Deducting Something You Did Not Pay For

What caught my eye was the amount of penalties at issue:

     Year                       Amount

     2002                       $  100,000

     2003                       $  105,000

     2004                       $1,822,000

     2005                       $1,785,000

     2006                       $1,355,000

The penalties total over $5.1 million. I had to look this case over, even though it weighs in at 123 pages.

It involves Martin Knapp, a CPA. He got his license in 1983.

He had worked at the IRS. He also taught accounting and taxation at Pepperdine and Los Angeles City College.

Not a bad resume, methinks.

He did something I never did: he specialized his practice. He focused on transportation workers, including airline pilots and railroad workers. He especially focused on mariners.

As of 2004 he employed 10 people.

Sounds successful to me.

He began his mariner practice around 1993. Two of his clients wound up in Tax Court, and it is there that our story begins.

The first client was Mr. Johnson, a deep-sea mariner. He would routinely work for four months and then take a two-month vacation.

The second was Mr. Westling, a tugboat captain in and around Alaska. He would work 30-day shifts on the tugboat.

Knapp amended Johnson’s return and prepared Mr. Westling’s return for 1996. He claimed a per diem for every day they were on the boat.

So what, right?

Here is the what: The per diem included a meal allowance, and their employers provided the meals.

I do not get it. How can someone get a deduction if that someone did not incur an expense in the first place?

The IRS flagged the returns, and both went to Tax Court.

Since they presented the same issue, the cases were consolidated.

In September, 2000 the Tax Court decided that neither could deduct meal expenses but they could deduct incidental expenses.

COMMENT: The incidental portion of a per diem is for tips and miscellaneous stuff, such as mouthwash. It is only a few bucks per day and nowhere near the amount allowed for meals. In short, there was a (very) minor victory and a very large defeat.

Mr Kapp did not represent in the Tax Court case, but he did read the decisions. He contacted the attorney who represented the IRS to request a face-to-face meeting. The attorney could not do this, as Kapp was an “interested” party. I could (hypothetically) have met with the attorney (as I had nothing to do with either Johnson or Westling), but Kapp was the CPA and therefore very much an interested party.

Kapp doubled down. He kept advising his clients that they could deduct meals even if meals were provided by their employer.

He tripled down. He created websites promoting his services to mariners and asserting that he could obtain tax refunds for them.

He quadrupled down. He wrote articles for Professional Mariner and The National Public Accountant. Here is an example:

The exciting news for mariners is that two U.S. Tax Court decisions last year settled the legal issue of allowing mariners to claim an almost unlimited amount of travel deductions while working away from home, without ever having to show the IRS any receipts, just like other transportation workers.”

Enter Examining Officer Tiffany Smith, who informed Kapp that he was the target of an IRS investigation for tax shelter promotion.

He sent her a 9-page letter detailing the relevant authority for the mariner deduction and arguing that the IRS does not oppose his position.

Does not oppose…?

Kapp wrote a letter he titled “Why is IRS Harassing Me for Twice Winning in U.S. Tax Court?”

This is going south ….

The investigation was transferred to George Campos, a revenue agent investigating tax promoters and abusive tax return preparers.

There is back and forth with Kapp and his attorney. In August, 2005 Campos and Kapp meet. Campos points out that there is no deduction for something one has not paid. Kapp asserts that “it does not matter if *** receive a meal or not, they’re still entitled to a deduction.”

Campos prepared an injunction.

Kapp’s attorney started to worry. He had an associate research the issue of mariners and meal deductions and memo the same. The result was pretty much the same as the IRS position, which was a bad place to be when you represent Kapp.

In early 2006 the Department of Justice sent Kapp a letter informing him that it was considering filing a lawsuit and providing him an opportunity to call and discuss the matter.

For all that is holy, Kapp, please STOP ….

At this point we are on page 55 of a 123-page court decision, and I am going to end it.

The IRS wanted him to stop. If he stops, he may yet walk away with all limbs still attached. Continue this quixotic quest, however, and he might lose it all.

The Court decided he was wrong and hardheaded. Not being without compassion, however, the Court reduced the penalties to $3,218,000.

There goes a lifetime of savings.

Oh, why, Kapp, why?

UberEats and Employer-Provided Lunches

It is 50 pages long. This is not the time of year for me to read this in detail.

I am referring to an IRS Technical Advice Memorandum. A TAM means that a taxpayer is under examination and the revenue agent has a question. The TAM answers the question.

This one has to do with excluding meals as income to employees when the meals are for the “convenience of the employer.”

I guess I long ago selected the wrong profession for this to be an issue. The instances have been few over the years where an employer has regularly brought in dinner during busy season. I had one employer who would do so on Tuesdays and Thursdays, but the offset was working until 9 p.m. or later. As I recall, one virtually needed a papal decree to deviate from their policies, and they had policies like the Colonel has chicken. At this age and stage, I would not even consider working for them, but at the time I was young and dumb.

The classic “convenience of the employer” example is a fireman: you have to be around in case of emergencies. There are other common reasons:

·      To protect employees due to unsafe conditions surrounding the taxpayer’s business premises;

·      Because employees cannot secure a meal within a reasonable meal period;

·      Because the demands of the employees' job functions allow them to take only a short meal break.

What has exacerbated the issue is not your job or mine, but the Googles and Microsofts of the world. For example, Google’s headquarter in Mountain View, California has over 15 cafeterias. Not to be overshadowed, Microsoft in Redmond, Washington has over two dozen. Why would one even bother to go to a grocery store?

Not my world. Not my reality.

The “reasonable meal period” has generally meant that there are limited dining options nearby. I have a family member who works at a nuclear facility. I do not know, but I would expect options thin-out the closer you get to said facility. That reasonable meal period is likely legit in his case.

The TAM is presented in question and answer form. Here is one of the answers:

While the availability of meal delivery is not determinative in every analysis concerning …, especially in situations where delivery options are limited, meal delivery should be a consideration in determining whether an employer qualifies under this regulation and generally when evaluating other business reasons proffered by employers as support for providing meals for the “convenience of the employer” under section 119.

So the IRS is working to incorporate the rising popularity of GrubHub and UberEats into the taxation of employer-provided meals. Wow, if you practice long enough…

I am not too worried about it, other than prompting a chuckle. Why? Because here at CTG command-center we do not provide the occasional lunch because of limited dining opportunities. Rather we bring-in lunch because of in-house training (as an example), and we want everyone there.

Think about it: we give you a sandwich and you get to hear me talk about taxes and watching paint dry.

I suspect you would rather just buy your own lunch.

Silicon Valley Cafeterias And Tax-Free Meals

I have a friend who lives and works on the north side of Cincinnati (or as we south-of-the-river-residents call it: “Ohio”). He works for significant company, and one of the perks is a company cafeteria. The cafeteria provides breakfast, should one choose, and of course it provides lunch. Free.

I admit I am a bit envious.

In this day and age when just about everything is taxed – at least once – you may wonder how this can happen. It has to do with Code Section 119:

(a) Meals and lodging furnished to employee, his spouse, and his dependents, pursuant to employment

There shall be excluded from gross income of an employee the value of any meals or lodging furnished to him, his spouse, or any of his dependents by or on behalf of his employer for the convenience of the employer, but only if—

(1)     in the case of meals, the meals are furnished on the business premises of the employer

                                                                     

How did this provision come to be?

It officially entered the Code in 1954, although employers were already taking the deduction (and employees excluding the income) under administrative and judicial decisions.  Prior to 1954 there was some inconsistency on what was required for the employee to omit the income. Sometimes the courts focused exclusively on the convenience of the employer. Other times the courts would look at whether there was a compensatory reason for the meal. Depending on the focus, they could arrive at different answers, of course.

So Congress stepped-in in 1954 and gave us Section 119. There were differences between the House and Senate bills (The House did not want a convenience-of-the-employer test, but the Senate did). Both House and Senate booted out the issue of “compensatory reason.” If it were primarily for the convenience of the employer, then the meals were free. Whether the employee considered it compensatory was beside the point.

Let’s use an extreme example to understand what Congress was after. In Olkjer, for example, the taxpayer was employed at a remote location in Greenland. The employer provided meals (and, in this case, lodging also) because there was nowhere else to go.

And there any number of examples like that. Think of emergency room personnel. Could they hypothetically get in a car and go to a restaurant for lunch? Of course they could. It would not serve the hospital’s needs, however, and hence they are required to stay on premises. The same can be said for casino workers.

Fast forward a few decades and we now have Silicon Valley. Take Google, for example. If you work at the Googleplex you can eat breakfast, lunch and dinner for free. I recall that the personal chef for the Grateful Dead was one of the early chefs at Google. These companies prey on each other’s chefs, too. Facebook hired a chef away from Google, for example. Facebook now serves Thai-spiced cilantro chicken and salmon with red curry sauce. Their chef will also prepare a special meal as an employee award or recognition. These meals can be quite upscale, featuring seven courses on white tablecloth.

No doubt Section 119 has come a long way from what Congress was thinking back in 1954.

And there is the rub.

In 2013 the Wall Street Journal published an article on these cafeterias, including the question whether the provision of gourmet-level meals were intended to be tax-free. Spring forward a year or so and the IRS has included the issue in their 2014-2015 Priority Guidance Plan. It appears the IRS is shifting resources to develop tax lines-of-reasoning requiring such benefits be reported as taxable compensation to employees.

How? Actually, the direction is fairly straightforward. The IRS will challenge the perk as not being “primarily” for the convenience of the employer. They cannot challenge whether there is a “compensatory” reason, as the reports to the 1954 tax Code makes it clear that Congress was not concerned with that issue.

The companies of course argue that such perks are “primarily” for their convenience. How?

           

·        Encourage employees to arrive early

·        Encourage employees to stay late

·        Employees do not waste time going out to eat

·        Maximize collaboration opportunities, as employees eat together rather than taking individual cars and dining alone elsewhere

·        Help retain people and foster employee trust

·        Help attract prospective employees

You must admit, the companies have a point. My hunch is that the IRS will restrict the definition of “convenience” to require a closer connection between the cafeteria perk and the alleged convenience.

What do I think? I have been in tax practice long enough to see provisions come into the tax Code, and then see practitioners take said provisions into places and distances that Congress or the IRS never intended. There is uproar, and Congress or the IRS then cracks-down. The practitioners regroup, study tape, develop new game plans and all parties eventually take the field again for the next game. It is just the wheel and rhythm of tax law and practice.

I suspect the same will happen here.

I have over the years worked unreasonable hours, and many (not all, mind you) CPA firms will make some provision for their staff during busy season. These meals have been tax-free, as the impetus for the meal was exclusively for the convenience of the CPA firm (as far as I was concerned). There was nothing there that approached this level, however.

But then, Google and Twitter and companies like them have taken this provision into places and distances that Congress likely never intended.

I admit I am a bit envious.