In United States v. Johnson, Anna S. Smith died in 1991, leaving a portion of her estate to her surviving children. On Jan. 21, 2011, the United States sought collection of an estate tax deficiency in connection with Anna’s estate. Her children filed a motion to dismiss on the grounds that: (1) the statute of limitations had run, (2) they didn’t have personal liability as beneficiaries of the estate under Internal Revenue Code Section 6324(a)(2) other than as to their receipts of life insurance proceeds, and (3) they weren’t subject to fiduciary liability under 31 U.S.C. Section 3713 because the estate had sufficient assets to pay the outstanding tax liability at the time the estate proceeds were distributed to the beneficiaries pursuant to a distribution agreement. The court allowed the government’s claims under IRC Section 6324 to proceed and concluded that the government had stated a claim for fiduciary liability under U.S.C. Section 3713.
On July 31, 2013, the United States filed an amended complaint, adding a claim seeking to foreclose against the distribution agreement and a claim as a third party beneficiary of the distribution agreement. Anna’s children asserted defenses, including the expiration of the statute of limitations and that the Section 6324 claims were barred because the property wasn’t included in Anna’s gross estate under IRC Sections 2034 through 2042. The parties filed cross motions for summary judgment on the question of whether the defendants, as successor trustees, were personally liable for unpaid estate taxes under Section 6324(a)(2). The court initially granted summary judgment in favor of the government on this claim.
The defendants then filed an amended answer, asserting that their liability was discharged in August 1997 pursuant to IRC Section 2204 as a result of their tender of a special lien under Section 6324A. They also asked the court to reconsider its Section 6324(a)(2) summary judgment ruling and instead find that the trust assets were included in Anna’s gross estate under IRC Section 2033. On Dec. 1, 2016, the court found for the defendants on all issues except for the liability of the defendants for one-fourth of their mother’s life insurance benefits each received. On May 1, 2017, the defendants filed a motion for attorney’s fees and costs under IRC Section 7430.
Was Position Substantially Justified?
Under Section 7430, the prevailing party may be awarded reasonable litigation costs incurred in connection with a determination, collection or refund of any tax, interest or penalty. A “prevailing party” is a person with a net worth of less than $2 million at the time the proceeding began who has “substantially prevailed” with respect to the amount in controversy or with respect to the most significant issue or set of issues presented. However, a person won’t be treated as the prevailing party if the government establishes that the position of the United States in the proceeding was “substantially justified.” The determination of whether a position was substantially justified is based on all the facts and circumstances. The government’s failure to prevail in the underlying litigation is a factor for consideration but doesn’t necessarily make its position unreasonable.
The defendants sought only those attorney’s fees related to the issues on which they substantially prevailed: (1) that the trust assets weren’t included in Anna’s gross estate, so there could be no transferee liability under Section 6324(a)(2), (2) that a Section 6324A special lien had been furnished to the IRS and was wrongfully rejected, so the defendants were therefore entitled to discharge under Section 2204 as a matter of law, and (e) that the government’s attempts to enforce the distribution agreement and foreclose its tax lien were untimely or otherwise improper.
The United States conceded that the defendants prevailed on both the amount in controversy and on the most significant issues presented and that the defendants met the net worth test. However, it argued that its position was substantially justified in connection with each of the three issues.
Discharge of the Defendants’ Fiduciary Liability
The government argued that the defendants weren’t validly discharged from personal liability under Section 2204 because they never made a written application for discharge. Although the defendants furnished a valid Section 6324A special lien, the government asserted that they were required to make a written application other than the one it received. The government cited Baccei v. United States for the proposition that the doctrine of substantial compliance wasn’t applicable when there was a clear statutory prerequisite known to the party seeking to apply the doctrine. The court found that this position wasn’t reasonable. The government couldn’t identify what the “proper” method of making a written application for discharge was. The court pointed out that under Baccei, substantial compliance with regulatory requirements may suffice when they’re procedural in nature and when the essential statutory purposes are fulfilled. Since the government didn’t make clear what the proper form for written application was, its position wasn’t substantially justified.
The government also argued that the IRS was substantially justified in rejecting the defendants’ proposed Section 6324A lien. However, the court concluded that the government’s arguments repeatedly contradicted its own published guidance, misinterpreted the plan language of statutes and regulations, ignored relevant positions of other statutes and regulations and conflicted with the purpose of Section 6166. Therefore, since the government failed to demonstrate that its position on Section 2204 discharge as a result of the special lien had a reasonable basis in fact or law, the court awarded the defendants attorney’s fees for all aspects of their defense to the U.S.C. Section 3713 claims, including the cost of the expert report that was necessary to establish the value of trust assets for purposes of the insolvency test under U.S.C. Section 3713 and the value of the stock for purpose of the special lien.
Defendants’ Liability as Trustees under Section 6324(a)(2)
In the underlying litigation, the government argued that trust assets were included in Anna’s gross estate under Sections 2034 through 2041, but the court concluded that the government’s position was inconsistent with the IRS statutory scheme and IRS published guidance. Here, the court found that the government didn’t present sufficient evidence to overcome the presumption that its position isn’t substantially justified if it conflicts with applicable published guidance. Therefore the court concluded that the government’s position wasn’t substantially justified and awarded the defendants their attorney’s fees for all aspects of their defense to the claims of trustee liability.
Enforcement of the Distribution Agreement and Foreclosure of its Tax Lien
The government argued that it had a reasonable basis to seek enforcement of the terms of the distribution agreement and to foreclose its tax lien. The court concluded that the government sat too long on its right to enforce the distribution agreement and had made numerous mistakes in connection with the tax lien. The government was at fault for numerous legal and factual errors, which couldn’t be justified. Therefore its position was unreasonable; the defendants can’t be made to pay for the government’s errors.
Reasonable Litigation Costs
The defendants sought $285,648 in attorney’s fees and $30,558 for the cost of the expert report, for a total award of $316,206. These fees represented fees only for the issues on which the government had substantial justification for its positions. The fees requested were limited to the Section 7430(c)(4) statutory billing rates for the years at issue where the actual billing rates were higher than the statutory rate, and reduced to the actual billing rates where they were lower than the statutory rate.
The government argued that the fees were too high for a case that didn’t go to trial and that they included hours that were “unnecessary, irrelevant and duplicative.” The defendants argued in response that the density and complexity of the subject matter was the primary reason for the expense. Furthermore, the government handed the case inefficiently. The court agreed with the defendants, awarding them the full requested reward of $316,206.