Given the size of the government, it is no surprise that the IRS often has an advantage over taxpayers in tax controversy matters. Indeed, the agency has an army of specialized attorneys on its payroll to defend tax actions in the federal courts. To alleviate some of this imbalance, Congress enacted section 7430, which when properly invoked, can shift some or all of a taxpayer’s litigation expenses onto the government.
But meeting the requirements of section 7430 is not always an easy task. In addition to net worth requirements, the taxpayer must show that they substantially prevailed on the most significant issue or amount in controversy. And even if the taxpayer satisfies these prerequisites, the IRS can defeat a motion for fees if it shows that it was substantially justified in prosecuting the matter.
However, a recent decision, Mann Construction Inc. v. U.S., No. 1:20-cv-11307 (E.D. Mich. Nov. 1, 2024), illustrates that the government’s substantial justification defense is not absolute. Rather, a so-called “qualified offer”—even for $1—can require the government to foot the taxpayer’s litigation fees if used in the proper circumstances, regardless of whether the IRS’ litigating position is reasonable or not.
Mann Construction’s Qualified Offer
The dispute at issue between the IRS and Mann Construction centered on reporting requirements related to an employee-benefit plan that had cash-value life insurance policies. In 2007, the IRS identified these transactions as “listed transactions,” requiring taxpayers to file IRS Forms, Reportable Transaction Disclosure Statements. See Notice 2007-83. According to the IRS, Mann Construction and its owners had failed to timely file the forms, resulting in penalty assessments.
The taxpayers paid the outstanding penalties and sought administrative refunds. During this administrative process, the taxpayers presented the IRS with qualified offers of $1. The IRS never acted on the offers and never refunded the penalty amounts. Accordingly, the taxpayers filed a lawsuit against the government, arguing that Notice 2007-83 was unlawful under the Administrative Procedure Act. After several years and multiple trips to the Sixth Circuit, the IRS eventually conceded the case by refunding the penalties and agreeing to not enforce Notice 2007-83 against the taxpayers or anyone else in the Sixth Circuit.
After prevailing in the lawsuit, the taxpayers filed a motion for an award of their litigation expenses under section 7430.
The Magistrate Judge’s Recommendation
A magistrate judge took a first shot at deciding the taxpayers’ motion. In the magistrate judge’s view the taxpayers had failed to make a qualified offer because their $1 offers were not reasonable. Therefore, the magistrate judge recommended that the motion be denied.
The District Court Judge’s Decision
The district court disagreed with the magistrate judge’s recommendation. Instead, the district court found that the taxpayers had made a qualified offer under the plain meaning of the statute and that section 7430 does not mandate reasonableness. Because the taxpayers extended a settlement offer ($1) that was more than the amount that they ultimately owed ($0), the court concluded that the taxpayers were entitled to their litigation fees. In support, the district court cited to another case, BASR P’ship v. U.S., 130 Fed. Cl. 286 (2017), aff’d, 915 F.3d 771 (Fed. Cir. 2019), which similarly held that a $1 offer was sufficient to meet section 7430.
The $1 Qualified Offer Strategy
Although the $1 qualified offer can’t be used in all tax disputes, it can be useful under certain circumstances. As shown in Mann Construction, a $1 qualified offer can be effective in all-or-nothing cases (e.g., penalty determinations). In penalty determinations, courts either find that the taxpayer is liable for the penalty or not liable for the penalty—there is no middle ground.
Example
Susan is a U.S. citizen. Her father is a non-resident alien. In 2020, Susan’s father gifts her $1 million to help her with the purchase of a house. Susan discusses the foreign gift with her tax preparer. However, the tax preparer erroneously advises her that there are no U.S. reporting requirements related to the receipt of the gift. Several years later, Susan learns from another tax preparer that she should have filed an IRS Form 3520, Annual Return to Report Transactions With Foreign Trusts And Receipt Of Certain Foreign Gifts. After Susan files the form late, the IRS imposes a $250,000 civil penalty against her under section 6039F of the Code. Here, Susan can make a qualified offer of $1. If the IRS denies the offer or refuses to act on the offer, Susan can seek to recoup her litigation expenses if a court concludes that Susan had reasonable cause for the late filing.
In addition, qualified offers (even of $1) may be effective where the IRS refuses to budget on an unclear area of tax law.
Example
After a lengthy examination, the IRS issues a Notice of Deficiency to Mary proposing additional income tax and accuracy-related penalties. Before issuing the Notice of Deficiency, the IRS issued Mary a 30-day letter that proposed the penalties. The IRS did not obtain written managerial approval for the penalty under section 6751(b) before issuing the 30-day letter.
Mary files a Tax Court petition. In the petition, Mary concedes that she owes the additional income taxes but disputes the proposed accuracy-related penalties under section 6751(b). IRS Chief Counsel concedes that the Tax Court has maintained its position that section 6751(b) approval must be obtained prior to the issuance of the 30-day letter. However, IRS Chief Counsel refuses to concede the penalty on the basis of other circuit court decisions that have overturned the Tax Court on this issue. Mary is outside of all of these circuit courts.
Mary files a $1 qualified offer regarding the penalties. With the qualified offer now at issue, IRS Chief Counsel must consider whether the agency is willing to risk the payment of attorneys’ fees after an adverse Tax Court decision (where it can’t argue that its position was substantially justified based on the circuit court decisions) in the hope that it may have a circuit court overturn the decision at a later point in time.
Taxpayers who intend to make a qualified offer should remember that there are specific requirements for making a qualified offer. These include: (i) the offer must be in writing; (ii) it must be made during a specific period of time; (iii) it must specify the offered amount; (iv) it must be designated as a qualified offer; and (v) it must remain open for a specified period of time. The failure to meet one or more of these requirements renders the offer invalid.
Summary
Qualified offers—including those made for a nominal $1—can be great strategic tools to resolve tax controversy matters with the IRS. Taxpayers should therefore consider using a $1 qualified offer where appropriate as a means to settle their tax dispute or receive an award of attorneys’ fees.
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