[Federal Register Volume 81, Number 40 (Tuesday, March 1, 2016)]
[Rules and Regulations]
[Pages 10479-10490]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-04401]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 301

[TD 9756]
RIN 1545-AX46


Regulations Under IRC Section 7430 Relating to Awards of 
Administrative Costs and Attorneys' Fees

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to awards of 
administrative costs and attorneys' fees. The final regulations conform 
the regulations to the amendments made in

[[Page 10480]]

the Taxpayer Relief Act of 1997 and the IRS Restructuring and Reform 
Act of 1998. The regulations affect taxpayers seeking attorneys' fees 
and costs.

DATES: 
    Effective date: The final regulations are effective on March 1, 
2016.
    Applicability date: For date of applicability, see Sec.  301.7430-
6.

FOR FURTHER INFORMATION CONTACT: Shannon K. Casta[ntilde]eda at (202) 
317-5437 (not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

I. In General

    This document contains final amendments to Treasury Regulations 
under section 7430 of the Internal Revenue Code (Code) relating to 
awards of administrative and attorneys' fees. Section 7430 generally 
permits a prevailing party in an administrative or court proceeding to 
seek an award for reasonable administrative and litigation costs 
incurred in connection with such proceedings. The amendments 
incorporate the 1997 and 1998 amendments to section 7430, which were 
enacted as part of the Taxpayer Relief Act of 1997 (TRA), Public Law 
105-34, 111 Stat. 788 (Aug. 5, 1997), and the IRS Restructuring and 
Reform Act of 1998 (RRA '98), Public Law 105-206, 112 Stat. 685 (Jul. 
22, 1998).
    The Treasury Department and the Internal Revenue Service published 
a notice of proposed rulemaking (REG-111833-99) in the Federal 
Register, 74 FR 61589, on November 25, 2009 (the NPRM), proposing 
amendments to the regulations under section 7430. A public hearing was 
scheduled for March 10, 2010. The Internal Revenue Service did not 
receive any requests to testify at the public hearing, and the public 
hearing was cancelled. Two written comments responding to the NPRM were 
received and are available for public inspection at http://www.regulations.gov or upon request. After consideration of the 
comments, the proposed regulations are adopted as revised by this 
Treasury Decision.

II. Statutory Provisions

    Section 7430 generally authorizes a court to award administrative 
and litigation costs, including attorneys' fees, to a prevailing party 
in an administrative or court proceeding brought by or against the 
United States in connection with the determination, collection, or 
refund of any tax, interest, or penalty. To qualify as a ``prevailing 
party'' a taxpayer must substantially prevail as to the amount in 
controversy or the most significant issue or set of issues in the 
proceeding, exhaust the administrative remedies, meet net worth and 
size limitations, and pay or incur the costs. The taxpayer generally 
cannot qualify for an award of such costs, however, if the government 
establishes that its position in the proceeding was substantially 
justified.
    The TRA contained several amendments to section 7430 that are 
incorporated in the amendments to the regulations. First, the TRA 
provided that a taxpayer has ninety days after the date the Internal 
Revenue Service mails to the taxpayer a final decision determining tax, 
interest, or a penalty, to file an application with the Internal 
Revenue Service to recover administrative costs. Section 7430 had 
previously been silent as to the timing for seeking administrative 
costs. Second, the TRA provided that a taxpayer has ninety days after 
the date the Internal Revenue Service mails to the taxpayer, by 
certified or registered mail, a final adverse decision regarding an 
award of administrative costs, to file a petition with the Tax Court. 
Section 7430 had previously been silent as to the timing for seeking 
review in the Tax Court. Third, the TRA clarified the application of 
the net worth and size limitations imposed by section 7430(c)(4) by 
providing that individuals filing joint returns should be treated as 
separate taxpayers for purposes of determining net worth. The TRA added 
trusts to the list of taxpayers subject to the net worth and size 
limitations and also specified the date on which the net worth and size 
determination should be made. Before the TRA's clarification of the net 
worth and size limitations, section 7430 had stated only that a 
prevailing party must meet the requirement of the first sentence of 
section 2412(d)(1)(B) of Title 28. Section 2412(d)(2)(B) establishes 
the net worth and size limitations of the Equal Access to Justice Act. 
See 28 U.S.C. 2412 (EAJA). The TRA also added section 7436 to the Code, 
which gives the Tax Court jurisdiction in certain employment tax cases. 
Section 7436(d)(2) provides that section 7430 applies to proceedings 
brought under section 7436.
    RRA '98 also contained several amendments affecting section 7430. 
First, RRA '98 increased the hourly rate limitation for attorneys' fees 
in section 7430(c)(1) from $110 per hour to $125 per hour. Second, two 
special factors were added that may be considered to allow an increase 
in an attorney's hourly rate: (1) Difficulty of the issues presented 
and (2) local availability of tax expertise. Prior to the enactment of 
RRA '98, the only special factor included in section 7430(c)(1) was the 
limited availability of qualified attorneys. Third, RRA '98 added a 
provision that requires a court to consider whether the Internal 
Revenue Service has lost cases with substantially similar issues in 
other circuit courts of appeal in deciding whether the Internal Revenue 
Service's position was substantially justified. Fourth, RRA '98 created 
an exception to the requirement that to recover attorneys' fees, the 
taxpayer must have paid or incurred the fees. The exception provides 
that if an individual who is authorized to practice before the Tax 
Court or the Internal Revenue Service is representing the taxpayer on a 
pro bono basis, then the taxpayer may petition for an award of 
reasonable attorneys' fees in excess of the amounts that the taxpayer 
paid or incurred, as long as the fee award is ultimately paid to the 
individual who represented the taxpayer or such individual's employer. 
The Treasury Department and the Internal Revenue Service are releasing, 
simultaneously with these final regulations, a revenue procedure 
detailing the procedures for the recovery of attorneys' fees in the pro 
bono context. Fifth, RRA '98 extended the period for recovery of 
reasonable administrative costs to include costs incurred after the 
date on which the first letter of proposed deficiency, commonly known 
as a 30-day letter, is mailed to the taxpayer. Previously, 
administrative costs only included costs incurred on or after the date 
of the receipt by the taxpayer of the notice of the decision of the 
Internal Revenue Service Office of Appeals, or the date of the notice 
of deficiency.

Summary of Regulations

    The final regulations reflect the changes made by the TRA as 
originated in the proposed regulations. Clarifying changes included in 
the proposed regulations and adopted here address the calculation of 
net worth. Section 7430 imposes net worth and size limitations on who 
can recover costs. First, the proposed and final regulations specify 
which limitations with respect to net worth and size apply when a 
taxpayer is an owner of an unincorporated business. Second, the 
proposed and final regulations clarify the net worth and size 
limitations in cases involving partnerships subject to the unified 
audit and litigation procedures of sections 6221 through 6234 of the 
Code (the TEFRA partnership procedures).
    The final regulations reflect a further clarification that was not 
included in the proposed regulations. The proposed regulations merely 
noted that the net

[[Page 10481]]

worth of taxpayers who filed joint returns should be calculated 
separately. The final regulations further explain how the separate 
calculation will be conducted in various situations. When taxpayers who 
file joint returns jointly petition the court and incur joint costs, 
each taxpayer qualifies for a separate net worth limitation of $2 
million, but the limitation will be evaluated jointly. As such, 
taxpayers will meet the net worth limitation so long as their combined 
assets are equal to or less than $4 million, regardless of how the 
assets are distributed. This prevents high net worth taxpayers from 
avoiding the net worth limitation by seeking costs on behalf of a 
spouse with a lower net worth. When taxpayers file a joint return, but 
petition the court separately and incur separate costs, the limitation 
will be evaluated separately. As such, each taxpayer will have his/her 
assets applied toward a separate $2 million cap for each spouse. This 
analysis protects the ability of spouses with fewer assets to seek 
representation when the spouse with higher-value assets is unwilling or 
unable to incur those costs.
    The final regulations do not adopt the proposed rule in Sec. Sec.  
301.7430-5(g)(1) and (2) that the net worth limitation is computed 
based on the fair market value of the taxpayer's assets. The existing 
section 7430 regulations do not address this issue and no comments from 
the public were received on this issue. The existing case law, however, 
generally recognizes that the net worth calculation is made based on 
the acquisition costs of the taxpayer's assets. Because the case law is 
clear and provides an existing standard for determining net worth, the 
final regulations follow the case law and do not adopt the proposed 
rule in Sec.  301.7430-5(g)(1) and (2) relating to the determination of 
the value of the taxpayer's assets. Accordingly, the final regulations 
add a new paragraph (6) to Sec.  301.7430-5(g) to clarify that for 
purposes of determining net worth, assets are valued based on the cost 
of their acquisition.
    Consistent with the changes made by RRA '98, the final regulations 
clarify that a taxpayer may be eligible to recover reasonable 
administrative costs from the date of the 30-day letter only if at 
least one issue (other than recovery of administrative costs) remains 
in dispute as of the date that the Internal Revenue Service takes a 
position in the administrative proceeding. This requirement follows RRA 
'98's prevailing party definition. Under the changes made by RRA '98, 
the position of the United States is established in the administrative 
proceeding on the earlier of the date the taxpayer receives the notice 
of the decision of the Internal Revenue Service Office of Appeals or 
the date of the notice of deficiency. Where the Internal Revenue 
Service concedes an issue in the Office of Appeals prior to issuing a 
notice of deficiency or notice of the decision of the Office of 
Appeals, the United States does not take a position, so an award of 
administrative costs is not available. Where the Internal Revenue 
Service concedes an issue in the notice of decision, the position of 
the United States is necessarily substantially justified. See, for 
example, Fla. Country Clubs, Inc. v. Commissioner, 122 T.C. 73, 78-86 
(2004), aff'd, 404 F.3d 1291 (11th Cir. 2005) (Where the Office of 
Appeals determined that taxpayer did not owe any additional tax after 
issuing a 30-day letter, but without ever issuing a notice of 
deficiency or notice of determination, the Internal Revenue Service did 
not take a position), Purciello v. Commissioner, T.C. Memo. 2014-50 
(Where the Internal Revenue Service conceded the matter at issue in 
full in the notice of decision, the Internal Revenue Service was 
substantially justified).

Summary of Comments and Explanation of Revisions

    The Treasury Department and the Internal Revenue Service received 
two written comments in response to the NPRM, both of which related to 
the provisions in the proposed regulations providing for the award of 
reasonable attorneys' fees when an individual is representing a party 
on a pro bono basis. This section addresses those comments. This 
section also describes the significant differences between the rules 
proposed in the NPRM and those adopted in the final regulations.
    As discussed in this preamble, prior to RRA '98, only those costs 
incurred by the taxpayer were eligible for payment under section 7430. 
RRA '98 provided that the court could award costs in excess of the 
costs actually incurred by the taxpayer if those costs were less than 
the reasonable attorneys' fees because an individual is representing 
the taxpayer on a pro bono basis. The statute defined pro bono as 
representation provided for no fee or for a fee which (taking into 
account all the facts and circumstances) is no more than a nominal fee. 
Finally, the statute directed that awards for pro bono representation 
must be paid to the representative or that representative's employer, 
as opposed to section 7430's general requirement that awards are paid 
to the taxpayer.

1. Persons on Whose Behalf Pro Bono Representation Must Be Provided

    Section 7430 establishes net worth and size limitations that a 
taxpayer must meet in order to recover administrative or litigation 
costs. The proposed regulations included an additional requirement 
related to a taxpayer's net worth: They stated that, for reasonable 
administrative costs to be awarded for legal services provided on a pro 
bono basis, the services must be provided to or on behalf of either (A) 
persons of limited financial means who meet the eligibility 
requirements for programs funded by the Legal Services Corporation, or 
(B) organizations operating primarily to address the needs of persons 
with limited means if payment of a standard legal fee would 
significantly deplete the organization's financial resources. Both of 
the commentators recommended revising the regulations to provide that 
organizations to whom or on whose behalf representation may be provided 
include low income taxpayer clinics, clinics participating in the 
Internal Revenue Service student tax clinic program, and clinics 
operating as approved clinics in the United States Tax Court. Both 
commentators also proposed changes in the proposed regulations' income 
limitation for persons on whose behalf pro bono legal representation 
must be provided. The proposed regulations provided an income 
limitation based on the eligibility requirements for programs funded by 
the Legal Services Corporation (see 42 U.S.C. 2996e(a)(1)(A)), which is 
125 percent of the current Federal Poverty Guidelines published by the 
United States Department of Health and Human Services. One commentator 
recommended that the limitation be expanded to include individuals and 
households whose incomes do not exceed 250 percent of the poverty level 
as determined in accordance with criteria established by the Director 
of the Office of Management and Budget. The other commentator 
recommended that the regulations should not contain an income threshold 
for persons on whose behalf pro bono representation is provided, and 
recommended that the only limitation should be that pro bono 
representation must be provided to persons with limited means if 
payment of a standard legal fee would significantly deplete the 
person's financial resources.
    The Treasury Department and the Internal Revenue Service have 
carefully considered both comments and have considered the difficulty 
of establishing

[[Page 10482]]

fair and easily applied limitations on eligibility for attorneys' fees 
for pro bono representation based upon the income and financial 
resources of the taxpayer. The Treasury Department and the Internal 
Revenue Service have determined that eligibility should not be limited 
based on the income or financial resources of the recipient of the 
representation beyond the limit provided by section 7430(c)(4)(A)(ii). 
As a result, the rule contained in the proposed regulations is not 
being finalized. This change makes it unnecessary to revise the 
eligibility requirements as proposed by the commentators.

2. Rate of Reimbursement for Attorneys Who Do Not Have a Customary 
Hourly Rate

    An example in the proposed regulations stated that an award for 
representation by attorneys employed by a low income taxpayer clinic 
who do not have a customary hourly rate would be limited to the rate 
prescribed under section 7430(c)(1)(B). Section 7430(c)(1)(B)(iii) 
provides for attorneys' fees based on prevailing market rates for the 
kind or quality of services furnished, except that the fee is limited 
to a statutory rate of $125 an hour plus cost of living adjustments, 
unless a special factor justifies a higher rate. One commentator stated 
that because of the difficulty of determining the prevailing market 
rates for the kind or quality of services furnished in the case of 
attorneys representing low income taxpayers, and because of the 
unlikelihood that a low income taxpayer clinic or student taxpayer 
clinic program would become involved in a case that would justify a 
rate in excess of the statutory rate, the rate for pro bono attorneys 
who do not have a customary hourly rate should be set at the statutory 
rate.
    After publishing the proposed regulations, the Treasury Department 
and the Internal Revenue Service determined that details such as the 
rate of compensation for pro bono attorneys who do not have a customary 
hourly rate would more logically be contained in a revenue procedure. 
The Treasury Department and the Internal Revenue Service are releasing 
simultaneously Rev. Proc. 2016-17, which provides that pro bono 
attorneys who do not charge an hourly rate receive the statutory rate 
for their services unless they establish that a special factor, as 
described in section 7430(c)(1)(B)(iii), applies to justify a higher 
hourly rate. The final regulations, therefore, do not contain the 
example in the proposed regulations on the rate applicable to pro bono 
attorneys who do not have a customary hourly rate. Instead, these 
recommendations are taken into account in Rev. Proc. 2016-17.

3. Enhanced Rate Based on Limited Availability of Pro Bono 
Representatives With Tax Expertise

    One commentator recommended a change to the section of the proposed 
regulations that provided that the limited local availability of tax 
expertise is a special factor that would justify an award at a rate 
higher than the statutory rate. The proposed regulations provided that 
limited local availability of tax expertise is established by 
demonstrating that a representative possessing tax expertise is not 
available in the taxpayer's geographical area. The commentator stated 
that she did not think this special factor produces a fair result in 
the case of pro bono representatives because, even if attorneys 
possessing tax expertise practice within a taxpayer's geographic area, 
those attorneys may not be willing or able to take on pro bono cases. 
The commentator suggested that the regulation be revised so that, in 
pro bono cases, the special factor based on the limited local 
availability of tax expertise would apply if there is no representative 
possessing tax expertise practicing within the taxpayer's geographic 
area who is willing or able to represent the taxpayer on a pro bono 
basis.
    The Treasury Department and the Internal Revenue Service disagree 
that the proposed rule does not produce a fair result in the case of 
pro bono representatives. The rule permits the award of an enhanced 
rate based on the limited local availability of tax expertise because 
such a circumstance reasonably could have an unfair impact on a 
taxpayer who pays or incurs liability for attorneys' fees. For example, 
the taxpayer who must go outside his geographic area to retain a 
representative with tax expertise might be required to pay more for the 
representation than the generally prevailing market rate for 
representatives in the taxpayer's geographic area. Taxpayers who are 
represented on a pro bono basis are entitled to the enhanced rate in 
the same manner as taxpayers who incur fees. Therefore, the final 
regulations adopt the rule in the proposed regulations without change.

4. Payments for Work Performed by Students and Hourly Rates for 
Students

    The proposed regulations did not discuss issues relating to the 
award of attorneys' fees based on the work of volunteer law students. 
Both commentators recommended clarifying the proposed regulations to 
state that payment for work performed by law students should be made to 
the attorneys under whom the students work or to such an attorney's 
employer rather than to the law students.
    One commentator expressed concern that fees may be awarded based on 
the work of law students who volunteer in low income taxpayer clinics 
and clinics participating in the Internal Revenue Service student 
taxpayer clinic program, but that such students do not have customary 
hourly rates. The commentator proposed setting an hourly rate for law 
students at 40 percent of the statutory hourly rate for attorneys. The 
commentator also requested clarification that the work of law students 
can be compensated as attorneys' fees or costs regardless of whether 
the students have special orders authorizing them to practice before 
the Internal Revenue Service.
    The Treasury Department and the Internal Revenue Service agree that 
awarding fees based on the work of volunteer students may be 
appropriate and are addressing this issue in a revenue procedure being 
released contemporaneously with these final regulations. In Rev. Proc. 
2016-17, the Treasury Department and the Internal Revenue Service 
clarify that work performed by students authorized to practice before 
the Internal Revenue Service or the Tax Court may be compensable at 35 
percent of the statutory hourly rate for attorneys, unless the student 
can demonstrate that a rate in excess of that 35 percent is 
appropriate, with the award payable to the clinic or organization with 
which the student is affiliated. Rev. Proc. 2016-17 further clarifies 
that with respect to students who are not authorized to practice before 
the Internal Revenue Service or the Tax Court, the requester will have 
the burden of proving that an award of costs is appropriate and what 
rate of compensation is reasonable.

5. Effective/Applicability Date

    The proposed regulations provided that the changes in Sec. Sec.  
301.7430-2, 301.7430-3, 301.7430-4, and 301.7430-5 would apply to costs 
incurred and services performed as of the date of publication of the 
final regulations, without regard to when a petition was filed. That 
meant that these changes could have applied in cases where a petition 
was filed before publication of the final regulations in the Federal 
Register. To ensure that these changes are not mandatory for cases in 
which a

[[Page 10483]]

petition was filed before publication of the final regulations in the 
Federal Register, the effective/applicability date in Sec.  301.7430-6 
of the final regulations has been revised to provide that the changes 
in Sec. Sec.  301.7430-2, 301.7430-3, 301.7430-4, and 301.7430-5 apply 
to costs incurred and services performed in cases in which the petition 
was filed on or after the date of publication of the final regulations 
in the Federal Register. However, taxpayers may rely on the changes 
contained in Sec. Sec.  301.7430-2, 301.7430-3, 301.7430-4, and 
301.7430-5 of the final regulations for costs incurred and services 
performed in which a petition was filed prior to March 1, 2016.
    In addition, no effective/applicability date was proposed with 
respect to the rules for qualified offers under Sec.  301.7430-7, but 
one has been added to the final regulations. Accordingly, under Sec.  
301.7430-7(f) of the final regulations, section 301.7430-7 applies to 
qualified offers made in administrative court proceedings described in 
section 7430 after December 24, 2003, except that section 301.7430-
7(c)(8) is effective as of the date these final regulations are 
published in the Federal Register.

Statement of Availability for IRS Document

    For copies of recently issued Revenue Procedures, Revenue Ruling, 
notices and other guidance published in the Internal Revenue Bulletin, 
visit the IRS Web site at http://www.irs.gov.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. It also has been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
these regulations and, because these regulations do not impose on small 
entities a collection of information requirement, the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) does not apply. Therefore, a 
Regulatory Flexibility Analysis is not required. Pursuant to section 
7805(f) of the Internal Revenue Code, the Notice of Proposed Rulemaking 
was submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business. No comments 
were received.

Drafting Information

    The principal author of these regulations is Shannon K. 
Casta[ntilde]eda, Office of Associate Chief Counsel (Procedure and 
Administration).

List of Subjects in 26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

Adoptions of Amendments to the Regulations

    Accordingly, 26 CFR part 301 is amended as follows:

PART 301--PROCEDURE AND ADMINISTRATION

0
Paragraph 1. The authority citation for part 301 continues to read in 
part as follows:

    Authority:  26 U.S.C. 7805 * * *


0
Par. 2. Section 301.7430-0 is amended by:
0
1. Adding an entry for Sec.  301.7430-3(c)(4).
0
2. Adding entries to Sec.  301.7430-4, paragraphs (b)(3)(iii)(A) 
through (F) and (d).
0
3. Revising the entries for Sec.  301.7430-5.
0
4. Revising the section heading for Sec.  301.7430-6.
0
5. Adding entries for Sec. Sec.  301.7430-7 and 301.7430-8.
    The additions and revisions read as follows:


Sec.  301.7430-0  Table of contents.

* * * * *


Sec.  301.7430-3  Administrative proceeding and administrative 
proceeding date.

* * * * *
    (c) * * *
    (4) First letter of proposed deficiency that allows the taxpayer an 
opportunity for administrative review in the Office of Appeals.
* * * * *


Sec.  301.7430-4  Reasonable administrative costs.

* * * * *
    (b) * * *
    (3) * * *
    (iii) * * *
    (A) In general.
    (B) Special factor.
    (C) Limited availability.
    (D) Local availability of tax expertise.
    (E) Difficulty of the issues.
    (F) Example.
* * * * *
    (d) Pro bono representation.
    (1) In general.
    (2) Requirements.
    (3) Nominal fee.
    (4) Payment when representation provided for a nominal fee.
    (5) Requirements.
    (6) Hourly rate.
    (7) Examples.


Sec.  301.7430-5  Prevailing party.

    (a) In general.
    (b) Position of the Internal Revenue Service.
    (c) Examples.
    (d) Substantially justified.
    (1) In general.
    (2) Position in courts of appeal.
    (3) Examples.
    (4) Included costs.
    (5) Examples.
    (6) Exception.
    (7) Presumption.
    (e) Amount in controversy.
    (f) Most significant issue or set of issues presented.
    (1) In general.
    (2) Example.
    (g) Net worth and size limitations.
    (1) Individuals.
    (2) Estates and trusts.
    (3) Others.
    (4) Special rule for charitable organizations and certain 
cooperatives.
    (5) Special rule for TEFRA partnerships.
    (6) Determining net worth.
    (h) Determination of prevailing party.
    (i) Examples.


Sec.  301.7430-6  Effective/applicability dates.


Sec.  301.7430-7  Qualified offers.

    (a) In general.
    (b) Requirements for treatment as a prevailing party based upon 
having made a qualified offer.
    (1) In general.
    (2) Liability under the last qualified offer.
    (3) Liability pursuant to the judgment.
    (c) Qualified offer.
    (1) In general.
    (2) To the United States.
    (3) Specifies the offered amount.
    (4) Designated at the time it is made as a qualified offer.
    (5) Remains open.
    (6) Last qualified offer.
    (7) Qualified offer period.
    (8) Interest as a contested issue.
    (d) [Reserved].
    (e) Examples.
    (f) Effective date.


Sec.  301.7430-8  Administrative costs incurred in damage actions for 
violations of section 362 or 524 of the Bankruptcy Code.

    (a) In general.
    (b) Prevailing party.
    (c) Administrative proceeding.
    (d) Costs incurred after filing of bankruptcy petition.
    (e) Time for filing claim for administrative costs.
    (f) Effective date.

[[Page 10484]]


0
 Par. 3. Section 301.7430-1 is amended by revising paragraphs 
(b)(1)(ii)(A), (d)(1)(i) and (ii) and (d)(2) introductory text to read 
as follows:


Sec.  301.7430-1  Exhaustion of administrative remedies.

* * * * *
    (b) * * *
    (1) * * *
    (ii) * * *
    (A) Requests an Appeals office conference in accordance with 
Sec. Sec.  601.105 and 601.106 of this chapter or any successor 
published guidance; and
* * * * *
    (d) * * *
    (1) * * *
    (i) The party follows all applicable Internal Revenue Service 
procedures for contesting the matter (including filing a written 
protest or claim, requesting an administrative appeal, and 
participating in an administrative hearing or conference); or
    (ii) If there are no applicable Internal Revenue Service 
procedures, the party submits to the Area Director of the area having 
jurisdiction over the dispute a written claim for relief reciting facts 
and circumstances sufficient to show the nature of the relief requested 
and that the party is entitled to the requested relief, and the Area 
Director denies the claim for relief in writing or fails to act on the 
claim within a reasonable period after the claim is received by the 
Area Director.
    (2) For purposes of paragraph (d)(1)(ii) of this section, a 
reasonable period is--
* * * * *

0
Par. 4. Section 301.7430-2 is amended by:
0
1. Revising paragraph (a).
0
2. Removing the semicolon at the end of paragraph (c)(3)(i)(B) and 
adding a period in its place, and adding a sentence at the end of the 
paragraph.
0
3. Adding a sentence at the end of paragraph (c)(3)(i)(E).
0
4. Revising paragraph (c)(3)(ii)(C), adding paragraph (c)(3)(iii)(C)., 
and revising paragraph (c)(5).
0
5. Adding a sentence at the end of paragraph (c)(7).
0
6. Revising paragraph (e).
    The additions and revisions read as follows:


Sec.  301.7430-2  Requirements and procedures for recovery of 
reasonable administrative costs.

    (a) Introduction. Section 7430(a)(1) provides for the recovery, 
under certain circumstances, of reasonable administrative costs 
incurred in connection with an administrative proceeding before the 
Internal Revenue Service. Paragraph (b) of this section lists the 
requirements that a taxpayer must meet to be entitled to an award of 
reasonable administrative costs from the Internal Revenue Service. 
Paragraph (c) of this section describes the procedures that a taxpayer 
must follow to recover reasonable administrative costs. Paragraphs (b) 
and (c) apply to requests for administrative costs regarding all 
administrative proceedings within the Internal Revenue Service.
* * * * *
    (c) * * *
    (3) * * *
    (i) * * *
    (B) * * * For costs incurred after January 18, 1999, if the 
taxpayer alleges that the United States has lost in courts of appeal 
for other circuits on substantially similar issues, the taxpayer must 
provide, for each such case, the full name of the case, volume and 
pages of the reporter in which the opinion appears, the circuit in 
which the case was decided, and the year of the opinion;
* * * * *
    (E) * * * This statement must identify whether the representation 
is on a pro bono basis as defined in Sec.  301.7430-4(d) and, if so, to 
whom payment should be made. Specifically, the statement must direct 
whether payment should be made to the taxpayer's representative or to 
the representative's employer.
    (ii) * * *
    (C) For costs incurred after January 18, 1999, if more than $125 
per hour (as adjusted for an increase in the cost of living pursuant to 
Sec.  301.7430-4(b)(3)) is claimed for the fees of a representative in 
connection with the administrative proceeding, an affidavit is 
necessary stating that a special factor described in Sec.  301.7430-
4(b)(3) is applicable, such as the difficulty of the issues presented 
in the case or the lack of local availability of tax expertise. If a 
special factor is claimed based on specialized skills and distinctive 
knowledge as described in Sec.  301.7430-4(b)(2)(ii), the affidavit 
should state--
    (1) Why the specialized skills and distinctive knowledge were 
necessary in the representation;
    (2) That there is a limited availability of representatives 
possessing these specialized skills and distinctive knowledge; and
    (3) How the representative's education and experience qualifies the 
representative as someone with the necessary specialized skills and 
distinctive knowledge.
    (iii) * * *
    (C) In cases of pro bono representation, time records similar to 
billing records, detailing the time spent and work completed, must be 
submitted for the requested fees.
* * * * *
    (5) Period for requesting costs from the Internal Revenue Service. 
To recover reasonable administrative costs pursuant to section 7430 and 
this section, the taxpayer must file a written request for costs within 
90 days after the date the final adverse decision of the Internal 
Revenue Service with respect to all tax, additions to tax, interest, 
and penalties at issue in the administrative proceeding is mailed or 
otherwise furnished to the taxpayer. For purposes of this section, 
interest means the interest that is specifically at issue in the 
administrative proceeding independent of the taxpayer's objections to 
the underlying tax, additions to tax, and penalties imposed. The final 
decision of the Internal Revenue Service for purposes of this section 
is the document that resolves the taxpayer's liability with regard to 
all tax, additions to tax, interest, and penalties at issue in the 
administrative proceeding (such as a Form 870 or closing agreement), or 
a notice of assessment for that liability (such as the notice and 
demand under section 6303), whichever is earlier mailed or otherwise 
furnished to the taxpayer. For purposes of this section, if the 90th 
day falls on a Saturday, Sunday, or a legal holiday, the 90-day period 
shall end on the next succeeding day that is not a Saturday, Sunday, or 
a legal holiday as defined by section 7503.
* * * * *
    (7) * * * Once a notice of decision denying (in whole or in part) 
an award for reasonable administrative costs is mailed by the Internal 
Revenue Service via certified mail or registered mail as required by 
paragraph (c)(6) of this section, a taxpayer may obtain judicial review 
of that decision by filing a petition for review with the Tax Court 
prior to the 91st day after the mailing of the notice of decision.
* * * * *
    (e) The following examples primarily illustrate paragraph (a) of 
this section:

    Example 1.  Taxpayer A receives a notice of proposed deficiency 
(30-day letter). A requests and is granted Appeals office 
consideration. The administrative file contains certain documents 
provided by A as substantiation for the tax matters at issue. 
Appeals determines that the information submitted is insufficient. 
Appeals then issues a notice of deficiency. After receiving the 
notice of deficiency but before the 90-day period for filing a 
petition with the Tax Court has expired, and before filing a 
petition with the Tax Court, A convinces Appeals that the 
information previously submitted and

[[Page 10485]]

reviewed by Appeals is sufficient and, therefore, the notice of 
deficiency is incorrect and A owes no additional tax. Pursuant to 
section 6212(d), the notice of deficiency is rescinded. Appeals then 
closes the case showing a zero deficiency and mails A a notice to 
this effect. Assuming that Appeals did not rely on any new 
information provided by A in rescinding the notice of deficiency and 
that all of the other requirements of section 7430 are satisfied, A 
may recover reasonable administrative costs incurred after the date 
of the 30-day letter (the administrative proceeding date as defined 
in Treas. Reg. Sec.  301.7430-3(c)). To recover these costs, A must 
file a request for administrative costs with the Appeals office 
personnel who settled A's tax matter, or if that person is unknown 
to A, with the Area Director of the area that considered the 
underlying matter, within 90 days after the date of mailing of the 
Office of Appeals' final decision that A owes no additional tax.
    Example 2.  Taxpayer B files a request for an abatement of 
interest pursuant to section 6404 and the regulations thereunder. 
The Area Director issues a notice of proposed disallowance of the 
abatement request (akin to a 30-day letter). B requests and is 
granted Appeals office consideration. No agreement is reached with 
Appeals and the Office of Appeals issues a notice of disallowance of 
the abatement request. B does not file suit in the Tax Court, but 
instead contacts the Appeals office within 180 days after the 
mailing date of the notice of disallowance of the abatement request 
to attempt to reverse the decision. B convinces the Appeals office 
that the notice of disallowance is in error. The Appeals office 
agrees to abate the interest and mails the taxpayer a notification 
of this decision. The mailing date of the notification from Appeals 
of the decision to abate interest commences the 90-day period from 
which the taxpayer may request administrative costs. Assuming that 
Appeals did not rely on any new information provided by B in 
reversing its notice of disallowance, and that all of the other 
requirements of section 7430 are satisfied, B may recover reasonable 
administrative costs incurred after the date the Area Director 
issued the notice of proposed disallowance of the abatement request 
(the administrative proceeding date as defined in Treas. Reg. Sec.  
301.7430-3(c)). To recover these costs, B must file a request for 
costs with the Appeals office personnel who settled B's tax matter, 
or if that person is unknown to B, with the Area Director of the 
area that considered the underlying matter within 90 days after the 
date of mailing of the Office of Appeals' final decision that B is 
entitled to abatement of interest.
    Example 3.  Taxpayer C receives a notice of proposed adjustment 
and employment tax 30-day letter. C requests and is granted Appeals 
office consideration. The administrative file contains certain 
documents provided by C to support C's position in the tax matters 
at issue. Appeals determines that the documents submitted are 
insufficient. Appeals then issues a notice of determination of 
worker classification. After receiving the notice of determination 
of worker classification but before the 90-day period for filing a 
petition with the Tax Court has expired, C convinces Appeals that 
the documents previously submitted and reviewed by Appeals 
adequately support its position and, therefore, C owes no additional 
employment tax. Appeals then closes the case showing a zero tax 
adjustment and mails C a no-change letter. Assuming that Appeals did 
not rely on any new information provided by C in reversing its 
notice of determination of worker classification, and that all of 
the other requirements of section 7430 are satisfied, C may recover 
reasonable administrative costs incurred after the date of the 
notice of proposed adjustment and 30-day letter (the administrative 
proceeding date as defined in Treas. Reg. Sec.  301.7430-3(c)). To 
recover these costs, C must file a request for administrative costs 
with the Appeals office personnel who settled C's tax matter, or if 
that person is unknown to C, with the Area Director of the area that 
considered the underlying matter, within 90 days after the date of 
mailing of the Office of Appeals' final decision that C owes no 
additional tax.

0
Par. 5. Section 301.7430-3 is amended by:
0
1. Revising paragraphs (b), (c)(1), and (3).
0
2. Adding paragraph (c)(4).
0
3. Revising paragraph (d).
    The addition and revisions read as follows:


Sec.  301.7430-3  Administrative proceeding and administrative 
proceeding dates.

* * * * *
    (b) Collection action. A collection action generally includes any 
action taken by the Internal Revenue Service to collect a tax (or any 
interest, additional amount, addition to tax, or penalty, together with 
any costs in addition to the tax) or any action taken by a taxpayer in 
response to the Internal Revenue Service's act or failure to act in 
connection with the collection of a tax (including any interest, 
additional amount, addition to tax, or penalty, together with any costs 
in addition to the tax). A collection action for purposes of section 
7430 and this section includes any action taken by the Internal Revenue 
Service under Chapter 64 of Subtitle F to collect a tax. Collection 
actions also include collection due process hearings under sections 
6320 and 6330 (unless the underlying tax liability is properly at 
issue), and those actions taken by a taxpayer to remedy the Internal 
Revenue Service's failure to release a lien under section 6325 or to 
remedy any unauthorized collection action as described by section 7433, 
except those collection actions described by section 7433(e). An action 
or procedure directly relating to a claim for refund after payment of 
an assessed tax is not a collection action.
    (c) Administrative proceeding date--(1) General rule. For purposes 
of section 7430 and the regulations thereunder, the term administrative 
proceeding date means the earlier of--
    (i) The date of the receipt by the taxpayer of the notice of the 
decision of the Internal Revenue Service Office of Appeals;
    (ii) The date of the notice of deficiency; or
    (iii) The date on which the first letter of proposed deficiency 
that allows the taxpayer an opportunity for administrative review in 
the Internal Revenue Service Office of Appeals is sent.
* * * * *
    (3) Notice of deficiency. A notice of deficiency is a notice 
described in section 6212(a), including a notice rescinded pursuant to 
section 6212(d). For purposes of determining reasonable administrative 
costs under section 7430 and the regulations thereunder, the following 
will be treated as a notice of deficiency:
    (i) A notice of final partnership administrative adjustment 
described in section 6223(a)(2).
    (ii) A notice of determination of worker classification issued 
pursuant to section 7436.
    (iii) A final notice of determination denying innocent spouse 
relief issued pursuant to section 6015.
    (4) First letter of proposed deficiency that allows the taxpayer an 
opportunity for administrative review in the Office of Appeals. 
Generally, the first letter of proposed deficiency that allows the 
taxpayer an opportunity for administrative review in the Office of 
Appeals is the first letter issued to the taxpayer that describes the 
proposed adjustments and advises the taxpayer of the opportunity to 
contact the Office of Appeals. It also may be a claim disallowance or 
the first letter of determination that allows the taxpayer an 
opportunity for administrative review in the Office of Appeals.
    (d) Examples. The provisions of this section are illustrated by the 
following examples:

    Example 1.  Taxpayer A receives a notice of proposed deficiency 
(30-day letter). A files a request for and is granted an Appeals 
office conference. At the Appeals conference no agreement is reached 
on the tax matters at issue. The Office of Appeals then issues a 
notice of deficiency. Upon receiving the notice of deficiency, A 
does not file a petition with the Tax Court. Instead, A pays the 
deficiency and files a claim for refund. The claim for refund is 
considered by the Internal Revenue Service and the Area Director 
issues a notice of proposed claim disallowance. A requests and is 
granted Appeals office consideration. A convinces Appeals that A's 
claim is correct and Appeals allows A's claim. A may recover 
reasonable

[[Page 10486]]

administrative costs incurred on or after the date of the notice of 
proposed deficiency (30-day letter), but only if the other 
requirements of section 7430 and the regulations thereunder are 
satisfied. A cannot recover costs incurred prior to the date of the 
30-day letter because these costs were incurred before the 
administrative proceeding date.
    Example 2. Taxpayer B files an individual income tax return 
showing a balance due. No payment is made with the return and the 
Internal Revenue Service assesses the amount shown on the return. 
The Internal Revenue Service issues a Notice Of Intent to Levy And 
Notice Of Your Right To A Hearing pursuant to sections 6330(a) and 
6331(d). B timely requests and is granted a Collection Due Process 
(CDP) hearing. In connection with the CDP hearing, B enters into an 
installment agreement as a collection alternative. The costs that B 
incurred in connection with the CDP hearing were not incurred in an 
administrative proceeding, but rather in a collection action. 
Accordingly, B may not recover those costs as reasonable 
administrative costs under section 7430 and the regulations 
thereunder.

0
Par. 6. Section 301.7430-4 is amended by:
0
1. Removing the language ``such'' the second time it appears in the 
second sentence and in the fifth sentence of paragraph (b)(2)(ii) and 
adding the language ``that'' in its place.
0
2. Revising paragraphs (b)(3)(i) and (b)(3)(iii)(B).
0
3. Revising the first sentence in paragraph (b)(3)(iii)(C) and adding a 
new second sentence following the first sentence.
0
4. Redesignating paragraph (b)(3)(iii)(D) as paragraph (b)(3)(iii)(F), 
adding new paragraphs (b)(3)(iii)(D) and (b)(3)(iii)(E), and revising 
newly redesignated paragraph (b)(3)(iii)(F).
0
5. Revising paragraph (c)(4).
0
6. Adding paragraph (d).
    The additions and revisions read as follows:


Sec.  301.7430-4  Reasonable administrative costs.

* * * * *
    (b) * * *
    (3) Limitation on fees for a representative--(i) In general. Except 
as otherwise provided in this section, fees incurred after January 18, 
1999, and described in paragraph (b)(1)(iv) of this section that are 
recoverable under section 7430 and the regulations thereunder as 
reasonable administrative costs may not exceed $125 per hour (as 
adjusted for an increase in the cost of living and, if appropriate, a 
special factor adjustment).
* * * * *
    (iii) * * *
    (B) Special factor. A special factor is a factor, other than an 
increase in the cost of living, that justifies an increase in the $125 
per hour limitation of section 7430(c)(1)(B)(iii). The undesirability 
of the case, the work and the ability of counsel, the results obtained, 
and customary fees and awards in other cases, are factors applicable to 
a broad spectrum of litigation and do not constitute special factors 
for the purpose of increasing the $125 per hour limitation. By 
contrast, the limited availability of a specially qualified 
representative for the proceeding, the limited local availability of 
tax expertise, and the difficulty of the issues are special factors 
justifying an increase in the $125 per hour limitation.
    (C) Limited availability. Limited availability of a specially 
qualified representative is established by demonstrating that a 
specially qualified representative for the proceeding is not available 
at the $125 per hour rate (as adjusted for an increase in the cost of 
living). The representative's special qualification must be based on 
nontax expertise. * * *
    (D) Limited local availability of tax expertise. Limited local 
availability of tax expertise is established by demonstrating that a 
representative possessing tax expertise is not available in the 
taxpayer's geographical area. Initially, this showing may be made by 
submission of an affidavit signed by the taxpayer, or by the taxpayer's 
counsel, that no representative possessing tax expertise practices 
within a reasonable distance from the taxpayer's principal residence or 
principal office. The hourly rate charged by representatives in the 
geographical area is not relevant in determining whether tax expertise 
is locally available. If the Internal Revenue Service challenges this 
initial showing, the taxpayer may submit additional evidence to 
establish the limited local availability of a representative possessing 
tax expertise.
    (E) Difficulty of the issues. In determining whether the difficulty 
of the issues justifies an increase in the $125 per hour limitation on 
the applicable hourly rate, the Internal Revenue Service will consider 
the following factors:
    (1) The number of different provisions of law involved in each 
issue.
    (2) The complexity of the particular provision or provisions of law 
involved in each issue.
    (3) The number of factual issues present in the proceeding.
    (4) The complexity of the factual issues present in the proceeding.
    (F) Example. The provisions of this section are illustrated by the 
following example:

    Example. Taxpayer A is represented by B, a CPA and attorney with 
a LL.M. Degree in Taxation with Highest Honors who regularly handles 
cases dealing with TEFRA partnership issues. B represents A in an 
administrative proceeding involving TEFRA partnership issues that is 
subject to the provisions of this section. Assuming A qualifies for 
an award of reasonable administrative costs by meeting the 
requirements of section 7430, the amount of the award attributable 
to the fees of B may not exceed the $125 per hour limitation (as 
adjusted for an increase in the cost of living), absent a special 
factor. B is not a specially qualified representative because 
extraordinary knowledge of the tax laws does not constitute 
distinctive knowledge or a unique and specialized skill constituting 
a special factor. A higher rate may be justified by another special 
factor, that is, the limited local availability of tax expertise or 
the difficulty of the issues.
* * * * *
    (c) * * *
    (4) Examples. The provisions of this section are illustrated by the 
following examples:

    Example 1.  After incurring fees for representation during the 
Internal Revenue Service's examination of A's income tax return, A 
receives a notice of proposed deficiency (30-day letter). A files a 
request for and is granted an Appeals office conference. At the 
conference no agreement is reached on the tax matters at issue. The 
Internal Revenue Service then issues a notice of deficiency. Upon 
receiving the notice of deficiency, A discontinues A's 
administrative efforts and files a petition with the Tax Court. A's 
costs incurred before the date of the mailing of the 30-day letter 
are not reasonable administrative costs because they were incurred 
before the administrative proceeding date. Similarly, A's costs 
incurred in connection with the preparation and filing of a petition 
with the Tax Court are litigation costs and not reasonable 
administrative costs.
    Example 2.  Assume the same facts as in Example 1 except that 
after A receives the notice of deficiency, in addition to 
petitioning the Tax Court, A recontacts Appeals and A convinces 
Appeals that the information previously submitted during the review 
by Appeals is sufficient and, therefore, the notice of deficiency is 
incorrect and A owes no additional tax. The Internal Revenue Service 
and A agree to a stipulated decision in the Tax Court case to 
reflect Appeals' decision. The Tax Court enters the decision. If A 
seeks administrative costs, A may recover costs incurred after the 
date of the mailing of the 30-day letter, costs incurred in 
recontacting Appeals after the issuance of the notice of deficiency, 
and costs incurred up to the time the Tax Court petition was filed, 
as reasonable administrative costs, but only if the other 
requirements of section 7430 and the regulations thereunder are 
satisfied. The costs incurred before the date of the mailing of the 
30-day letter are not reasonable administrative costs because they 
were incurred before the administrative proceeding date, as set 
forth in Sec.  301.7430-3(c)(1)(iii). A's costs incurred in 
connection with the filing of a petition with the Tax

[[Page 10487]]

Court are not reasonable administrative costs because those costs 
are litigation costs. Similarly, A's costs incurred after the filing 
of the petition are not reasonable administrative costs, as they are 
litigation costs.

    (d) Pro bono representation--(1) In general. Fees recoverable under 
section 7430 and the regulations thereunder as reasonable 
administrative costs may exceed the attorneys' fees paid or incurred by 
the prevailing party if such fees are less than the reasonable 
attorneys' fees because an individual is representing the prevailing 
party on a pro bono basis. In addition to attorneys' fees, reasonable 
costs incurred or paid by the individual providing the pro bono 
representation that are normally billed separately also may be 
recovered under this section. The Treasury Department and the Internal 
Revenue Service may, in revenue rulings, notices, or other guidance 
published in the Internal Revenue Bulletin, provide for additional 
rules that apply for awards of costs for pro bono representation for 
purposes of this paragraph (d).
    (2) Requirements. Pro bono representation is established by 
demonstrating--
    (i) Representation was provided for no fee or for a fee that 
(taking into account all the facts and circumstances) constitutes a 
nominal fee;
    (ii) The representative intended to provide representation for no 
fee or for a nominal fee from the commencement of the representation. 
Intent to provide representation for no fee or for a nominal fee may be 
demonstrated through documentation such as a retainer agreement. An 
individual will not be considered to have represented a client on a pro 
bono basis if the facts demonstrate that the individual anticipated a 
fee greater than a nominal fee or provided representation on a 
contingency fee basis. The fact that the representative intended to 
seek recovery of fees under section 7430 will not prevent the 
representative from satisfying this requirement.
    (3) Nominal fee. A nominal fee is defined as a fee that is 
insignificantly small or minimal. A nominal fee is a trivial payment, 
bearing no relation to the value of the representation provided, taking 
into account all the facts and circumstances.
    (4) Payment when representation provided at no charge or for a 
nominal fee. A prevailing party who receives representation at no 
charge or for a nominal fee and who satisfies the requirements under 
this section is eligible to receive reasonable fees in excess of the 
fees actually paid or incurred. Payment will be made to the 
representative or the representative's employer.
    (5) Recordkeeping. Contemporaneous records must be maintained, 
demonstrating the work performed and the time allocated to each task. 
These records should contain similar information to billing records.
    (6) Examples. The provisions of this section are illustrated by the 
following example:

    Example 1.  Taxpayer A, an attorney, files a petition with the 
Tax Court and pays a $60 filing fee. A appears pro se in the court 
proceeding. If A prevails, he will not be entitled to an award of 
reasonable litigation costs for his services. A is rendering 
services on his own behalf, not providing pro bono representation. 
His lost opportunity costs are not compensable under section 7430. A 
may recover the filing fee as a litigation cost, but only if the 
other requirements of section 7430 and the regulations thereunder 
are satisfied.

0
Par. 7. Section 301.7430-5 is revised to read as follows:


Sec.  301.7430-5  Prevailing party.

    (a) In general. For purposes of an award of reasonable 
administrative costs under section 7430 in the case of administrative 
proceedings commenced after July 30, 1996, a taxpayer is a prevailing 
party (other than by reason of section 7430(c)(4)(E)) only if--
    (1) At least one issue (other than recovery of administrative 
costs) remains in dispute as of the date that the Internal Revenue 
Service takes a position in the administrative proceeding, as described 
in paragraph (b) of this section;
    (2) The position of the Internal Revenue Service was not 
substantially justified;
    (3) The taxpayer substantially prevails as to the amount in 
controversy or with respect to the most significant issue or set of 
issues presented; and
    (4) The taxpayer satisfies the net worth and size limitations 
referenced in paragraph (f) of this section.
    (b) Position of the Internal Revenue Service. The position of the 
Internal Revenue Service in an administrative proceeding is the 
position taken by the Internal Revenue Service as of the earlier of--
    (1) The date of the receipt by the taxpayer of the notice of the 
decision of the Internal Revenue Service Office of Appeals; or
    (2) The date of the notice of deficiency or any date thereafter.
    (c) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1. Taxpayer A receives a notice of proposed deficiency 
(30-day letter). A pays the amount of the proposed deficiency and 
files a claim for refund. A's claim is considered and a notice of 
proposed claim disallowance is issued by the Area Director. A does 
not request an Appeals office conference and the Area Director 
issues a notice of claim disallowance. A then files suit in a United 
States District Court. A cannot recover reasonable administrative 
costs because the notice of claim disallowance is not a notice of 
the decision of the Internal Revenue Service Office of Appeals or a 
notice of deficiency. Accordingly, the Internal Revenue Service has 
not taken a position in the administrative proceeding pursuant to 
section 7430(c)(7)(B).
    Example 2. Taxpayer B receives a notice of proposed deficiency 
(30-day letter). B disputes the proposed adjustments and requests an 
Appeals office conference. The Appeals office determines that B has 
no additional tax liability. B requests administrative costs from 
the date of the 30-day letter. B is not the prevailing party and may 
not recover administrative costs because all of the proposed 
adjustments in the case were resolved as of the date that the 
Internal Revenue Service took a position in the administrative 
proceeding.

    (d) Substantially justified--(1) In general. The position of the 
Internal Revenue Service is substantially justified if it has a 
reasonable basis in both fact and law. A significant factor in 
determining whether the position of the Internal Revenue Service 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 Internal Revenue Service 
personnel. The appropriate Internal Revenue Service personnel are 
personnel responsible for reviewing the information or arguments, or 
personnel who would transfer the information or arguments in the normal 
course of procedure and administration to the personnel who are 
responsible.
    (2) Position in courts of appeal. Whether the United States has won 
or lost an issue substantially similar to the one in the taxpayer's 
case in courts of appeal for circuits other than the one to which the 
taxpayer's case would be appealable should be taken into consideration 
in determining whether the Internal Revenue Service's position was 
substantially justified.
    (3) Example. The provisions of this section (d) are illustrated by 
the following example:

    Example. The Internal Revenue Service, in the conduct of a 
correspondence examination of taxpayer A's individual income tax 
return, requests substantiation from A of claimed medical expenses. 
A does not respond to the request and the Internal Revenue Service 
issues a notice of deficiency. After receiving the notice of 
deficiency, A presents sufficient

[[Page 10488]]

information and arguments to convince a tax compliance officer that 
the notice of deficiency is incorrect and that A owes no tax. The 
revenue agent then closes the case showing no deficiency. Although A 
incurred costs after the issuance of the notice of deficiency, A is 
unable to recover these costs because, as of the date these costs 
were incurred, A had not presented relevant information under A's 
control and relevant legal arguments supporting A's position to the 
appropriate Internal Revenue Service personnel. Accordingly, the 
position of the Internal Revenue Service was substantially justified 
at the time the costs were incurred.

    (4) Included costs. (i) An award of reasonable administrative costs 
shall only include costs incurred on or after the administrative 
proceeding date as defined in section 301.7430-3(c) of this chapter.
    (ii) If the Internal Revenue Service takes a position in an 
administrative proceeding, as defined in paragraph (b) of this section, 
and the position is not substantially justified, the taxpayer may be 
permitted to recover costs incurred before the position was taken, but 
not before the dates set forth in this paragraph (d)(4).
    (5) Examples. The provisions of this section may be illustrated by 
the following examples:

    Example 1.  Pursuant to section 6672, taxpayer D receives from 
the Area Director Collection Operations (Collection) a proposed 
assessment of trust fund taxes (Trust Fund Recovery Penalty). D 
requests and is granted Appeals office consideration. Appeals 
considers the issues and decides to uphold Collection's recommended 
assessment. Appeals notifies D of this decision in writing. 
Collection then assesses the tax and notice and demand is made. D 
timely pays the minimum amount required to commence a court 
proceeding, files a claim for refund, and furnishes the required 
bond. Collection disallows the claim, but Appeals, on 
reconsideration, reverses its original position, thus upholding D's 
position. If Appeals' initial determination was not substantially 
justified, D may recover administrative costs incurred on or after 
the mailing of the proposed assessment of trust fund taxes, because 
the proposed assessment is the first determination letter that 
allows the taxpayer an opportunity for administrative review in the 
Internal Revenue Service Office of Appeals.
    Example 2.  Taxpayer E receives a notice of proposed deficiency 
(30-day letter). E pays the amount of the proposed deficiency and 
files a claim for refund. E's claim is considered and a notice of 
proposed disallowance is issued by the Area Director. E requests and 
is granted Appeals office consideration. No agreement is reached 
with Appeals and the Office of Appeals issues a notice of claim 
disallowance. E does not file suit in a United States District Court 
but instead contacts the Appeals office to attempt to reverse the 
decision. E convinces the Appeals officer that the notice of claim 
disallowance is in error. The Appeals officer then abates the 
assessment. E may recover reasonable administrative costs if the 
position taken in the notice of claim disallowance issued by the 
Office of Appeals was not substantially justified and the other 
requirements of section 7430 and the regulations thereunder are 
satisfied. If so, E may recover administrative costs incurred from 
the mailing date of the 30-day letter because the requirements of 
paragraph (c)(2) of this section are met. E cannot recover the costs 
incurred prior to the mailing of the 30-day letter because they were 
incurred before the administrative proceeding date.

    (6) Exception. If the position of the Internal Revenue Service was 
substantially justified with respect to some issues in the proceeding 
and not substantially justified with respect to the remaining issues, 
any award of reasonable administrative costs to the taxpayer may be 
limited to only reasonable administrative costs attributable to those 
issues with respect to which the position of the Internal Revenue 
Service was not substantially justified. If the position of the 
Internal Revenue Service was substantially justified for only a portion 
of the period of the proceeding and not substantially justified for the 
remaining portion of the proceeding, any award of reasonable 
administrative costs to the taxpayer may be limited to only reasonable 
administrative costs attributable to that portion during which the 
position of the Internal Revenue Service was not substantially 
justified. Where an award of reasonable administrative costs is limited 
to that portion of the administrative proceeding during which the 
position of the Internal Revenue Service was not substantially 
justified, whether the position of the Internal Revenue Service was 
substantially justified is determined as of the date any cost is 
incurred.
    (7) Presumption. If the Internal Revenue Service did not follow any 
applicable published guidance in an administrative proceeding commenced 
after July 30, 1996, the position of the Internal Revenue Service, on 
those issues to which the guidance applies and for all periods during 
which the guidance was not followed, will be presumed not to be 
substantially justified. This presumption may be rebutted. For purposes 
of this paragraph (d)(7), the term applicable published guidance means 
final or temporary regulations, revenue rulings, revenue procedures, 
information releases, notices, and announcements published in the 
Internal Revenue Bulletin and, if issued to or with respect to the 
taxpayer, private letter rulings, technical advice memoranda, and 
determination letters (Sec.  601.601(d)(2) of this chapter). Also, for 
purposes of this paragraph (d)(7), the term administrative proceeding 
includes only those administrative proceedings or portions of 
administrative proceedings occurring on or after the administrative 
proceeding date as defined in Sec.  301.7430-3(c).
    (e) Amount in controversy. The amount in controversy shall include 
the amount in issue as of the administrative proceeding date as 
increased by any amounts subsequently placed in issue by any party. The 
amount in controversy is determined without increasing or reducing the 
amount in controversy for amounts of loss, deduction, or credit carried 
over from years not in issue.
    (f) Most significant issue or set of issues presented. (1) In 
general. Where the taxpayer has not substantially prevailed with 
respect to the amount in controversy the taxpayer may nonetheless be a 
prevailing party if the taxpayer substantially prevails with respect to 
the most significant issue or set of issues presented. The issues 
presented include those raised as of the administrative proceeding date 
and those raised subsequently. Only in a multiple issue proceeding can 
a most significant issue or set of issues presented exist. However, not 
all multiple issue proceedings contain a most significant issue or set 
of issues presented. An issue or set of issues constitutes the most 
significant issue or set of issues presented if, despite involving a 
lesser dollar amount in the proceeding than the other issue or issues, 
it objectively represents the most significant issue or set of issues 
for the taxpayer or the Internal Revenue Service. This may occur 
because of the effect of the issue or set of issues on other 
transactions or other taxable years of the taxpayer or related parties.
    (2) Example. The provisions of this section may be illustrated by 
the following example:

    Example.  In the purchase of an ongoing business, Taxpayer F 
obtains from the previous owner of the business a covenant not to 
compete for a period of five years. On audit of F's individual 
income tax return for the year in which the business was acquired, 
the Internal Revenue Service challenges the basis assigned to the 
covenant not to compete and a deduction taken as a business expense 
for a seminar attended by F. Both parties agree that the covenant 
not to compete is amortizable over a period of five years; however, 
the Internal Revenue Service asserts that the proper basis of the 
covenant is $25,000, while F asserts the basis is $50,000 and claims 
a deduction of $10,000 in the year in which the business was 
acquired. F deducted $12,000 for the seminar. The Internal Revenue 
Service determines that the deduction for the seminar should be

[[Page 10489]]

disallowed entirely. In the notice of deficiency, the Internal 
Revenue Service adjusts the amortization deduction to reflect the 
change to the basis of the covenant not to compete, and disallows 
the seminar expense. Thus, of the two adjustments determined for the 
year under audit, the adjustment attributable to the disallowance of 
the seminar is larger than that attributable to the covenant not to 
compete. Due to the impact on the next succeeding four years, 
however, the covenant not to compete adjustment is the most 
significant issue to both F and the Internal Revenue Service.

    (g) Net worth and size limitations--(1) Individuals. A taxpayer who 
is a natural person meets the net worth and size limitations of this 
paragraph if the taxpayer's net worth does not exceed two million 
dollars. For purposes of determining net worth, individuals filing a 
joint return, and jointly incurring administrative or litigation costs 
shall have their net worth determined jointly, with all assets and 
liabilities treated as joint for purposes of the net worth evaluation, 
and applying a joint cap of four million dollars. Individuals who file 
a joint return, but incur separate administrative or litigation costs, 
by retaining separate representation, and/or seeking individual 
administrative review or petitioning the court individually, such as 
under section 6015, shall have their net worth determined separately, 
with only those assets and liabilities reasonably attributable to each 
spouse considered against separate caps of two million dollars per 
spouse.
    (2) Estates and trusts. An estate or a trust meets the net worth 
and size limitations of this paragraph if the estate or trust's net 
worth does not exceed two million dollars. The net worth of an estate 
shall be determined as of the date of the decedent's death provided the 
date of death is prior to the date the court proceeding is commenced. 
The net worth of a trust shall be determined as of the last day of the 
last taxable year involved in the proceeding.
    (3) Others. (i) A taxpayer that is a partnership, corporation, 
association, unit of local government, or organization (other than an 
organization described in paragraph (g)(4) of this section) meets the 
net worth and size limitations of this paragraph if, as of the 
administrative proceeding date:
    (A) The taxpayer's net worth does not exceed seven million dollars; 
and
    (B) The taxpayer does not have more than 500 employees.
    (ii) A taxpayer who is a natural person and owns an unincorporated 
business is subject to the net worth and size limitations contained in 
paragraph (g)(3)(i) of this section if the tax at issue (or any 
interest, additional amount, addition to tax, or penalty, together with 
any costs in addition to the tax) relates directly to the business 
activities of the unincorporated business.
    (4) Special rule for charitable organizations and certain 
cooperatives. An organization described in section 501(c)(3) exempt 
from taxation under section 501(a), or a cooperative association as 
defined in section 15(a) of the Agricultural Marketing Act, 12 U.S.C. 
1141j(a) (as in effect on October 22, 1986), meets the net worth and 
size limitations of this paragraph if, as of the administrative 
proceeding date, the organization or cooperative association does not 
have more than 500 employees.
    (5) Special rule for TEFRA partnership proceedings. (i) In cases 
involving partnerships subject to the unified audit and litigation 
procedures of subchapter C of chapter 63 of the Internal Revenue Code 
(TEFRA partnership cases), the TEFRA partnership meets the net worth 
and size limitations requirements of this paragraph (g) if, on the 
administrative proceeding date--
    (A) The partnership's net worth does not exceed seven million 
dollars; and
    (B) The partnership does not have more than 500 employees.
    (ii) In addition, each partner requesting fees pursuant to section 
7430 must meet the appropriate net worth and size limitations set forth 
in paragraph (g)(1), (g)(2), or (g)(3) of this section. For example, if 
a partner is an individual, his or her net worth must not exceed two 
million dollars as of the administrative proceeding date. If the 
partner is a corporation, its net worth must not exceed seven million 
dollars and it must not have more than 500 employees.
    (6) Determining net worth. For purposes of determining net worth 
under this paragraph (g), assets are valued based on the cost of their 
acquisition.
    (h) Determination of prevailing party. If the final decision with 
respect to the tax, interest, or penalty is made at the administrative 
level, the determination of whether a taxpayer is a prevailing party 
shall be made by agreement of the parties, or absent an agreement, by 
the Internal Revenue Service. See Sec.  301.7430-2(c)(7) regarding the 
right to appeal the decision of the Internal Revenue Service denying 
(in whole or in part) a request for reasonable administrative costs to 
the Tax Court.

0
Par. 8. Section 301.7430-6 is revised to read as follows:


Sec.  301.7430-6  Effective/applicability dates.

    Sections 301.7430-2 through 301.7430-6, other than Sec. Sec.  
301.7430-2(b)(2), (c)(3)(i)(B), (c)(3)(i)(E), (c)(3)(ii)(C), 
(c)(3)(iii)(C), (c)(5), (c)(7), and (e); Sec. Sec.  301.7430-3(c)(1), 
(c)(3), (c)(4), and (d); Sec. Sec.  301.7430-4(b)(3)(i), (b)(3)(ii), 
(b)(3)(iii)(B), (b)(3)(iii)(C), (b)(3)(iii)(D), (b)(3)(iii)(E), 
(b)(3)(iii)(F), (c)(2)(ii), (c)(4), and (d); and Sec. Sec.  301.7430-
5(a), (b), (c)(3), (d)(2), (d)(3), (d)(4), (d)(5), (d)(7), (f)(2), 
(g)(1), (g)(2), (g)(3), (g)(5), and (g)(6) apply to claims for 
reasonable administrative costs filed with the Internal Revenue Service 
after December 23, 1992, with respect to costs incurred in 
administrative proceedings commenced after November 10, 1988. Section 
301.7430-2(c)(5) is applicable to costs incurred and services performed 
in cases in which the petition was filed on or after March 1, 2016, 
except for the last two sentences, which are applicable March 23, 1993. 
Sections 301.7430-2(b)(2), and (c)(3)(i)(B) (except the last sentence); 
301.7430-4(b)(3)(ii), (b)(3)(iii)(C) (except the first two sentences), 
and (c)(2)(ii) (except for references to the statutory cap as $125); 
and 301.7430-5(a) (except the parenthetical of 5(a) and all of 
5(a)(1)), and the first and last sentence of (d)(7) are applicable for 
administrative proceedings commenced after July 30, 1996. Sections 
301.7430-1(e), 301.7430-2(c)(2), 7430-3(a)(4) and (b) are applicable 
with respect to actions taken by the Internal Revenue Service after 
July 22, 1998. The last sentence of Sec.  301.7430-2(c)(3)(i)(B), the 
first two sentences of Sec.  301.7430-2(b)(3)(iii)(C), Sec. Sec.  
301.7430-2(c)(3)(i)(E), (c)(3)(ii)(C), (c)(3)(iii)(C), (c)(7), (e); 
301.7430-3(c)(1), (c)(3), (c)(4), (d); 301.7430-4(b)(3)(i), 
(b)(3)(iii)(B), (b)(3)(iii)(E), (b)(3)(iii)(F), (c)(2)(ii) (to the 
extent it references the statutory cap as $125), (c)(4), (d); the 
parenthetical of Sec.  301.7430-5(a) and Sec. Sec.  301.7430-5(a)(1), 
(b), (d)(2), (d)(3), (d)(4), (d)(5), (d)(7), except the first and last 
sentences, (f)(2), (g)(1), (g)(2), (g)(3), (g)(5), and (g)(6) apply to 
costs incurred and services performed in cases in which the petition 
was filed on or after March 1, 2016.

0
Par. 9. Section 301.7430-7 is amended by:
0
1. Adding paragraph (c)(8).
0
2. Amending paragraph (e) by adding Examples 16 and 17.
0
3. Revising paragraph (f).
    The additions and revisions read as follows:


Sec.  301.7430-7  Qualified offers.

* * * * *
    (c) * * *
    (8) Interest as a contested issue. To constitute a qualified offer, 
an offer must specify the offered amount of the taxpayer's liability 
(determined without

[[Page 10490]]

regard to interest, unless interest is a contested issue in the 
proceeding), as provided in paragraphs (c)(1)(ii) and (c)(3) of this 
section. Therefore, a qualified offer generally may only include an 
offer to compromise tax, penalties, additions to the tax, and 
additional amounts. Interest may only be included in a qualified offer 
if interest is a contested issue in the proceeding. For purposes of 
this section, interest is a contested issue in the proceeding only if 
the court in which the proceeding could be brought would have 
jurisdiction to determine the amount of interest due on the underlying 
tax, penalties, additions to the tax, and additional amounts. Examples 
of proceedings in which interest might be a contested issue include 
proceedings in which the increased interest rate for large corporate 
underpayments under section 6621(c) is imposed by the Internal Revenue 
Service and interest abatement proceedings brought under section 6404. 
Interest is not a contested issue in the proceeding if the court that 
would have jurisdiction over the proceeding would not have jurisdiction 
to determine the amount or rate of interest, regardless of whether the 
taxpayer attempts to raise interest as an issue in the proceeding. 
Consequently, interest will not be a contested issue in the vast 
majority of tax cases because they merely involve the straightforward 
application of statutory interest under section 6601. Accordingly, in 
those cases, interest may not be included in the offer.
* * * * *
    (e) * * *

    Example 16. Qualified offer may not compromise interest unless 
it is a contested issue. Taxpayer J receives a notice of deficiency 
making an adjustment resulting in a deficiency in tax of $6,500 plus 
a penalty of $500. Interest is not a contested issue in the 
proceeding. Within the qualified offer period, J submits a written 
offer to settle the case for a deficiency of $1,000, including all 
taxes, penalties, and interest. The offer states that it is a 
qualified offer for purposes of section 7430(g) and that it will 
remain open for acceptance by the Internal Revenue Service for a 
period of 90 days. Section 7430(g)(2)(B) and paragraph (c)(3) of 
this section state that the amount of a qualified offer must be 
without regard to interest unless interest is at issue in the 
proceeding. Since J's offer attempts to compromise interest, which 
is not a contested issue in the proceeding, it is not a qualified 
offer.
    Example 17. Qualified offer based on new defense or legal 
theory. Taxpayers K and L received a statutory notice of deficiency 
for tax year 2005, a tax year when they were married and filed a 
joint income tax return. Taxpayer K files a separate petition 
claiming innocent spouse relief and simultaneously submits an offer 
purporting to be a qualified offer. The offer states that K is 
entitled to innocent spouse relief and offers to settle the 2005 
deficiency as to K. K's innocent spouse claim was not raised during 
K and L's audit, nor was it raised during their appeals conference. 
Additionally, at no time prior to or contemporaneously with 
submitting the offer did K file with the Internal Revenue Service a 
Form 8857, Request for Innocent Spouse Relief, or otherwise provide 
the information specified in Sec.  1.6015-5(a) of this chapter. K's 
offer is not a qualified offer because K did not file a Form 8857 or 
otherwise provide substantiation or legal and factual arguments 
necessary to allow for informed consideration of the merits of the 
innocent spouse claim as required by paragraph (c)(4) of this 
section, contemporaneously with the offer or prior to making the 
offer.

    (f) Effective/applicability date. This section is applicable with 
respect to qualified offers made in administrative or court proceedings 
described in section 7430 after December 24, 2003, except that 
paragraph (c)(8) is effective as of March 1, 2016.


Sec. Sec.  301.7430-1, 301.7430-2, 301.7430-4, and 301.7430-5   
[Amended]

0
Par. 10. For each section listed in the table, remove the language in 
the ``Remove'' column and add in its place the language in the ``Add'' 
column as set forth below:

------------------------------------------------------------------------
             Section                    Remove                Add
------------------------------------------------------------------------
Sec.   301.7430-1(f)(2)(i)......  district director.  Internal Revenue
                                                       Service office
Sec.   301.7430-1(f)(3)(ii).....  district director.  Internal Revenue
                                                       Service office
Sec.   301.7430-1(f)(3)(iii)....  district director.  Internal Revenue
                                                       Service office
Sec.   301.7430-1(f)(4)(i)......  district director.  Internal Revenue
                                                       Service office
Sec.   301.7430-1(g) Example 6    district director.  Internal Revenue
 third and fourth sentences.                           Service office
Sec.   301.7430-1(g) Example 7    district director.  Internal Revenue
 third and fourth sentences.                           Service office
Sec.   301.7430-1(g) Example 8    district director.  Internal Revenue
 second and fourth sentences.                          Service office
Sec.   301.7430-1(g) Example 9    such..............  these
 second sentence.
Sec.   301.7430-2(b)(2) fourth    such..............  these
 and fifth sentences.
Sec.   301.7430-2(c)(4) first     which.............  that
 sentence.
Sec.   301.7430-2(c)(6) second    such..............  the
 sentence.
Sec.   301.7430-4(b)(3)(ii)       $110..............  $125
 first and second sentences.
Sec.   301.7430-4(c)(2)(i) third  Such..............  These
 sentence.
Sec.   301.7430-4(c)(2)(i)        which.............  that
 fourth sentence.
Sec.   301.7430-4(c)(2)(ii)       $110..............  $125
 second and third sentences.
Sec.   301.7430-5(h) first        such..............  an
 sentence.
------------------------------------------------------------------------



John Dalrymple,
Deputy Commissioner for Services and Enforcement.

    Approved: January 19, 2016.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2016-04401 Filed 2-29-16; 8:45 am]
 BILLING CODE 4830-01-P