F I L E D
                                                               United States Court of Appeals
                                                                       Tenth Circuit
                    UNITED STATES CO URT O F APPEALS
                                                                    October 12, 2006
                                 TENTH CIRCUIT                     Elisabeth A. Shumaker
                                                                       Clerk of Court


 PEOPLE’S SOURCE
 IN TER NA TIO N A L, LLC ; WILLIAM
 M EG NEY S; ANNETTE M EG NEY S,

               Plaintiffs - Appellants,
                                                        No. 06-1116
          v.                                           (D. Colorado)
                                             (D.C. No. 05-CV-1935-PSF-M JW )
 U N ITED STA TES O F A M ER ICA;
 INTERNA L REVENU E SERVICE;
 LINDA FARM ER; ANGELA RIZOR,

               Defendants - Appellees.



                            OR D ER AND JUDGM ENT *


Before HA RTZ, EBEL, and T YM KOVICH, Circuit Judges.


      People’s Source International, LLC, W illiam M egneys, and Annette

M egneys (Taxpayers) appeal the district court’s denial of their motion for

attorney fees incurred in bringing an action against the Internal Revenue Service


      *
       After examining the briefs and appellate record, this panel has determined
unanimously that oral argument would not materially assist the determination of
this appeal. See Fed. R. App. P. 34(a)(2); 10th Cir. R. 34.1(G). The case is
therefore ordered submitted without oral argument. This order and judgment is
not binding precedent, except under the doctrines of law of the case, res judicata,
and collateral estoppel. The court generally disfavors the citation of orders and
judgments; nevertheless, an order and judgment may be cited under the terms and
conditions of 10th Cir. R. 36.3.
(IRS). W e hold that their claim for fees must be denied because they did not

exhaust their administrative remedies with the IRS. Therefore, we affirm the

district court.

                                 BACKGROUND

       The IRS issued a letter (commonly referred to as a bypass letter) to

Taxpayers on September 28, 2005, informing them that the IRS w ould be

contacting them directly regarding their tax obligations because their attorney had

failed to respond to repeated requests for information and meetings. On

October 4, 2005, Taxpayers faxed to IRS G roup M anager Linda Farmer and

Revenue Officer Angela Rizor a letter objecting to this direct comm unication and

stating that Taxpayers would file suit unless the bypass letter was retracted by

4:00 p.m. that day. The next day they filed a complaint in the United States

District Court for the District of Colorado seeking a temporary restraining order

and a permanent injunction to prevent the IRS from contacting them directly. The

district court dismissed the complaint without prejudice for failure to state a claim

because Taxpayers had not stated a basis for the court’s jurisdiction. Taxpayers

on October 19, 2005, filed an amended complaint against the United States, the

IRS, the IRS Commissioner, M s. Farmer, and M s. Rizor, seeking injunctive relief

and up to $1 million in damages allegedly caused by the bypass letter.

       On December 15, 2005, the IRS informed Taxpayers that it had determined

it to be in the best interests of the agency to withdraw the bypass letter. At the

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scheduling conference before the magistrate judge on December 19, 2005,

Taxpayers’ counsel agreed to withdraw the complaint for damages and the motion

for injunctive relief. The only issue remaining was Taxpayers’ claim that 26

U.S.C. § 7430 entitled them to attorney fees.

      Taxpayers filed a motion for attorney fees (titled “M otion for Costs,

Determination or Settlement; or Rejection of Settlement”) on January 3, 2006.

On February 12, 2006, they filed a motion to reinstate their claims except for the

damage claim (thereby leaving only the claim for injunctive relief), stating that if

the case had not been settled, it should proceed. The magistrate judge denied this

motion, finding that all issues other than attorney fees had been settled at the

scheduling conference. On February 24 the magistrate judge issued a

recommendation that Taxpayers’ motion for attorney fees be denied. The district

court adopted the recommendation.

                                   D ISC USSIO N

      A.     Statutory R ight to Attorney Fees

      Under the Internal Revenue Code a court may award a “prevailing party”

its “reasonable litigation costs” incurred in connection with an administrative or

court proceeding relating to its tax obligations. 26 U.S.C. § 7430(a)(1). The

statute sets several limitations on a party’s right to recover litigation expenses. In

particular, “[a] judgment for reasonable litigation costs shall not be awarded . . .

in any court proceeding unless the court determines that the prevailing party has

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exhausted the administrative remedies available to such party within the Internal

Revenue Service.” 

A party qualifies as a prevailing party only

if (1) it substantially prevailed with respect to the amount in controversy or the

most significant issue or set of issues presented and (2) the IRS’s litigation

position was not substantially justified. See 

(B).

      B.     Application to This Case

      On appeal Taxpayers raise four issues, all related to their attorney-fee

claim. They assert that the case is not moot, their motion to reinstate claims

(seeking injunctive relief) should have been granted, the district court should have

then granted injunctive relief, and they exhausted their administrative remedies.

W e review for abuse of discretion a district court’s denial of attorney fees under

§ 7430. See Pate v. United States, 

, 459 (10th Cir. 1993).

      W e agree with Taxpayers that the case is not moot; the IRS does not argue

otherwise. “A case is moot [only] when the issues presented are no longer ‘live’

or the parties lack a legally cognizable interest in the outcome.” City of Erie v.

Pap’s A.M ., 

, 287 (2000) (internal quotation marks omitted).

Taxpayers have an ongoing interest in recovering attorney fees.

      As for Taxpayers’ substantive issues, they argue that their motion to

reinstate claims should have been granted and urge us to rule that the district

court should have granted injunctive relief against the IRS. Presumably they are




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seeking this relief because they must be prevailing parties to recover litigation

expenses.

      But we need not address these arguments, because even if Taxpayers w ere

prevailing parties, their attorney-fee claim is barred by their failure to exhaust

their administrative remedies. See § 7430(b)(1); Kenlin Indus., Inc. v. United

States, 

, 786 (4th Cir. 1991) (“The initial or threshold requirement

imposed on a taxpayer asserting a claim under Section 7430 is the exhaustion of

administrative remedies before suit.”). The Treasury Regulations implementing

§ 7430 detail when a taxpayer will be deemed to have exhausted its administrative

remedies. In a dispute over the assessment, collection, or refund of any tax,

administrative remedies are exhausted once the taxpayer participates in an

Appeals office conference. See Treas. Reg. § 301.7430-1(b) (as amended in

2003). To exhaust administrative remedies when contesting revocation of tax-

exempt status, the taxpayer must comply with the requirements of 26 U.S.C.

§ 7428(b). See 

(as amended in 2003). In all other situations

(including appeal of a bypass letter), § 301.7430-1(d) is the catch-all provision

for exhaustion. It states:

      A party has not exhausted the administrative remedies available
      within the Internal Revenue Service with respect to a matter other
      than [one for which an Appeals office conference is available or one
      regarding revocation of tax-exempt status] unless, prior to filing an
      action in a court of the United States . . .
             (I) The party submits to the district director of the district
             having jurisdiction over the dispute a written claim for relief

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             reciting facts and circumstances sufficient to show the nature
             of the relief requested and that the party is entitled to such
             relief; and
             (ii) The district director has denied the claim for relief in
             writing or failed to act on the claim within a reasonable period
             after such claim is received by the district director.

7430-1(d) (as amended in 2003).

      Taxpayers sent their letter to the wrong place and filed suit without

allowing a reasonable period to respond. Their fax of October 4, 2005, went to

Group M anager Linda Farmer and Revenue Officer Angela Rizor, not to the

district director; and they filed suit the next day. W hen the government waives its

sovereign immunity and consents to suit, as in 26 U.S.C. § 7430, those seeking to

sue the government must strictly comply with the terms of the waiver. See

Lehman v. Nakshian, 

, 161 (1981); Libutti v. United States, 

, 807-08 (N.D.N.Y. 1995). Accordingly, Taxpayers cannot recover

under § 7430.

      Taxpayers argue that there is no statutory provision for appealing a bypass

letter. This argument is meritless. Taxpayers fail to explain why the Treasury

Regulation does not provide an avenue for administrative review. They also

argue, however, that because the damage would be done before the agency needed

to respond, any appeal would have been futile. As evidence of futility they allege

that they received no response to their appeal, appropriately sent to the district

director, of a communication from the IRS that they characterize as a second



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bypass letter. But the documents necessary to sustain this allegation were not

included in the record below. In any event, the statute contains no futility

exception to the exhaustion requirement. See Lilly v. IRS (In re Lilly), 

, 573 (4th Cir. 1996).

                                  C ON CLU SIO N

      The district court did not abuse its discretion in denying Taxpayers’ motion

for attorney fees. The judgment of the district court is AFFIRMED.

                                       ENTERED FOR THE COURT


                                       Harris L Hartz
                                       Circuit Judge




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