Sutherland Lumber-Southwest, Inc. v. Comm'r of Internal Revenue, 23936–97.

• Citation: 114 T.C. 197,114 T.C. No. 14,24 Employee Benefits Cas. 2358
• Decision Date: 28 March 2000
• Docket Number: No. 23936–97.,23936–97.
• Parties: SUTHERLAND LUMBER–SOUTHWEST, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

114 T.C. 197

114 T.C. No. 14

24 Employee Benefits Cas. 2358

SUTHERLAND LUMBER–SOUTHWEST, INC., Petitioner

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 23936–97.

United States Tax Court.

March 28, 2000.

Corporate taxpayer petitioned for redetermination of deficiencies arising, in part, from disallowed expense deductions for company-owned airplane for nonbusiness flights of employees. Taxpayer moved for partial summary judgment. The Tax Court, Gerber, J., held that company was not limited in its deduction to the amount reportable as income by employees for expenses incurred for company airplane for nonbusiness flights of employees.

Motion granted. P provided its employees with the use of the company-owned aircraft for nonbusiness flights. P notified its employees to report the value of the flights as imputed income. P deducted the expenses incurred in providing the flights. R, relying on sec. 274(e)(2), I.R .C., determined that deductions for expenses incurred in providing employees with nonbusiness flights on a company-owned airplane are limited to the amount reported as imputed income to the recipient employees. P contends that its expense deductions are not subject to sec. 274, I.R.C., or, in the alternative, if subject to sec. 274, I.R.C., are excepted from the restriction of sec. 274, I.R.C., by application of sec. 274(e)(2), I.R.C.Held: Sec. 274(e)(2), I.R.C., excepts from the effect of sec. 274, I.R.C., deductions of an employer's expenses in connection with an entertainment facility and does not limit or peg the amount deductible to the amount reportable by employees; i.e., the value of the benefit received.Anne G. Batter, for petitioner.

Robert M. Fowler, for respondent.

OPINION

GERBER, J.

The parties filed cross-motions for partial summary judgment, seeking resolution of whether petitioner is allowed to deduct its expenses in operating its company aircraft for the benefit of employees or whether the deduction is limited to the value of the use of the aircraft—the amount reportable by petitioner's employees. The parties' controversy raises the question of whether and how section 274 ¹ applies for petitioner's 1992 and 1993 taxable years.

Background

Petitioner is a corporation with its principal place of business in Kansas City, Missouri. Petitioner's president and vice president are Dwight Sutherland (Dwight) and Perry Sutherland (Perry), respectively. Petitioner is principally engaged in the retail lumber business with outlets located in eight Texas cities. In addition to the retail lumber business, petitioner owned a 1976 Model 25 Lear Jet, which was used for travel related to the lumber business and for its air charter service business operated out of Kansas City. Dwight and Perry also used the plane for travel related to their positions as directors of other businesses (director's flights), for other business and charitable purposes (nonvacation flights), and for vacation travel (vacation flights). In 1992, the plane was used approximately 30 percent for charter business, 23 percent for director's flights, 18 percent for nonvacation flights, 24 percent for vacation flights, and 5 percent for other purposes. In 1993, the plane was used approximately 16 percent of the time for charter business, 16 percent for director's flights, 32 percent for nonvacation flights, 24 percent for vacation flights, and 11 percent for other purposes.

Use of the aircraft for director's flights, nonvacation flights, and vacation flights was reported by Dwight and Perry as compensation in connection with their employment with petitioner. Petitioner calculated and reported the amount of imputed income for Dwight and Perry in accord with the valuation formula provided in section 1.61–21(g), Income Tax Regs. Petitioner, in accord with section 162, deducted its costs incurred in operating the aircraft, including those flights taken for director's flights, nonvacation flights, and vacation flights. Respondent agrees that petitioner correctly applied and calculated the imputed income and associated deduction figures pursuant to sections 61 and 162, leaving the applicability of section 274 as the only matter in controversy.

Respondent determined income tax deficiencies of $341,631 and $119,558 for petitioner's 1992 and 1993 tax years, respectively. The deficiency determinations were based on adjustments to deductions involving airplane expenses, net operating loss, environmental tax, alternative minimum tax, and contributions. Petitioner moved for partial summary judgment solely with respect to the disallowance of a portion of its claimed deduction for expenses to operate the aircraft, asking the Court to hold either that section 274 does not apply or, if section 274 applies, that section 274(e)(2) excepts petitioner from the provisions of section 274. If we decide that petitioner is correct with respect to either contention, petitioner's partial summary judgment motion will be granted.

Respondent, in his cross-motion for partial summary judgment, asks the Court to hold that section 274 is applicable and, further, that section 274(e)(2) limits petitioner's deduction to the value of the benefits received by employees with respect to the vacation flights. Likewise, if respondent's position is incorrect with respect to either contention, petitioner's partial summary judgment motion will be granted and respondent's denied.

Respondent conceded that petitioner is entitled to deduct the expenses for operating the aircraft for flights attributable to the lumber business, the air charter business, the nonvacation flights, and the director's flights.

Discussion

The parties' cross-motions for partial summary judgment ² involve employee fringe benefits. Normally, answers to such matters may be found in sections 61, 162, 132, and related sections. Here, however, we are confronted with the more vexing combination of those sections with section 274, which provides special rules for disallowance of certain deductions in connection with entertainment, amusement, or recreation activities. Simplifying matters, the parties agree that the value of the vacation use of the aircraft is reportable by the employees as compensation and that petitioner is entitled to deduct some amount in connection with that same use. We consider whether petitioner, under section 274, may deduct its aircraft operating costs in full or whether petitioner's deduction is limited to the amount reportable as compensation by the employees. In that regard, the parties agree that, without considering section 274, petitioner has correctly deducted its expenses incurred in operating the aircraft and notified its employees to report the value of the use of the aircraft.

Section 162(a) generally provides that a taxpayer is allowed a deduction for all ordinary and necessary expenses paid or incurred by the taxpayer in carrying on a trade or business. An expenditure is “ordinary and necessary” if the taxpayer establishes that it is directly connected with, or proximately related to, the taxpayer's activities. See Bingham's Trust v. Commissioner, 325 U.S. 365, 370, 65 S.Ct. 1232, 89 L.Ed. 1670 (1945). Deductions are a matter of legislative grace, and petitioner must prove that it is entitled to the claimed deductions. See Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84, 112 S.Ct. 1039, 117 L.Ed.2d 226 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 54 S.Ct. 788, 78 L.Ed. 1348 (1934).

As an ordinary expense of carrying on a trade or business, a taxpayer/employer may deduct expenses paid as compensation for personal services. See sec. 162(a)(1). If the compensation is paid in the form of noncash fringe benefits, section 1.162–25T, Temporary Income Tax Regs., 50 Fed.Reg. 747, 755 (Jan. 7, 1985), amended 50 Fed.Reg. 46006, 46013 (Nov. 6, 1985), provides that an employer may take a deduction for expenses incurred in providing the benefit if the value of the noncash fringe benefit is includable in the recipient employee's gross income. See also sec. 1.61–21(b), Income Tax Regs. (employee is required to include in gross income the value of any fringe benefit received). The employer may not deduct the amount included by the employee as compensation but is required to deduct the employer's costs incurred in providing the benefit to the employee. See sec. 1.162–25T, Temporary Income Tax Regs., supra.

Some deductions previously allowable under section 162 were disallowed by the enactment of section 274, among other sections. Section 274 was enacted to eliminate or curb perceived abuses with respect to business expense deductions for entertainment and travel expenses and for gifts. See H. Rept. 1447, 87th Cong., 2d Sess. (1962), 1962–3 C.B. 402, 423; S. Rept. 1881, 87th Cong., 2d Sess. (1962), 1962–3 C.B. 703, 730–731. Section 274(a)(1)(A) generally provides for the disallowance of deductions, otherwise allowable under chapter 1 of the Internal Revenue Code, involving an entertainment, amusement, or recreation activity. Section 274(a)(1)(B) disallows the deduction of otherwise allowable expenses incurred with respect to a facility used in connection with such an activity. See Harrigan Lumber Co. v. Commissioner, 88 T.C. 1562, 1564–1565, 1987 WL 31365 (1987), affd. without published opinion 851 F.2d 362 (11th Cir.1988).

Although section 274(a) is designed generally to prohibit deductions for certain entertainment-related expenses, section 274(e)(2) provides that the deduction disallowance provision of section 274(a) will not apply to:

Expenses treated as compensation.—Expenses for goods, services, and facilities, to the extent that the expenses are treated by the taxpayer, with respect to the recipient of the entertainment, amusement, or recreation, as compensation to an employee on the taxpayer's return of tax under this chapter and as wages to such employee for purposes of chapter 24 (relating to withholding of income tax at source on wages). [...