Frederick M. and Cheryl A. Prouty - Page 7

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          section 7430.  See Rule 232(e).  Upon satisfaction of these                 
          requirements, a taxpayer may be entitled to reasonable costs                
          incurred in connection with the administrative proceeding.  See             
          sec. 7430(a)(1) and (2), (c)(1) and (2).                                    
               To be a prevailing party, the taxpayer must substantially              
          prevail with respect to either the amount in controversy or the             
          most significant issue or set of issues presented and satisfy the           
          applicable net worth requirement.  See sec. 7430(c)(4)(A).                  
               Respondent argues that petitioners have not shown that they            
          satisfy the net worth requirements of section 7430(c)(4)(A)(ii).            
          Because petitioners, even if they meet the net worth                        
          requirements, will nevertheless not be treated as prevailing                
          parties if respondent can establish that his position in the                
          administrative proceedings was substantially justified, we                  
          examine this factor first.  See sec. 7430(c)(4)(B).                         
               Substantial Justification                                              
               The Commissioner's position is substantially justified if,             
          based on all of the facts and circumstances and the legal                   
          precedent relating to the case, the Commissioner acted                      
          reasonably.  See Pierce v. Underwood, 487 U.S. 552 (1988); Sher             
          v. Commissioner, 89 T.C. 79, 84 (1987), affd. 861 F.2d 131 (5th             
          Cir. 1988).  In other words, to be substantially justified, the             
          Commissioner's position must have a reasonable basis in both law            
          and fact.  See Pierce v. Underwood, supra; Rickel v.                        

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