STATE OF ALASKA

IN THE MATTER OF: CASE NO. 1-OTA-97

ALASKA INDEPENDENT BLIND, INC.

I. INTRODUCTION

Alaska Independent Blind, Inc., (AIB), moved for attorney’s fees and costs after successfully appealing a Department of Revenue (DR) informal conference decision respecting AIB’s tax liability.  This motion raises an important question of first impression concerning the authority of an Administrative Law Judge (ALJ) in the Office of Tax Appeals to award a prevailing taxpayer costs and fees.

AIB’s claim for attorney’s fees is based on Section 7430 of the Internal Revenue Code (IRC), 26 U.S.C. 7430, which authorizes an award of attorney’s fees and costs to taxpayers who prevail in administrative or court proceedings.     AIB contends that Section 7430 is incorporated by AS 43.20.021(a) in the Alaska Net Income Tax Act (AS 43.20) and authorizes the ALJ to award costs and fees in this appeal.  The Department of Revenue (DOR) opposes the motion on the grounds that IRC § 7430 is not incorporated and that the Administrative Law Judge (ALJ) has no authority to order DOR to pay attorney’s fees.

II.  FACTS AND PROCEEDINGS

 AIB, a nonprofit corporation, raises funds from pull-tab games conducted under its Alaska charitable gaming permit.  The tax issue that was resolved in AIB’s favor in the first round of this appeal was whether AIB’s expenditures of pull-tab proceeds for its own charitable programs constituted deductible business expenses in determining AIB’s unrelated business taxable income from gaming. The ALJ issued a decision on September 19, 1997 granting AIB’s motion for summary judgment.

DOR moved for reconsideration of the decision.  Shortly thereafter, AIB and DOR agreed to a settlement.  The settlement stipulation provided for withdrawal of the original decision and entry of an order that AIB’s expenditures of gaming proceeds for its own charitable programs were deductible as business expenses.  The stipulation also provided that AIB could move for an award of attorney’s fees and could cite the withdrawn opinion in support of its request for fees.  The Administrative Law Judge (ALJ) issued a final order approving the stipulation on October 28, 1997.

AIB filed its motion for attorney’s fees on November 14, 1997.  DOR filed its opposition on December 12, 1997.  AIB replied on December 26, 1997.

 Charles F. Schuetze, Of Counsel, Davis & Davis, P.C., represented AIB.  Stephen C. Slotnick, Assistant Attorney General, Deborah Vogt, Deputy Commissioner, and Carl A. Meyer, Chief of Appeals, represented DOR.

III. DISCUSSION

A. The Independent Judgment Standard Applies

At the outset, it is necessary to determine whether the ALJ should use the independent judgment or rational basis standard of review in deciding the legal issues presented by this motion.

DOR argues that the rational basis standard applies because the incorporation issue implicates fundamental tax policy.  More specifically, DOR contends that by adopting a broad incorporation provision and broad exception to it, the legislature implicitly granted the agency charged with the administration of the tax statutes the discretion to interpret and implement them in a manner that best effects Alaska’s tax policy.   DOR maintains that the legislature intended that the courts should defer to DOR’s interpretation in cases involving the issue of whether a particular section of the IRC is incorporated under AS 43.20.021.

On the other hand, AIB contends that the independent judgment standard of AS 43.05.435(2) applies because the legal issues do not involve complex tax statues or implicate the specialized knowledge and expertise of DOR.  I agree with the taxpayer on this point.

The independent judgment standard applies here for several reasons.  First, in a recent case involving an issue of incorporation the Alaska Supreme Court applied the independent judgment standard of review. State v. OSG Bulk Ships, Inc., Op. No. 4951 (Feb. 20, 1998) (OSG).  The issue in OSG was whether a provision of the IRC that excluded foreign shipping income in calculating gross income was incorporated under AS 43.20.021.  The Supreme Court noted that the determination was a question of pure statutory construction to be decided in the independent judgment of the Court.  Id. at footnote 6.

Second, the fact that the federal statute at issue here provides for a taxpayer remedy is an additional, compelling reason to apply the independent judgment standard.   While DOR’s tax expertise might be especially probative in deciding whether a complex statute affecting tax liability has been incorporated under AS 43, that tax expertise is not useful in determining whether a statute authorizing fee awards to prevailing taxpayers has been incorporated.  The issue in this case is within the special expertise of the courts, not the taxing agency.

B.  The Internal Revenue Code provision for prevailing party attorney’s fees is impliedly excepted to by other provisions of Alaska law.

AS 43.20.021 (a) adopts by reference thousands of sections of the IRC, including Section 7430, and provides that those federal statutes have " full force and effect under this chapter (AS 43.20) unless excepted to or modified by other provisions of this chapter."   The dispute here revolves around whether Section 7430 is "excepted to or modified by" other provisions of the Alaska tax laws.

AIB contends that Section 7430 is incorporated pursuant to AS 43.20.021(a) because AS 43.20 contains no express exception to the provision for the award of fees to a prevailing taxpayer.  AIB also contends that the provision for prevailing party attorney’s fees is consistent with the legislation that established the Office of Tax Appeals and advances the legislative goals of correcting a perceived imbalance between DOR and the taxpayer and creating a level playing field for the resolution of tax appeals.

DOR’s position is that there is an implicit exception to incorporation of Section 7430 in the overall structure of Title 43, the Alaska tax law.  DOR argues that many parts of the IRC, like Section 7430, that fall within the broad incorporation provision of AS 43.20.021(a) are implicitly contrary to other Alaska tax provisions or policies and are therefore "excepted to".  DOR cites the following reasons for concluding that the federal attorney’s fees provision is excepted to:

• (1) Alaska has established tax appeal and judicial review proceedings that differ in important respects from the federal scheme for adjudicating tax cases and section 7430 is a part of the federal scheme;
• (2) The legislative history of Section 7430 demonstrates that it serves an exclusively federal policy of harmonizing tax court proceedings with other federal court proceedings; and
• (3) The legislative history of the Office of Tax Appeals enabling legislation shows that the Alaska legislature did not intend to have fees awarded in administrative tax appeals.  Finally, DOR argues that, even assuming Section 7430 is effectively incorporated, it applies only to proceedings in court or before the IRS, neither of which includes the Office of Tax Appeals¹.

There is no express exception to Section 7430 in AS 43.20.  In fact, there is no provision relating to tax appeal proceedings or procedures in AS 43.20.   The Alaska statutory provisions for tax appeals are in a different chapter, AS 43.05.²  Nor is there any express exception to awarding costs and attorney’s fees to a prevailing taxpayer in AS 43.05.  And it is true, as AIB contends, that allowing a prevailing taxpayer to recover the costs of successfully appealing a DOR decision is fully consistent with the legislative purpose in establishing the Office of Tax Appeals to hear and decide taxpayer appeals.  If the analysis ended here AIB would prevail on its claim that a prevailing taxpayer may recover attorney’s fees in an administrative appeal.  But the inquiry doesn’t end with examining the Alaska tax statutes for an express exception to IRC Section 7430.

In cases interpreting and applying the broad incorporation provision of AS 43.20.021 (a) the Alaska Supreme Court has decided that IRC provisions, which are ostensibly adopted by reference, may be "excepted to" by implication in the absence of an express exception.    Gulf Oil Corp. v. State, Dept. of Revenue, 755 P.2d 372, 380 (Alaska 1988); State v. OSG Bulk Ships, Inc., Op. No. 4951 (Feb. 20, 1998) (OSG).

The incorporation issue in OSG involved IRC Section 883, which exempts foreign shipping income from federal taxable income.  The Court found an implied exception to IRC Section 883 from the fact that the apportionment methodology employed by AS 43.20 and AS 43.19 for determining the Alaska taxable income of a multi-national taxpayer differed fundamentally from the sourcing methodology employed by the IRC.   The court concluded that the IRC exemption of foreign shipping income was inconsistent with the Alaska apportionment method and, therefore, impliedly excepted to.³

 In these cases, the Court did not limit its analysis to looking for an express exception in AS 43.20 to the particular IRC provision at issue.  Instead, the Court considered the purpose of the IRC provision and whether applying it in the context of the Alaska income tax would be consistent with the methodology and policy of AS 43.20.  The instant case calls for a similar analysis.

The first step is to examine IRC Section 7430, its legislative history and its purpose.   Section 7430 (a) provides:
 In any administrative or court proceeding which is brought by or against
 the United States in connection with the determination, collection, or refund
 of any tax, interest, or penalty under this title, the prevailing party may be
awarded a judgment or a settlement for--

• (1) reasonable administrative costs incurred in connection with such administrative proceedings within the Internal Revenue Service, and
• (2) reasonable litigation costs incurred in connection with such court proceeding.

Other parts of Section 7430 provide substantial limitations and conditions on cost awards. One of the most significant limitations is the net worth limitation on taxpayers that are eligible to be considered prevailing parties.  Eligibility is restricted to businesses with a net worth of not more than seven million or more than 500 employees, and individuals with a net worth of no more than two million.  26 USCA § 7430 (c) (4).  Another significant limitation is that no costs may be awarded if the IRS establishes that its position was substantially justified.  26 USCA § 7430 (c) (4) (B).

 Until 1998, an additional, substantial limitation applicable to fee awards in administrative proceedings prohibited a prevailing taxpayer from recovering any costs incurred before the earlier of the date that IRS Office of Appeals issued its decision or the IRS issued the notice of deficiency.  26 USCA § 7430 (c)(2).  Since those events normally occur at the end of the IRS appeals process, that restriction in effect precluded awards for almost all of the costs and fees incurred by taxpayers in administrative proceedings.  In July 1998, after the motion for costs and fees was submitted for decision in this appeal, Section 7430 was amended to allow costs incurred at the start of the IRS appeal process⁴.

 Section 7430 was first added to the IRC in 1982 as a part of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. No. 97-248, §292, 96 Stat.324, 572-74.     The intent of Congress in enacting Section 7430 was to "deter abusive actions or overreaching by the Internal Revenue Service," and to "enable individual taxpayers to vindicate their rights regardless of their economic circumstances."⁵

The legislative history⁶ demonstrates that another purpose for enacting Section 7430 was, as DOR argues, to harmonize tax court proceedings with other federal court proceedings. Before section7430 was enacted taxpayers that prevailed in civil tax cases with the IRS could recover litigation costs under the Equal Access to Justice Act of 1980 (EAJA).  The EAJA, a small business relief measure, authorized courts to award costs and fees to small businesses and individuals who prevailed in civil actions against the United States, including actions for judicial review of agency decisions, unless the government showed that its position was substantially justified, or unless the award would be unjust.  28 USC § 2412 (current version).    EAJA, however, applied only to proceedings in Article III courts, not to cases in Tax Court.  McQuiston v. Comm’r, 78 T.C. 807(1982).  Enactment of Section 7430 made the cost award authorization applicable to tax cases in all courts and replaced the EAJA as the sole authority for a prevailing party to recover costs in tax cases. Smith v. Brady, 972 F.2d 1095 (9th Cir. 1992).

DOR’s argument that Section 7430 is inapplicable on its face is not persuasive.  The fact that Section 7430 by its express terms applies to court actions involving the United States and to administrative proceedings within the IRS is not fatal to incorporation under AS 43.20.021 (a).  When IRC provisions are considered part of Alaska law the federal terms may be interpreted as referring to Alaska analogs, i.e. "DOR" can be substituted for "IRS". See, Wien  Air Alaska, Inc. v. State, Dep’t of Revenue, 647 P.2d 1087, 1093 (Alaska 1992).

 DOR’s argument that Section 7430 implements specific federal policies and procedures that serve no Alaska purpose is more persuasive.  Section 7430 is the tax counterpart to the EAJA.  Like the EAJA, Section 7430 authorizes cost and fee awards to small businesses and individuals to effectuate a broad federal policy of reducing the financial burden incurred by citizens of limited means when contesting abusive federal agency action. The main function of Section 7430, both historically and presently, is to compensate small taxpayers for the high cost of contesting unreasonable IRS action in court.
 
Alaska does not have a counterpart to the EAJA.  Alaska has not enacted legislation, like the EAJA, aimed primarily at affording fee relief to small businesses and individuals that are not able to absorb the cost of challenging government authority on an equal footing with  large corporations.  Nor has Alaska enacted a specific provision for cost and fee awards to taxpayers as part of a more comprehensive ‘Taxpayer Bill of Rights", aimed at curbing perceived abuses of power by the taxing agency⁷.
 
Alaska has established comprehensive procedures for adjudicating state tax disputes.  Those procedures  are found in Title 43, Chapter 5 of the Alaska Statutes.  Taxpayer appeals that challenge the validity of a tax on constitutional grounds may be taken directly to Superior Court after the DOR issues its informal conference decision.  AS 43.05.242.  All other taxpayer appeals from DOR informal conference decisions involving state taxes are heard by an ALJ in the Office of Tax Appeals.  AS 43.05.241; AS 43.05.405.   The ALJ issues the final administrative decision for the state. AS 43.05.465.   Either party may appeal the final decision of the ALJ to Superior Court, which decides the appeal on the administrative record.  AS 43.05.480.

There is a specific provision under Alaska law for awarding costs and attorney’s fees in superior court proceedings for judicial review of final administrative decisions, including tax appeals.  That authority is Rule 508 of the Alaska Rules of Appellate Procedure. Section 7430 clearly conflicts with Rule 508.  Under Rule 508 the court has broad discretion to award costs and reasonable attorney’s fees to the prevailing party.   The court may award actual fees  to the appellee if the court determines that the appeal was frivolous or was brought simply for the purpose of delay.  Under Rule 508, unlike Section 7430, the agency is entitled to recover costs and fees if it is the prevailing party.  Moreover, Rule 508, unlike Section 7430, allows even the largest corporate taxpayer to recover costs and fees because there are no net worth limitations on prevailing parties.
  8

Further support for the conclusion that Section 7430 does not apply to Alaska corporate income tax appeals can be found in the structure of the IRC.  Section 7430 is found in Chapter 76 of the IRC entitled "Judicial Proceedings".   The four subchapters of chapter 76 are "Civil Actions by the United States" (Subchapter A), "Proceedings by Taxpayers and Third Parties"(Subchapter B), "The Tax Court" (Subchapter C), and "Court Review of Tax Court Decisions" (Subchapter D).  All of Chapter 76 is ostensibly adopted under AS 43.20.021(a) but very little, if any, of that Chapter seems to apply to Alaska because it addresses specific federal proceedings and procedures that differ from those of the Alaska judicial system.   For example, IRC sections 7441-7448 create the United States Tax Court.  These sections are expressly adopted by AS 43.20.021 but Alaska has never had a Tax Court.  The only logical conclusion is that these sections are implicitly excepted to⁸.

For the reasons discussed above, I conclude that the IRC provision for awarding costs and fees in tax cases is implicitly excepted to, instead of incorporated, under AS 43.20.021.  AIB suggests, however, that even if Section 7430 is not applicable, AS 43.05.460 provides authority for the ALJ to award costs and attorney’s fees to a taxpayer who prevails in administrative appeal proceedings before the Office of Tax Appeals.

C. AS 43.05.460 and 465 do not authorize the ALJ to award attorney fees to a prevailing taxpayer.

AS 43.05.460 is a part of the 1996 legislation that established the Office of Tax Appeals to hear and decide taxpayers’ appeals from DOR informal conference decisions.  Titled "Enforcement", it provides that the ALJ "may impose sanctions on the parties for failure to comply with a subpoena, and order respecting discovery, and any other matter regarding the conduct of the appeal."  It further that the ALJ shall be guided by the practices of state courts in imposing sanctions for similar offenses in civil proceedings.  The statute specifically lists various types of remedies that an ALJ may order and states that the ALJ may  "grant any other relief that the administrative law judge considers appropriate."

AIB’s contention that this statute authorizes the ALJ to sanction the DOR is well taken.  The DOR, as one of the parties to an appeal before the Office of Tax Appeals, may be sanctioned for failing to comply with orders respecting the conduct of the appeal.  But it is not so clear that the ALJ may order DOR to pay a fine or pay attorney’s fees as a sanction.

The specific remedies that are listed as available sanctions are orders limiting evidence or claims to protect a party from prejudice that may occur from discovery violations.  The listed sanctions do not include paying costs.  The catchall provision authorizing the ALJ to grant "any other appropriate relief" could be interpreted to include ordering DOR to pay costs in appropriate circumstances.  But a very similar statute has been construed as not authorizing a court to award attorney’s fees against a state agency as a sanction for violating court rules.  People v. District Court, City and County of Denver, 808 P. 2d 831 (Colo. 1991).

In any event, it is not necessary to decide here whether AS 43.05.460 authorizes an ALJ to order DOR to pay costs and fees when DOR has violated a rule or an order respecting discovery.   In this case AIB is seeking costs and fees as a prevailing party.  Under these circumstances reliance on AS 43.05.460 is misplaced.  That statute concerns sanctions for misconduct by a party during the appeal proceedings.  Cost recovery by a prevailing party is a different matter, as evidenced by its separate treatment in the Alaska Rules of Court.  See, Rules 508 and 510 of the Rules of Appellate Procedure; Civil Rules 82 and 95.

One additional statute must be considered.  AS 43.05.465  provides that the ALJ "may grant relief, provide remedies, and issue any order that is appropriate"  in deciding a tax appeal.   Although this broad language might be interpreted as implicit authority for the ALJ to order DOR to pay attorney’s fees to a prevailing taxpayer, several concerns militate against that interpretation.  First, Alaska court decisions forbid an award of attorney fees incurred in administrative proceedings in the absence of specific legislative authorization.  Cook Inlet Pipeline Co. v. Alaska Public Utilities Comm., 836 P.2d 343,354 (Alaska 1992).   In the absence of any express provision in AS 43.05. 400-.499 for awarding costs or fees⁹ ,  the authority  to award  attorney’s fees against DOR should not be implied.  See, People v. District Court, supra, 808 P.2d at 835-836  ("An award of attorney’s fees to be payable from public funds implicates sensitive budget and funding considerations, and authority to intrude into these areas is not to be lightly implied.")

Furthermore, the legislative history of the legislation that established the Office of Tax Appeals indicates that the legislature did not intend to authorize an ALJ to award prevailing party attorney’s fees.  Given the fact that fee awards to a prevailing party in a tax case may involve large sums of money and also implicate important policy considerations, one would expect some discussion of the issue if the legislature intended to authorize the ALJ to award prevailing party fees.  But the legislative record contains only one passing reference to attorney’s fees in the context of a legislator’s question relating to fee awards to discourage the filing of spurious tax actions in court.  In that brief exchange, DOR Deputy Commissioner , Deborah Vogt, stated that no fees could be awarded in administrative appeal proceedings.   House Resource Committee Hearing on HB 341, Tape 96-6, side B at 1800.  Moreover, if the legislature intended to empower the ALJ to make large fee awards to prevailing taxpayers one would expect some provision for fee awards in the fiscal note for the legislation establishing the Office of Tax Appeals.  There is none.

For the reasons discussed above I am compelled to conclude that the ALJ lacks the authority to award costs and fees to AIB in this appeal.

THEREFORE, IT IS ORDERED THAT:

1.  The motion for costs and attorney’s fees is denied.

2.  Given the importance and breadth of the issues presented by AIB’s motion for costs and fees, either party  may request reconsideration of any part of this decision within 30 days of the date of service.  This decision will become a public record under AS 43.05.470 when it becomes final.

Dated this August 3, 1998.

 
Shelly Higgins, Chief Administrative Law Judge
 

Footnotes: