McKee

MEMORANDUM **

The IRS assessed a tax deficiency of $164,765 upon the McKees for tax years 1999-2000. After negotiations in which the IRS acknowledged key errors were made in calculating that figure, a settlement was reached in which the deficiency was reduced to $44,535. The McKees petitioned for reasonable litigation costs under 26 U.S.C. § 7430 , but were denied by the Tax Court. Because we find that the Tax Court abused its discretion in finding that the position of the IRS was “substantially justified” we reverse the Tax Court and grant the McKees’s petition.

The IRS bears the burden of proving that its position in the proceedings below was “substantially justified.” 1 In the settlement negotiations, the IRS admitted that it made errors in applying its own code and regulations. The Tax Court’s finding that the IRS was excused because its own regulations were “complex” was an abuse of discretion.

The settlement resulted in a net reduction in the deficiency by 73%. Thus the McKees “substantially prevailed” with respect to the total amount in controversy. 2 Under IRS regulations, the McKees are excused from further exhaustion of remedies.

We remand to the Tax Court for an…