Collecting attorney fees from the IRS.

Recently a district court in New Jersey reviewed the rules and requirements in the tax code under which taxpayers can collect a reasonable reimbursement for attorney fees they pay to litigate tax cases they win.

Daniel Scheingold, John Orem and Edward Trueblood were officers of IE Inc. and Street Holding Co. Both entities failed to remit withheld payroll taxes to the IRS. The government assessed penalties of $1,883,307.95 and $172,679.85 against Scheingold as a responsible party at each of the two corporations. He made a $10,000 qualified offer to settle his liability, which the government rejected. At trial the court found Orem and Trueblood to be responsible parties and liable for the unpaid taxes. Scheingold, found innocent, instituted a suit against the IRS for reimbursement of his legal fees, which were in excess of the statutory limit of $125 per hour.

Result. For the taxpayer. Under IRC section 7430, in certain cases taxpayers are entitled to reimbursement of reasonable litigation costs and attorney fees. To be eligible, taxpayers must be the prevailing party in litigation against the government. There is an important exception: No reimbursement is due if the government can establish its litigation position was substantially justified. After reviewing the testimony and evidence in this case, the court found the government's position was substantially justified. Normally this would have been the end. However, there is an exception to the substantial justification rule. If the taxpayer had made a qualified offer the government rejected and the final outcome (judgment) is equal to or less than the offer, then the taxpayer is treated as the prevailing party and entitled to reimbursement. Even though the offer in this case was only $10,000, it was reasonable given the taxpayer's circumstances; therefore he was entitled to reimbursement.

Section 7430(g) defines a qualified offer as one made in writing during the qualified offer period that specifies the offer amount, is designated as qualified and remains open for the required time. The qualified offer period starts with receipt of the first letter stating the deficiency and ends 30 days before the case is set for trial. The offer must stay open until it is rejected, the trial begins or 90 days has elapsed, whichever is earliest. Because Scheingold's offer met all of these conditions, he was entitled to reasonable costs and attorney fees.

The maximum stated rate for such fees is $125 per hour, though the rate can be higher in limited cases. The U.S. Supreme Court in Pierce v. Underwood interpreted the rule allowing higher fees as one where the defendant shows the attorney is qualified for the proceeding in a specialized sense beyond simple legal knowledge. There is a split among the circuit courts of appeal as to the correct interpretation of the Supreme Court decision. The Seventh, Ninth and Eleventh circuits interpret the rule as allowing higher fees if the attorney has specialized expertise in a particular area of law. The Fourth, Fifth and D.C. circuits require expertise outside of American law. The Third Circuit has not ruled definitively. The district court chose to side with the Seventh, Ninth and Eleventh circuits. Scheingold's attorney's skill in tax investigation and assessment litigation and his background as a special agent for the IRS provided him with the expertise to justify a higher hourly rate.

This case points out for CPAs the split in the circuits about fees in excess of the statutory rate as well as the special rules for qualified offers.

* United States v. Scheingold, Orem and Trueblood, 293 FSupp2d 447, 2004-1 USTC [paragraph] 50, 116.

Prepared by Edward J. Schnee, CPA, PhD, Hugh Culverhouse Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.