UNITED STATES OF AMERICA, ü No. 07-56408 Plaintiff-Appellee,

v. ý D.C. No. CV-06-02136-GPS

MARTIN A. KAPP, OPINION Defendant-Appellant. þ

The Internal Revenue Service (“IRS”) disallowed the deductions, and Johnson and Westling filed petitions in the Tax Court. In 2000, the Tax Court held that although the mariners could deduct travel expenses while working away from home, Johnson and Westling could not deduct the full M&IE rate because they had not actually incurred meal expenses. Johnson v. Comm’r, 115 T.C. 210, 215 (2000); Westling v. Comm’r, 80 T.C.M. (CCH) 373, 373 (2000). They were permitted to deduct the incidental expenses portion of the M&IE rate, however, because the mariners paid for items including personal hygiene supplies and bottled water at the ship’s store. Johnson, 115 T.C. at 215; Westling, 80 T.C.M. (CCH) at 376. After these rulings, the IRS modified its Revenue Procedures and issued two Chief Counsel Advisories which concluded that the taxpayer may not claim the full M&IE rate when only incidental expenses are incurred. See, e.g., Rev. Proc. 2002-63 § 4.05, 2002-2 C.B. 691; I.R.S. Chief Counsel Advisory 200242038 (October 18, 2002), 2002 WL 31341876, at *13; I.R.S. Chief Counsel Advisory 200343025 (October 24, 2003), 2003 WL 22422671, at *6.

After the Johnson and Westling decisions, Kapp wrote several articles in a trade publication, The Professional Mariner, discussing potential tax deductions available to mariners. Kapp theorized about the different deductions available to deep sea mariners, and acknowledged that “claiming this additional meal deduction [when meals are provided] is considered double dipping.” He asserted that tug and barge mariners were entitled to claim the full M&IE deduction, reduced by the amount of their grocery allowance.1 Although he temporarily stopped claiming deductions on behalf of deep sea mariners, he continued to file returns claiming the deduction on behalf of his tug and barge mariner clients.

In November 2003 the IRS notified Kapp that he was under investigation for conducting a tax shelter promotion. Attorney Dennis Perez represented Kapp. Perez and Kapp met with George Campos, the IRS agent in charge of the investigation, several times in 2004 and 2005. In a March 2005 meeting, the IRS informed Kapp that the mariner’s tax deduction was not allowed under the Internal Revenue Code (“I.R.C.”). A memorandum dated April 18, 2005 drafted by an attorney in Perez’s firm concluded that little authority supported Kapp’s position that either deep sea mariners or tug and barge mariners were entitled to deduct the full M&IE amount, because both types of mariners are typically provided meals by their employer at no cost.2

NOTES
1A per person grocery allowance is typically provided to the captain of a ship to cover the costs of providing meals to the mariners while they are working. The captain uses the money to obtain groceries for the entire crew, and the food is cooked on board the ship.

2Although Kapp may have been able to assert the attorney-client privilege and work product protection, the memorandum was produced by his counsel during discovery.

During the course of the litigation, Kapp was deposed by the government. He stated that he did not routinely ask mariners whether they were provided meals free of charge by their employer before claiming a deduction on their behalf. Additionally, he acknowledged that while he stopped claiming the full M&IE deduction for deep sea mariners after the Johnson decision, he began claiming it again in late 2005 or early 2006 based on purported endorsement of his position by Campos, and because he needed to be more aggressive in claiming deductions to provide negotiating room with the IRS.

Subsequent to the judgment enjoining Kapp, the Tax Court published two cases specifically addressing Kapp’s position regarding tug and barge mariners. See Zbylut v. Comm’r, 95 T.C.M. (CCH) 1172, 1175 (2008); Balla v. Comm’r, 95 T.C.M. (CCH) 1090, 1093 (2008). Relying on the Johnson decision, both cases held that tug and barge mariners could not use the regulations that permit deemed substantiated deductions for meals when no expense was incurred by the taxpayer. Zbylut, 95 T.C.M. (CCH) at 1175; Balla, 95 T.C.M. (CCH) at 1093.

[1] The I.R.C. § 162 permits taxpayers to deduct reasonable business expenses paid or incurred during the taxable year, including travel expenses such as meals and lodging.3 I.R.C. § 162(a). However, § 274 disallows such deductions unless the taxpayer meets strict substantiation requirements. I.R.C. § 274(d). Section 274(d) also contains a provision that allows the Secretary of the Treasury (“Secretary”) to create regulations that eliminate some or all of the substantiation requirements when the expense is below a prescribed amount. I.R.C. § 274(d). The applicable § 274 regulations authorize the Commissioner of Internal Revenue (“Commissioner”) to create optional methods of computing travel expenses, including a per diem deduction for meals and incidental expenses, which satisfy the substantiation requirements of § 274(d). Treas. Reg. § 1.274-5(j)(1).

[2] The Commissioner issued Revenue Procedures which specify the Federal Travel Regulations M&IE rate as the amount that a taxpayer may deduct in lieu of substantiating the actual cost of meals.4 Rev. Proc. 90-60, §§ 3.02, 4.03, 1990-2 C.B. 651. The Commissioner updates these Revenue

NOTES:
3Unless otherwise indicated, all section references are to the Internal Revenue Code in effect during the years at issue.

4Revenue Procedure 90-60 § 4.03 provides in relevant part:

Procedures annually, but the relevant provisions have remained substantially the same since 2000. See, e.g., Rev. Proc. 2000-39, 2000-2 C.B. 340; 2001-47, 2001-2 C.B. 332; 2004-60, 2004-2 C.B. 682; 2005-67, 2005-2 C.B. 729. Travel expenses below the threshold M&IE amounts are deemed substantiated and the taxpayer is not required to provide documentation in order to deduct the expense. Rev. Proc. 90-60, § 4.03, 1990-2 C.B. 651.

III. Standard of Review

A summary judgment granting a permanent injunction is generally reviewed for abuse of discretion. Sprint Tel. PCS, L.P. v. County of San Diego, 490 F.3d 700, 708 (9th Cir. 2007). However, we review “any determination underlying the grant of an injunction by the standard that applies to that determination.” Id. (quoting Ting v. AT & T, 319 F.3d 1126, 1134-35 (9th Cir. 2003)). “Thus, we review a district court’s findings of fact for clear error and its determinations of law. . . de novo”. Id.

The determination that there are no genuine issues of material fact that preclude the entry of summary judgment is reviewed de novo, viewing the evidence in the light most favorable to the nonmoving party. See United States v. Alameda Gateway Ltd., 213 F.3d 1161, 1164 (9th Cir. 2000).

[5] The applicable regulations further define what conduct is subject to penalty under § 6694. The regulations provide that a person has a reasonable basis for his position “if a reasonable and well-informed analysis by a person knowledgeable in tax law would lead such a person to conclude that the position has approximately a one in three, or greater, likelihood of being sustained on the merits . . .” Treas. Reg. § 1.6694-2(b)(1). Additionally, the substantial authority standard is objective, and is not affected by the taxpayer’s subjective belief in the correctness of his position. Treas. Reg. § 1.6662-4(d)(3)(i). The government bears the burden of proving each element for enjoining a tax preparer by a preponderance of the evidence. See UniteStates v. Estate Pres.  Servs., 202 F.3d 1093, 1102 (9th Cir. 2000). (Bold and color added for emphasis)

The I.R.C. gives the Secretary and the Commissioner discretionary authority to issue regulations to ease the burden on taxpayers, who would otherwise have to meet the extensive substantiation requirements of § 274 in order to claim deductions for business related travel. I.R.C. § 274(d); see additionally Balla, 95 T.C.M. (CCH) at 1092. The regulations, however, do not eliminate the requirement in § 162 that expenses must be paid or incurred in order to be deducted.5

NOTES:
5Kapp points to an opinion issued by the General Counsel for the Office of the Inspector General at the Department of Justice that examines the per  diem travel allowances paid to border patrol agents. He claims that the opinion supports his position that expenses need not be paid or incurred to be deducted. The opinion concludes that border patrol agents can accept complimentary meals provided by their hotel without affecting their per diem. However, the border patrol agents, unlike mariners, incur other meal related expenses while traveling.

[7] The regulations reflect the requirements of § 162. In the first section outlining their purpose, the regulations state that they “provide[ ] an optional method for employees and self employed individuals who pay or incur meal costs to use in computing the deductible costs of business meal and incidental expenses paid or incurred while traveling away from home.” Rev. Proc. 90-60, §1, 1990-2 C.B. 651 (emphasis added). After the Johnson decision, the regulations were altered to provide a method for computing the applicable deduction for incidental expenses when no meal costs are paid and incurred. See, e.g., Rev. Proc. 2002-63 § 4.05, 2002-2 C.B. 691.

[9] Kapp’s assertion that deep sea mariners were permitted to take the mariners tax deduction is patently unreasonable in light of the ruling in the Johnson case. In that case, which arose from conduct nearly identical to the conduct that is the basis of the injunction, the court stated “[w]e do not read the revenue procedures to allow a taxpayer to use the full M&IE rates when he or she incurs only incidental expenses.” Johnson, 115 T.C. at 227. Kapp unsuccessfully attempts to distinguish Johnson, but the clear implication of the holding is that taxpayers may not deduct meal expenses when no such expenses are incurred. Id. Kapp acknowledged as much himself in his The Professional Mariner articles.

[10] Even accepting the accuracy of Kapp’s description of his interaction with Campos, the conduct is not an affirmation of Kapp’s position allowing him to claim the deduction on behalf of deep sea mariners, especially in light of the Johnson ruling. Because a well-informed analysis of the issue by a personknowledgeable in tax law would not lead to the conclusion that Kapp’s position had at least a one in three chance of being sustained on the merits, his position was unreasonable and not based on substantial authority.

[11] Kapp argues that claiming the mariner’s tax deduction for tug and barge mariners was reasonable because Johnson applied only to deep sea mariners. He contends that taking the deduction on behalf of tug and barge mariners, who return to port more frequently, presented novel issues. Although the Johnson case arose from a slightly different factual situation, the principles of the Tax Court’s holding clearly extend to tug and barge mariners. The essence of the court’s holding is that individuals may not deduct the full M&IE rate when they do not incur meal expenses. Johnson, 115 T.C. at 227. By extension, if tug and barge mariners do not incur meal expenses, they may not take a deduction. The frequency of a mariner’s return to port is irrelevant to the holding of the case.

[13] Additionally, in two rulings issued after the district court entered the injunction against Kapp, the Tax Court rejected the contention that tug and barge mariners were entitled to deduct the full M&IE allowance when no meal costs were incurred. Zbylut, 95 T.C.M. (CCH) at 1175; Balla, 95 T.C.M. (CCH) at 1093.6 While we cannot evaluate the reasonableness of Kapp’s position in light of these rulings issued after the IRS investigation, it is worth noting that the Tax Court stated that the issues presented were not novel, and relied heavily on the reasoning in Johnson to reach its conclusion.Zbylut, 95 T.C.M. (CCH) at 1175; Balla, 95 T.C.M. (CCH) at 1093.

NOTES:
6Kapp argues that these cases are distinguishable because the court found that neither taxpayer worked on board a common carrier. Therefore, they could not benefit from the provisions of 41 C.F.R. § 301-11.17, which provides that common carrier meals are not counted against the federal M&IE rate. As explained above, however, the common carrier exception only comes into play if the taxpayer is entitled to a per diem deduction for travel expenses in the first place, i.e., pays or incurs some travel related expenses.

The district court’s finding that an injunction is necessary is a fact sensitive determination which we review for clear error. See Sprint Tel. PCS , 490 F.3d at 708.

[16] The injunction is also appropriate as to deductions for tug and barge mariners. Kapp asserts that he would never claim the deduction after the Balla and Zbylut cases, unless they are overturned on appeal, and that an injunction is not warranted. Kapp’s conduct, however, suggests that an injunction is necessary. Although his attorney represented that Kapp would stop claiming the deduction for tug and barge mariners, he continued to claim these deductions. Given that Kapp acted in a manner contrary to the assurances he provided to the government, and continued to claim deductions for deep sea mariners in spite of clear authority to the contrary, the district court did not abuse its discretion in issuing the injunction.

The taxpayer bears the burden of establishing a good faith defense. I.R.C. § 6694(a)(3); Treas. Reg. § 1.6694-2(e)(2). (Bold and color added for emphasis) Kapp argues that he is not subject to a penalty because he acted in good faith by seeking the advice of numerous government officials and attorneys. He asserts that he contacted several attorneys at the main IRS office in Washington, D.C. to seek comment on his Professional Mariner articles, and to discuss the ability of tug and barge mariners to take the mariner’stax deduction in light of the Johnson ruling. He also contacted a high ranking General Services Administration (“GSA”) employee responsible for administering the Federal Travel Regulations, to confirm his understanding that meals provided by a common carrier need not be deducted from the per diem M&IE amount. Additionally, he claims to have relied on the advice of Steven Stolar and Ellin Palmer, two private sector attorneys. Finally, he asserts that he is entitled to assert a good faith defense because several of the returns he prepared claiming the mariner’s tax deduction were audited by the IRS, and the agency did not require any changes.

[19] Kapp also claims to have relied on the advice of private sector attorneys Stolar and Palmer, but he has failed to show that either attorney qualifies as a preparer. Even assuming that they qualify, Kapp failed to demonstrate that either was aware of all of the relevant facts underlying the returns he filed claiming the mariner’s deduction. The record shows that he had general conversations with Palmer about travel regulations and the Johnson case, and that Stolar reviewed and agreed with his Professional Mariner articles. General conversations about regulations and cases and review of an article, however, do not demonstrate that either Stolar or Palmer analyzed the relevant facts and advised Kapp that his position was correct. Kapp’s counsel during the investigation, the only attorneys who appear to have analyzed his position in light of all the relevant facts, concluded that he was not entitled to claim the deduction. (Bold and color added for emphasis)

[20] Finally, Kapp is not entitled to rely on “no change” determinations made in IRS audits. See I.R.C. § 6110(k)(3) (“a written determination may not be used or cited as precedent”).

[21] The district court’s injunction prevents Kapp from preparing returns claiming a tax deduction for meals that are provided to mariners at no cost. The Tax Court’s decisions in Johnson, Balla and Zbylut, however, prevent any tax preparer from claiming such a deduction. The injunction does not place Kapp at a unique disadvantage relative to other tax preparers.

[22] Additionally, the injunction does not prevent Kapp from claiming deductions for mariners that he is entitled to claim for other clients.7 Section 162 requires that all business expenses must be paid or incurred in order to be deducted.

NOTES:
7Kapp notes that the regulations permit employees to receive tax-free per diem or hourly travel allowance payments instead of deducting expenses on their tax returns. Rev. Proc. 90-60, §§ 3.03, 4.01, 1990-2 C.B. 651. He argues that an employee, such as an airline pilot, can collect this payment when traveling regardless of whether he pays or incurs expenses. However, the code limits per diem allowances to the amount that the payor reasonably anticipates will be incurred by the employee. Rev. Proc. 90-60, § 3.01(1), 1990-2 C.B. 651.

granting summary judgment for the government. A disputed fact is material only if it can affect the outcome of the suit under governing law. In re Barboza, 545 F.3d 702, 707 (9th Cir. 2008), (citing Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 248 (1986)). Kapp argues that there were disputed facts related to his discussions with a GSA official regarding deductions for common carrier meals, his interactions with IRS attorneys, his reliance on the advice of his own counsel, and numerous “no change” audit letters issued by the IRS. However, even if we accept Kapp’s assertions, these facts are not material because they would not entitle him to assert a good faith defense under § 6694 and the associated regulations. Treas. Reg. § 1.6694- 2(d). As discussed in Section IV(E), supra, the individuals Kapp consulted do not fall within the definition of a preparer, and he was not entitled to rely on their advice because they were not aware of all the relevant facts. Additionally, audit letters he relies on are not precedential. I.R.C. § 6110(k)(3). Therefore, the district court did not err in granting summary judgment for the government.

5156 UNITED STATES v. KAPP