Recoverable Costs

A taxpayer who is the prevailing party in a legal dispute with the IRS may be entitled to recover some of his or her litigation-related costs. There have been numerous suits outlining the costs taxpayers can recover if they hire an attorney. When taxpayers represent themselves, however, what expenses they can recover in court are not as clear. Recently, the Tax Court addressed this issue.

John and Rebecca Dunaway represented themselves before the Tax Court in a dispute with the IRS over their 2001 tax return. The Dunaways were successful, and the IRS conceded its position in the deficiency notice was not substantially justified. The Dunaways then sued to recover their costs under IRC section 7430. The IRS disagreed with the amounts the couple claimed.

Result. In part for the IRS and in part for the taxpayer. Section 7430 allows the prevailing party to recover reasonable litigation and administration costs. By definition reasonable costs include court costs, attorney fees, expert witness costs and expenses to prepare the case.

The Dunaways asked to recover the value of their time to research the tax issues involved in the dispute. Based on prior cases, the Tax Court rejected this part of the claim. The couple also requested lost wages. The court rejected this claim as well because of a lack of substantiation rather than on the merits. With proper backup, future taxpayers may be able to recover lost wages. If they do, they most likely will have to include this part of the recovery in their income.

The Tax Court did allow the Dunaways to be reimbursed for postage, photocopying and office supplies. However, it limited the recovery to the amounts the couple could substantiate. Future taxpayers involved in similar disputes should carefully document all costs if they want to be reimbursed for them.

The couple then requested reimbursement for mileage and parking. The IRS objected on the grounds section 7430(a) does not list these costs. The court rejected the IRS argument. The code says litigation costs “include” the items listed there. The Tax Court concluded the word include should be interpreted broadly, meaning the listed items were to be considered representative of the types of items allowed. It does not mean the list was complete.

Since this interpretation by the Tax Court is consistent with the way in which other courts have interpreted the use of the word in other places in the law, it is likely this is the correct interpretation. Therefore in the future taxpayers should document and claim all costs related to any litigation, not just the costs that are listed in the IRC or in this case.

Being able to recover all reasonable out-of-pocket costs and potentially lost wages should encourage taxpayers to litigate cases where the IRS appears to have no reasonable basis for the items in a deficiency notice.

John M. and Rebecca A. Dunaway v. Commissioner 124 TC no. 7.

Prepared by Edward J. Schnee, CPA, PhD, Hugh Culverhouse Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.