Suppose you discover an error in your 2001 tax return. You’ve forgotten to include a $55,065 deduction that will lower your taxes by $13,769. You timely amend your return to get the deduction (you have three years from the due date of the return or the filing date, whichever is later, to amend a return), and make a claim for the refund. The IRS questions your refund claim and eventually denies it. You appeal internally (administratively) within the IRS, and, after spending $7,253 on accountants and attorneys, prevail, and get your check for $14,921 (inclusive of about $1,200 of interest). You file a Tax Court claim for the $7,253 you spent on fighting (rightly) the IRS, because Section 7430 of the Internal Revenue Code allows you to recover funds when you are the prevailing party in an administrative or court proceeding. Do you get your $7,253?
The Tax Court looked at that issue today. A taxpayer filed his 2001 tax return and had a Roth IRA (converted from a regular IRA under §408A(d)(3), and timely filed and paid his tax. In October 2001, he reconverted his IRA back to a regular IRA under §408A(d)(6), and asked for a refund of $13,769. The IRS disputed the refund, and denied it as the reconversion wasn’t timely.
The taxpayer went to the IRS’ National Office of Chief Counsel a ruling as to whether or not the reconversion was timely. The Office of Chief Counsel ruled it was. The taxpayer resubmitted his amended tax return, attaching a copy of the letter from the Office of Chief Counsel. Eventually the taxpayer got his refund along with additional interest. Still, the taxpayer was out the costs of fighting the IRS of $7,253.
After filing a claim with the IRS Appeals Office (which was denied), the case went to the Tax Court. Unfortunately, to win a claim under §7430, the petitioner must be the “prevailing party.” The IRS must have adopted a “position” on the matter. And that only happens, according to the Tax Court, if there’s a notice of deficiency or an IRS appeals office ruling—neither of which occurred in this case.
The Tax Court sympathizes with the petitioner, and notes,
“…[T]axpayers (such as petitioners herein) who do a good job at the administrative level of resolving issues and getting respondent to realize the error of his ways are precluded from recovering administrative costs incurred in achieving those favorable results. To the contrary, taxpayers who do not do as good a job at the administrative level and who receive adverse Appeals Office notices of decision or notices of deficiency, but who later convince respondent to concede issues or who substantially prevail in litigation on the issues, are able to seek a recovery of administrative costs. In effect, taxpayers who do a better job at the administrative level of resolving issues raised by respondent on audit are prejudiced in their ability to recover administrative costs under section 7430.”
But “Courts do not have the power to repeal or amend the enactments of the legislature even though they may disagree with the result.” (Metzger Trust v. Commissioner, 76 T.C. 42, 59 (1981), affd. 693 F.2d 459 (5th Cir. 1982) So our unlucky taxpayer is out the money, because he was good at going through the administrative system. There’s a moral here, but I don’t like it at all.
Case: Kwestel v. Commissioner, T.C. Memo 2007-135
