U.S. v. Kapp

• Decision Date: 04 May 2009
• Docket Number: No. 07-56408.,07-56408.
• Citation: 564 F.3d 1103
• Parties: UNITED STATES of America, Plaintiff-Appellee, v. Martin A. KAPP, Defendant-Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

564 F.3d 1103

UNITED STATES of America, Plaintiff-Appellee, v. Martin A. KAPP, Defendant-Appellant.

No. 07-56408.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted December 10, 2008.

Filed May 4, 2009.

Alan F. Broidy, Esq., Law Offices of Alan F. Broidy, APC, Los Angeles, CA, for the defendant-appellant.

Richard T. Morrison, Deputy Assistant Attorney General, Gilbert S. Rothenberg, Jonathan S. Cohen and Gretchen M. Wolfinger,

Attorneys, Tax Division, U.S. Department of Justice, Washington, DC, for the plaintiff-appellee.

Appeal from the United States District Court for the Central District of California, George P. Schiavelli, District Judge, Presiding. D.C. No. CV-06-02136-GPS.

Before: JEROME FARRIS and KIM McLANE WARDLAW, Circuit Judges, and WILLIAM W. SCHWARZER, District Judge.^*

SCHWARZER, District Judge:

Martin A. Kapp appeals the district court's entry of a permanent injunction preventing him from preparing or assisting in preparing federal tax returns that assert the position that mariners are entitled to an unreimbursed deduction for meal expenses while working on board a ship, when no meal expenses are actually incurred (the "mariner's tax deduction"). He also appeals the grant of summary judgment for the government and the denial of his cross motion for summary judgment. We have jurisdiction of this timely appeal under 28 U.S.C. § 1291, and affirm the judgment of the district court.

I. Facts and Procedural History

Kapp is a Certified Public Accountant who specializes in preparing federal income tax returns for individuals employed in the transportation industry. This case relates to his preparation of federal tax returns for mariners who work on oceangoing ships and who are at sea for long periods without returning to port ("deep sea mariners"), and mariners who work on tug boats and barges ("tug and barge mariners"), which return to port more frequently. Deep sea mariners are provided meals by their employer while working on board the ship. Tug and barge mariners also typically do not incur meal related expenses.

Between approximately January 1997 and February 2006 Kapp prepared tax returns for mariners who lived on vessels in the course of their employment that claimed the mariner's tax deduction. Two of these returns were for Marin Johnson and Jim Westling, who were employed as deep sea mariners during the tax year in question. Both individuals were provided meals at no cost, but claimed a deduction based on the number of days at sea multiplied by the full meals and incidental expenses ("M & IE") rate.

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 WL 1310661 (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

On May 2, 2005 Perez wrote a letter to Campos detailing Kapp's position on deductions for tug and barge mariners. He followed with a second letter on July 27, 2005 which stated that "although Mr. Kapp does not necessarily agree with the position you articulated for the first time in our meeting last month ... he has agreed to cease claiming meal deductions as he has done previously." Campos did not respond to the letters. After completing his investigation, Campos prepared a final report concluding that "Mr. Kapp is instrumental in preparing erroneous returns and incorrectly interpreting the Internal Revenue Code." The government filed a complaint in April 2006 seeking an injunction that would prevent Kapp from claiming deductions for meals that are provided to an employee without cost.

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.

Both parties moved for summary judgment in February 2007. Kapp asserted that he was entitled to summary judgment because his position regarding the deemed substantiated deductions for mariners was legally correct and taken in good faith. The government argued that an injunction was proper because Kapp continued to claim the mariner's tax deduction even though he knew the deduction was improper. In August 2007 the district court granted summary judgment for the government and permanently enjoined Kapp from preparing tax returns that claim a deduction for meals that are provided to mariners without cost. The injunction also required that Kapp provide a list of clients for whom he prepared returns claiming these deductions, post a link to the court's order on his websites, and explain to his clients that the court determined that he had incorrectly advised them about the mariner's tax deduction.

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.

II. Statutory Overview

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).

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 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.

Additionally, the Federal Travel Regulations provide that the M & IE rate must be adjusted for a meal furnished to the taxpayer (except as provided in § 301-11.17) by deducting the appropriate amount. 41 C.F.R. § 301-11.18. However, "[a] meal provided by a common carrier or a complimentary meal provided by a hotel/motel does not affect your per diem." 41 C.F.R. §...