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Click here for the full text of this decision FACTS:A husband and wife each died leaving a fractional interest in 16 tracts of Louisiana timberland that were held by a trust. The wife’s estate filed its initial estate tax return and claimed a 50 percent fractionalization discount from the pro rata fair market value of her interest in the tracts. The husband’s estate filed an amended estate tax return, and a claim for a refund, using a 50 percent fractionalization discount for the tracts. The Internal Revenue Service issued notices of proposed adjustments, rejecting the estates’ claimed fractionalization discounts, and setting forth the agency’s position that the only discount should have been the estimated costs of a hypothetical partition in kind. The estates filed protest letters in response to the notices of proposed adjustments. The protest letters stated that any attempt to partition the tracts would be vigorously resisted by the remaining co-owners. Settlement offers by the estates were rejected by the IRS, which issued notices of deficiency. Both estates filed petitions in the Tax Court for re-determination of deficiencies. The Tax Court held that the estates had established 55 percent as the average amount by which non-controlling fractional interests in Louisiana timberland were discounted, and that an additional 5 percent discount was appropriate in these cases due to peculiar circumstances with respect to the decedents’ remaining family members. The estates filed a motion for an award of reasonable litigation costs and administrative expenses. The Tax Court denied the motion and held that the position taken by the IRS in the administrative and judicial proceedings was substantially justified, which negated the statutory authority to award costs and expenses to the prevailing party. HOLDING:The court reverses the judgment of the Tax Court and remands the case to the Tax Court for a determination of the amount of fees and costs to be awarded to the taxpayers. A prevailing party in a tax case cannot be awarded reasonable administrative and litigation costs if the United States meets its burden to establish that its position in the proceeding was substantially justified. The Tax Court held that the IRS’s position was substantially justified because 1. during the administrative and pretrial proceedings, the estates did not present facts or arguments to the IRS to discredit the IRS’s position that partition was a viable alternative; and 2. over the course of proceedings leading up to trial, the estates increased the amount of discount claimed from 25 percent to 50 percent, from 50 percent to 60 percent, and from 60 percent to 90 percent. The Tax Court based its determination on the argument that the IRS received insufficient information from the estates with respect to the viability of partitioning the tracts at issue. But the court notes that the appraisal report from the husband’s estate explained that the fair market value of an undivided interest in timberland is generally less than the pro rata portion of the fair market value of the whole, as a result of the lack of marketability and the lack of control over the management of the property. The court also notes that the husband’s estate’s initial tax return contained a supplemental statement asserting that an in-kind partition of the property could only be accomplished with the unanimous consent of all remaining co-owners and the co-trustees of the trust, and that, under the circumstances, the likelihood of an in-kind partition was so remote as to be negligible. The filings regarding the wife’s estate contained similar information in the appraisal report, tax return and supplemental statement. The court points out that the estates’ protest letter also set forth in detail the legal bases justifying the estates’ claimed fractionalization discounts. Consequently, the court finds it clear that, before the IRS issued the notices of deficiency, the estates had provided enough information to the IRS to alert it to the fact that the in-kind partition described in the IRS expert’s report was not viable, and that his estimate of the costs of a hypothetical partition in kind was speculative and unsupported. The court holds that the IRS, which was charged with the knowledge of the legal precedents against its position, had a duty to examine the information provided by the estates and to make some effort to substantiate a demand for payment of additional taxes in a notice of deficiency. The court holds that the Tax Court therefore abused its discretion by accepting the IRS’s argument that its position was substantially justified because the estates failed to furnish detailed information about the risks and difficulties of partition. The court finds that such a justification would make sense only if the IRS had changed its position after it received the information detailed above. The IRS’ post-trial brief demonstrates that it did not change its position after it came into possession of the information. Therefore, the court holds that the evidence offers no support for an assumption that the IRS would not have issued notices of deficiency, and would not have maintained its position that no fractionalization discount was warranted, even if it had in its possession all of the evidence presented by the taxpayers at trial. Additionally, the court holds that the Tax Court abused its discretion by relying on the increases in the discounts claimed by the estates as proof of substantial justification. The IRS’s consistent position was that no discounts should be allowed other than the costs of partition estimated in the IRS expert’s report. The IRS had already taken its position at the time of its notice of deficiency, a position that it maintained in its answer to the estates’ petition and, indeed, throughout the litigation; thus the court holds that the post-trial increase from 60 to 90 percent had no effect whatsoever on the litigating position of the IRS. OPINION:E. Grady Jolly, C.J.; Jolly and Davis, JJ., and Engelhardt, D.J.

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