T.C. Memo. 2008-71

UNITED STATES TAX COURT

EDWARD D. CLARK, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 11946-06. Filed March 19, 2008.

June L. Harris and Ellin Vicki Palmer, for petitioner.

Michael W. Berwind, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COHEN, Judge: Respondent determined the following

deficiencies and penalties with respect to petitioner’s Federal

income tax:
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 Penalty 

Year Deficiency Sec. 6662(a)

2002 $11,459 $2,291.80

2003 12,491 2,498.20

2004 9,506 1,901.20

After concessions, the issues for decision are:

(1) Whether for the years in issue petitioner may exclude

from gross income wages earned while working in international

waters; 

(2) whether for the years in issue petitioner may deduct at

Federal per diem rates meal expenses that petitioner did not pay

or incur; and 

(3) whether for the years in issue petitioner is subject to

accuracy-related penalties pursuant to section 6662(a).

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect during the years in issue,

and all Rule references are to the Tax Court Rules of Practice

and Procedure.

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference. 

Petitioner resided in Scotland, the United Kingdom, when he filed

his petition.

Petitioner is a citizen of the United States but resided in

Scotland during the years in issue. Petitioner was employed at

various times during the years in issue by Maersk Line, Ltd.
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(Maersk) as a second officer aboard two of Maersk’s vessels, the

Able and the Invincible. The Able is an undersea surveillance

ship and was operated by Maersk under a subcontracting

arrangement with the U.S. Navy and the U.S. Military Sealift

Command. The Invincible is a guided missile tracking ship and

was operated by Maersk under a subcontracting arrangement with

the U.S. Air Force and the U.S. Military Sealift Command. While

petitioner was at work during the years in issue, Maersk provided

him with meals and lodging without charge. Maersk did not

provide petitioner with a per diem allowance for work-related

meals or incidental expenses.

At all times when petitioner was working aboard either the

Able or the Invincible during the years in issue, those vessels

were either docked in foreign ports or sailing in international

waters. The locations of the Able and the Invincible for the

periods when petitioner was employed by Maersk aboard the vessels

during the years in issue are reflected below:

Vessel Dates Location

Able 1/1/02-1/8/02 International waters

 1/9/02-1/15/02 Glasgow, Scotland

Invincible 6/18/02-9/10/02 Singapore

 9/11/02-9/26/02 International waters

 9/27/02-10/09/02 Singapore

10/10/02-10/22/02 International waters

10/23/02-10/28/02 Okinawa, Japan

10/29/02-10/30/02 International waters

 10/31/02-11/1/02 Okinawa, Japan

 11/2/02-11/10/02 International waters

11/11/02-11/12/02 Singapore
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11/13/02-12/22/02 International waters

12/23/02-12/24/02 Singapore

Invincible 5/23/03-5/28/03 Sasebo, Japan

 5/29/03-6/12/03 International waters

 6/13/03-6/14/03 Sasebo, Japan

 6/15/03-6/23/03 International waters

 6/24/03-6/25/03 Sasebo, Japan

 6/26/03-7/10/03 International waters

 7/11/03-7/14/03 Sasebo, Japan

 7/15/03-8/13/03 International waters

 8/14/03-8/17/03 Sasebo, Japan

 8/18/03-9/11/03 International waters

 9/12/03-11/3/03 Singapore

 11/4/03-11/5/03 International waters

 11/6/03-11/20/03 Singapore

 11/21/03-12/8/03 International waters

 12/9/03-12/12/03 Singapore

Invincible 6/17/04-7/1/04 Jabel Ali, U.A.E.

 7/2/04-7/2/04 Bahrain

 7/3/04-7/14/04 International waters

 7/15/04-7/25/04 Bahrain

 7/26/04-9/4/04 International waters

 9/5/04-9/13/04 Singapore

 9/14/04-9/14/04 International waters

 9/15/04-9/16/04 Singapore

Invincible 10/25/04-10/29/04 Bahrain

 10/30/04-11/3/04 International waters

 11/4/04-11/14/04 Jebel Ali, U.A.E.

11/15/04-12/15/04 International waters

12/16/04-12/21/04 Bahrain

Between September 16 and October 25, 2004, petitioner was on paid

sick leave from Maersk and was recuperating in Singapore, where

the Invincible was docked when petitioner became ill, and at home

in Scotland. During 2002 petitioner worked in international

waters for a total of 88 days and in foreign ports for a total of

117 days. During 2003 petitioner worked in international waters

for a total of 115 days and in foreign ports for a total of 89
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days. During 2004 petitioner worked a total of 90 days in

international waters and in foreign ports for a total of 92 days. 

Petitioner was not employed in the United States at any time

during the years in issue.

Petitioner filed Federal income tax returns for 2002, 2003,

and 2004 and attached to them Forms 2555-EZ, Foreign Earned

Income Exclusion, claiming that all of his income in those years

was foreign earned income excluded from gross income under

section 911 for Federal income tax purposes. On his 2002 return

petitioner reported $20 in taxable interest and $63,641.48 in

gross wages consisting of:

Wage income (Maersk) $42,235.06

Military retirement pay 14,903.64

Vacation pay 6,502.78

 Total 63,641.48

On his 2003 return petitioner reported gross wages of $70,510.66

consisting of:

Wage income (Maersk) $46,295.42

Military retirement pay 15,106.20

Vacation pay 9,078.35

Interest income 30.69

 Total 70,510.66

Petitioner received additional interest income of $31 in 2003

that he failed to report. On his 2004 return petitioner reported

$50 in taxable interest and gross wages of $58,992 consisting of:

Wage income (Maersk) $42,567.40

Military retirement pay 6,365.93

Vacation pay 10,058.67 

 Total 58,992.00
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Petitioner received an additional $9,051 of military retirement

pay in 2004 that he failed to report. Petitioner has conceded

that the interest income and U.S. military retirement pay he

received in the years in issue are not excludable as foreign

earned income.

Petitioner’s earned income for the years in issue consists

of wage income and vacation pay. The amount of petitioner’s

earned income for each of the years in issue is:

Year Total Earned Income

2002 $48,737.84

2003 55,373.77

2004 52,626.07 

OPINION

Income Earned in International Waters

U.S. citizens are generally taxed on their worldwide income

unless a specific exclusion applies. Sec. 61(a) (“gross income

means all income from whatever source derived”); Cook v. Tait,

265 U.S. 47, 56 (1924); Specking v. Commissioner, 117 T.C. 95,

101-102 (2001), affd. sub nom. Umbach v. Commissioner, 357 F.3d

1108 (10th Cir. 2003), affd. sub nom. Haessly v. Commissioner, 68

Fed. Appx. 44 (9th Cir. 2003). 

Section 911(a) provides in relevant part that a qualified

individual may elect to exclude, subject to limitations set forth

in section 911(b)(2), his or her foreign earned income from gross

income. Section 911(b)(1)(A) defines an individual’s “foreign
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earned income” as “the amount received by such individual from

sources within a foreign country or countries which constitute

earned income attributable to services performed by such

individual”. 

“A legislative regulation is made pursuant to a specific

grant of authority, often without precise congressional guidance,

to define a statutory term or prescribe a method of executing a

statutory provision.” Coca-Cola Co., & Includible Subs. v.

Commissioner, 106 T.C. 1, 19 (1996). Legislative regulations are

entitled to Chevron deference and are given controlling weight

unless they are arbitrary, capricious, or manifestly contrary to

the statute. Chevron U.S.A., Inc. v. Natural Res. Def. Council,

Inc., 467 U.S. 837, 843-844 (1984). The regulations promulgated

under the specific delegation of authority by Congress in section

911(d)(9) provide the following definition of a “foreign country”

for purposes of the foreign earned income exclusion under section

911:

(h) Foreign country. The term “foreign country”

when used in a geographical sense includes any

territory under the sovereignty of a government other

than that of the United States. It includes the

territorial waters of the foreign country (determined

in accordance with the laws of the United States), the

air space over the foreign country, and the seabed and

subsoil of those submarine areas which are adjacent to

the territorial waters of the foreign country and over

which the foreign country has exclusive rights, in

accordance with international law, with respect to the

exploration and exploitation of natural resources.

Sec. 1.911-2(h), Income Tax Regs. 
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Petitioner does not challenge the validity of the regulation

defining a “foreign country” for purposes of section 911

primarily as any territory under the sovereignty of a Government

other than that of the United States. Under general principles

of international law, international waters are not under the

sovereignty of any nation. United States v. Louisiana, 394 U.S.

11, 23 (1969). Thus, international waters are not a “foreign

country” for purposes of section 911, and income petitioner

earned while traveling in international waters is not “foreign

earned income” excludable from gross income. See Plaisance v.

United States, 433 F. Supp. 936, 938-939 (E.D. La. 1977). 

Without addressing or challenging the regulatory definition

of “foreign country” under section 1.911-2(h), Income Tax Regs.,

petitioner argues that we should read section 911 in conjunction

with the general sourcing rules under section 863(c) and conclude

that petitioner’s income earned while traveling in international

waters is foreign source income. Section 863(c) provides special

sourcing rules for certain transportation income when that

transportation begins or ends in the United States or one of its

possessions. Because U.S. citizens are subject to tax on their

worldwide income, sourcing rules are generally not relevant to

U.S. citizens. See Great-West Life Assur. Co. v. United States,

230 Ct. Cl. 477, 678 F.2d 180, 183 (1982); sec. 1.1-1(b), Income

Tax Regs. 
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Even if general sourcing rules were applicable in this case

to override the plain meaning of section 911 and the regulations,

section 863(c) would not apply to petitioner’s situation because

his voyages neither began nor ended in the United States or one

of its possessions. Rather, section 863(d) would require

petitioner to include income earned in international waters as

income from “ocean activities” sourced in the United States. See

Arnett v. Commissioner, 473 F.3d 790, 797 (7th Cir. 2007), affg.

126 T.C. 89 (2006). Section 863(d) provides, in relevant part,

as follows:

SEC. 863(d). Source Rules for Space and Certain

Ocean Activities.--

(1) In general.--Except as provided in

regulations, any income derived from a space or

ocean activity--

(A) if derived by a United States

person, shall be sourced in the United States

* * *

* * * * * * *

(2) Space or ocean activity.--For purposes of

paragraph (1)--

(A) In general.--The term “space or

ocean activity” means--

* * * * * * *

(ii) any activity conducted on or

under water not within the jurisdiction

(as recognized by the United States) of

a foreign country, possession of the

United States, or the United States.

* * * * * * *
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(B) Exception for certain activities.--

The term “space or ocean activity” shall not

include--

(i) any activity giving rise to

transportation income (as defined in

section 863(c))

For purposes of the Internal Revenue Code, the definition of

“United States person” includes any citizen of the United States. 

Sec. 7701(a)(30)(A). Although he resides in Scotland, petitioner

is a U.S. citizen. His income earned in international waters is

income from a “space or ocean activity” as defined in section

863(d)(2). Thus, that income is sourced in the United States. 

Sec. 863(d)(1)(A). 

While petitioner may, as the parties have stipulated,

exclude income earned in foreign ports from gross income, his

income earned while working in international waters does not

constitute foreign earned income for purposes of the exclusion

under section 911 and must be included in his gross income for

the years in issue. 

Meal Expense Deductions

Section 162 permits taxpayers to deduct all ordinary and

necessary business expenses paid or incurred during the taxable

year and specifically includes traveling expenses (including

amounts expended for meals and lodging other than amounts that

are lavish or extravagant under the circumstances) while away

from home in the pursuit of a trade or business. Sec. 162(a)(2). 
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Section 274(d) generally disallows any deduction under section

162 for, among other things, “any traveling expense (including

meals and lodging while away from home)” unless the taxpayer

complies with stringent substantiation requirements as to the

amount, time and place, and business purpose of the expense. 

Sec. 274(d)(1). Section 274(d) authorizes the Secretary to

provide by regulations that some or all of these substantiation

requirements “shall not apply in the case of an expense which

does not exceed an amount prescribed pursuant to such

regulations.” 

Under the applicable section 274 regulations, the

Commissioner is authorized to prescribe rules under which

optional methods of computing expenses, including per diem

allowances for ordinary and necessary expenses for traveling away

from home, may be regarded as satisfying the substantiation

requirements of section 274(d). Sec. 1.274-5(j), Income Tax

Regs. Under this authority, the Commissioner issued Rev. Proc.

2001-47, 2001-2 C.B. 332 (applicable to petitioner’s travel

January through September 2002); Rev. Proc. 2002-63, 2002-2 C.B.

691 (applicable to petitioner’s travel October 2002 through

October 2003); Rev. Proc. 2003-80, 2003-2 C.B. 1037 (applicable

to petitioner’s travel November 2003 through September 2004); and

Rev. Proc. 2004-60, 2004-2 C.B. 682 (applicable to petitioner’s

travel October through December 2004) (collectively, the
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applicable revenue procedures). Under the applicable revenue

procedures, taxpayers may elect to use, in lieu of substantiating

actual expenses, certain authorized methods for deemed

substantiation of employee lodging, meal, and incidental expenses

incurred while traveling away from home. Rev. Proc. 2002-63,

sec. 1, 2002-2 C.B. at 691; Rev. Proc. 2003-80, sec. 1, 2003-2

C.B. at 1037; and Rev. Proc. 2004-60, sec. 1, 2004-2 C.B. at 682,

each provide the following introduction:

SECTION 1. PURPOSE

This revenue procedure updates * * * [the previous

revenue procedure relating to per diem allowances] by

providing rules under which the amount of ordinary and

necessary business expenses of an employee for lodging,

meal, and incidental expenses or for meal and

incidental expenses incurred while traveling away from

home will be deemed substantiated under section 1.274-5

of the Income Tax Regulations when a payor (the

employer, its agent, or a third party) provides a per

diem allowance under a reimbursement or other expense

allowance arrangement to pay for the expenses. In

addition, this revenue procedure provides 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. This revenue procedure also provides an optional

method for use in computing the deductible costs of

incidental expenses paid or incurred while traveling

away from home by employees and self-employed

individuals who do not pay or incur meal costs and who

are not reimbursed for the incidental expenses. Use of

a method described in this revenue procedure is not

mandatory, and a taxpayer may use actual allowable

expenses if the taxpayer maintains adequate records or

other sufficient evidence for proper substantiation. 

* * * 
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Rev. Proc. 2001-47, sec. 1, 2001-2 C.B. at 332, is almost

identical to the passage quoted above, but the following sentence

is omitted:

This revenue procedure also provides an optional method

for use in computing the deductible costs of incidental

expenses paid or incurred while traveling away from

home by employees and self-employed individuals who do

not pay or incur meal costs and who are not reimbursed

for the incidental expenses.

Rev. Proc. 2002-63, sec. 4.05, 2002-2 C.B. at 694; Rev.

Proc. 2003-80, sec. 4.05, 2003-2 C.B. at 1040; and Rev. Proc.

2004-60, sec. 4.05, 2004-2 C.B. at 685, expressly provide that

taxpayers who do not pay or incur meal expenses when traveling

away from home may use, in lieu of providing actual receipts to

substantiate incidental expenses, an established per diem rate of

$2 or $3, depending on which revenue procedure is applicable for

the date of travel. Rev. Proc. 2001-47, sec. 4, 2001-2 C.B. at

333-334, which provides specific rules for the per diem

substantiation method, does not contain a similar provision. 

However, we have held previously that the incidental portion of

the per diem rates for meals and incidental expenses (M&IE) may

be used as deemed substantiation of incidental expenses when

meals are provided by a taxpayer’s employer. Johnson v.

Commissioner, 115 T.C. 210, 210-211 (2000). The applicable

revenue procedures provide that the Federal M&IE rate will be

applied, with stated exceptions, in the same manner as applied

under the Federal Travel Regulations, 41 C.F.R. secs. 301-311, in
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effect at the time each respective revenue procedure was

released.

Maersk furnished petitioner with lodging and meals without

charge while he was working on its vessels during the years in

issue. Although petitioner did not pay for his meals while at

sea or while docked in foreign ports, he argues that he is 

entitled to deduct the full M&IE per diem rate for those days for

which he must include income earned in international waters. 

Petitioner asserts that the applicable revenue procedures permit

him to deduct the full applicable M&IE rate for work-related

travel even though all of his meals were provided to him free of

charge by Maersk, but his only argument in support of this

assertion rests on the absence of any explicit requirement in

Internal Revenue Service publications that a taxpayer actually

pay for his meals in order to qualify for the standard meal

allowance deduction.

Petitioner argues further that this issue is novel to the

Court. We disagree. In Johnson v. Commissioner, supra, the

taxpayer, also a merchant seaman, deducted the full Federal M&IE

rates on his return even though all of his meals were provided to

him free of charge by his employer. We held that, because the

taxpayer’s actual expenses consisted solely of incidental

expenses, his use of the M&IE rates to calculate his deductions

for business expenses due to travel away from home was limited to
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the incidental portion of those rates. Id. at 210-211. The

taxpayer established that he had incurred incidental expenses

during his travel away from home and was allowed to use the

incidental portion of the M&IE rates to substantiate those

expenses in lieu of providing actual receipts. 

The purpose of the Federal per diem rates is to ease the

burden of substantiating travel expenses away from home, not to

eliminate the requirement that those expenses be incurred before

they can be claimed as deductions from income. Although

petitioner contends that the Court has not yet addressed this

issue, we explicitly stated in Johnson v. Commissioner, supra at

227: “We 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.” Petitioner is not entitled to deductions for meal

expenses he did not pay or incur. See Balla v. Commissioner,

T.C. Memo. 2008-18. He is, however, as respondent has conceded,

entitled to a miscellaneous itemized deduction for incidental

expenses as permitted in Johnson, and the applicable revenue

procedures for the years in issue, but only with respect to those

days when petitioner was working in international waters and for

which he must include income earned. 
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Accuracy-Related Penalty

Section 6662 imposes a 20-percent accuracy-related penalty

on any underpayment of Federal income tax attributable to a

taxpayer’s negligence or disregard of rules or regulations or

substantial understatement of income tax. Sec. 6662(a) and

(b)(1) and (2). Section 6662(d) defines “substantial

understatement of income tax” as an amount exceeding the greater

of 10 percent of the tax required to be shown on the return or

$5,000. Under section 7491(c), the Commissioner bears the burden

of production with regard to penalties and must come forward with

sufficient evidence indicating that it is appropriate to impose

the penalty. Higbee v. Commissioner, 116 T.C. 438, 446 (2001). 

However, once the Commissioner has met the burden of production,

the burden of proof remains with the taxpayer, including the

burden of proving that the penalty is inappropriate because of

reasonable cause or substantial authority. Id. at 446-447; Rule

142(a).

The accuracy-related penalty under section 6662(a) will not

be imposed with respect to any portion of the underpayment as to

which the taxpayer acted with reasonable cause and in good faith. 

Sec. 6664(c)(1). The decision as to whether a taxpayer acted

with reasonable cause and in good faith is made by taking into

account all of the pertinent facts and circumstances. Sec.

1.6664-4(b)(1), Income Tax Regs. The most important factor is
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the extent of the taxpayer’s effort to assess his proper tax

liability. This factor includes in some circumstances the 

taxpayer’s reasonable and good faith reliance on the advice of a

tax professional. Id.

Respondent’s burden of production has been met. Petitioner

has conceded that he received, but failed to include in gross

income, the following amounts of interest income and U.S.

military retirement pay in the years in issue:

U.S. Military 

Year Interest Income Retirement Pay

2002 $20 $14,904.00

2003 31 15,106.20

2004 50 15,417.00

Petitioner also concedes that he either failed to report that

income on his returns for the years in issue or improperly

excluded it as foreign earned income. 

Because petitioner’s income earned in international waters

is includable in his gross income, petitioner also improperly

excluded from gross income the following amounts, calculated by

multiplying petitioner’s total earned income for each year by the

ratio of days worked in international waters to total days worked

for that year:

 Days Worked in Amount Includable

Year International Waters in Gross Income

2002 88 (205 total days worked) $20,921.60

2003 115 (204 total days worked) 31,215.60 

2004 90 (182 total days worked) 26,023.54
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Petitioner excluded all his income for the years in issue as

foreign source income on his returns, claiming that he had no

Federal tax liability and that he was entitled to refunds of all

taxes withheld during those years. If, for any year in issue,

the amount of gross income that petitioner failed to include as

required results in an understatement of income tax exceeding

$5,000, then petitioner is subject to the accuracy-related

penalty for a “substantial understatement” for that year. Sec.

6662(a) and (b)(2). If, however, the resulting understatement of

income tax does not exceed $5,000 for any of the years in issue,

then petitioner is not liable for the penalty under section

6662(a) unless that understatement is the result of petitioner’s

negligence or disregard of rules and regulations. Sec. 6662(a)

and (b)(1). 

Petitioner argues that he was not negligent in preparing his

returns for the years in issue. Petitioner testified at trial

that he had reviewed several publications on the Internal Revenue

Service’s Web site to assist him in preparing his returns. 

Petitioner’s testimony focused on his prior review of special

rates that transportation workers may use to calculate business

expense deductions, specifically meal expenses. However,

petitioner did not claim any deductions for expenses on his

returns for the years in issue. His testimony on this point

relates to his position at trial and on brief that he is entitled
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to standardized meal expense deductions for meal expenses he

neither paid nor incurred, rather than the position he took on

his returns, in which he claimed that he was liable for no

Federal income tax. Petitioner did not consult a tax

professional before taking this position on his returns.

Petitioner also testified at trial that he read the

instructions to Form 2555-EZ before he completed his returns for

the years in issue. Those instructions state, in relevant part,

that foreign earned income does not include amounts paid by the

U.S. Government. Petitioner improperly and unreasonably excluded

his U.S. military retirement pay from gross income for all years

in issue.

 Petitioner argues that he should not be liable for the

accuracy-related penalties under section 6662 because, in spite

of his failure “to account for some minimal interest and military

retirement pay income” for the years in issue, his returns were

timely and substantially accurate. However, petitioner’s returns

were not substantially accurate. Petitioner haphazardly prepared

his returns for the years in issue, incorrectly characterizing

all of his income as wages and failing to include $9,051 of

retirement pay in 2004. He then excluded all of that income as

foreign earned income, disregarding the instructions that clearly

stated his military retirement pay was ineligible for the

exclusion. 
- 20 -

Petitioner has failed to show that his positions on his

returns for the years in issue were taken with reasonable cause

and in good faith within the meaning of section 6664(c)(1). He

has presented no evidence that he acted in reasonable reliance on

the advice of a tax professional in asserting the positions taken

on his returns. He claims that he read the instructions to Form

2555-EZ before claiming the foreign earned income exclusion of

all of his income for the years in issue; however, those

instructions make clear that U.S. military retirement pay is not

foreign earned income. Petitioner failed to include his military

retirement pay as gross income and instead characterized those

amounts as wage income and excluded them.

Petitioner’s general arguments that his income earned in

international waters is foreign source income excludable under

section 911 from gross income, while extensive, ignore the plain

provisions of section 911 and the legislative regulations. 

Petitioner relies on the general sourcing rules of sections 861

through 865, but those sections do not provide a rule for

sourcing income in petitioner’s particular situation. Petitioner

has not addressed the terms of the statute and the regulations

under section 911 and, in excluding all of his income from gross

income for Federal income tax purposes, has not shown that he

took care to assess properly his tax liability or that he had

reasonable cause in failing to do so. Thus, petitioner is liable
- 21 -

for the accuracy-related penalty under section 6662 for

underpayments attributable to negligence or disregard of rules or

regulations. 

In reaching our decision, we have considered all arguments

made, and, to the extent not mentioned, we conclude that they are

irrelevant, moot, or without merit.

To reflect the foregoing,

Decision will be entered

under Rule 155.