Townsend Industries Inc. v. U.S.

• Decision Date: 15 September 2003
• Docket Number: No. 02-3756.,02-3756.
• Citation: 342 F.3d 890
• Parties: Townsend Industries, Inc., Appellant, v. United States of America, Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

342 F.3d 890

Townsend Industries, Inc., Appellant, v. United States of America, Appellee.

No. 02-3756.

United States Court of Appeals, Eighth Circuit.

Submitted: May 16, 2003.

Filed: September 15, 2003.

Bruce B. Graves, argued, Des Moines, IA, for appellant.

Joel McElvain, argued, Dept. of Justice, Washington, DC (Teresa E. McLaughlin, on the brief), for appellee.

Before BOWMAN and BYE, Circuit Judges, and ERICKSEN,¹ District Judge.

BOWMAN, Circuit Judge.

This is a case about the taxability of business and entertainment expenses spent on a Canadian fishing trip. After the Internal Revenue Service determined that the per-employee cost of Townsend Industries' annual fishing trip was wages, it assessed deficiencies against the company for the 1996 and 1997 tax years. Townsend paid a portion of the deficiency and filed a 26 U.S.C. § 7422 (2000) suit seeking a refund. After a bench trial, the District Court found in favor of the Government, held that the expenses involved in the trips were employee wages within the meaning of the Internal Revenue Code, and ruled that a portion of these wages should have been withheld for income tax and Social Security and Medicare taxes. Townsend appeals that decision, and we reverse.

Townsend Industries, based in Altoona, Iowa, manufactures the T-51, a product that allows offset printers to produce two-color documents in a single pass through the printing press. For the last forty years, Townsend has gathered its salespeople² for an annual, two-day meeting at its headquarters involving its corporate staff and some factory workers. Following that meeting, the company has sponsored a four-day expense-paid fishing trip to a resort in Ontario, Canada (two of the four days spent traveling to-and-from the resort on a bus). Aside from a dinner at which the company owner, Robert Townsend, and its CEO, John Jorgenson, spoke about the state of the company, the employees and salespeople spent their time largely as they wished (though the vast majority fished). Nevertheless, business discussions were conducted on an on-going basis during the trip.

We apply the same standards of review that we apply in other cases when we review a district court's decision in a taxpayer's suit to reclaim taxes paid. See United States v. Boyle, 469 U.S. 241, 249 n. 8, 105 S.Ct. 687, 83 L.Ed.2d 622 (1985). Accordingly, we review the District Court's findings of fact for clear error and its conclusions of law de novo. Boles Trucking, Inc. v. United States, 77 F.3d 236, 242 n. 3 (8th Cir.1996) (citing Boyle, 469 U.S. at 249 n. 8, 105 S.Ct. 687). The District Court's holding that Townsend failed to establish that its trips had a business purpose is a legal conclusion that we review de novo. Cf. Boyle, 469 U.S. at 249 n. 8, 105 S.Ct. 687 (explaining that presence of elements constituting "reasonable cause" is a question of law).

The question of whether the per-employee cost of the trips amounted to taxable wages and whether Townsend should have withheld a portion of these costs turns on whether each employee could have deducted these costs as business expenses. A taxpayer may exclude certain fringe benefits from his or her gross income and thereby avoid paying income tax on these benefits. Section 132(d) of the Internal Revenue Code excludes "working condition fringe" benefits from an individual's wages and provides that "`working condition fringe' means any property or services provided to an employee of the employer to the extent that, if the employee paid for such property or services, such payment would be allowable as a deduction under section 162 or 167." 26 U.S.C. § 132(d) (2000).

In turn, § 162(a)(2) allows a deduction for "traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business." 26 U.S.C. § 162(a)(2). Any deduction for travel and entertainment is substantially limited by § 274, which disallows deductions for certain expenses and provides heightened reporting requirements. Section 274(a)(1)(A) disallows deduction for entertainment expenses:

With respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, unless the taxpayer establishes that the item was directly related to, or, in the case of an item directly preceding or following a substantial and bona fide business discussion (including business meetings at a convention or otherwise), that such item was associated with, the active conduct of the taxpayer's trade or business.

26 U.S.C. § 274(a)(1)(A) (emphasis added). Section 274(d) adds an important substantiation requirement and forbids deductions for entertainment expenses:

unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer's own statement (A) the amount of such expense or other item, (B) the time and place of the travel, entertainment, amusement, recreation, or use of the facility or property, or the date and description of the gift, (C) the business purpose of the expense or other item, and (D) the business relationship to the taxpayer of persons entertained, using the facility or property, or receiving the gift.

26 U.S.C. § 274(d)(4).

The Treasury Department has promulgated regulations that provide a further gloss on the Internal Revenue Code and that govern whether "working condition fringe" benefits and travel and entertainment expenses are deductible. For purposes of this case, 26 C.F.R. § 1.132-5 (2003), which governs "working condition fringes," adds nothing. Section 1.162-2, which deals with traveling expenses, adds some important requirements to the deductibility of travel expenses and § 1.162-2(a) provides that "[o]nly such traveling expenses as are reasonable and necessary in the conduct of the taxpayer's business and directly attributable to it may be deducted." 26 C.F.R. § 1.162-2(a) (emphasis added). The regulation then explains that where personal and business travel are mixed, travel expenses may only be deducted "if the trip is related primarily to the taxpayer's trade or business." 26 C.F.R. § 1.162-2(b)(1). However, even if the trip is not primarily business-related, expenses "which are properly allocable to the taxpayer's trade or business" may still be deducted. Id.

The regulations governing § 274 of the Internal Revenue Code add additional requirements for this section's "directly related to" and substantiation requirements. Section 1.274-2(c)(3) add's four requirements that the taxpayer must meet in order to deduct entertainment and travel expenses. The expense will only be considered directly related to, or associated with, the active conduct of business if:

(i) . . . the taxpayer had more than a general expectation of deriving some income or other specific trade or business benefit . . . .

(ii) . . . the taxpayer actively engaged in a business meeting, negotiation, discussion, or other bona fide business transaction, other than entertainment, for the purpose of obtaining such income or other specific trade or business benefit . . . .

(iii) In light of all the facts and circumstances of the case, the principal character or aspect of the combined business and entertainment . . . was the active conduct of the taxpayer's trade or business. . . It is not necessary that more time be devoted to business than to entertainment to meet this requirement. The active conduct of trade or business is considered not to be the principal character or aspect of combined business and entertainment activity on hunting or fishing trips . . . unless the taxpayer clearly establishes to the contrary.

(iv) The expenditure was allocable to the taxpayer and a person or persons with whom the taxpayer engaged in the active conduct of trade or business during the entertainment . . .

26 C.F.R. § 1.274-2(c)(3)(i)-(iv). Temporary regulations govern the "adequate records" requirement in § 274(d) and explain that in the absence of written, contemporaneous records, the taxpayer must establish the business nature of the expense "[b]y his own statement, whether written or oral, containing specific information in detail. . . and [b]y other corroborative evidence sufficient to establish" the business nature of the expense. Id. § 1.274-5T(c)(3)(i)(A)-(B).

What these many statutes and regulations boil down to is a requirement that Townsend prove that its fishing trips were reasonable and necessary business expenses that were directly related to, or associated with, the active conduct of Townsend's business. Further, Townsend must demonstrate its business purpose by showing: that it had more than a general expectation of deriving some income or other trade or business benefit from the trip; that its employees actively engaged in business meetings, negotiations, discussions, or other bona fide business transactions; and that the principal character of the combined business and entertainment was the active conduct of Townsend's trade or business. Finally, Townsend faces an evidentiary hurdle and must prove the business nature of its expenses by "adequate records," by its own statements, or by other corroborative evidence.

The District Court determined that Townsend failed to establish a business purpose and ruled in favor of the Government. The District Court first determined that the "fishing trips were not an ordinary and necessary business expense in light of the lax attendance policy for the trip, and the disconnect between the sales meeting and the fishing trip." Order at 7 (Aug. 21, 2002). Notwithstanding Townsend's unusual, inclusive business philosophy, the District Court determined that there was only a brief business meeting held during each of the trips and that it could not say that "a voluntary, company-wide, all-expense-paid, employer-sponsored fishing trip with one brief business meeting [was] an ordinary and necessary...