Don’t Expect The IRS to Cover Your Expensive Lawyer

I get daily updates about the new and exciting (as if anything tax related were exciting) developments coming from both our friends in Washington and our illustrious judicial branch. The legislative updates I usually understand just by reading the headlines. The court cases. . .not so much.

Today was a bad one with TC Memo 2016-192 and its headline “IRS’s Position Was Justified Until Individual Denied Appeals Review.” Okay. . .what does that mean? Unfortunately, the summary wasn’t much help.

After reading through the case, I FINALLY got it. Since I spent so much time trying to cut the crap, I figured I’d write about it.

Here’s an overview of the case: some guy–let’s call him Michael*–got divorced. The kids lived with his ex-wife, but Michael still thought he should claim the kids on the return despite it not being specified in the divorce proceedings. The IRS found that some other unspecified (but obviously his ex-wife) person claimed the kids on her return before Michael did. Therefore, the IRS said Michael couldn’t claim the kids.

Hilarious hijinks ensued, which led to tons of legal fees on Michael’s part to try to prove that he could actually claim the kids rather than this mysterious other person.

After all was said and done, including over ten thousand dollars in lawyer fees, Michael was finally able to claim his kids.

Michael got what he wanted, but he also had a huge legal bill on his hands. So his lawyer pointed to Internal Revenue Code Section 7430 that says that the IRS has to cover the legal fees for court cases they lose.

Well, sort of. It actually says the IRS must cover “reasonable administrative costs.” That turned out to be a problem.

Michael submitted his legal fees–well in excess of any sort of child deduction he was likely to get–expecting the IRS to cough up. The Tax Court looked at the attorney fees of $11,797 and said, “Uh, no way, man.”

This picture seems vaguely relevant

This picture seems vaguely relevant

The problem for Michael was two-fold:

Problem #1: The attorney fees submitted by Michael included ALL the attorney fees related to the IRS denying the kids on the return. He had his lawyer address every single letter and notice and form filing well before the issue would go to court, and he wanted the IRS to pay for that. The Tax Court shook its judicial head, saying that these were just normal filing costs–especially since the IRS was totally justified in denying Michael’s claim with all the confusion involved. Those not insignificant fees were not going to be covered by the government.

Problem #2: Section 7430 has that “reasonable” term in there. Reasonable means something totally different to each person. In this case, Michael’s lawyer considered reasonable to be $325 an hour. The government considered “reasonable” to mean $200 an hour in 2015 and 2016 based on Rev. Proc. 2015-53. Guess who one that argument? (hint: it wasn’t the lawyer)

So what can we learn from this? The first lesson is that getting a divorce makes things difficult. But, more proximate to the court case, don’t expect the IRS to cover your legal fees. If you’re right, they’ll cover some of them. Just not nearly as much as you’d like.

Of the $11,797 Michael submitted, he got $2,120 back.

Considering the cost vs. benefit of the whole proceeding, I’m guessing Michael’s in the market for a new tax lawyer. Though at least he got those child tax deductions.

*Because his name is Michael