In Matter of Max Oshman, DTA No. 825941 (N.Y.S. Div. of Tax App., Apr. 3, 2014), a New York State Administrative Law Judge ruled that the Department of Taxation and Finance must reimburse the legal fees of an individual taxpayer who had been improperly assessed as a “responsible person” liable for the unpaid withholding taxes of a limited liability company. However, the taxpayer’s reimbursement award was limited to $75 for each hour billed by his attorneys and accountants— the maximum award generally allowed by law—because the taxpayer did not provide any information regarding the existence of special factors to support the reimbursement of fees paid at a higher per-hour rate.

Facts. Following notification from the IRS of the results of a federal audit of a business, Plot Developers LLC, the Department initiated an audit of Plot Developers for the 2007, 2008 and 2009 tax years. Plot Developers had failed to notify the Department of the results of the federal audit, and the federal audit adjustments potentially affected Plot Developers’ New York withholding tax liability. The Department made multiple attempts to contact Plot Developers and one of its partners but never received any responses. At no point during its audit, however, did the Department attempt to contact Max Oshman, the Petitioner in this case.

After failing to receive any responses from Plot Developers or the one partner the auditor attempted to contact, the Department issued assessments for unpaid withholding taxes against the business and individuals the Department identified as the business’s “responsible persons.” The Department assessed Mr. Oshman as a responsible person based on information from a New York return filed by Plot Developers for the 2004 tax year, which listed Mr. Oshman as holding a 33.33% interest in the business at that time.

Subsequently, Mr. Oshman filed a timely request for a conference with the Bureau of Conciliation and Mediation Services (“BCMS”). At the BCMS, Mr. Oshman’s representatives submitted documentation showing that Mr. Oshman did not hold an interest in Plot Developers during the years under audit, and thus could not be a responsible person. The Department then canceled the assessments.

Mr. Oshman requested reimbursement of fees paid to an accounting firm and a law firm that assisted him in challenging the assessments. The accounting firm billed at an hourly rate of $295, and the law firm’s invoices showed hourly rates of $275 and $565. Mr. Oshman also provided an affidavit confirming that his net worth remained below $2 million at all times from the date of assessment to the present, the threshold to qualify for attorneys’ fees.

The law. Under Tax Law § 3030, a taxpayer may collect reasonable administrative and legal costs incurred in connection with an administrative or court proceeding (including a proceeding before BCMS), as long as the taxpayer is the “prevailing party” in the proceeding. An individual generally will be treated as the prevailing party if he or she (i) substantially prevailed with respect to an amount in controversy or with respect to the most significant issues or set of issues presented in the controversy; (ii) timely submits an application for reimbursement of expenses, along with an itemized statement of any attorneys’ fees incurred identifying the time expended and the hourly rate charged by the attorney; and (iii) has a net worth that does not exceed $2 million at the time the action was filed. However, an individual will not be treated as a prevailing party entitled to reimbursement of expenses if the Department is able to establish that its position in the controversy was “substantially justified.” The Tribunal has held that a position of the Department will be substantially justified as long as the Department had a “reasonable basis” in both fact and law for having taken the position.

The law further provides that attorneys’ fees in excess of $75 per hour are not reimbursable unless there is a determination that an increase in the cost of living or another special factor, such as the limited availability of qualified attorneys for the proceeding, justifies a higher rate. Fees from advisors that are not attorneys will be treated as attorneys’ fees as long as the advisor is authorized to practice before the Division of Tax Appeals.

The decision. Because the Department canceled the assessments against Mr. Oshman after the BCMS proceeding, the ALJ concluded that Mr. Oshman “clearly” satisfied the general criteria of being the “prevailing party” with respect to that proceeding. Further, the ALJ found that the Department was not substantially justified in assessing Mr. Oshman because there was no reasonable basis for the assessment, since the Department had relied solely upon information that was approximately four years old and never made an attempt to contact Mr. Oshman prior to issuing the assessment. The ALJ further determined that expenses paid by Mr. Oshman to an accounting firm were reimbursable as attorneys’ fees because the accounting firm was qualified to appear before the Division of Tax Appeals.

However, because Mr. Oshman did not provide any information supporting the reimbursement of fees at a rate higher than the statutory cap of $75 per hour, the ALJ limited reimbursement of Mr. Oshman’s attorney’s fees to the $75 per hour rate.

Additional Insights

The Taxpayer Bill of Rights Act of 1997 added provisions to the Tax Law providing for the reimbursement of “reasonable” administrative and litigation expenses incurred by individuals with a net worth of $2 million or less, and businesses with 500 or fewer employees and a net worth of $7 million or less. Because the law does not allow for such expenses to be reimbursed when the Department loses with respect to a position that was “substantially justified,” and the Department is treated as having a sufficiently substantial justification for a position as long as it had a “reasonable basis” for its position, reimbursement awards under the law have been relatively rare. As this case shows, however, a taxpayer may qualify for reimbursement when the Department makes an especially egregious error. Also, it is not necessary to proceed to a hearing before an ALJ to obtain such fees, since in this case the matter was resolved at BCMS and fees were nonetheless awarded.

The law’s $75-per-hour cap on attorneys’ fees is a significant limitation on the amount of reimbursement awards allowed under the law. However, the law explicitly states that a court may determine that “an increase in the cost of living” or another “special factor,” such as limited availability, justifies a higher hourly rate. Since the $75 fee cap has not been adjusted since 1997, when petitioning for reimbursement of attorneys’ fees, at a minimum taxpayers should consider taking the position that inflation since 1997 justifies reimbursement at a higher rate.