Opinion ID: 3064659
Heading Depth: 2
Heading Rank: 4

Heading: Entry of the Injunction

Text: [4] The district court enjoined Kapp from preparing tax returns claiming the mariner’s tax deduction under I.R.C. § 7407. An injunction is proper under § 7407 if the court finds that the tax preparer has engaged in conduct subject to penalty under § 6694, and an injunction is appropriate to prevent recurrence of the violation. Section 6694 provides that a tax return preparer is subject to penalty if he prepares a return with understated liability due to an unreasonable position not supported by substantial authority. I.R.C. § 6694. [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 United States v. Estate Pres. Servs., 202 F.3d 1093, 1102 (9th Cir. 2000). Thus, the district court properly enjoined Kapp if (1) he prepared a return that understated liability, (2) due to an unreasonable position, i.e., a position that objectively had a UNITED STATES v. KAPP 5147 less than one in three chance of being sustained on the merits, and (3) an injunction is appropriate to prevent recurrence.
liability. Kapp argues that mariners do not have to pay or incur meal expenses in order to claim a deduction under the regulations that allow certain expenses to be deemed substantiated without documentation. He notes that meals provided by common carriers are not required to be subtracted from the allowed per diem deduction amount, and that ships are included within the definition of common carriers. C.F.R. § 301-11.17, -10.100. Therefore, he reasons that mariners who are provided meals while on board a ship should be allowed to claim the full M&IE allowance for days at sea, even though no meal expense is incurred. Kapp also creates several complicated hypothetical examples to support his argument that under the § 274 regulations, certain travelers could claim a deduction for deemed substantiated expenses when no actual costs are incurred. [6] Kapp’s argument is based on a misunderstanding of the regulations that create the deemed substantiated exception. He essentially argues that Executive Branch agency regulations can be manipulated to subvert provisions of the I.R.C. enacted by Congress. The regulations are intended to interpret and assist in the enforcement of the I.R.C., not to undermine it. 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 5 Kapp 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 5148 UNITED STATES v. KAPP [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 selfemployed 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
[8] Therefore, a meal provided by a common carrier need not be deducted from the per diem M&IE rate under 41 C.F.R. § 301-11.17, but a taxpayer cannot take the per diem deduction if he does not incur any meal related expenses. Rev. Proc. 90-60, §1, 1990-2 C.B. 651. Additionally, Kapp’s examples of individuals who may attempt to manipulate the regulations to claim impermissible deductions when they do not incur expenses does not alter the requirement in § 162 that expenses must be paid or incurred in order to be deducted. Because Kapp claimed deductions on behalf of mariners who did not pay or incur meal expenses, he prepared returns that understated liability. C. Kapp’s position was unreasonable. Kapp argues that even if he incorrectly claimed the mariner’s tax deduction for taxpayers who incurred no meal costs, his position was not unreasonable and was supported by subdiem 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. UNITED STATES v. KAPP 5149 stantial authority. The analysis of the reasonableness of his position differs slightly for deep sea and tug and barge mariners, and we discuss each group separately.
[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. Kapp claims that he recently resumed the practice of taking a deduction on behalf of his deep sea mariner clients based on alleged approval of the position by Campos. In his declaration submitted in opposition to the government’s summary judgment motion Kapp stated that: I had a long meeting with IRS Agent George Cam- pos on August 12, 2005, during which I reviewed my legal position with him in detail . . . . At the end of the meeting, Mr. Campos sort of threw his arm around me and stated ‘Now I understand.’ Since Mr. Campos at no time during or after the . . . meeting stated that he disagreed with my position, or that my position was frivolous, I interpreted Mr. Campos’[s] statement as an endorsement of my legal position . . . [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 5150 UNITED STATES v. KAPP behalf of deep sea mariners, especially in light of the Johnson ruling. Because a well-informed analysis of the issue by a person knowledgeable 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. [12] A memorandum prepared by an associate of Kapp’s lawyer Perez concluded there was little support for Kapp’s position that tug and barge mariners could deduct meal expenses when no cost was incurred. Although Kapp claims that he asked Perez to play “devil’s advocate” and draft a memorandum that laid out the arguments in opposition to his position, the memorandum presents an even-handed examination of the issues and states that “little if any authority relied on by Mr. Kapp supports the position that he takes.” After thoroughly analyzing a host of Tax Court cases and IRS publications, the memorandum concludes that although the “analysis does not foreclose the possibility that Mr. Kapp could ultimately be successful on the issue . . . . it appears to me that the weight of authority favors the Government on this issue.” Shortly after the date of this memorandum, Perez wrote a letUNITED STATES v. KAPP 5151 ter to Campos stating that although Kapp did not agree with the position taken by the IRS, he agreed to stop claiming the deduction. [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. [14] Although there was no precedent at the time Kapp prepared the returns that specifically stated tug and barge mariners may not claim the mariner’s tax deduction, a wellinformed analysis by a person knowledgeable in tax law would have led to the conclusion that Kapp’s position had less than a one in three chance of being sustained on the merits. Therefore, his position was unreasonable and not supported by substantial authority. 6 Kapp 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. 5152 UNITED STATES v. KAPP
recurrence. 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. [15] Kapp acknowledged that although he stopped claiming the mariner’s tax deduction for deep sea mariners after the Johnson case, he later began claiming it based on a purported endorsement of his position by Campos, and because he needed negotiating room with the IRS. Kapp’s weak justification for claiming the deduction in light of clear precedent to the contrary supports the issuance of an injunction as to deep sea mariners. [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.
[17] A tax preparer who prepares a return that understates liability due to an unreasonable position may still avoid a penalty under § 6694 if he can show that there is reasonable cause for the understatement and he acted in good faith. I.R.C. § 6694(a)(2)(B), (a)(3). The associated § 6694 regulations list five factors to consider in evaluating whether the tax preparer can assert the good faith defense: (1) the nature of the error, UNITED STATES v. KAPP 5153 (2) the frequency of the errors, (3) the materiality of the errors, (4) the preparer’s normal office practice, and (5) reliance on advice of another preparer. Treas. Reg. § 1.6694 2(d). The taxpayer bears the burden of establishing a good faith defense. I.R.C. § 6694(a)(3); Treas. Reg. § 1.6694-2(e)(2). 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’s tax 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. [18] Although Kapp made efforts to seek comment on and support for his position, his efforts do not allow him to claim the good faith defense. The government employees contacted by Kapp do not qualify as preparers under the regulations, and he was not entitled to rely on their advice. See Treas. Reg. § 301.7701-15(a); 301.7701-15(a)(6) (defining a “preparer” as a person who prepares returns for compensation and specifically excluding IRS employees performing official duties). Even if the government employees qualified as preparers under the regulations, Kapp is not entitled to rely on their advice unless he can demonstrate that they were aware of all the relevant facts. Treas. Reg. § 1.6694-2(d)(5)(ii). The correspondence between the GSA employee and Kapp does not 5154 UNITED STATES v. KAPP demonstrate that the GSA employee was aware that the taxpayers in question do not pay or incur any meal expenses. Additionally, the IRS attorneys contacted by Kapp informed him that they could not officially comment on his articles, and that there was no procedure to set up a meeting to provide advice specific to his situation. [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. [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”). Therefore, Kapp is not entitled to assert a good faith defense for his violations of § 6694, and the district court did not err in entering the injunction against him under § 7407.