Clark v. Comm'r , 95 T.C.M. 1265 ( 2008 )

T.C. Memo. 2008-71
UNITED STATES TAX COURT
EDWARD D. CLARK, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11946-06. Filed March 19, 2008.
June L. Harris and Ellin Vicki Palmer, for petitioner.
Michael W. Berwind, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: Respondent determined the following
deficiencies and penalties with respect to petitioner’s Federal
income tax:
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Penalty
Year Deficiency Sec. 6662(a)
2002 $11,459 $2,291.80
2003 12,491 2,498.20
2004 9,506 1,901.20
After concessions, the issues for decision are:
(1) Whether for the years in issue petitioner may exclude
from gross income wages earned while working in international
waters;
(2) whether for the years in issue petitioner may deduct at
Federal per diem rates meal expenses that petitioner did not pay
or incur; and
(3) whether for the years in issue petitioner is subject to
accuracy-related penalties pursuant to section 6662(a).
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect during the years in issue,
and all Rule references are to the Tax Court Rules of Practice
and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated
facts are incorporated in our findings by this reference.
Petitioner resided in Scotland, the United Kingdom, when he filed
his petition.
Petitioner is a citizen of the United States but resided in
Scotland during the years in issue. Petitioner was employed at
various times during the years in issue by Maersk Line, Ltd.
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(Maersk) as a second officer aboard two of Maersk’s vessels, the
Able and the Invincible. The Able is an undersea surveillance
ship and was operated by Maersk under a subcontracting
arrangement with the U.S. Navy and the U.S. Military Sealift
Command. The Invincible is a guided missile tracking ship and
was operated by Maersk under a subcontracting arrangement with
the U.S. Air Force and the U.S. Military Sealift Command. While
petitioner was at work during the years in issue, Maersk provided
him with meals and lodging without charge. Maersk did not
provide petitioner with a per diem allowance for work-related
meals or incidental expenses.
At all times when petitioner was working aboard either the
Able or the Invincible during the years in issue, those vessels
were either docked in foreign ports or sailing in international
waters. The locations of the Able and the Invincible for the
periods when petitioner was employed by Maersk aboard the vessels
during the years in issue are reflected below:
Vessel Dates Location
Able 1/1/02-1/8/02 International waters
1/9/02-1/15/02 Glasgow, Scotland
Invincible 6/18/02-9/10/02 Singapore
9/11/02-9/26/02 International waters
9/27/02-10/09/02 Singapore
10/10/02-10/22/02 International waters
10/23/02-10/28/02 Okinawa, Japan
10/29/02-10/30/02 International waters
10/31/02-11/1/02 Okinawa, Japan
11/2/02-11/10/02 International waters
11/11/02-11/12/02 Singapore
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11/13/02-12/22/02 International waters
12/23/02-12/24/02 Singapore
Invincible 5/23/03-5/28/03 Sasebo, Japan
5/29/03-6/12/03 International waters
6/13/03-6/14/03 Sasebo, Japan
6/15/03-6/23/03 International waters
6/24/03-6/25/03 Sasebo, Japan
6/26/03-7/10/03 International waters
7/11/03-7/14/03 Sasebo, Japan
7/15/03-8/13/03 International waters
8/14/03-8/17/03 Sasebo, Japan
8/18/03-9/11/03 International waters
9/12/03-11/3/03 Singapore
11/4/03-11/5/03 International waters
11/6/03-11/20/03 Singapore
11/21/03-12/8/03 International waters
12/9/03-12/12/03 Singapore
Invincible 6/17/04-7/1/04 Jabel Ali, U.A.E.
7/2/04-7/2/04 Bahrain
7/3/04-7/14/04 International waters
7/15/04-7/25/04 Bahrain
7/26/04-9/4/04 International waters
9/5/04-9/13/04 Singapore
9/14/04-9/14/04 International waters
9/15/04-9/16/04 Singapore
Invincible 10/25/04-10/29/04 Bahrain
10/30/04-11/3/04 International waters
11/4/04-11/14/04 Jebel Ali, U.A.E.
11/15/04-12/15/04 International waters
12/16/04-12/21/04 Bahrain
Between September 16 and October 25, 2004, petitioner was on paid
sick leave from Maersk and was recuperating in Singapore, where
the Invincible was docked when petitioner became ill, and at home
in Scotland. During 2002 petitioner worked in international
waters for a total of 88 days and in foreign ports for a total of
117 days. During 2003 petitioner worked in international waters
for a total of 115 days and in foreign ports for a total of 89
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days. During 2004 petitioner worked a total of 90 days in
international waters and in foreign ports for a total of 92 days.
Petitioner was not employed in the United States at any time
during the years in issue.
Petitioner filed Federal income tax returns for 2002, 2003,
and 2004 and attached to them Forms 2555-EZ, Foreign Earned
Income Exclusion, claiming that all of his income in those years
was foreign earned income excluded from gross income under
section 911 for Federal income tax purposes. On his 2002 return
petitioner reported $20 in taxable interest and $63,641.48 in
gross wages consisting of:
Wage income (Maersk) $42,235.06
Military retirement pay 14,903.64
Vacation pay 6,502.78
Total 63,641.48
On his 2003 return petitioner reported gross wages of $70,510.66
consisting of:
Wage income (Maersk) $46,295.42
Military retirement pay 15,106.20
Vacation pay 9,078.35
Interest income 30.69
Total 70,510.66
Petitioner received additional interest income of $31 in 2003
that he failed to report. On his 2004 return petitioner reported
$50 in taxable interest and gross wages of $58,992 consisting of:
Wage income (Maersk) $42,567.40
Military retirement pay 6,365.93
Vacation pay 10,058.67
Total 58,992.00
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Petitioner received an additional $9,051 of military retirement
pay in 2004 that he failed to report. Petitioner has conceded
that the interest income and U.S. military retirement pay he
received in the years in issue are not excludable as foreign
earned income.
Petitioner’s earned income for the years in issue consists
of wage income and vacation pay. The amount of petitioner’s
earned income for each of the years in issue is:
Year Total Earned Income
2002 $48,737.84
2003 55,373.77
2004 52,626.07
OPINION
Income Earned in International Waters
U.S. citizens are generally taxed on their worldwide income
unless a specific exclusion applies. Sec. 61(a) (“gross income
means all income from whatever source derived”); Cook v. Tait,
265 U.S. 47, 56 (1924); Specking v. Commissioner, 117 T.C. 95,
101-102 (2001), affd. sub nom. Umbach v. Commissioner, 357 F.3d
1108 (10th Cir. 2003), affd. sub nom. Haessly v. Commissioner, 68
Fed. Appx. 44 (9th Cir. 2003).
Section 911(a) provides in relevant part that a qualified
individual may elect to exclude, subject to limitations set forth
in section 911(b)(2), his or her foreign earned income from gross
income. Section 911(b)(1)(A) defines an individual’s “foreign
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earned income” as “the amount received by such individual from
sources within a foreign country or countries which constitute
earned income attributable to services performed by such
individual”.
“A legislative regulation is made pursuant to a specific
grant of authority, often without precise congressional guidance,
to define a statutory term or prescribe a method of executing a
statutory provision.” Coca-Cola Co., & Includible Subs. v.
Commissioner, 106 T.C. 1, 19 (1996). Legislative regulations are
entitled to Chevron deference and are given controlling weight
unless they are arbitrary, capricious, or manifestly contrary to
the statute. Chevron U.S.A., Inc. v. Natural Res. Def. Council,
Inc., 467 U.S. 837, 843-844 (1984). The regulations promulgated
under the specific delegation of authority by Congress in section
911(d)(9) provide the following definition of a “foreign country”
for purposes of the foreign earned income exclusion under section
911:
(h) Foreign country. The term “foreign country”
when used in a geographical sense includes any
territory under the sovereignty of a government other
than that of the United States. It includes the
territorial waters of the foreign country (determined
in accordance with the laws of the United States), the
air space over the foreign country, and the seabed and
subsoil of those submarine areas which are adjacent to
the territorial waters of the foreign country and over
which the foreign country has exclusive rights, in
accordance with international law, with respect to the
exploration and exploitation of natural resources.
Sec. 1.911-2(h), Income Tax Regs.
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Petitioner does not challenge the validity of the regulation
defining a “foreign country” for purposes of section 911
primarily as any territory under the sovereignty of a Government
other than that of the United States. Under general principles
of international law, international waters are not under the
sovereignty of any nation. United States v. Louisiana, 394 U.S.
11, 23 (1969). Thus, international waters are not a “foreign
country” for purposes of section 911, and income petitioner
earned while traveling in international waters is not “foreign
earned income” excludable from gross income. See Plaisance v.
United States, 433 F. Supp. 936, 938-939 (E.D. La. 1977).
Without addressing or challenging the regulatory definition
of “foreign country” under section 1.911-2(h), Income Tax Regs.,
petitioner argues that we should read section 911 in conjunction
with the general sourcing rules under section 863(c) and conclude
that petitioner’s income earned while traveling in international
waters is foreign source income. Section 863(c) provides special
sourcing rules for certain transportation income when that
transportation begins or ends in the United States or one of its
possessions. Because U.S. citizens are subject to tax on their
worldwide income, sourcing rules are generally not relevant to
U.S. citizens. See Great-West Life Assur. Co. v. United States,
230 Ct. Cl. 477, 678 F.2d 180, 183 (1982); sec. 1.1-1(b), Income
Tax Regs.
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Even if general sourcing rules were applicable in this case
to override the plain meaning of section 911 and the regulations,
section 863(c) would not apply to petitioner’s situation because
his voyages neither began nor ended in the United States or one
of its possessions. Rather, section 863(d) would require
petitioner to include income earned in international waters as
income from “ocean activities” sourced in the United States. See
Arnett v. Commissioner, 473 F.3d 790, 797 (7th Cir. 2007), affg.
126 T.C. 89 (2006). Section 863(d) provides, in relevant part,
as follows:
SEC. 863(d). Source Rules for Space and Certain
Ocean Activities.--
(1) In general.--Except as provided in
regulations, any income derived from a space or
ocean activity--
(A) if derived by a United States
person, shall be sourced in the United States
* * *
* * * * * * *
(2) Space or ocean activity.--For purposes of
paragraph (1)--
(A) In general.--The term “space or
ocean activity” means--
* * * * * * *
(ii) any activity conducted on or
under water not within the jurisdiction
(as recognized by the United States) of
a foreign country, possession of the
United States, or the United States.
* * * * * * *
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(B) Exception for certain activities.--
The term “space or ocean activity” shall not
include--
(i) any activity giving rise to
transportation income (as defined in
section 863(c))
For purposes of the Internal Revenue Code, the definition of
“United States person” includes any citizen of the United States.
Sec. 7701(a)(30)(A). Although he resides in Scotland, petitioner
is a U.S. citizen. His income earned in international waters is
income from a “space or ocean activity” as defined in section
863(d)(2). Thus, that income is sourced in the United States.
Sec. 863(d)(1)(A).
While petitioner may, as the parties have stipulated,
exclude income earned in foreign ports from gross income, his
income earned while working in international waters does not
constitute foreign earned income for purposes of the exclusion
under section 911 and must be included in his gross income for
the years in issue.
Meal Expense Deductions
Section 162 permits taxpayers to deduct all ordinary and
necessary business expenses paid or incurred during the taxable
year and specifically includes traveling expenses (including
amounts expended for meals and lodging other than amounts that
are lavish or extravagant under the circumstances) while away
from home in the pursuit of a trade or business. Sec. 162(a)(2).
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Section 274(d) generally disallows any deduction under section
162 for, among other things, “any traveling expense (including
meals and lodging while away from home)” unless the taxpayer
complies with stringent substantiation requirements as to the
amount, time and place, and business purpose of the expense.
Sec. 274(d)(1). Section 274(d) authorizes the Secretary to
provide by regulations that some or all of these substantiation
requirements “shall not apply in the case of an expense which
does not exceed an amount prescribed pursuant to such
regulations.”
Under the applicable section 274 regulations, the
Commissioner is authorized to prescribe rules under which
optional methods of computing expenses, including per diem
allowances for ordinary and necessary expenses for traveling away
from home, may be regarded as satisfying the substantiation
requirements of section 274(d). Sec. 1.274-5(j), Income Tax
Regs. Under this authority, the Commissioner issued Rev. Proc.
2001-47, 2001-2 C.B. 332 (applicable to petitioner’s travel
January through September 2002); Rev. Proc. 2002-63, 2002-2 C.B.
691 (applicable to petitioner’s travel October 2002 through
October 2003); Rev. Proc. 2003-80, 2003-2 C.B. 1037 (applicable
to petitioner’s travel November 2003 through September 2004); and
Rev. Proc. 2004-60, 2004-2 C.B. 682 (applicable to petitioner’s
travel October through December 2004) (collectively, the
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applicable revenue procedures). Under the applicable revenue
procedures, taxpayers may elect to use, in lieu of substantiating
actual expenses, certain authorized methods for deemed
substantiation of employee lodging, meal, and incidental expenses
incurred while traveling away from home. Rev. Proc. 2002-63,
sec. 1, 2002-2 C.B. at 691; Rev. Proc. 2003-80, sec. 1, 2003-2
C.B. at 1037; and Rev. Proc. 2004-60, sec. 1, 2004-2 C.B. at 682,
each provide the following introduction:
SECTION 1. PURPOSE
This revenue procedure updates * * * [the previous
revenue procedure relating to per diem allowances] by
providing rules under which the amount of ordinary and
necessary business expenses of an employee for lodging,
meal, and incidental expenses or for meal and
incidental expenses incurred while traveling away from
home will be deemed substantiated under section 1.274-5
of the Income Tax Regulations when a payor (the
employer, its agent, or a third party) provides a per
diem allowance under a reimbursement or other expense
allowance arrangement to pay for the expenses. In
addition, this revenue procedure provides an optional
method for employees and self-employed 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. This revenue procedure also provides an optional
method for use in computing the deductible costs of
incidental expenses paid or incurred while traveling
away from home by employees and self-employed
individuals who do not pay or incur meal costs and who
are not reimbursed for the incidental expenses. Use of
a method described in this revenue procedure is not
mandatory, and a taxpayer may use actual allowable
expenses if the taxpayer maintains adequate records or
other sufficient evidence for proper substantiation.
* * *
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Rev. Proc. 2001-47, sec. 1, 2001-2 C.B. at 332, is almost
identical to the passage quoted above, but the following sentence
is omitted:
This revenue procedure also provides an optional method
for use in computing the deductible costs of incidental
expenses paid or incurred while traveling away from
home by employees and self-employed individuals who do
not pay or incur meal costs and who are not reimbursed
for the incidental expenses.
Rev. Proc. 2002-63, sec. 4.05, 2002-2 C.B. at 694; Rev.
Proc. 2003-80, sec. 4.05, 2003-2 C.B. at 1040; and Rev. Proc.
2004-60, sec. 4.05, 2004-2 C.B. at 685, expressly provide that
taxpayers who do not pay or incur meal expenses when traveling
away from home may use, in lieu of providing actual receipts to
substantiate incidental expenses, an established per diem rate of
$2 or $3, depending on which revenue procedure is applicable for
the date of travel. Rev. Proc. 2001-47, sec. 4, 2001-2 C.B. at
333-334, which provides specific rules for the per diem
substantiation method, does not contain a similar provision.
However, we have held previously that the incidental portion of
the per diem rates for meals and incidental expenses (M&IE) may
be used as deemed substantiation of incidental expenses when
meals are provided by a taxpayer’s employer. Johnson v.
Commissioner, 115 T.C. 210, 210-211 (2000). The applicable
revenue procedures provide that the Federal M&IE rate will be
applied, with stated exceptions, in the same manner as applied
under the Federal Travel Regulations, 41 C.F.R. secs. 301-311, in
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effect at the time each respective revenue procedure was
released.
Maersk furnished petitioner with lodging and meals without
charge while he was working on its vessels during the years in
issue. Although petitioner did not pay for his meals while at
sea or while docked in foreign ports, he argues that he is
entitled to deduct the full M&IE per diem rate for those days for
which he must include income earned in international waters.
Petitioner asserts that the applicable revenue procedures permit
him to deduct the full applicable M&IE rate for work-related
travel even though all of his meals were provided to him free of
charge by Maersk, but his only argument in support of this
assertion rests on the absence of any explicit requirement in
Internal Revenue Service publications that a taxpayer actually
pay for his meals in order to qualify for the standard meal
allowance deduction.
Petitioner argues further that this issue is novel to the
Court. We disagree. In Johnson v. Commissioner, supra, the
taxpayer, also a merchant seaman, deducted the full Federal M&IE
rates on his return even though all of his meals were provided to
him free of charge by his employer. We held that, because the
taxpayer’s actual expenses consisted solely of incidental
expenses, his use of the M&IE rates to calculate his deductions
for business expenses due to travel away from home was limited to
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the incidental portion of those rates. Id. at 210-211. The
taxpayer established that he had incurred incidental expenses
during his travel away from home and was allowed to use the
incidental portion of the M&IE rates to substantiate those
expenses in lieu of providing actual receipts.
The purpose of the Federal per diem rates is to ease the
burden of substantiating travel expenses away from home, not to
eliminate the requirement that those expenses be incurred before
they can be claimed as deductions from income. Although
petitioner contends that the Court has not yet addressed this
issue, we explicitly stated in Johnson v. Commissioner, supra at
227: “We 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.” Petitioner is not entitled to deductions for meal
expenses he did not pay or incur. See Balla v. Commissioner,
T.C. Memo. 2008-18. He is, however, as respondent has conceded,
entitled to a miscellaneous itemized deduction for incidental
expenses as permitted in Johnson, and the applicable revenue
procedures for the years in issue, but only with respect to those
days when petitioner was working in international waters and for
which he must include income earned.
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Accuracy-Related Penalty
Section 6662 imposes a 20-percent accuracy-related penalty
on any underpayment of Federal income tax attributable to a
taxpayer’s negligence or disregard of rules or regulations or
substantial understatement of income tax. Sec. 6662(a) and
(b)(1) and (2). Section 6662(d) defines “substantial
understatement of income tax” as an amount exceeding the greater
of 10 percent of the tax required to be shown on the return or
$5,000. Under section 7491(c), the Commissioner bears the burden
of production with regard to penalties and must come forward with
sufficient evidence indicating that it is appropriate to impose
the penalty. Higbee v. Commissioner, 116 T.C. 438, 446 (2001).
However, once the Commissioner has met the burden of production,
the burden of proof remains with the taxpayer, including the
burden of proving that the penalty is inappropriate because of
reasonable cause or substantial authority. Id. at 446-447; Rule
142(a).
The accuracy-related penalty under section 6662(a) will not
be imposed with respect to any portion of the underpayment as to
which the taxpayer acted with reasonable cause and in good faith.
Sec. 6664(c)(1). The decision as to whether a taxpayer acted
with reasonable cause and in good faith is made by taking into
account all of the pertinent facts and circumstances. Sec.
1.6664-4(b)(1), Income Tax Regs. The most important factor is
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the extent of the taxpayer’s effort to assess his proper tax
liability. This factor includes in some circumstances the
taxpayer’s reasonable and good faith reliance on the advice of a
tax professional. Id.
Respondent’s burden of production has been met. Petitioner
has conceded that he received, but failed to include in gross
income, the following amounts of interest income and U.S.
military retirement pay in the years in issue:
U.S. Military
Year Interest Income Retirement Pay
2002 $20 $14,904.00
2003 31 15,106.20
2004 50 15,417.00
Petitioner also concedes that he either failed to report that
income on his returns for the years in issue or improperly
excluded it as foreign earned income.
Because petitioner’s income earned in international waters
is includable in his gross income, petitioner also improperly
excluded from gross income the following amounts, calculated by
multiplying petitioner’s total earned income for each year by the
ratio of days worked in international waters to total days worked
for that year:
Days Worked in Amount Includable
Year International Waters in Gross Income
2002 88 (205 total days worked) $20,921.60
2003 115 (204 total days worked) 31,215.60
2004 90 (182 total days worked) 26,023.54
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Petitioner excluded all his income for the years in issue as
foreign source income on his returns, claiming that he had no
Federal tax liability and that he was entitled to refunds of all
taxes withheld during those years. If, for any year in issue,
the amount of gross income that petitioner failed to include as
required results in an understatement of income tax exceeding
$5,000, then petitioner is subject to the accuracy-related
penalty for a “substantial understatement” for that year. Sec.
6662(a) and (b)(2). If, however, the resulting understatement of
income tax does not exceed $5,000 for any of the years in issue,
then petitioner is not liable for the penalty under section
6662(a) unless that understatement is the result of petitioner’s
negligence or disregard of rules and regulations. Sec. 6662(a)
and (b)(1).
Petitioner argues that he was not negligent in preparing his
returns for the years in issue. Petitioner testified at trial
that he had reviewed several publications on the Internal Revenue
Service’s Web site to assist him in preparing his returns.
Petitioner’s testimony focused on his prior review of special
rates that transportation workers may use to calculate business
expense deductions, specifically meal expenses. However,
petitioner did not claim any deductions for expenses on his
returns for the years in issue. His testimony on this point
relates to his position at trial and on brief that he is entitled
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to standardized meal expense deductions for meal expenses he
neither paid nor incurred, rather than the position he took on
his returns, in which he claimed that he was liable for no
Federal income tax. Petitioner did not consult a tax
professional before taking this position on his returns.
Petitioner also testified at trial that he read the
instructions to Form 2555-EZ before he completed his returns for
the years in issue. Those instructions state, in relevant part,
that foreign earned income does not include amounts paid by the
U.S. Government. Petitioner improperly and unreasonably excluded
his U.S. military retirement pay from gross income for all years
in issue.
Petitioner argues that he should not be liable for the
accuracy-related penalties under section 6662 because, in spite
of his failure “to account for some minimal interest and military
retirement pay income” for the years in issue, his returns were
timely and substantially accurate. However, petitioner’s returns
were not substantially accurate. Petitioner haphazardly prepared
his returns for the years in issue, incorrectly characterizing
all of his income as wages and failing to include $9,051 of
retirement pay in 2004. He then excluded all of that income as
foreign earned income, disregarding the instructions that clearly
stated his military retirement pay was ineligible for the
exclusion.
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Petitioner has failed to show that his positions on his
returns for the years in issue were taken with reasonable cause
and in good faith within the meaning of section 6664(c)(1). He
has presented no evidence that he acted in reasonable reliance on
the advice of a tax professional in asserting the positions taken
on his returns. He claims that he read the instructions to Form
2555-EZ before claiming the foreign earned income exclusion of
all of his income for the years in issue; however, those
instructions make clear that U.S. military retirement pay is not
foreign earned income. Petitioner failed to include his military
retirement pay as gross income and instead characterized those
amounts as wage income and excluded them.
Petitioner’s general arguments that his income earned in
international waters is foreign source income excludable under
section 911 from gross income, while extensive, ignore the plain
provisions of section 911 and the legislative regulations.
Petitioner relies on the general sourcing rules of sections 861
through 865, but those sections do not provide a rule for
sourcing income in petitioner’s particular situation. Petitioner
has not addressed the terms of the statute and the regulations
under section 911 and, in excluding all of his income from gross
income for Federal income tax purposes, has not shown that he
took care to assess properly his tax liability or that he had
reasonable cause in failing to do so. Thus, petitioner is liable
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for the accuracy-related penalty under section 6662 for
underpayments attributable to negligence or disregard of rules or
regulations.
In reaching our decision, we have considered all arguments
made, and, to the extent not mentioned, we conclude that they are
irrelevant, moot, or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.