Can You Recoup Attorneys’ Fees from the IRS?

Stories abound about innocent taxpayers being hounded by the IRS and forced to incur extensive legal fees to fight back. A dispute can drag on for years and taxpayers may have to litigate before the IRS gives up. Can a taxpayer be compensated by the government for these costs? It depends.

Rules for recovery. The IRS must reimburse a taxpayer for legal fees and other costs if all of the following conditions are met:

1. The taxpayer exhausted all administrative remedies.
2. The taxpayer did not unreasonably protract the proceedings.
3. The taxpayer is the winner.  Technically, this means the taxpayer must substantially prevail and the IRS cannot show that its position was substantially justified. The IRS is presumed to not be substantially justified if it fails to follow its own regulations, rulings, notices, and announcements (and any private letter ruling issued to the taxpayer who is in a contest with the IRS regarding the subject of the ruling). A court will also consider whether the IRS position runs counter to decisions by federal courts. A taxpayer is the prevailing party if he or she made a settlement offer that the IRS rejected and at trial the taxpayer’s liability is determined to be equal to or less  than the offer.
4. Administrative and litigation costs are reasonable. This includes attorneys’ fees, fees for expert witnesses, paralegal fees, studies and reports, and other related costs. It can also include costs to recovery the fees from the IRS.

Cap on attorney’s fees. Even if a taxpayer does everything the law requires to be eligible for a recovery, he or she may not receive the actual amount of attorney’s fees. The law generally caps the recovery to a fixed hourly rate (e.g., $200 per hour in 2015). This rate is considerably lower than the current average rate for attorneys’ fees in the U.S. (see http://www.justice.gov/sites/default/files/usao-dc/legacy/2014/07/14/Laffey%20Matrix_2014-2015.pdf).

The court can award a higher rate for special factors (e.g., difficulty of the issues, availability of local tax expertise), but general expertise in tax law is not a special factor warranting a higher hourly rate.

You may not recover attorneys’ fees if you represent yourself, despite all of the time an effort you may put into the matter.

Net worth. Even if all of the conditions for a recovery are met, a taxpayer cannot receive any recovery if his or he net worth exceeds $2 million at the time the petition was filed. The $2 million net worth limit is not adjusted for inflation.

Conclusion

If you’ve been successful in fighting the IRS, check to see whether you’re entitled to recover your attorneys’ fees and related costs. But be realistic about the chances for reimbursement because you may not be made whole. Unfortunately, “unfairness” isn’t the standard for recovery.