Allen v. Commissioner

84 T.C.M. 636 (2002)

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Allen v. Commissioner

United States Tax Court
84 T.C.M. 636 (2002)

Facts

The Allens (plaintiffs) sued their insurance company to recover the cost of repairing their residence and for punitive damages for the insurer’s bad faith. The insurer paid the Allens $102,000 in 1990. In 1991, the parties settled all the Allens’ claims, and the insurer paid another $130,000. The Internal Revenue Service (IRS) concluded that approximately $104,000 of the 1991 payment was for punitive damages and thus was taxable. The Allens administratively appealed this conclusion by submitting evidence to an IRS appeals officer regarding their repair costs. The appeals officer rejected the Allens’ appeal, relying on insurance-litigation documents reflecting the Allens’ punitive-damages demand. The Allens sued the IRS commissioner (defendant) in the United States Tax Court. In preparing for trial, the Allens’ new counsel discovered from the insurer’s attorney that the insurer did not attribute any of its 1991 payment to punitive damages. The commissioner learned about the insurer’s view three days before trial. Nevertheless, the commissioner proceeded to trial, which the Allens won. The Allens sought litigation costs pursuant to Internal Revenue Code (code) § 7430. The Tax Court denied the Allens’ request, ruling that the commissioner’s position was substantially justified. The United States Court of Appeals for the Ninth Circuit reversed in part. Per the Ninth Circuit, the commissioner’s position was substantially justified until three days before trial, when the commissioner learned about the insurer’s attorney’s expected testimony. The Ninth Circuit remanded the case to the Tax Court to decide whether the Allens were entitled to costs for the period starting three days before trial. The commissioner objected to awarding any costs because the Allens allegedly did not exhaust their administrative remedies, as required by § 7430(b)(1). Per the commissioner, the Allens did not sufficiently participate in the appeals process because they did not provide the appeals officer with certain engineering reports showing the damage to their residence and did not obtain information from the insurer until shortly before trial.

Rule of Law

Issue

Holding and Reasoning (Cox, J.)

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