The IRS will absolutely, positively not pay your attorneys' fees (or will they?).

• Author: Bonnette, Harris L., Jr.

The answer to the question posed in the above parenthetical is, of course, yes. Although not popular within the IRS, [section] 7430 of the Internal Revenue Code (I.R.C.) is a fee shifting statute which compels the IRS to pay attorneys' fees and costs incurred by a taxpayer in most administrative proceedings before the IRS and court proceedings before most U.S. federal courts, provided a series of requirements are met.

This article is a primer on the recovery of attorneys' fees and costs from the IRS in administrative and court proceedings. Given the IRS' recent proposed regulations interpreting I.R.C. [section] 7430 in November 2009 (and published in the Internal Revenue Bulletin on December 28, 2009, 2009-52 I.R.B. 1000), this article also addresses those proposed regulations.

Section 7430 speaks in terms of administrative and litigation "costs." To be consistent with the statute, references in this article to "costs" include those costs we traditionally think of as costs, such as court filing fees, administrative fees, and court reporter costs, as well as attorneys' fees and expert witness fees. (1)

The flow chart at the end of this article assists in evaluating the eligibility for an award of costs. The flow chart is divided into two sections, one for administrative costs incurred in proceedings before the IRS and the other for litigation costs incurred in court proceedings. Litigation costs are addressed first. Thereafter, qualified offers and administrative costs are addressed.

Litigation Costs

The flow chart first asks whether the taxpayer was involved in litigation of a tax matter in a U.S. court. Tax matters are matters relating to the determination, collection, or refund of any tax, interest, or penalty, and the litigation can be brought by or against the United States. (2) The most common instances are, for example, when the IRS audits a tax return and concludes that adjustments should be made. If the taxpayer does not settle those adjustments, the IRS issues a notice of deficiency permitting the taxpayer to file a petition in the U.S. Tax Court to resolve the dispute. (3) In this example, the taxpayer is involved in litigation of a tax matter (the adjustments to the tax return) in the Tax Court, a U.S. court. Alternatively, if the taxpayer chose to pay the determined tax instead of petitioning the Tax Court, the taxpayer could later file suit in U.S. district court for a refund of the tax paid. (4) Another example is when the United States, through its agency the IRS, initiates a law suit in a U.S. district court seeking to reduce a federal tax lien to judgment. (5) This lawsuit is brought by the IRS as a part of its effort to collect unpaid tax.

Other than pro bono and contingent fee cases discussed below, most taxpayers pay or incur costs in litigation of a tax matter. Fees are "incurred" when there is a legal obligation to pay them. (6) When a third party having no direct interest in the litigation pays costs on behalf of taxpayer, the taxpayer "incurs" such costs so long as the taxpayer assumes 1) an absolute obligation to repay costs regardless of whether taxpayer is successful in a motion for an award under I.R.C. [section] 7430, or 2) a contingent obligation to pay the costs in the event taxpayer is able to recover them under I.R.C. [section] 7430. (7)

In cases when an attorney is representing a taxpayer on a pro bono basis, the taxpayer does not "incur" any costs. However, I.R.C. [section] 7430(c)(3)(B) permits the recovery of costs in excess of what the taxpayer paid or incurred (which is usually nothing in pro bono cases), provided that the award of costs is paid directly to the attorney or the attorney's employer (such as a legal aid organization). The proposed regulations expand these requirements by providing that 1) the legal services must be provided on a no fee or nominal fee basis; 2) the legal services were provided to or on behalf of persons with limited financial means and are eligible for programs offered by legal aid organizations; and 3) the attorney intended to perform services for a no fee or a nominal fee from the outset of the representation. (8)

A taxpayer must meet the net worth requirements to qualify for an award of litigation costs. (9) A taxpayer's net worth is computed using fair market value of the assets at the time the civil proceeding is commenced. (10) The taxpayer's net worth must be equal to or less than the following thresholds: 1) $2,000,000 for individuals, (11) estates, (12) and trusts; (13) 2) $7,000,000 and less than or equal to 500 employees for unincorporated businesses, partnerships, corporations, associations, and units of local government; and 3) unlimited net worth for 501(c)(3) organizations and cooperative associations. The burden to prove the taxpayer meets the net worth requirements is on the taxpayer. (14)

A taxpayer must exhaust all available administrative remedies within the IRS prior to initiating litigation in order to recover litigation costs. (15) Exhausting administrative remedies means that if the taxpayer is given an opportunity for an IRS appeals office conference prior to initiating litigation, the taxpayer must seek that appeals office conference. An opportunity to participate in an appeals office conference is typically given through a so-called "30-day letter" in tax return audit cases, (16) and denial of a claim for refund notices in refund cases. (17) Specific notices of appeal rights are given when liens are filed; (18) notices of intent to levy are issued; (19) and proposed offers in compromise and installment agreements are denied. (20)

If the taxpayer is given an opportunity for an appeals office conference, the taxpayer must timely and properly exercise the right to have that conference. (21) Thus, for example, if the IRS issues a 30-day letter at the conclusion of an audit...