Deductible personal costs: IRS Chief Counsel Advice allows favorable treatment.
This Chief Counsel Advice concluded that Sec. 274(a) did not disallow those deductions.
S, an S corporation whose shareholders are all members of one family, owns fractional interests in two jet aircrafts. S presented flight logs documenting the aircrafts' use as follows:
* Business percentage--5
* Personal percentage--95
The personal use was by the shareholders and two non-family employees.
S incurred operating expenses and depreciation attributable to maintaining these aircrafts, which it deducted on its S corporation income tax return. Therefore, these deductions flowed through to the shareholders on their individual income tax returns.
S properly determined the standard industry fare level (SIFL) value of each personal flight under Regs. Sec. 1.61-21 and reported that value as compensation for the shareholder or employee. More than 75 percent of the value of these personal flights was attributable to shareholders; the balance was attributable to employees.
The shareholders' income for personal use of the aircrafts was offset by the deductions for the aircrafts' expenses and depreciation flowing through to shareholders from their S corp's tax return.
Because these deductions were more than 10 times the amount of income reported by the shareholders and employees, the shareholders claimed a very "significant" net deduction for the costs of the personal use of the S corporation's aircrafts--much of which was attributable to use by these shareholders or other family members.
Relevant Statutes and Regulation
Sec. 274(a)(1)(A) generally disallows deductions for entertainment, amusement or recreation unless directly related to, or associated with (under certain conditions), the active conduct of the taxpayer's trade or business.
Sec. 274(e)(2) provides that Sec. 274(a) does not apply to expenses for goods, services and facilities to the extent that the taxpayer treats the expenses, with respect to the recipient of the entertainment, amusement or recreation, as compensation to an employee on the taxpayer's income tax return and as wages to that employee for income tax withholding purposes.
Regs. Sec. 1.61-21(g) contains the fringe benefit rules and methodology for valuing non-commercial flights on employer-provided aircraft.
Does Sec. 274(a)(1)(A) disallow an S corporation's deductions for the amount of expenses of providing corporate aircraft for the personal use of a shareholder or employee, in excess of the value of the flights included in the shareholder's or employee's income under the methodology of Regs. Sec. 1.61-21(g)?
The IRS explained that Sec. 274(e)(2), as interpreted in Sutherland LumberSouthwest Inc vs. Commissioner, 114 T.C. 197 (2000), aff'd 255 F. 3d 495 (8 Cir. 2001), excepts the type of deductions in this situation from disallowance under Sec. 274(a)(1)(A).
In Sutherland, the IRS contended that the Sec. 274(e)(2) exception applied only to the amount included in employee compensation and wages, and that Sec. 274(a) disallowed any deduction for the flight expenses exceeding the amount treated as the employee's compensation and wages.
In holding that Sec. 274(a) did not disallow the deductions in Sutherland, the Tax Court concluded that when an employer includes in the employee's income the value of the vacation flight as determined under the fringe benefit rules of Regs. Sec. 1.61-21(g), the employer satisfies the requirements for the exception to the deduction disallowance in Sec. 274(e)(2) with respect to the vacation flight.
IRS' Prior Action
The IRS acquiesced to Sutherland (see Action on Decision (AOD) 2002-02, Feb. 11, 2002). The AOD stated that the IRS will not litigate this issue in cases where a taxpayer demonstrates that it has properly included in compensation and wages the value of an employee's vacation flight in accordance with Regs. Sec. 1.61-21(g). This AOD stated that, in such cases, the IRS will allow the taxpayer's full deduction for the flight's costs.
Note: Sutherland Lumber-Southwest, Inc. was a regular (C) corporation.
In the instant situation, S has included the flights' value under the SIFL rates in the flight recipients' incomes for the year involved, just as Sutherland Lumber did. This case is identical to Sutherland except for the recipients' status as C corporation employees versus S corporation shareholders as well as employees. The IRS did not think these distinctions were significant.
Accordingly, under Sutherland and the current IRS position, the IRS national office concluded that Sec. 274(a) did not disallow the deductions at issue.
Observation: This Chief Counsel Advice rationale also may apply to other situations where an S corporation provides taxable, properly valued fringe benefits to employee-shareholders.
By Stuart R. Josephs, CPA
Stuart R. Josephs, CPA, has a San Diegobased Tax Assistance Practice (TAP) that specializes in assisting practitioners in resolving their clients' tax questions and problems. Josephs, chair of the Federal Subcommittee of CalCPA's Committee on Taxation, can be reached at (619) 469-6999 or email@example.com.
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|Author:||Josephs, Stuart R.|
|Date:||Mar 1, 2004|
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