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Kenney v. United States


October 29, 2004



On July 30, 2004, following the parties cross-motions for summary judgment, I issued an order the effect of which was to give plaintiff more than half of the funds the government had seized. A final judgment was entered on July 11, 2004, under which plaintiff recovered $83,413.00 and defendant recovered $72,944.98, plus a proportionate share of accrued interest, from the $156,357.08 deposited with the Clerk of Court at the outset of this litigation. I also ordered each party to bear its own costs, in part because plaintiff had not specifically sought fees in his complaint or in his motion. Now before me is plaintiff's motion for an award of litigation costs under section 7430 of Title 26 of the United States Code. 26 U.S.C. § 7430. Since an award of litigation costs would require amending the final judgment, I will construe plaintiffs request as a motion to amend a final judgment under Federal Rule of Civil Procedure 59(e).*fn1 FED. R. CIV. P. 59(e).

Under section 7430, a taxpayer may recover reasonable litigation costs if he establishes that he is the prevailing party in the litigation. 26 U.S.C. § 7430(a). A party is considered to be the prevailing party if (1) he has substantially prevailed with respect to either the amount in controversy or the most significant issues or set of issues presented, and (2) he meets the requirements of the first sentence of 28 U.S.C. § 2412(d)(1)(B), except to the extent that differing procedures are established by the court and he meets the net worth requirements of 28 U.S.C. § 2412(d)(2)(B).*fn2 26 U.S.C. § 7430(c)(4)(A). The court may not award litigation costs to the plaintiff if he failed to exhaust the administrative remedies available within the Internal Revenue Service ("IRS"), or if the government establishes that its position in the proceeding was substantially justified. 26 U.S.C. § 7430 (b)(1), (c)(4)(B).

The government contends that plaintiff failed to exhaust his administrative remedies within the IRS, and that its litigation position was substantially justified. It bases both arguments on the grounds that plaintiff failed to notify the IRS of his intent to raise the doctrine of equitable subrogation as a theory of relief prior to the commencement of this litigation. Because plaintiff did properly raise his subrogation rights before the government prior to filing this action, I find that plaintiff exhausted his administrative remedies within the IRS. I also find that the government's position lacked substantial justification.

In actions involving liens, a taxpayer is deemed not to have exhausted his administrative remedies unless he submitted a written request for relief to the district director "reciting facts and circumstances sufficient to show the nature of relief requested and that the party is entitled to such relief" prior to filing an action in court. 26 C.F.R. § 301.7430-1(d)(I). The taxpayer must also demonstrate that the district director "denied the claim for relief in writing or failed to act on the claim within a reasonable period of time after such claim [was] received." 26 C.F.R. § 301.7430-1(d)(ii).

The government's position is substantially justified if it is "justified in substance or in the main" and "has a reasonable basis in law and fact." Norgaard v. Commissioner, 939 F.2d 874, 881 (9th Cir. 1991) (quoting Pierce v. Underwood, 487 U.S. 552, 565 (1988)). "To be substantially justified means, of course, more than merely undeserving of sanctions for frivolousness." Pierce, 487 U.S. at 566. In making a determination on the reasonableness of the government's position, it is necessary to look to both the government's prelitigation administrative actions, as well as its later litigating position. Huffman v. Commissioner, 978 F.2d 1139, 1147 (9th Cir. 1992). While the government's position in the litigation is initially determined from its answer, courts also look to the parties' conduct within each stage of the case. Id. at 1148. A significant factor in determining whether the government's position is substantially justified as of a given date is whether, "on or before that date, the taxpayer has presented all relevant information under the taxpayer's control and relevant legal arguments supporting the taxpayer's position to the appropriate IRS personnel." 26 C.F.R. § 301.7430-5(c).

The government asserts that the burden is on the taxpayer to demonstrate that its position was not substantially justified. While a previous version of section 7430 did place the burden on the taxpayer, section 7430 was amended in 1996 to require the government to establish that its position in the proceedings was substantially justified. 26 U.S.C. § 7430(c)(4)(B)(I); Taxpayer Bill of Rights 2, Pub. L. 104-168, § 701, 110 Stat. 1452, 1463-1464 (1996); Guitierrez v. Barnhart, 274 F.3d 1255, 1262 n.3 (9th Cir. 2001); Maggie Management Co. v. Commissioner, 108 T.C. 430, 437-38 (1997). Plaintiff informed the government of his subrogation claim well before the filing of this action. On June 18, 2002, plaintiff sent a letter to the IRS asserting that his rights were greater than the federal tax lien rights of the IRS. Declaration of Benjamin Sanchez ("Sanchez Decl.") ¶ 11; Ex. 1. In the letter, plaintiff informed the IRS that he had made all mortgage payments on their jointly-owned residence from his separate property since the date of their separation. Sanchez Decl., Ex. 1. He further explained that "when such earnings are used to pay installments on the notes executed by both spouses . . . the spouse is entitled to a right of subrogation." Id.

Plaintiff also cited a California state court case, Vides v. Vides, 215 Cal. App. 2d 601 (Cal. Ct. App. 1963), which addressed the right of subrogation. Sanchez Decl., Ex. 1. In Vides, the plaintiff made separate property payments on loans held jointly by her and her husband. Id. at 602. The California Court of Appeal held that "the wife's use of her separate funds to discharge this obligation of the community [gave] her a right at least akin to subrogation." Id. at 603 (citing Cal. Civ. Code § 2903). The court also cited to Section 2903 of California Civil Code. Id. That section, titled "Right to Redeem; Subrogation" provides, in relevant part, "Every person, having an interest in property subject to a lien, has a right to redeem it from the lien . . . and by such redemption, becomes subrogated to all the benefits of the lien." Cal. Civ. Code § 2903.

Plaintiff's assertion of his subrogation rights and the citation to Vides in his June 18, 2002 letter put the IRS on notice of his subrogation claim. The IRS subsequently denied plaintiff's claim in writing on two separate occasions. Sanchez Decl., Exs. 2, 3; Declaration of David L. Denier Exs. C, E. By articulating the nature of his claims, requesting relief, and receiving two separate written denials from the IRS, plaintiff exhausted his administrative remedies. See 26 C.F.R. § 301.7430-1(d).

The government has also failed to establish that its litigation position was substantially justified. Courts determine the reasonableness of the government's position based on the facts available to the government and the controlling legal precedent at the time. Fields v. Commissioner, 84 T.C.M. (CCH) 710 (2002). The government's position may not be substantially justified if it failed to adequately investigate its case. Kenagy v. United States, 942 F.2d 459, 464 (8th Cir. 1991). This is not a case where the government is claiming that plaintiff failed to bring certain facts to its attention. Rather, the government claims that plaintiff failed to apprise them of the precise legal doctrine upon which he relied. This argument is unavailing. First, it is hard to conceive that the IRS is unfamiliar with the subrogation doctrine upon which plaintiff relied, given the number of liens the IRS files and the fact that the doctrine of subrogation, and its application to the law of liens, has existed in California for over a century. Shaffer v. McCloskey, 101 Cal. 576, 579 (1894); see also Caito v. United California Bank, 20 Cal. 3d 694 (1978); In re Kemmerrer, 114 Cal. App. 2d 810, 814 (Cal. Ct. App. 1952).

Second, plaintiff referred to his "right of subrogation" in his June 18, 2002 letter to the government. The government did not respond to plaintiff's contention until the summary judgment stage, when it conceded that doctrine applied. See Def.'s Reply to Pl.'s Mot. for Summary Judgment. The IRS never explains why it considers its position substantially justified when it conceded the taxpayer was at least partially correct during litigation. Plaintiff should not be penalized for the government's decision to wait until summary judgment before adequately researching its legal position.

As I explained in my June 30, 2004 Order, plaintiff was entitled to one-half of the $167,269.00 in payments made by him on the promissory notes between 1989 and 2002, or $83,634.50. While the government agreed that plaintiff was entitled to a one-half interest in the payments made on Donna Kenney's behalf, it "advanced no equitable reason why plaintiff should not recover the entire $83,624.50 he advanced on Donna's behalf." June 30, 2004 Order. Certainly its position that it was entitled to the entire $156,357.08 was entirely unreasonable.

Plaintiff was the prevailing party in this case in that he recovered more than half of the $156,357.08 originally claimed by the IRS. He fully exhausted his administrative remedies within the IRS before filing this lawsuit. The government's position at both the administrative level and during the litigation was not substantially justified. As a result, plaintiff is entitled to an award of litigation costs under 26 U.S.C. § 7430.

For the foregoing reasons, IT IS HEREBY ORDERED that plaintiff's motion for an award of litigation costs under 26 U.S.C. § 7430 is GRANTED. The final judgment entered on July 11, 2004 is amended nunc pro tunc pursuant to Rule 59(e) of the Federal Rules of Civil Procedure as follows: the final sentence stating, "Each party shall bear its own costs" shall be stricken and replaced with "Plaintiff shall have his litigation costs pursuant to 26 U.S.C. § 7430."

While plaintiff is entitled to attorney fees and court costs under section 7430, plaintiff failed to comply with Local Rule 54-5. As a result, the court is unable to determine whether plaintiff's attorney fee request is reasonable. The parties shall meet and confer to determine an appropriate award. If the parties are unable to resolve this matter on their own, plaintiff shall file a declaration containing a detailed accounting of his litigation costs with the Court in compliance with Local Rule 54-5. Plaintiff's counsel shall use his best effort to allocate his time between the subrogation claim and the diminishing interest claim.

Bernard Zimmerman United States Magistrate Judge

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