Appeal from an order of the United States Tax Court, Williams, J., denying appellants' motion for litigation costs under § 7430 of the Internal Revenue Code of 1986. Reversed and remanded.
Lumbard, Meskill, and Winter, Circuit Judges.
Herbert Weiss and the Estate of Roberta Weiss appeal from an order of Judge B. John Williams, Jr., of the Tax Court entered on October 23, 1987, denying their motion for litigation costs in the amount of $1,184.86 which were incurred when they successfully challenged a deficiency notice issued by the Internal Revenue Service for the 1982 tax year.
During 1982, Herbert Weiss and Roberta Weiss ("tax-payers") purchased an interest in a limited partnership known as Transpac Drilling Venture ("Transpac"). Transpac was formed and commenced business after September 3, 1982. Taxpayers received a form K-1 from Transpac for 1982. That form indicated that their distributive share of the losses of Transpac for 1982 was $42,837. Taxpayers claimed this amount as a loss deduction on their 1982 tax return.
The Commissioner of Internal Revenue sent a statutory notice of deficiency to taxpayers for 1982 in the amount of $10,972 on April 9, 1986. An accompanying statement explained that the Internal Revenue Service ("IRS") had recomputed taxpayers' income-the income they had reported for 1982 was increased by the amount of the partnership loss they had deducted because, the statement explained, they had failed to establish under any provision of the Internal Revenue Code (the "Code") that they were entitled to any portion of those losses. No non-partnership items were raised by the deficiency notice.
On July 7, 1986, taxpayers timely filed a petition in the Tax Court which alleged that the Tax Court lacked jurisdiction because Transpac was a partnership formed after September 3, 1982. They explained that because of its time of formation, the partnership was subject to the partnership audit and litigation procedures of § 6221 et seq. of the 1986 Code*fn1 and that in disallowing their deduction for the partnership loss for 1982, the Commissioner had failed to comply with those provisions by not conducting a partnership level audit before issuing the deficiency notice. On September 12, 1986, the Commissioner's District Counsel filed a motion to extend time to answer the taxpayers' petition until November 15, 1986, because he had not yet received the administrative file and was consequently unable to respond. The Tax Court granted this motion.
After receiving and reviewing the administrative file, the District Counsel filed a motion to dismiss for lack of jurisdiction on November 3, 1986. The Commissioner conceded that Transpac was a partnership to which the partnership audit and litigation procedures of § 6221 et seq. of the Code apply and that the IRS had not complied with those procedures in issuing the deficiency notice to the taxpayers. The taxpayers did not object and, on November 14, 1986, the Tax Court ordered the case dismissed for a lack of jurisdiction.
On January 9, 1987, taxpayers filed a motion for an award of $1,184.86 of litigation costs under § 7430 of the Code.*fn2 In support of this motion they alleged that they met § 7430's requirements for the award of litigation costs: (1) they had prevailed with respect to the most significant issue presented in the action (i.e., that the deficiency notice was improperly issued); (2) the position of the Commissioner was not "substantially justified" within the meaning of § 7430(c)(4); (3) they had exhausted their administrative remedies since none was available to them; and (4) the amount they claimed was reasonable.
The Commissioner filed a notice of objection on February 5, 1987 arguing that the Tax Court lacked jurisdiction to hear this petition because the underlying action had been dismissed for lack of jurisdiction. In an opinion dated April 23, 1987, the Tax Court rejected this argument and found that it had jurisdiction to consider the motion for litigation costs but that it would not decide the merits until the Commissioner responded to the allegations in taxpayers' motion.
The Commissioner's response of July 27 agreed that the taxpayers had substantially prevailed with respect to the amount in controversy, had exhausted their administrative remedies and had satisfied the net worth requirement for the award of litigation costs applied by § 7340.*fn3
The Commissioner opposed the award of litigation costs, however, on the grounds that his conduct in this case was justified and that the amount of attorneys' fees requested was not reasonable. In addition, the IRS District Counsel attorney assigned to the case, Michael Goldbas, submitted an affidavit in which he maintained that he had reviewed all known files and documents related to the administrative action leading to the Commissioner's issuance of the deficiency notice. He also asserted that the District Counsel had not reviewed the notice of deficiency prior to its issuance and that the District Counsel first became involved in the case when the taxpayers' petition was served on the Commissioner. This absence of involvement by the District Counsel in the issuance of the deficiency notice, the IRS argued, meant that, under § 7430(c)(2)(B), the notice did not constitute the "position of ...