We have talked about what it takes to recover attorney’s fees from the IRS in prior posts here, here, and here. The recent Court of Claims case of BASR Partnership v. United States, takes almost all possible defenses to attorney’s fees and puts them on display in one case. For that reason the case deserves discussion. One reason the IRS may have tried so hard to avoid attorney’s fees in this case stems from the fact that the taxpayer engaged in what the IRS no doubt considered abusive tax shelter activity and only avoided tax and penalties due to a snafu. So, the fight over fees just added insult to injury with the IRS feeling that the taxpayers should have paid significant liabilities for its activities and yet ending up with no tax as well as payment by the IRS for the representation it received.
In 2013, the Court of Federal Claims determined that the IRS did not timely issue an FPAA to BASR. The IRS appealed to the Federal Circuit and lost again. The IRS requested a Petition for En Banc Rehearing and the court denied that as well. The government does not lightly seek en banc review. It must have felt strongly on the merits of the FPAA issue, but I am not going to discuss that issue in this post.
After winning these significant victories which kept the IRS from making adjustments to the partnership for what the IRS viewed as abusive tax shelter activities, the taxpayer and its attorneys at Sutherland Asbill & Brennan sought attorney’s fees, and they sought fees at a higher rate than the statutory rate for attorney’s fees. The IRS filed a motion to conduct limited discovery concerning the fees and the taxpayer responded. After a conference with the court the taxpayer was required to “produce the client’s fee agreement, a copy of all legal bills sent to the client, and any proof of payment from the client.” Then the IRS filed an objection to the motion for litigation costs and requested oral argument. The taxpayer requested “fees for fees” seeking to add to its recovery and get reimbursed for the cost of fighting about the existence and amount of the fee award.
The first thing the taxpayer needs to do in seeking to recover fees is show that it is a “prevailing party” which means it must have (1) substantially prevailed with respect to the amount in controversy; (2) the IRS position was not substantially justified; and (3) the statutory requirements regarding net worth are met. The taxpayer can meet the first two parts of this test, which are otherwise quite difficult to meet, if it makes a proper qualified offer and that is why we have discussed qualified offers to a significant extent in the prior posts cited above. Making a qualified offer is the most direct path to obtaining fees since it moves the taxpayer past the substantially justified barrier. In this case BASR made a qualified offer of $1 to the IRS to settle the FPAA issue. As you can tell from the litigation I described above, the IRS did not settle the FPAA issue and fought it all the way to making the request for en banc reconsideration. Because the IRS lost completely on the statute of limitation issue, the effect of its loss was that the taxpayer did better in the litigation than the $1 offer it made to the IRS since it owed $0 after winning the statute of limitation argument. This put the taxpayer over a big hurdle to becoming a prevailing party and appeared to leave it only with net worth requirement.
In addition to showing that it was the prevailing party, BASR also needed to meet statutory tests set out in IRC 7430(b) involving (1) exhaustion of administrative remedies, (2) showing the fees and costs are allocable to the IRS and (3) showing that it did not unreasonably protract the proceeding. My clients often fail the exhaustion of administrative remedies test because they do not avail themselves of the opportunity to go to Appeals prior to going to Tax Court. Here, the IRS foreclosed the taxpayer’s option of using Appeals because it said that Appeals would not consider Son of Boss transactions.
Taxpayer argued that it needed the increased fee because it could not find any attorneys with expertise on this issue willing to take the case at the statutory rate. Because of the billing rates of the firm it used, BASR seeks fees at a rate essentially twice what the statute suggests. Almost no tax firm bills out at the statutory rate and taxpayers will always argue that their case is novel or complex but getting a higher rate than the one set in the statute is not necessarily easy just because the rate is out of sync with today’s fee schedules.
The IRS makes an argument regarding every possible issue that would prevent BASR from obtaining fees. First, it argued that BASR did not pay or incur any litigation costs because the engagement letter was with William Pettinati, his wife and his son. Second, the IRS argued that BASR was not a real party in interest because all of the fees were paid by these individuals. Third, the IRS argues that the real parties in interest have net worths in excess of the statutory maximum. Forth, the IRS argues that BASR did not make a qualified offer because the case did not involve a tax liability and the qualified offer provision does not apply to “any proceeding in which the amount of tax liability is not in issue.” A clear example of this language would be a collection due process case in which the underlying merits of the liability were not at issue. Fifth, the IRS argued that offer to settle for $1 was not made during the qualified offer period because the IRS never sent a letter of proposed deficiency so no qualified offer period ever began. Sixth, the IRS argued that the offer of $1 was a sham since it was so low as to not be meaningful or in good faith. Since I regularly make $1 offers when I make a qualified offer, I followed this particular argument with interest. I have not encountered this argument from the IRS in the cases in which I have sought recovery. Seventh, the IRS argued that the court should exercise its discretion not to award attorney’s fees since doing so would be unjust because of taxpayer’s participation in an invalid Son of Boss tax scheme. Eighth, the IRS argued that the requested fees were unreasonable both because they exceeded the statutory maximum and because some were not in connection with a court proceeding. Ninth, the IRS argued that BASR should not get paralegal fees for clerical tasks and tenth it argued that it should not receive fees for fighting the fee request.
The court walks through the responses filed by BASR before getting to its own conclusions on each of the issues raised by the IRS. I will skip the responses and head straight to the court’s analysis. Spoiler alert – the taxpayer gets attorney’s fees.
The Court found BASR was a prevailing party looking at partnership law. It found that the individuals paid the costs because BASR was essentially defunct but that under Texas partnership law they had the right to bring the action on behalf of the partnership and to be reimbursed for doing so. The Court was not persuaded that the form of the action trumped the substance. It found that BASR had no money and therefore its net worth did not exceed the statutory maximum. It found that BASR did have a liability at issue and that the offer was made during the qualified offer period. It found that an offer of $1 was a reasonable amount to offer for a party that thought it did not owe the liability. It found that even though the taxpayer may have engaged in tax shelter activities, the issue in this case was liability and it was not liable for the taxes so no basis existed for denying the fees on the basis of the shelter scheme. It found that the fees were reasonable under the circumstances and that the paralegal fees were also reasonable. It did make slight downward adjustments in fees and costs but these adjustments were minor in the scheme of the requested fees. Finally, it found, what other courts have also found, that a prevailing party can receive fees for fighting fees.
This case is a handbook for those battling about attorney fees. While giving fees to a tax shelter promoter may seem galling, the fees result here from the untimeliness of the IRS action. The case not only provides an issue by issue review of almost all of the issues that come up in an attorney’s fee case but also stands for the proposition that courts should not look at the equities of the underlying tax in determining if the taxpayer should receive attorney’s fees.