Reversing and remanding a Tax Court decision, the Ninth Circuit held that a taxpayer was entitled to recover attorneys' fees and litigation costs after the IRS unilaterally conceded that the taxpayer could receive innocent spouse relief. According to the appeals court, the concession was not a settlement for purposes of the qualified offer rule, and thus the taxpayer was the prevailing party eligible to recover court costs under Sec. 7430.
Facts: Barbara Jane Knudsen was married until 2008. From 1998 to 2001, she did not work outside the home and had no earned income, while her husband was a practicing attorney. The couple filed joint federal tax returns for those years but never paid the tax owed. In June 2005, the IRS sent them a notice of intent to levy related to the unpaid taxes. Knudsen filed a request for innocent spouse relief in December 2008 that in May 2009 was denied by the IRS because it was made after the two-year limitation period then in effect under Regs. Sec. 1.6015-5(b)(1). Subsequently, Knudsen petitioned the Tax Court for relief, and the IRS sent her innocent spouse claim to its Cincinnati Centralized Innocent Spouse Operation, where it was denied twice.
In April 2010, Knudsen made a qualified offer under Sec. 7430(g), offering to pay $50 per year to settle her tax liability for years 1998 to 2001. The IRS did not respond and, by law, the offer expired after 90 days.
In July 2011, the IRS announced in Chief Counsel Notice CC-2011-017 that the two-year innocent spouse request period would be enlarged, and informed Knudsen that her request for innocent spouse relief would be granted. The IRS sent Knudsen a proposed supplemental stipulation of settled issues stating she would be granted relief under a settlement. Knudsen, however, would not agree that it was a settlement and requested court costs as the prevailing party under Sec. 7430.
The dispute was heard in 2013 by the Tax Court, which denied her request for attorneys' fees and costs, holding that the concession was a settlement because the IRS made an offer when it conceded the issue and the taxpayer accepted the offer by receiving its benefits rather than rejecting the concession and proceeding with a trial. Knudsen appealed the decision to the Ninth Circuit.
Issues: Under Code Sec. 7430, a taxpayer may be granted court costs if he or she is the prevailing party. Generally, a taxpayer is a prevailing party only if the IRS's position is not substantially justified or if the qualified offer rule applies. The qualified offer rule applies if the IRS would have accepted a taxpayer's qualified offer (defined in Sec. 7430(g)(1)) to pay an amount greater than the taxpayer's final tax liability. The qualified offer rule, however, does not apply to a settlement between the taxpayer and the IRS. The IRS argued that its unilateral concession was a settlement for purposes of the qualified offer rule, and thus the rule did not apply, while Knudsen argued that it was not a settlement and the qualified offer rule did apply.
Holding: The Ninth Circuit disagreed with the Tax Court and held that the concession was not a settlement because it was not a contract. Per the Restatement (Second) of Contracts, a contract is a bargain in which the parties mutually agree to an exchange and consideration. In Knudsen's case there was no exchange between her and the IRS and no negotiations regarding the settlement. Because the IRS's concession was not a settlement, the qualified offer rule applied. The Ninth Circuit held that Knudsen was entitled to her costs as the prevailing party under the rule because the IRS had conceded she owed nothing and she had made an offer in compromise to pay $200.
- Knudsen, No. 13-72077 (9th Cir. 7/15/15), reversing and remanding T.C. Memo. 2013-87
—By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota—Duluth.