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CPA Penalized for Aiding and Abetting Tax Understatements on More Than 5,000 Tax Returns

(Parker Tax Publishing July 2019)

The Tax Court held that a CPA was liable for tax return penalties under Code Sec. 6701 as a result of aiding and abetting the underpayment of tax on 5,167 tax returns and/or schedules that the CPA prepared for tax years 2002 through 2006. According to the court, the IRS satisfied its burden of proving that the CPA prepared tax returns for the years at issue with knowledge that the returns and/or schedules prepared would result in understatements of tax. Kapp v. Comm'r, T.C. Memo. 2019-84.


Martin Kapp is a CPA who prepared thousands of tax returns and/or schedules for mariner taxpayers for the tax years 2000 through 2006. The tax returns and schedules consistently claimed expense deductions for meals and incidental expenses using annual per diem revenue procedures permitting taxpayers to deduct the cost of meals and incidental (M&IE) expenses paid or incurred without the need to substantiate the amount. It was standard operating practice of marine companies (i.e., deep sea, tugboat, offshore, offshore oil rig, and marine ferry) to provide meals at no cost to mariners.

Some of Kapp's mariner clients were involved in litigation in the Tax Court relating to the deductibility of meals and incidental expenses. In Johnson v. Comm'r, 115 T.C. 210 (2000) and Westling v. Comm'r, T.C. Memo. 2000-289, the Tax Court held that mariner taxpayers were entitled to deduct incidental expenses incurred while at sea. However, the Tax Court did not hold that they were entitled to deductions for meals, the cost of which they did not incur. The court held that the mariner taxpayers' use of the M&IE expense rates was limited to the portions thereof that were attributable to incidental expenses.

Kapp claimed a full victory in the Johnson and Westling cases and indicated in websites and advertisements that mariners could use the per diem revenue procedures to deduct the cost of meals even if furnished by the employer. Kapp and his employees continued to prepare returns and schedules claiming such deductions.

Beginning in November 2003 and into 2004, the IRS investigated Kapp's return preparation practices. There was a series of meetings between Kapp and his counsel and IRS representatives. Kapp was advised in writing in the spring of 2005 by his counsel that there was little if any authority which would permit a mariner taxpayer to use the per diem revenue procedures to deduct the cost of meals furnished by the employer. Despite this advice, Kapp continued to prepare returns and schedules claiming such deductions and continued to assert in public domains that mariner taxpayers could qualify for a meal deduction in such circumstances.

The United States filed a complaint in April 2006 seeking an injunction to restrain and enjoin Kapp from preparing federal income tax returns based on the mariner tax deduction. In August 2007, a district court granted the government's motion for summary judgment, holding that Kapp be permanently enjoined pursuant to Code Sec. 7407 and that the so-called mariner tax deduction was illegal and in violation of Code Sec. 6694. The order related to the period January 1, 2000, through August 20, 2007. In compliance with the order of the district court to provide a list of persons or entities for whom he prepared returns (or portions of a return) asserting or claiming the position that mariners may claim a tax deduction for meals provided without cost, Kapp filed a 117-page client list naming more than 5,000 taxpayers. Kapp appealed the entry of permanent injunction, and the Ninth Circuit, in U.S. v. Kapp, 564 F.3d 1103 (9th Cir. 2009), affirmed the decision of the district court. After the permanent injunction, the Tax Court issued two additional opinions relating to Kapps's mariner clients - Zbylut v. Comm'r, T.C. Memo. 2008-44; Balla v. Comm'r, T.C. Memo. 2008-18 - again making clear that the Johnson decision addressed the issue that a mariner taxpayer cannot deduct the cost of meals furnished by the employer.

In June 2008, the IRS assessed Code Sec. 6701 penalties based on 5,193 tax returns and/or schedules prepared by Kapp for the period 2000 through 2006. The IRS issued lien and levy notices, and Kapp submitted a written request for a CDP hearing. At the CDP hearing, Kapp challenged the penalties. After notices of determination were issued, Kapp filed a timely petition with the Tax Court challenging the penalties. The Tax Court dismissed as to tax years 2000 and 2001 for lack of jurisdiction. Therefore, the penalties at issue before the Tax Court were the penalties based on 5,167 tax returns and/or schedules that Kapp prepared for tax years 2002 through 2006.

Code Sec. 6701(a) provides that any person -

(1) who aids or assists in, procures, or advises with respect to, the preparation or presentation of any portion of a return, affidavit, claim, or other document,

(2) who knows (or has reason to believe) that such portion will be used in connection with any material matter arising under the internal revenue laws, and

(3) who knows that such portion (if so used) would result in an understatement of the liability for tax of another person,

must pay a penalty with respect to each such document in the amount determined under Code Sec. 6701(b).

Code Sec. 6701(b) provides that the amount of the penalty imposed by Code Sec. 6701(a) is $1,000.

Tax Court's Decision

The Tax Court held that there was clear and convincing evidence that Kapp met all three elements under Code Sec. 6701 and was liable for the penalties under that provision. With respect to the first two elements, the court observed that Kapp is a licensed CPA who prepared and/or assisted in the preparation of tax returns for mariner clients. The court also noted that (1) the record reflected that Kapp repeatedly gave advice to his clients regarding deductions for meals which were provided without cost to them; (2) Kapp prepared tax returns and/or schedules claiming such deductions for hundreds of taxpayers during the years at issue; (3) Kapp was very public in the advertisement and promotion of his tax preparation services; (4) Kapp expressed the clear view that mariners could properly claim deductions for meals irrespective of whether they expended any of their own funds for the meals; and (5) Kapp prepared the tax returns or portions of tax returns (the mariner schedules) fully knowing and for the express purpose of their submission to the IRS. There was no serious doubt, in the court's mind, that the submissions of the mariner tax returns were intended to be used in connection with a material matter arising under the internal revenue laws. The court thus concluded that the first two elements of Code Sec. 6701(a) were satisfied.

With respect to the third element of Code Sec. 6701(a) - that the person know that the "portion of a return" (if used) would result in an understatement of tax - the court observed that this requirement has two integral parts:

(1) the knowledge requirement; and

(2) the understatement requirement.

The clear direction in Code Sec. 6701(a)(3), the court said, requires a finding that the person preparing or presenting the portion of the return have knowledge that the document (if used) would result in an understatement of tax. The court noted that Kapp was the tax return preparer of the returns involved in the Johnson and Westling cases and that both cases held that the taxpayer in each case could deduct the incidental expense portion of the M&IE per diem rates, but did not hold that the taxpayer could use the M&IE per diem rates to deduct meal expenses he did not incur and that were, in fact, provided to him by his employer. And the court noted, those decisions were decided two years before the first tax year at issue in the instant case. While it was unclear to the court as to the extent of Kapp's involvement in the Johnson and Westling litigation, Kapp testified to his direct involvement and that highlighted for the court the inconsistency of his statements, advertisements, and promotions, suggesting that he had "won twice in Tax Court." Given Kapp's assertion of his involvement in the litigation of those two cases, the court said there was no doubt that he clearly knew how the Tax Court decided the issues relating to claimed deductions of mariner expenses.

For a discussion of the practitioner penalty under Code Sec. 6701, see Parker Tax ¶262,175.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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