Accounting fees limited.

According to Internal Revenue Code section 7430, if the Internal Revenue Service loses its case against a taxpayer in a tax dispute in which its position was not substantially justified, that taxpayer is entitled to recover reasonable administrative and litigation costs. However, section 7430(c)(1)(B) (iii) limits the recovery of attorney fees to $110 an hour (adjusted for inflation) unless a special factor, such as the limited availability of qualified attorneys for a particular proceeding, justifies a higher rate.

In a recent Tax Court case, Robert T. Cozean v. Commissioner (1 09 TC no. 10), the IRS issued a $700,000 deficiency notice to a taxpayer stating that various items of income had not been reported and that certain deductions had been denied. Two weeks before the trial, the IRS conceded and settled the case. The taxpayer then filed a motion for award of litigation costs in order to recover his attorney's fees of $250 an hour and related accounting fees of $170 an hour. The taxpayer argued that these rates were reasonable because the number of attorneys qualified to handle such a case was limited. The IRS argued that the taxpayer's recovery should be limited to the statutory cap because no special factors existed.

The court ruled in favor of the government. It cited Pierce v. Underwood (487 U.S. 552, 1988) in which the U.S. Supreme Court ruled that in order to qualify for special factor treatment and recover more than the statutory limit, a taxpayer must prove that his attorney possesses a distinctive knowledge or a specialized skin needed in that particular case. In other words, limited availability of attorneys in a particular field or geographical area does not create a special factor. For special factor status to be considered, the attorney must possess some nonlegal or technical ability other than his or her tax expertise.

For example, recoveries in excess of the statutory amount might be allowed when an attorney specializes in the law of other countries and/or is literate in foreign languages.

The court cautioned that factors such as novelty and difficulty of the issues, the undesirability of the case, the work and ability of counsel, the results obtained and the customary fees and awards in other cases should not be considered in determining whether an upward adjustment of the hourly rate is warranted.

Observation: In Cozean, the taxpayer's CPA was authorized to practice before the IRS and the Tax Court. Such CPAs should advise their clients that section 7430 (c)(3) subjects accounting fees to the same limitations as legal fees and, in the absence of a special factor, are subject to the statutory cap.