Arrow lent petitioner $ 1,895,126 on August 13, 2001 . The three loans were evidenced by promissory notes signed on or near the dates of the respective loans . On August 15, 2001, petitioner and Mr . Larik entered into a stock purchase agreement which provided that petitioner was to purchase Mr . La nik's shares for $2,605,126 . 2 In relevant part, the stock purchase agreement states : B . Prior to the Effective Date [March 31, 2001], the parties agreed that, on the Effective Date , Trollope [Petitioner ] would purchase the Shares from Shareholder [ Mr . Larik], and Shareholder would sell the Shares to Trollope , on the t&rms and conditions, which are set forth hereinafter . C . At all times since the Effective Date, although Shareholder remains the record owner of th e Shares as of the date of this Agreement , the parties have considered the Shares to hale been acquired by Trollope . The purpose of this Agreement is to provide for the necessary documentation io give effect .to that understanding . Section 9 of the stock purchase agreement further states : This Agreement cancels and supersedes al l a . other previous or contemporaneous agreements , between the parties , with the exception f the Separation Agreement ,3 whether oral or writ en , relating to the subject matter hereof . This Agr~ement may be amende d 2Specifically , petitioner was to pay $ 709,905 to Arrow to cover the $ 700,000 Arrow lent to Mr . balance of $1,895,126 to Mr . Larik for the purchase of 1,500 shares constituting a 50-percent ownership stake in Arrow . arik plus interest and the 3On Aug . 15, 2001, Mr . Larik and Arrow entered into a separation agreement indicating that Mr . Larik agreed to terminate his employment with Arrow . -4- only pursuant to a written document signed by all parties and not by oral statements or course of 'conduct . b . This Agreement shall be binding on and inur e to the benefit of the parties and their successors and . assigns . g . In the event of Shareholder [Mr . Larik]'s death or any incapacity, Trollope [petitioner] shall not have the right to terminate this Agreement and agrees, if any monies are still outstanding and payable to Shareholder under this Agreement, to pay such monies to Shareholder or his estate (emphasis added) . The stock purchase agreement further provides for Arrow's transfer to Mr . Larik of corporate assets consisting of a n automobile and a golf membership . Immediately following the signing of the stock purchas e agreement, petitioner paid Mr . Larik $1,895,126 and Mr . Lari k transferred 1,500 Arrow shares to petitioner . Petitioner assumed Mr . Larik's $700,000 in shareholder loans and $9,905 of interest secured by Mr . Larik's,1,500 shares .4 Arrow transferre d corporate assets consisting of a golf course membership and a car to Mr . Larik . As a result of these transactions, petitioner became the sole shareholder of Arrow . On August 16, 2001, petitioner offered to sell Arrow 1,500 shares of common stock in exchange for the cancellation of the .ii. $1,895,126 loan . Arrow accepted the offer .and purchase d 4The loan was not repaid by petitioner to Arrow, but rather was "assumed " by petitioner through debits and credits to Arrow's general ledger . -5- petitioner's 1,500 shares and canceled both petitioner' s $1,895,126 loan and the $709,905 of debt and interest petitioner had assumed from Mr . Larik . After the transaction of August 16, 2001, but before Jun e 21, 2004, respondent audited Arrow's 2 ',001 return . An effort t o obtain a statement from Mr . Larik describing the stock purchase transaction failed because the business relationship between petitioner and Mr . Larik had soured . On or about June 21, 2004, respondent commenced an examination of petitioner's 2001 Form 1040, U .S . Individual Income Tax Return. Sometime in December 2004, respondent issue d petitioner a-°30-day letter indicating that respondent intended t o treat Arrow's purchase of the,shares petitioner received from Mr . Larik as a constructive dividend . On August 17, 2006, petitioner's representatives held a conference with Internal Revenue Service Appeals Officer Barbara Byrnes . At this conference petitioner's representatives informe d I Ms .-Byrnes that petitioner had not edeived a constructiv e dividend from Arrow, but rather had s#epped in to facilitate a stock redemption as Arrow's agent . .On September 26, 2006, respondent issued a notice of deficiency to petitioner . Petitioner filed a timely .petition with this Court, and on February 6, 207, respondent filed his answer . At the time respondent filed his answer respondent had -6- received a final draft and preliminary drafts of the . stock purchase agreement, petitioner's own statements regarding th e intention of the parties involved in the transaction, and certain informal correspondence . Petitioner submitted materials to respondent during the formal discovery process in December 2007 which caused respondent to concede the case . On January 28, 2008, the parties,filed a stipulation of settled issues in which respondent conceded the dividend income adjustment of $2,605,126 and the itemized *deductions adjustment of $64,497 . Petitioner's motion?for an award of reasonable litigation and administrative costs was filed on February 11,~ 2008 . . Discussio n Taxpayers are eligible for awards of reasonable fees an d ,costs incurred in certain administrative,and court proceedings if .they meet the requirements of section 7430 . To qualify under ,section 7430, taxpayers must establish that .they : (1)'Were th e prevailing party within the meaning of section 7430(c.)(4) ; (2) exhausted the applicable administrative remedies ;' (3) did not unreasonably protract the proceedings ; and (4) have claimed costs that are reasonable . 'This factor is relevant only for the award .of reasonable litigation costs . -7- Respondent concedes that petition r exhausted al l administrative remedies and did not un easonably protract the proceedings . Respondent contends : ( 1 ~1 -Petitioner was not a prevailing party because respondent's osition "was substantially justified" under section 7430(c) (4) (B) (i) ; (2) petitioner was no t a prevailing party .because he failed to meet the net worth requirements of section 7430(c) ( 4 ) (A) ( L i ) ; and (3) the amount of costs petitioner claims is not reasonable under section 7430(a)(2) and (c)(1) . Because we find respondent's position to have been substantially justified, we need not consider the latter two arguments . "Substantially justified" is defined as "justified to a degree that could .satisfy a reasonable person"'and having a "reasonable basis .both in law and fact" . Pierce v . Underwood , 487 U .S . 552, 565 (1988) (quotation marks omitted) ;6 Huffman v . Commissioner , 978 F .2d 1139, 1147 n .8 (9th Cir . 1992), affg . in part, revg . in part and remanding T .C . Memo . 1991-144 . It i s respondent's burden to prove that his position was substantially justified . See sec . 7430(c) (4) (B) (i) . Respondent's position may be incorrect and yet be substantially) justified "if a reasonabl e 6Although the dispute in Pierce V} . Underwood , 487 U .S . 552 (1988), arose under the provisions of_ the Equal Access to Justice Act (EAJA), 28 U .S .C . sec . 2412(d), .t1~e relevant provisions of the EAJA are almost identical to sec .I7430 . Commissioner , 109 T .C . 227, 232 n .9 ( 997) . Accordingly, . we consider the holding in Pierce v . Underwood , supra, to be applicable to the case before us . I Cozean v . -8- :person could think it correct" . See Pierce v . Underwood , supr a at 566 n .2 . Whether respondent acted reasonably ultimately turns on the available information which formed the basis for ,respondent's position, as well as on the relevant law . See ;; Coastal Petroleum Refiners, Inc . v . Commissioner , 94 T .C . 685 , 688-690 (1990) . The fact that the Commissioner eventually loses or concedes a case does not by itself establish that the ,Commissioner's position is unreasonable . Maggie Mgmt . Co . v . Commissioner ,' 108 T .C . 430, 443 (1997) . However, it is a factor that may be considered . Id . The Court of Appeals for the Ninth Circuit, to which an iappeal in this case would lie, has held that the reasonableness of the Commissioner's position is analyzed separately for .the administrative and judicial proceedings . Huffman v . { Commissioner , supra at 1143 . Respondent's position wa s ,consistent throughout the administrative and litigation process . The Appeals officer took the position, on the basis of petitioner's stock purchase agreement, that petitioner .received a constructive dividend from Arrow . Respondent took the identica l rposition before this Court in his answer . ' 7The position of the Commissioner in the proceeding in this a Court is the position set forth in the answer .. Commissioner , 978 F .2d 1139, 1147-1148 (9th Cir . 1992), affg . in part and revg . in part and remanding T .C . Memo 1991-144 ; Maggie Mdmt . Co .. v . Commissioner , 108 T .C . 430, 442 (1997) . Huffman v . -9- Petitioner . argues that respondent is not substantiall y justified because he (1) failed to investigate the facts t o justify the position in the 30-day let ter and his answer and (2 ) applied an unreasonable legal position to the facts . disagree . I . Investigation of Fact s A significant factor in determining whether the Commissione r acted reasonably as of a given date is whether, on or before that date, the taxpayer presented all rele\ant information under the taxpayer's control . Corson v . Commissioner, 123 T .C . 202, 206- 207 (2004) ; sec . 301 .7430 - 5(c)(1), Proced . & Admin . Regs . Thus, whether the Commissioner acted reasonably may turn,upon th e available facts which formed the basis for the Commissioner's position . DeVenney v . Commissioner , 85 T .C . 927, 930 ( 1985) ; see Nalle v . . Commissioner , 55 F .3d 189, 191-192 ( 5th Cir . 1995), affg . T .C . Memo . 1994-182 . Respondent has shown that the only evidence he had access to during the administrative appeal process and at the time of hi s r answer was the stock purchase agreement and various documents petitioner prepared for the administr tive appeal process and litigation . Petitioner maintains , relying on Powers v . Commissioner , . 100 T .C . 457 ( 1993 ), re d . in part on other grounds 43 F .3d 172 (5th Cir . 1995 ), that it was respondent ' s duty t o audit petitioner's return and to unco,er more information before -10- issuing a notice of deficiency . In Powers , the Commissioner made, no effort to contact the taxpayer before issuing the notice of deficiency . By contrast, respondent engaged in a multiyear dialogue with petitioner and Arrow before issuing the notice of deficiency and gave petitioner ample time during th e .administrative appeal process to submit materials supporting petitioner's position . See Flynn v . Commissioner , T .C .: Memo . 2005-8 . Petitioner submitted materials to respondent during the formal . discovery process in December 2007 which caused respondent to concede the case . Petitioner has not alleged that these materials were unavailable to him earlier in the dispute . Accordingly, we find that petitioner did not furnish respondent with all of the relevant information under his control . See Corson-v . Commissioner , supra at. 206-207 . II . Reasonableness of Legal Positio n Respondent contends that his position to apply dividend treatment was substantially justified during the administrative appeal process and at the time of his answer . Petitioner's stoc k 'purchase agreement specifies that petitioner had the primary obligation to acquire Mr . Larik's stock, even in the event of Mr . Larik's death . The agreement does not indicate that the stock ,purchase was part of an integrated transaction intended to redeem ,,Mr . Larik's shares . The record indicates that the stock purchase -11- agreement was the only primary source ocument regarding the transactions that respondent possessed during the administrativ e appeal process and at the time of his Answer .' Respondent argues that this agreement, coupled with peti ioner's subsequent transfer of 1,500 shares of Arrow stoc to Arrow, could lead a reasonable person to conclude that pet itioner received a constructive distribution from Arrow . The substantive issue in controve rsy was whether the sale of Mr . Larik's shares to petitioner . and t he subsequent purchase of the shares by Arrow should be treated as a single integrate d transaction resulting in exchange treatment under section 302(a ) or as a series of independent transactions resulting in a dividend to petitioner under sections 301(a) and 302(b)(1) . Whether a distribution in connection With a cancellation or redemption of stock is essentially equivalent to . the distributio n of a taxable dividend under sections 301(a) and 302(b)(1) depends upon the facts and circumstances of e .ch'case . See Zenz v . Quinlivan , 213 F .2d 914 (6th Cir . 195L ) We have applied dividend treatment where a shareholder has the primary obligation to acquire stock, but a corporatio n 'Petitioner also sent respondent letters during the administrative appeal process outlining his and Mr . Larik's intent to integrate the transactions . Because of the partisan nature of these documents, we do not give them as much weight as the stock purchase agreement,(cid:127)which was ostensibly prepared for no other purpose than to effect the intent of petitioner and Mr . Larik. I -12- instead redeems and relieves the shareholder of his obligation . See, e-.g .., . Schroeder v . Commissioner ,._831 F .2d 856 (9th Cir . ;1987),- affg . Skyline Memorial Gardens, Inc . , T .C . Memo . 1985-334 ; Sullivan v . United States , 363 F .2d 724 (8th Cir . 1966), ; Wall v . United States , 164 F .2d 462 (4th Cir . 1947) ; see also Rev . Rul . 69-608, 1969-2 C .B . 42 . Petitioner argues that responden t unreasonably applied the law to the facts because petitioner had no pre-existing contract to buy Mr . Larik's shares and received no financial gain from the subsequent transfer of those shares to Arrow . For a position to be substantially justified ; "substantial evidence" must exist to support it . Pierce v . Underwood , 48 7 U .S . at 564 . "That phrase does not mean a large or considerabl e amount of evidence, but rather such relevant evidence as a .reasonable mind, might accept as adequate to support a ,Ii conclusion .'" Id . at 564-565 (quoting Consol . Edison Co . v . NLRB , 305 U .S . 197, 229 (1938)) . The Commissioner's position may be incorrect but substantially justified "if a reasonable person could think it correct" . Id . at 566 n .2 . We find that the stock .purchase agreement, standing by itself, constituted evidence adequate to support respondent's legal conclusion . See id . at 564 . Petitioner, as president and chief executive officer of Arrow, could have-stated in th e corporate minutes, the loan documents, the stock purchase -13- agreement, or the separation agreement that it was the intention of petitioner and Mr . Larik to treat the individual transaction s as part . of an overall integrated transaction, but he did not do so .9 On the basis of the evidence available to respondent, as well as the facts and circumstances, we hold that respondent's legal position was substantially justified in both the administrative and judicial proceedings . III . Conclusio n Because we conclude that petitioner was not the prevailing party with respect to any of the issues, he is precluded fro m recovering administrative and litigat on costs, and we need no t address whether petitioner has satisf ed the other elements o f section 7430 . To reflect the foregoing, Atn appropriate order and decis iln will be entered . 9The record indicates that respondent had no access to any primary source documents other than the stock purchase agreement before the initiation of formal discovery . However, the aforementioned documents were readily available to petitioner .