The Internal Revenue Code
("IRC") generally allows taxpayers to deduct from income all
ordinary, necessary and reasonable expenses paid or incurred
during a taxable year in carrying on the taxpayer's trade or
business. IRC Section 274 modifies the foregoing general
rule by prohibiting taxpayers from deducting expenses paid
or incurred with respect to any facility, including
aircraft, which is used in connection with entertainment,
amusement, or recreation (hereinafter, "recreation").
Prior to enactment of the Act,
the Eighth Circuit Court of Appeals had held in Sutherland
Lumber v. Commissioner of Internal Revenue that the
limitation contained in IRC Section 274(a) did not apply to
flights provided by a taxpayer to the taxpayer's
shareholders and employees on a company-operated aircraft
for recreational purposes if the taxpayer imputed fringe
benefit income to the shareholders and employees for the
value of flights. Therefore, the company could deduct the
expenses for such flights.
The Act in effect overrules the
Sutherland Lumber decision by limiting the deduction permitted
to taxpayers for the expenses associated with the provision of
flights to certain "Specified Individuals" for recreational
purposes to the amount imputed to the Specified Individuals as
fringe benefit income for such flights. The term "Specified
Individuals" includes any person who is the direct or indirect
owner of more than 10% of any class of equity security of the
taxpayer, and any officer or director of the taxpayer. The Act
does not limit the deduction permitted to companies for the
expenses associated with operating flights for entertainment,
amusement, or recreational purposes for employees who are not
"Specified Individuals".
Open Questions
1. "Personal" Flights Might Not
All Be Subject to IRC 274.
The Act raises more questions
than it answers. For example, are all flights for which
income must be imputed to the employee under the fringe
benefits regulations subject to the IRC Section 274
limitation created by the Act? Presumably, the answer to
that question is qualified "no".
When a taxpayer provides a flight
to an employee for purposes unrelated to the taxpayer's trade or
business, the fringe benefit regulations require that the
taxpayer must impute income (or charge) to the employee for the
value of the flight. However, not all flights provided to an
employee under conditions requiring the imputation of fringe
benefit income constitute flights for recreational purposes.
In various rulings, the IRS has
recognized that routine personal uses by an employee of a
company vehicle for purposes unrelated to the trade or business
of the employer are not subject to IRC Section 274 if the use of
the vehicle by the employee is for purposes other than
recreation. In applying this concept to aircraft, the IRS agreed
in the Sutherland Lumber case that IRC Section 274 does not
apply to situations where a taxpayer provides a flight to an
employee for purposes related to another business of the
employee, or for charitable purposes. It is of course unclear
what, if any, other types of situations where a taxpayer
provides a flight to an employee for purposes unrelated to the
trade or business of the taxpayer may be excluded from the scope
of IRC Section 274, or whether the IRS will continue in the
aftermath of the Act to recognize any such flights as being
outside the scope of IRC Section 274.
2. Business Travelers and
Recreation Travelers Sharing a Flight
It is also unclear from the
text of the Act what effect, if any, the Act will have on
taxpayers' ability to deduct expenses associated with
operating mixed-use flights conducted primarily for business
purposes, where some passengers are traveling primarily for
business purposes, and other passengers are traveling
primarily for recreational purposes. The passengers
traveling for recreation could be either company employees
or the spouse or guests of the business travelers.
In either situation, arguably the
fact that the flights served primarily business purposes should
allow full deductibility, with only the marginal costs, if any,
incurred for those traveling for recreational purposes being
subject to the limitation created by the Act. This
interpretation is supported by legislative history underlying
IRC Section 274 and various Tax Court and IRS rulings. Yet,
currently, there is no guidance on point, and it is conceivable
that the IRS could assert that the expenses incurred for such
flights would have to be apportioned in some manner, thereby
limiting full deductibility of such expenses.
3. Travel for Both Business and
Recreational Purposes
Similarly, it is unclear from the
text of the Act how to treat flights where an employee travels
for both business and recreational purposes. Treasury
regulations provide that when a taxpayer furnishes air
transportation to an employee to a particular destination on a
taxpayer-provided aircraft, and the purpose of the employee in
traveling to the destination serves both a personal and a
business purpose, income must be imputed to the employee only if
the personal purpose of the flight is primary.
The determination of whether a
flight is primarily for personal or business purposes is based
on a facts and circumstances analysis. Factors to be considered
in making such a determination include the amount of time spent
on personal activities and the amount of time spent of
activities relating to the taxpayer's trade or business. For
example, according to treasury regulations, if a taxpayer spends
one week at a destination on business activities, and an
additional five weeks at the destination for recreational
purposes, the trip will be considered primarily personal in
nature in the absence of a clear showing to the contrary.
Presumably, then, it should be reasonable to assert that if the
business purpose of a flight is primary, IRC Section 274 should
not apply.
