Court imposed on petitioner a penalty of $ 15,000 and on Mr. Sulla a liability of $ 10,500.
This case is before the Court to consider whether P must pay a
penalty pursuant to
counsel must pay certain of R's costs pursuant to sec.
arguments, which were continued by P's counsel, who further
advocated the frivolous argument that the regulations under sec.
income in the form of remuneration for services and bank
interest received from sources within the United States is not
subject to tax.
1. Held: P is liable for a penalty under
I.R.C., since his position in this case is frivolous.
2. Held, further, P's counsel is liable for R's
excess costs under
knowingly and recklessly made frivolous arguments, thus
unreasonably and vexatiously multiplying these proceedings.
OPINION
119 T.C. 285">*285 HALPERN, Judge: This case is before the Court to consider whether petitioner must pay a penalty pursuant to
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Background
Previous Proceedings
119 T.C. 285">*286 Previously, this case was before the Court on respondent's motions for summary judgment and to award damages (the motions for summary judgment and for damages, respectively). By order dated June 6, 2001 (the June 6 order), we granted the motion for summary judgment, took under advisement the motion for damages, and ordered petitioner and Mr. Sulla to prepare to show cause why a penalty under
June 6 Order
The following is extracted or summarized from the June 6 order and is helpful to explain our imposition of a penalty and costs.
By notice of deficiency dated December 21, 1998 (the notice), respondent determined a deficiency of $ 3,407 in petitioner's 1996 income tax and additions to tax of $ 669.52, $ 295.35, and $ 165.64 under sections 6651(a)(1) (failure to file a return), 6651(a)(2) (failure to pay tax), and 6654(a) (failure to pay estimated tax), respectively.
The facts that we relied on in granting the motion for summary judgment are as follows:
During 1996, petitioner was employed by Thunderbug, Inc. (Thunderbug), a domestic (United States) corporation doing business as Magnum Motorsport. During 1996, petitioner2002 U.S. Tax Ct. LEXIS 56">*59 received remuneration in the amount of $ 29,251 from Thunderbug as compensation for labor or services performed by petitioner in the United States. Petitioner also received interest in 1996 from American Savings Bank in the amount of $ 13. Petitioner failed to file a U.S. Income tax return for 1996. Petitioner did not make any estimated tax payments for 1996. Petitioner was a citizen of the United States for 1996, and continues to be a citizen of the United States to the present.
119 T.C. 285">*287 In granting the motion for summary judgment, we rejected petitioner's arguments that he (1) did not receive any wages (as defined by section 3401(a)) or gross income from any source that could be included as taxable income, thereby making his income exempt from taxes, and (2) is not required to file a Form 1040, U.S. Individual Income Tax Return, because that form (for 1996) does not have an Office of Management and Budget approval number and is therefore a bogus form he is allowed by law to ignore without penalty.
With respect to the motion for damages, we set forth the provisions of
2002 U.S. Tax Ct. LEXIS 56">*60 A taxpayer's position is frivolous "if it is contrary to established law and unsupported by a reasoned, colorable argument for change in the law. * * * The inquiry is objective. If a person should have known that his position is groundless, a court may and should impose sanctions."
This Court has imposed penalties on taxpayers for making arguments similar to those made by petitioner. See Aldrich v. Commissioner, supra [1993 Tax Ct. Memo LEXIS 291]; McCart v. Commissioner, supra [1993 Tax Ct. Memo LEXIS 108];
With respect to the imposition of costs on Mr. Sulla, we set forth the pertinent2002 U.S. Tax Ct. LEXIS 56">*61 provisions of
The "Declaration of Paul J. Sulla, Jr." and "Petitioner's Memorandum of Points and Authorities in Opposition to Motion for Summary Judgment", signed by Paul J. Sulla, Jr., both attached to petitioner's memorandum, indicate Mr. Sulla's advocacy of petitioner's nonmeritorious positions in this case. * * *
As stated, we ordered both petitioner and Mr. Sulla to show cause why they should not be sanctioned under
Pertinent Events Preceding the 2001 Trial Session
Respondent determined the deficiencies in, and additions to, tax set forth in the notice on the basis of (1) information reported to respondent by petitioner's employer, Thunderbug, and his bank, American Savings Bank, and (2) the fact that 119 T.C. 285">*288 petitioner did not file any return for 1996 or pay any estimated tax.
The petition was filed on March 22, 1999, petitioner appearing on his own behalf. Mr. Sulla did not enter his appearance until June 21, 2000.
By the petition, petitioner denies "having any 'income' from any source for * * * [1996] that is the subject of a tax." He denies "being required2002 U.S. Tax Ct. LEXIS 56">*62 to file any annual return" for 1996. Finally, he denies "being liable for any penalties/additions to tax for" 1996.
On May 20, 1999, respondent received from petitioner a request for the production of documents. By that request, petitioner asked for "[a]ll records that Respondent intends to use at trial to establish that the
By letter dated August 5, 1999, petitioner delivered to respondent petitioner's "Demand for Answers to a More Definite Statement", in which, among other things, petitioner demanded answers to the following questions:
On the first page of the 1040 Instruction Booklet, the Commissioner of the IRS states "Thank you for making this nations's tax system the most effective system of voluntary compliance in the world".
(1) Why does the Commissioner say that?
(2) What does that mean?
(3) And how does it affect the Demandant [petitioner]?
* * * * * * *
Is the United States/Internal Revenue service, Honolulu appeals Office #500892002 U.S. Tax Ct. LEXIS 56">*63 in this case, in a condition of bankruptcy? If so, what authority does the United State/Internal Revenue Service, Honolulu Appeals Office #50089 claim as a right to make a claim against the Demandant in United States/Internal Revenue Service, Honolulu Appeals Office #50089's name as a principal?
* * * * * * *
What facts are relied upon, if any, to assert that Demandant is a citizen, state resident, juristic person, or other legal person belonging to the Internal Revenue Service, Honolulu Appeals Office #50089?
State all facts relied upon which would put the Demandant in any venue, or jurisdiction other than one of common law?
* * * * * * *
Is the statute, ordinance or regulation that you rely on to compel me to file tax returns, and pay a tax founded upon duties owed by citizen, resident or creation of the state?
119 T.C. 285">*289 (a) If so, what state?
(b) Where is the definition of that state found in the statutes, ordinances, 2002 U.S. Tax Ct. LEXIS 56">*64 or regulations relief [sic] upon?
On January 19, 2000, respondent's counsel sent a letter to petitioner advising him that his position was frivolous and that respondent would ask the Court to impose damages against him under
In a letter dated April 6, 2000, from petitioner to respondent's counsel, petitioner states the following:
I reviewed the sections of the code that you supplied me
In another2002 U.S. Tax Ct. LEXIS 56">*65 letter to respondent's counsel, dated May 4, 2000, petitioner states: "Provide me any documentation to support any claim that my services to Thunderbug did not have a fair market value of $ 29,264.00 and that the property that Thunderbug gave me in return did not have a fair market value of $ 29,264.00. Provide me any documentation that you may have to show that 'income' is the subject of the tax."
This case was set for trial at the trial session of this Court commencing on June 19, 2000, in Honolulu, Hawaii (the 2000 trial session). Petitioner prepared a trial memorandum (the trial memorandum), as required by our standing pretrial order. 1 In the trial memorandum, petitioner claims that:
(1) "Based on advice from his professionals Petitioner challenges Respondent's claim that Petitioner has failed to comply with the law by not filing federal income tax returns."
(2) "Based on advice from his professionals2002 U.S. Tax Ct. LEXIS 56">*66 Petitioner challenges Respondent's claim that petitioner is a 'taxpayer' as defined by
Attached to respondent's copy of the trial memorandum are documents purporting to be letters to petitioner from the 119 T.C. 285">*290 aforementioned "professionals". The principal argument of those so-called professionals is that the filing and payment of taxes is voluntary.
At the call of the case from that calendar at the 2000 trial session, petitioner informed the presiding Judge, Judge Marvel, that he was attempting to hire an attorney to represent him. That attorney was Mr. Sulla (who, as stated, entered his appearance on June 21, 2000). In a subsequent telephone conference among Judge Marvel, Mr. Sulla, and respondent's counsel, Judge Marvel advised Mr. Sulla that, if petitioner continued to present frivolous arguments, the Court would impose penalties. The Court further advised Mr. Sulla that he bore the responsibility to straighten his client out. Petitioner's request for a continuance was granted.
By letter to respondent's counsel dated September 12, 2000, Mr. Sulla reviewed petitioner's arguments as to why he did not owe income tax for 1996. 2002 U.S. Tax Ct. LEXIS 56">*67 Those arguments include the following: (1) Petitioner had no income from any source taxable under the Internal Revenue Code; (2) no provision of the Internal Revenue Code obligates petitioner to file a Form 1040, U.S. Individual Income Tax Return, and, therefore, payment of the Federal income tax is voluntary, and (3) the Form 1040 provided by the Internal Revenue Service is a "bootleg" request because it does not conform to the requirements of the Paperwork Reduction Act of 1980, as amended, in that the form does not display a control number, an expiration date, or a statement whether the form is voluntary or mandatory. Mr. Sulla did not disavow those positions, but asked of respondent's counsel: "Any responses or interpretations, supported by authorities, which you would assert in opposition to the positions taken by [petitioner]".
On September 18, 2000, Mr. Sulla filed a status report with the Court advising the Court of petitioner's "newly- revealed" interpretation of the Internal Revenue Code and supporting regulations, i.e., that, under regulations interpreting
By letter to Mr. Sulla dated October 4, 2000, respondent's counsel advised Mr. Sulla that "the arguments presented by or on behalf of Mr. Takaba to date have been found to be frivolous."
By letter to Mr. Sulla dated February 5, 2001, respondent's counsel reiterated his advice that petitioner's arguments (including the 861 argument) were frivolous. He quoted from and referred Mr. Sulla to
The Court of Appeals for the Ninth Circuit, to which any appeal in this case will lie, has stated, "Compensation for labor or services, paid in the form of wages or salary, has been universally held by the courts of this republic to be income, subject to the income tax laws currently applicable."
He stated: "Although you apparently understood our arguments in this case, you dismissed them as 'a normal response from a tax collector'. But you provide no support for your interpretation of
Mr. Sulla reiterated the 861 argument in his declaration attached to petitioner's "Memorandum in Opposition to 119 T.C. 285">*292 Motion for Summary Judgment and Motion for Damages" (sometimes, petitioner's memorandum): "[T]he clear and unequivocal language contained under the several provisions of
Also attached to petitioner's memorandum is petitioner's affidavit. Attached to the affidavit are Exhibits, including an Exhibit B, a letter to the Internal Revenue Service, dated April 11, 2001, in which, among other things, petitioner states:
pursuant to the filing of the attached and completed IRS Form(s)
2002 U.S. Tax Ct. LEXIS 56">*71 I hereby challenge, controvert and/or refute any and all claims that I made any "wages" as defined in Title 26 United States Code(USC) section 3401(a) and/or that I received any remuneration from any source for the afore said year(s) that is includable in "gross income", as defined in the operative sections of the IRC as listed in Title 26 Code of Federal Regulations (CFR)
2001 Trial Session
At the 2001 trial session, Mr. Sulla attempted to show cause why we should not make absolute our orders sanctioning him and petitioner under
[I]n essence, Your Honor, I am stating that a U.S. person earning income from a U.S. source, whether it be interstate or intrastate, while he's in the United States, as long as it's not from a federal possessions corporation or a -- involved, or federal government involved, that would not be taxable income as defined and as stated in the regulations, Code of Regulations; and it would * * * be considered * * * exempt income.
He stated that he found support for his analysis in
Discussion
By the motion for damages, respondent has asked that we impose a penalty on petitioner in the amount of $ 25,000, or in such lesser amount that we deem appropriate, pursuant to
In pertinent part,
(a) Tax Court Proceedings. --
(1) Procedures instituted primarily for delay, etc. -- Whenever it appears to the Tax Court that --
(A) proceedings2002 U.S. Tax Ct. LEXIS 56">*74 before it have been instituted or maintained by the taxpayer primarily for delay,
119 T.C. 285">*294 (B) the taxpayer's position in such proceeding is frivolous or groundless, or
(C) the taxpayer unreasonably failed to pursue available administrative remedies, the Tax Court, in its decision, may require the taxpayer to pay to the United States a penalty not in excess of $ 25,000.
(2) Counsel's liability for excessive costs. -- Whenever it appears to the Tax Court that any attorney or other person admitted to practice before the Tax Court has multiplied the proceedings in any case unreasonably and vexatiously, the Tax Court may require --
(A) that such attorney or other person pay personally the excess costs, expenses, and attorneys' fees reasonably incurred because of such conduct * * *
Respondent asks that we impose2002 U.S. Tax Ct. LEXIS 56">*75 damages on petitioner under
2002 U.S. Tax Ct. LEXIS 56">*76 Petitioner relies on the 861 argument to defend against imposition of a
Ignoring these statutory provisions, petitioners argue that their2002 U.S. Tax Ct. LEXIS 56">*77 compensation for services * * * and interest do not constitute gross income because these items of income are not listed in
Petitioner's position, that respondent erred in determining a deficiency in, and additions to, petitioner's 1996 Federal income tax, is frivolous, since all of petitioner's arguments in support of that position are frivolous. Petitioner deserves a penalty under
119 T.C. 285">*296 We have set forth in some detail the various arguments made by petitioner during2002 U.S. Tax Ct. LEXIS 56">*79 the course of this litigation. Petitioner has wandered far afield from the track established by the petition, that he had no income from any source subject to tax and is not required to file a return (themselves frivolous arguments). At various times, he has argued that the
1. Introduction
2002 U.S. Tax Ct. LEXIS 56">*80
In
In
2. Bad Faith
a. Petitioner's Initial Arguments
2002 U.S. Tax Ct. LEXIS 56">*84 In the view of the Court of Appeals for the Ninth Circuit, "bad faith" is present when an attorney knowingly or recklessly raises a frivolous argument.
Any reservation of the Petitioner's prior arguments by Petitioner's counsel at that time while signaling to Respondent's counsel and to Court that Petitioner's counsel was informally conceding these arguments is not inconsistent. This negotiating posture by Petitioner's counsel at the initial contact with the Court and Respondent would normally be construed, among professionals in negotiations, as a strong signal of a parties' primary position. * * *
A party may retain any number of different theories of action or defense "in reserve". The reservation of positions has no bearing on what the party ultimately corresponds, argues or pleads. * * * [Emphasis added.]
119 T.C. 285">*299 By the time of the September 12 letter and the status report, Mr. Sulla had ample time to review petitioner's initial arguments. We believe from Mr. Sulla's statements2002 U.S. Tax Ct. LEXIS 56">*86 in the surreply that he knew those arguments were frivolous but, in order to gain a tactical advantage, did not disclaim them. Thus, Mr. Sulla knowingly maintained petitioner's frivolous arguments, and that constitutes bad faith. 5
2002 U.S. Tax Ct. LEXIS 56">*87 b. The 861 Argument
Moreover, we believe that Mr. Sulla was reckless in making the 861 argument. The Court of Appeals for the Ninth Circuit has not defined the term "reckless" for purposes of determining whether an attorney acts in bad faith by recklessly making a frivolous argument. "Recklessness involves a greater degree of fault than negligence but a lesser degree of fault than intentional wrongdoing." Black's Law Dictionary 1277 (7th ed. 1999). In certain areas of the law, scienter (the fact of an act's having been done knowingly) is an element of recklessness. See
119 T.C. 285">*300 For a public official to recover damages for a defamatory falsehood relating to his official conduct, the official must prove that the statement was made with "' actual malice' that is, with knowledge that it was false or with reckless disregard of whether it was false or not".
We find that Mr. Sulla was reckless in making the 861 argument. We do so because (1) there were obvious reasons for Mr. Sulla to doubt his interpretation of the regulations and (2) the conclusions to be drawn from the 861 argument2002 U.S. Tax Ct. LEXIS 56">*90 are so inherently improbable that only a reckless man would have made that argument. As stated, the 861 argument is that the regulations under
(a) General rule. (1)
* * * * * * *
(b) Citizens or residents of the United States liable to tax. In general, all citizens of the United States, wherever resident, * * * are liable to the income taxes imposed by the Code whether the income2002 U.S. Tax Ct. LEXIS 56">*91 is received from sources within or without the United States. * * *
Mr. Sulla acknowledges the authority of Treasury Regulations. In Petitioner's Memorandum of Points and Authorities in Opposition to Motion for Summary Judgment (exhibit A to petitioner's memorandum), Mr. Sulla states: "When the Treasury regulations are published they become official notice to the public of what the law requires." In that same document, he quotes from
Mr. Sulla may have dismissed respondent's arguments as "a normal response from a tax collector", but he cannot disregard authority that was placed in front of his eyes and that was plain to see. We have no doubt that Mr. Sulla realized that there was some risk that the 861 argument was frivolous. Such risk was apparent from the conclusion of the legal research firm that he consulted that no case, rule, or regulation supported the 861 argument. We need not concern ourselves with the subjective valuation that Mr. Sulla placed on that risk. It is sufficient that the risk was significant and plain to see, and that he saw it. We need not concern ourselves with idiosyncratic thinking or tolerate willful obtuseness. Cf.
3. Unreasonable and Vexatious Multiplication of the Proceedings
Mr. Sulla unreasonably and vexatiously2002 U.S. Tax Ct. LEXIS 56">*94 multiplied the proceedings before the Court by championing petitioner's initial, frivolous arguments and by introducing a new frivolous argument, the 861 argument. Either action is a ground to find him liable for excess costs. This case should have concluded 119 T.C. 285">*303 with petitioner's capitulation shortly after Mr. Sulla made his appearance. Mr. Sulla's actions caused needless delay; if he caused additional expense to respondent, he should bear those additional expenses. See
Before proceeding to determine the excess costs that Mr. Sulla must bear, we pause to state that we are mindful that there can be a thin line between zealous advocacy and frivolity. We must be careful not to cross that line and impose costs on zealous (but unsuccessful) advocacy. We must be careful not to stifle the enthusiasm or chill the creativity that is the very lifeblood of the law.
4. Costs
"Attorney's fees awarded under
2002 U.S. Tax Ct. LEXIS 56">*96 Respondent asks reimbursement for 58 hours of Mr. Lau's time at $ 150 an hour. Mr. Lau is the attorney with day-to-day119 T.C. 285">*304 responsibility for the case. He is an attorney employed in the Office of Chief Counsel in Honolulu, Hawaii. He has been a member of the Hawaii State Bar since 1982. He has detailed the time he spent on the case from June 20, 2000, onward, which involves time spent on research, drafting, telephone calls, review of submissions to the Court, consultations with Mr. Hochman, and appearances. Based on various factors, including the cost of living and attorney wages in Honolulu, Hawaii, and awards in previous cases, respondent asks reimbursement at a rate of $ 150 an hour for Mr. Lau's time. The hourly rate properly charged for the time of a Government attorney is the "amount to which attorneys of like skill in the area would typically be entitled for a given type of work on the basis of an hourly rate of compensation."
Respondent asks reimbursement for 21.75 hours of Mr. Hochman's time, at a rate of $ 200 an hour. Mr. Hochman is Mr. Lau's supervisor. He is an Associate Area Counsel in the Office of Chief Counsel in Honolulu, Hawaii. Mr. Hochman has been practicing law since at least 1982. Respondent asks reimbursement at a rate of $ 200 an hour for Mr. Hochman's time. Mr. Sulla does not question the reasonableness of that rate. All of the hours claimed for Mr. Hochman were expended after Mr. Sulla filed the status report. We believe that 21.75 hours was reasonably necessary for Mr. Hochman to do the work he described. We find that $ 200 is a reasonable hourly charge for Mr. Hochman's time and that he reasonably expended 21.75 excess hours on this litigation. The lodestar amount for Mr. Hochman's time is $ 4,350.
The total lodestar amount for the time of Mr. Lau and Mr. Hochman is $ 10,500. Respondent has not itemized costs2002 U.S. Tax Ct. LEXIS 56">*99 for travel expense, photocopying, or supplies used in preparing the cases. Respondent limits his request for costs to the total lodestar amount. We shall require Mr. Sulla to pay costs in that amount.
5. Conclusion
We find that $ 10,500 is a reasonable amount for respondent's excess attorney's fees incurred by reason of Mr. Sulla's unreasonable and vexatious multiplication of these proceedings. Therefore, we shall make the order to show cause absolute and order Mr. Sulla personally to pay respondent $ 10,500 pursuant to
To reflect the foregoing,
An appropriate order will be issued and an order and decision will be entered.
1. There is no copy of petitioner's trial memorandum in the record, but both parties describe it in their filings.↩
2. There is some question whether it is necessary for a court to find that a taxpayer acted in bad faith in order to impose a penalty on him under
3. There is some question whether it is necessary for a court to find that a taxpayer acted in bad faith in order to impose a penalty on him under
4. In
5. Mr. Sulla's conduct with respect to petitioner's initial arguments (and, indeed, the 861 argument) also raises questions under the Rules.