A taxpayer has the right to request from the Tax Court an award of attorney fees and costs spent in tax appeals against the IRS. See 26 U.S.C. § 7430(a). However, there are multiple prerequisites that the taxpayer must meet before being entitled to an award of legal fees. If the taxpayer fails to strictly follow the prerequisites, the Tax Court will deny legal fees. As a practical matter, it is difficult for the taxpayer to receive legal fees. I typically advise taxpayers that we can determine during the course of litigation if we may be in a good position to recover legal fees at the end; however, the taxpayer should not count on recovering legal fees as part of the tax appeal. I do not undertake representation that the source of the payment of my legal fees will be recovering the fees from the IRS.
One foundational prerequisite to recovering legal fees is the obligation to exhaust administrative remedies.[1] In basic terms, this means that the taxpayer must follow all administrative steps available to resolve the tax prior to filing a petition with the Tax Court to contest the tax.
In the realm of IRS tax audits and assessment of additional tax, at the conclusion of an audit typically the IRS will inform the taxpayer of a proposed audit adjustment along with the taxpayer’s ability to review the matter with the auditor and appeal the audit determination to the office of IRS Independent Appeals. IRS Appeals serves as a way to avoid the logjam and litigation-heavy processes of Tax Court. A high percentage of tax appeals are resolved at IRS Appeals. It is usually in the best interest of the taxpayer and the government to see if the case can be resolved at IRS Appeals before litigating in Tax Court. However, the Taxpayer does not have to go to IRS Appeals. If the Taxpayer does not timely elect to refer the case to Appeals, the IRS will issue the Notice of Deficiency, also called the 90-day letter, and give the taxpayer the right to challenge the tax assessment in Tax Court.
In Veal-Hill v. Commissioner of Internal Revenue,[2] the taxpayer did not appeal to IRS Appeals when it had the opportunity to do so. So after the 90-day letter, called a Notice of Determination, the taxpayer filed a petition in Tax Court to challenge the tax. At that time, the IRS referred the case to IRS Appeals, which is the common practice after a case is filed in Tax Court and the matter had not previously been to Appeals. At Appeals, the taxpayers demonstrated that they were substantially correct in their tax position and the assessment was lowered from $84,000 down to $500. This is a nice victory for the taxpayer.
Despite an overwhelmingly favorable result to the taxpayer, the Tax Court and Seventh Circuit Court of Appeals denied the taxpayer’s request for legal fees. The reason: failure to exhaust administrative remedies because the taxpayers did not take the case to IRS appeal before filing a petition in Tax Court. The Seventh Circuit stated the law: “For matters in which a conference with the IRS Office of Appeals is available to resolve disputes, a party exhausts administrative remedies only by (1) participating in a conference ‘prior to filing a petition in the Tax Court’, or (2) requesting a conference, even if none is granted, ‘prior to the issuance of a statutory notice [of deficiency].’ 26 C.F.R. § 301.7430-1(b).”[3]
The taxpayer who believes that he or she has a good case against the IRS wherein legal fees may be awarded must make sure to request a conference with IRS Appeals. Otherwise, the taxpayer will fail to exhaust administrative remedies and lose the ability to recover legal fees even if prevailing against the IRS and lowering the income tax assessment by 99%.
Jared M. Le Fevre is a Partner in the Tax, Trusts and Estates Practice Group of Crowley Fleck PLLP. Mr. Le Fevre represents taxpayers before the IRS, IRS Independent Office of Appeals, Tax Court, Federal District Court and state tax agencies throughout Montana, Wyoming, North Dakota, Idaho, and Utah. Mr. Le Fevre is involved in federal and state and local tax audits, appeals, and tax resolution throughout these western states. Mr. Le Fevre also advises clients on the tax effects of business and real estate transactions.
[1] 26 U.S.C. § 7430(b).
[2] Veal-Hill v. Comm’r of Internal Revenue, –Fed.Appx.—, 2020 WL 4208459, at *2 (7th Cir. July 22, 2020).
[3] Veal-Hill, 2020 WL 4208459, at *2.