Kappsized or Scuttled?! Sailor Tax Returns In Troubled Waters.

Kappsized or Scuttled?!

By James MacGuire

 

My phones have been ringing constantly regarding the amended returns and letters sent to former clients of Mr. Martin A Kapp.

Here are the top questions –

  • Was Kapp required to prepare these amended returns by the court order? NO
  • Did Kapp furnish a copy of these amended returns to anyone other than the taxpayer? I do not know. He was not required to, but I have not been able to receive a definite answer.
  • Do I HAVE to file these amended returns? NO
  • Has the IRS made any public statements as to whether they will not assess interest and penalties even if I voluntarily file the amended return and pay the amount due? NO they have not
  • When can I be audited until? Tax year 2004 April 15th or the applicable extension deadline (if you filed an extension)of 2008,Tax Year 2005 April 15th or the applicable extension deadline of 2009, Tax Year 2006 April 15th or the applicable extension deadline of 2010

Have things been made better by recent events? Was your profession considered a contender for the IRS’ dirty dozen tax schemes 15 years ago? Was your accountant sending out amended returns for you to consider filing because of his issues with the Internal Revenue Service, a United States attorney, and a United States District Court Judge? Do you still believe that there is a better good to be served? That the United States of America has formed a huge conspiracy to prevent mariners from taking deductions that were won by several tax court cases? Even though it seems only one accountant interprets the cases this way? That there is only one accountant out there who is looking out for mariners’ best interests? His own former attorney wrote, “even if we are able to convince the IRS that ‘meals’ were not provided, the mariners did not incur their own meal expenses and thus a deduction at per diem rate would not be appropriate”. I goggled “maritime tax” five minutes ago and the first result was an indictment notice by the Department of Justice. Now we’re looking at thousands of mariners who are affected by this. This suggests that thousands of mariners cheated on their taxes. What statement does this make? How do you think this sits with the IRS?
Reading between the lines –

Citing an unsigned form letter sent from (Martin A. Kapp C.P.A., E.A. An Accounting Corporation.)

Prior to the Johnson and Westling decisions, no other accountant had ever sought Tax Court guidance:

  1. In 85 years on travel deductions for merchant sailors while out to sea
  2. On reliance upon IRS Notice 95-50 which stated no receipts are required for incurred travel expenses under $75 per incident

Why is this? How come in 85 years no accountant or attorney stood up for mariners’ rights? Goodness, we’ve only had the Internal Revenue Code for 68 years. Perhaps the reality is that things were better before someone stirred the pot.

My clients know that I am happy to explain ALL of the advantages and pitfalls associated with certain tax positions. To do this, you need to have a basic “big picture” understanding of how this system operates in practice.

Time to put things in perspective –

Here’s your hypothetical. You’re the chief engineer onboard a T-6 tanker that runs jet fuel from Texas City, Texas to Haifa, Israel. While sailing back from Israel through the Med, and upon performing a steering gear check before entering Gibraltar, one of the steering gear motors has failed. You notify the bridge, the Captain calls the company, and the port engineer notifies you that a new motor is on a plane as he speaks. You sit on the hook waiting for the new motor and it arrives on a launch 21 hours later.

The new motor is installed and the vessel has an uneventful trip back to Texas. Upon reaching port, the Officer in Charge of Marine Inspection (OCMI) from the Coast Guard comes on board to inspect the motor installation. Upon inspecting the motor, the OCMI has you execute a change over (going from motor 1 to motor 2) while the steering gear is operating. When the motors are changed over, there is excessive noise and subsequent vibrations indicating a possible problem with the crossover valves. The OCMI tells you he’s going to issue an 835 (deficiency) with a compliance date set forth in the following month.
Sounds pretty simple, right? OCMI notes a deficiency, gives some leeway understanding that the vessel is struggling to meet demand and make money. Now here’s the twist. The Chief Engineer decides to take it upon himself to disagree with the OCMI’s assessment, and inform him that he is incorrect because the CFR’s are vague on this matter. The Chief Engineer informs the OCMI that he will not comply with his instructions and will be appealing this matter to the senior OCMI. The Chief Engineer asserts that when he was in the Coast Guard, their vessels were not required to meet this requirement and therefore this applies to their vessel as well. Phones start ringing after the OCMI informs his commanding officer of the event.
Result-
What would happen in the prior scenario? My first guess would be that when the captain or company was informed of his statements the Chief Engineer would be on a fast train back to his port of engagement. Hopefully he lives in a state with good unemployment rates J This is common sense for us as we have dealt with the Coast Guard. In my experience, the inspectors would always try to work with the company to reach an “equivalent level of safety” and verify that proper steps are being taken. It’s within their power to do more (pull the certificate of inspection for review as an example) but they aren’t out to “get us”. They are in the business of enforcing safety, but they’re going to give you the benefit of the doubt if you work with them.

Collateral Damage –

There are other issues raised. If your company is known to defy Coast Guard instructions, how much leniency are you going to receive on subsequent vessel inspections? Once you’ve made a name for yourself, it’s a difficult bell to un-ring. We’ve all sailed with people who made those “big mistakes” that they have spent the rest of their careers living down. Additionally, the Chief Engineer never thought of what would be involved with addressing the issue and moving on. It was probably a relatively inexpensive repair that could have been taken care of before they left port. THIS SIMPLY SHOULD NOT HAPPEN. Accept the assessment and move on.

The Process –

The IRS isn’t in the business of enforcing safety. Their tasks as an executive agent of the government are to enforce the Internal Revenue Code, process taxpayer information, assess deficiencies, collect back taxes etc… Like the Coast Guard, agents are given discretion in determining types of deficiencies and methods of collection.

The IRS examines a return, and if it believes there is a discrepancy, it will probably audit. Audits can be administered in the form of a correspondence type (they send you a letter and you respond), office type (you have to bring all your receipts into one of their offices), or field audit (they come to your home or place of business). It is within the scope of power of the IRS to bypass audits, and immediately assess (freeze assets, tell you of your right to petition the tax court, etc…). It is not common however. Usually there is a reason to bypass – drug dealer might move all their money to another country, etc… The IRS will try to work with you, and if you don’t like the way things turned out, you can usually appeal. Agents at the appeals level have a lot more leeway in settling issues. They don’t want you going to court. It’s expensive for both parties, and the tax courts (and most all courts for that matter) are flooded with petitions already. Even if you went through an audit, and an appeal, they still have ways to settle disagreements. Virtually every issue is resolved by the time it reaches the appeals level.

How do you determine if you are right or wrong with a position? We have a type of hybrid legal system that applies to the IRS as well. Our tax positions are derived from both statutes and common law precedent. Statutes are laws written by the legislature. The Internal Revenue Code is comprised of statutes. Each of these laws were written by the legislature, passed by the house and the senate, and signed into law by the president (unless they overturned a veto). We are all bound to these statutes at varying degrees, IRS and judges included.

Our common law system on the other hand evolves within the courts. A judge hears a case and makes a ruling based on the applicable law. These decisions set precedents that future cases in other courts may be bound to. Of course different decisions are weighed differently by the courts. A U.S. Supreme Court decision holds ultimate authority as opposed to a District Court decision (trial court level) which will not hold much authority, if any. It’s a chain of command, and once a decision is rendered, it molds and shapes the law in a new way. This is how our legal system evolves. The legislature needs time to put a bill into law, but the courts can rule on a legal issue in a timelier manner.
Sometimes, the legislature delegates the power to determine how a particular statute will be interpreted and enforced to another agency (such as the IRS). With the IRS, the legislature will leave decisions to them that they feel the IRS is better equipped to handle. The IRS is given certain powers and is tasked with executing the legislative intent. The IRS can also take positions on matters that have not been addressed by the courts or the legislature. From all of this comes a multitude of sources of information such as treasury regulations, revenue rulings, IRS publications, IRS rulings etc… In short, all of these facets are taken into consideration when forming a tax position.
Result –
Why am I explaining this? To answer the question I originally imposed, “How come in 85 years no accountant or attorney stood up for mariners’ rights?” THEY KNEW TO LEAVE WELL ENOUGH ALONE. BEFORE THESE COURT DECISIONS, MARINERS HAD A REASONABLE EXPECTATION OF SUCCESS IF THEY WERE AUDITED FOR DEDUCTING MEALS AND INCIDENTAL EXPENSES. What does that mean? It means that the Department of Justice could not have prosecuted Mr. Kapp on the same grounds that they just did. The DOJ used Johnson and Westling (his self proclaimed victories) AGAINST him.
The instant the plaintiffs in Johnson and Westling LOST their cases, the system evolved. The Courts made a statement of law which fine tuned issues unaddressed previously by other courts or the legislature. MARINERS NO LONGER HAD A REASONABLE EXPECTATION OF SUCCESS IF THEY WERE AUDITED FOR DEDUCTING MEALS. The tax court refused meal deductions as the Mariners received free meals while onboard ship. Without this reasonable expectation of success, you cannot take that position. If audited before the decision, an appeals agent would most likely have tried to meet you half way. After the decision, you no longer could contend that you were entitled to the full deduction, only the miniscule incidental portion.
Ex: Before the decisions you’re working on a coastal tanker 200 days annually. You could justify (with proper documentation) a SMIE deduction of $7,600. After the decision, you can justify a SMIE deduction of $600. If the first was audited, at the appeals level, you could probably reach an agreement somewhere in the middle. Isn’t half of $7,600 better than $600? And this all goes back to my initial example: in practice things aren’t as cut and dry as in the books.

Collateral Damage –

Remember the Chief Engineer earlier? How do you think the IRS would act if you refused to mediate things and dragged them into the U.S. Tax Court? Cost them time and money. And to keep doing it, cases such as Johnson, Westling, Jewett, Livermore, (all losses). The courts firmly stating that mariners who receive meals onboard ship are NOT entitled to the Meals portion of the SMIE. And then the preparer still takes these meal deductions on clients’ returns. And the CLIENTS did not know the preparer was doing this. What might you do as the IRS? Gee, I don’t know. Perhaps get the Department of Justice to indict the preparer? Go figure…
Conclusions –

My clients and friends say the same thing over and over “I just don’t want to pay more than I have to, AND I don’t want to have any problems with the IRS”. So now what? You pick up and move on. Don’t forget though. There will always be scams and cons that seem too good to be true. Taxes are no exception. If you would like an idea how deep the rabbit hole goes, go to www.pbs.org/wgbh/pages/frontline/shows/tax/view/ and watch “Tax Me If You Can”. Bogus tax scams are everywhere, even in the biggest, most respected accounting firms in the country.

So how do you stay safe? Your first indication of an issue is when one professional takes a position and asserts that they are the only person who knows the secret way to execute it properly. It’s all public information. I have given the “sailor tax” dilemma as a research problem to students in some of my entry level tax classes at Northeastern University. They all came up with the same conclusion, “mariners who receive meals onboard ship may deduct ONLY the incidental expense portion of the SMIE as per the decisions rendered in Johnson and Westling”.
There’s nothing wrong with a firm who specializes in your particular trade (mine does). I encourage clients to question. Ask a second opinion. SMIE deductions are great, but let’s not forget that it is only one part of big picture planning. There are plenty of legal sheltering venues available at your disposal. Form a constructive tax plan that meets your current and future goals.

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This article was written for gCaptain.com by James MacGuire, MaguireTaxes.com