[Federal Register Volume 77, Number 148 (Wednesday, August 1, 2012)]
[Rules and Regulations]
[Pages 45480-45487]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-18693]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9597]
RIN 1545-BF34
Deductions for Entertainment Use of Business Aircraft
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations relating to the use
of business aircraft for entertainment. These final regulations affect
taxpayers that deduct expenses for entertainment, amusement, or
recreation provided to specified individuals. The final regulations
reflect statutory amendments under the American Jobs Creation Act of
2004 (AJCA) and the Gulf Opportunity Zone Act of 2005 (GOZA).
DATES: Effective Date: These regulations are effective August 1, 2012.
Applicability Date: For dates of applicability, see Sec. Sec.
1.61-21(g)(14)(iii), 1.274-9(e), and 1.274-10(h).
FOR FURTHER INFORMATION CONTACT: Michael Nixon (section 274), (202)
622-4930; or Lynne A. Camillo (section 61), (202) 622-6040 (not toll-
free numbers).
SUPPLEMENTARY INFORMATION:
Background
This document contains final amendments to the Income Tax
Regulations, 26 CFR part 1, relating to the disallowance under section
274 of the Internal Revenue Code (Code) of deductions for the use of
business aircraft for entertainment.
On June 15, 2007, a notice of proposed rulemaking (REG-147171-05)
regarding the use of business aircraft for entertainment was published
in the Federal Register (72 FR 33169). Written and electronic comments
responding to the notice of proposed rulemaking were received. A public
hearing on the proposed regulations was held on October 25, 2007. After
consideration of all the comments, the proposed regulations are adopted
as amended by this Treasury decision. The comments and revisions are
discussed in the preamble.
Explanation of Provisions and Summary of Comments
1. Determination of Costs
a. Application of Disallowance to Fixed Costs
The proposed regulations provide that expenses subject to
disallowance under section 274(a) include variable costs such as fuel
and landing fees, and fixed costs such as depreciation, hangar fees,
pilot salaries, and other items not directly related to an individual
flight. Commentators suggested that the final regulations should limit
expenses subject to disallowance to the direct or variable costs of a
flight and exclude fixed costs. The final regulations do not adopt this
comment because section 274(e)(2) does not explicitly differentiate
between fixed and variable expenses and because such an interpretation
is contrary to Congressional intent.
b. Charter Rate Safe Harbor
The proposed regulations requested comments on whether, as an
alternative to determining actual expenses, the final regulations
should allow taxpayers to determine the amount of expenses paid or
incurred for entertainment flights by reference to charter rates. The
proposed regulations asked for specific comments on the availability of
substantiated actual, published, undiscounted charter rates charged to
the general public by companies that meet certain requirements.
Commentators generally endorsed the inclusion of a charter rate
safe harbor in the final regulations. They suggested that the IRS
establish rates either by conducting a survey of average charter rates
by region or by authorizing representatives of the industry to create a
charter rate reporting system. One commentator suggested that if the
IRS does not establish charter rates, individual taxpayers should be
allowed to determine charter rates. Commentators also stated that a
charter rate safe harbor should include rates for rentals of small
piston aircraft, which taxpayers use extensively for business but
normally are not chartered.
The difficulty of determining accurate and reliable charter rates
continues to be an impediment to establishing a charter rate safe
harbor. Accordingly, the final regulations do not include these rules.
However, the final regulations authorize the IRS to adopt charter rate
or other safe harbors in future published guidance, see Sec.
601.601(d).
c. Depreciation
The proposed regulations permit a taxpayer to elect to compute
depreciation expenses on a straight-line basis for all of the
taxpayer's aircraft and all taxable years for purposes of calculating
expenses subject to disallowance, even if the taxpayer uses another
method to compute depreciation for other purposes. The proposed
regulations provide a transition rule for applying the straight-line
election to aircraft placed in service in taxable years preceding the
election, which requires the taxpayer to apply the straight-line method
as if it had been applied from the year the aircraft was placed in
service.
A commentator requested that the final regulations allow a separate
election for each aircraft. The final regulations do not allow an
aircraft-by-aircraft election. Requiring taxpayers to make the election
for all aircraft appropriately balances the policies of promoting
business investment through the allowance of additional first-year
depreciation and denying a tax benefit for entertainment use of
business aircraft.
The commentator also suggested that changing depreciation methods
under the transition rule may result in disallowing more than 100
percent of the cost of the aircraft. In response to the comment, the
final regulations clarify that, in any taxable year, the depreciation
disallowance does not exceed the amount of otherwise allowable
depreciation. Thus, the sum of the allowable depreciation and the
depreciation disallowed will not exceed 100 percent of basis,
regardless of the taxable year a taxpayer makes the straight-line
election.
The final regulations provide examples illustrating how taxpayers
determine depreciation and basis under the election.
[[Page 45481]]
d. Interest Expense
A commentator asked for clarification on whether interest is an
expense that is subject to disallowance. In response to this comment,
the final regulations clarify that interest is subject to disallowance
if the underlying debt is secured by or properly allocable to an
aircraft used for entertainment.
e. Aircraft Aggregation
The proposed regulations provide that a taxpayer may aggregate
expenses for aircraft of similar cost profiles to calculate expenses
subject to disallowance. The proposed regulations require that aircraft
have the same engine type and number and suggest other factors relevant
to whether aircraft are of a similar cost profile.
A commentator requested that the final regulations make the
aircraft aggregation rules less restrictive. The commentator opined
that taxpayers should be allowed to aggregate the expenses of all
aircraft to alleviate the administrative burden of computing and
allocating expenses to entertainment use of the aircraft. The
commentator stated that, alternatively, the rules inappropriately
require similar cost profiles to include the same number of engines and
require an unduly detailed analysis of the aircraft characteristics.
The final regulations retain the aircraft aggregation rules.
Aggregating the expenses of all aircraft regardless of cost
characteristics would create unacceptable distortions in the amount of
expenses allocated to the use of each aircraft. The rules are
sufficiently broad and flexible for taxpayers to easily apply them.
2. Allocation of Costs to Flights
a. Primary Purpose Test
The proposed regulations provide two alternative methods for
allocating the costs associated with the use of an aircraft to provide
entertainment to specified individuals. The occupied seat hours or
miles allocation method divides the total expenses for the year by the
number of occupied seat hours or occupied seat miles to determine a per
seat or per mile rate, and it applies the rate to the number of hours
or miles of entertainment use. The flight-by-flight method allocates
expenses to a flight and then to the passengers on the flight according
to the entertainment or nonentertainment character of the travel.
Commentators suggested that the final regulations adopt a primary
purpose test for identifying disallowed expenses. Under a primary
purpose test, the primary purpose of a flight would determine whether
any costs associated with specified individuals traveling for
entertainment on that flight are disallowed. Generally, if the primary
purpose of a flight is business, no more than the additional or
incidental costs associated with specified individuals traveling for
entertainment aboard that flight would be disallowed. Some commentators
suggested that if the primary purpose of a flight is business, no costs
should be allocated to entertainment. One commentator advocated that
the final regulations include a primary purpose test as a safe harbor
for smaller aircraft.
The final regulations do not adopt a primary purpose test. Section
274(e)(2) applies if a taxpayer provides entertainment, amusement, or
recreation to a specified individual and does not depend on either the
reason the taxpayer provides the entertainment or the overall use of
the aircraft. Disregarding entertainment use by a specified individual
is contrary to Congressional intent in amending section 274(e)(2) to
disallow expenses allocable to entertainment use of aircraft by
specified individuals.
b. Effect of Allocation Rules
Commentators suggested the passenger-by-passenger allocation of
costs in the proposed regulations imposes an undue administrative
burden on taxpayers. One commentator stated that the regulations result
in excess disallowance and are unworkable due to their inconsistency
with the primary purpose test. Another commentator said that
determination of the character of each passenger's use could be
difficult and asked for more examples illustrating when a use is
entertainment.
The final regulations retain the occupied seat hours or miles and
flight-by-flight allocation rules. Before the amendment of section
274(e)(2), taxpayers were required to maintain records of the character
of the use of aircraft by employees to comply with the income inclusion
rules of section 61 and Sec. 1.61-21. Any additional administrative
burden resulting from the requirement to identify, and allocate
expenses to, entertainment use of aircraft is limited and is inherent
in the statutory requirement to allocate expenses to entertainment use.
The final regulations do not include additional examples of
entertainment use because entertainment use is defined for purposes of
section 274 in Sec. 1.274-2(b)(1) and is therefore beyond the scope of
this regulation.
3. Allocation of Disallowance to Expenses
The proposed regulations provide that the disallowance provisions
are applied on a pro rata basis to all disallowed expenses. A
commentator requested clarification of how an amount that is treated as
compensation to or reimbursed by a specified individual is allocated to
disallowed expenses. The commentator noted that it is necessary to
determine the amount of disallowed expenses that represents
depreciation to properly adjust an aircraft's basis.
In response to this comment, the final regulations clarify that any
amounts disallowed and any amounts reimbursed or treated as
compensation are applied to total expenses subject to disallowance on a
pro rata basis. The final regulations include an example illustrating
this rule.
4. Bona Fide Security Concerns
The proposed regulations do not exempt expenses for entertainment
travel from disallowance under section 274 when there is a business
need to use the aircraft to provide security pursuant to Sec. 1.132-
5(m). A commentator argued that the final regulations should provide
that the excess cost of using a private aircraft for bona fide security
concerns should not be subject to disallowance. Section 1.132-5(m)
reduces the amount of income inclusion for the fringe benefit under
circumstances in which a bona fide security concern exists, but does
not convert an entertainment flight into a business flight. Because
section 274(e) does not provide an exception to disallowance for
expenses related to the use of a private aircraft for bona fide
security concerns, the final regulations do not adopt this comment.
5. Aircraft as Entertainment Facilities
The proposed regulations do not address the use of aircraft as
entertainment facilities, but requested comments on whether additional
guidance on this question should be issued. Commentators suggested that
the same rules in the proposed regulations should apply to the use of
aircraft as entertainment facilities and requested that the final
regulations clarify when and how the rules apply to entertainment
facilities.
These regulations interpret section 274(e)(2). Section 274(e)(2) is
an exception to the disallowance provisions of section 274(a). Expenses
for entertainment facilities are disallowed under section 274(a)(1)(B).
Therefore, the final regulations clarify that section 274(e)(2) and the
associated regulations apply to expenses for
[[Page 45482]]
entertainment facilities as well as entertainment activities. However,
the final regulations do not include specific rules for the use of
aircraft as entertainment facilities, which are addressed elsewhere in
the section 274 regulations.
6. Deadhead Flights
The proposed regulations provide that an aircraft flying without
passengers en route to pick up, or after having discharged, passengers
(deadhead flight) is generally treated as having the same number and
character of passengers as the leg of the trip on which passengers are
on board. A commentator suggested that the final regulations allow any
reasonable method to determine expenses related to deadhead flights.
The final regulations do not adopt this rule because it would be
difficult to administer.
Another commentator asked that the final regulations provide
examples including mathematical computations for expenses for deadhead
flights. In response to this comment, the final regulations include
examples illustrating the computation of expenses for a deadhead
flight.
7. Leases to Third Parties
The proposed regulations provide that expenses allocable to a lease
or charter of an aircraft to an unrelated third party in a bona-fide
business transaction for the charter period are not subject to the
expense disallowance. A commentator suggested that the rules for leases
and charters to third parties should clarify that ``charter period''
includes ``lease period,'' that not only expenses but also flight hours
or miles attributable to a charter period are removed from the seat/
hour or seat/mile calculation, and that a taxpayer may use any
reasonable method to allocate expenses to a charter period.
The seat hour or seat mile calculation is a method of allocating
expenses to entertainment use. If expenses are not subject to the
expense disallowance, then no allocation is required, and seat hours or
miles attributable to a charter period are not included in that
calculation. The final regulations change the term charter period to
the term lease or charter period. The final regulations also clarify
that whether a third party is unrelated to the taxpayer is determined
under section 267(b) or 707(b).
8. Section 274(e)(8) Exception
A commentator asked for clarification on whether the proposed
regulations modify the section 274(e)(8) exception for ``entertainment
sold to customers.'' Another commentator asked for clarification on
what constitutes ``adequate and full consideration'' for purposes of
the section 274(e)(8) exception.
The proposed and final regulations, which provide guidance on the
section 274(e)(2) exception, state that the section 274(a) disallowance
for the use of a taxpayer-provided aircraft for entertainment does not
apply to expenses that meet the exceptions of section 274(e). As stated
in Sec. 1.274-2(f)(2)(ix), section 274(e)(8) applies only to taxpayers
that are in the trade or business of providing entertainment to
customers, and only to entertainment sold to customers. However, the
final regulations do not provide additional rules on the section
274(e)(8) exception, which is outside the scope of the regulations.
9. Travel on Regularly Scheduled Commercial Airlines
A commentator requested that the final regulations include an
exception for entertainment flights by employees of commercial
passenger or cargo airlines on flights operated by their employers. The
commentator also noted that identifying entertainment use by specified
individuals on these flights and allocating expenses to this use would
be extremely burdensome. While the final regulations do not provide a
general exception to the disallowance rules for taxpayers that are
commercial passenger or cargo airlines because a general exception is
not supported by the statute, the final regulations provide a special
rule for specified individuals on regularly scheduled flights of
taxpayers that are commercial passenger airlines. This rule treats
expenses of entertainment flights by specified individuals in the same
manner as expenses of entertainment flights by non-specified
individuals under certain circumstances.
10. Charitable Contribution Deduction
A commentator suggested that the final regulations should include
rules on charitable contribution deductions for the fixed costs of
using aircraft for charitable purposes. These rules are outside the
scope of the regulations; therefore, the final regulations do not adopt
this comment.
11. Income Inclusion and Compensation
Section 274(e)(2) and the proposed regulations provide, in general,
that expenses are not disallowed to the extent of the amount a taxpayer
treats as compensation to, or includes in the income of, a specified
individual. A commentator requested that the final regulations include
a ``safe harbor deduction'' of the amount of compensation claimed for
the specified individual. The final regulations do not adopt this
comment because section 274(e)(2) already operates as a safe harbor
deduction to the extent of amounts treated as compensation and income,
up to the amount of expenses properly allocable to that entertainment
use.
The proposed regulations additionally provide, in effect, that
expenses are not disallowed to the extent of the amount a specified
individual reimburses the taxpayer. A commentator asked that the final
regulations include examples of how these rules apply when an employee
pays for a flight and that the regulations specify that the taxpayer
has income in that circumstance. The final regulations retain examples
from the proposed regulations that illustrate the amount of expenses
disallowed when amounts are treated as compensation or when an employee
reimburses the taxpayer. The circumstances under which the taxpayer has
income from reimbursements is beyond the scope of these regulations.
Effective/Applicability Date
The final regulations apply to taxable years beginning after August
1, 2012.
Effect on Other Documents
Notice 2005-45 (2005-1 CB 1228) is obsoleted as of August 1, 2012.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866, as
supplemented by Executive Order 13563. Therefore, a regulatory
assessment is not required. Section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations.
Because the regulations do not impose a collection of information on
small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6)
does not apply. Pursuant to section 7805(f) of the Code, the notice of
proposed rulemaking that preceded these final regulations was submitted
to the Chief Counsel for Advocacy of the Small Business Administration
for comment on its impact on small business, and no comments were
received.
Drafting Information
The principal authors of these regulations are Michael Nixon of the
Office of Associate Chief Counsel (Income Tax and Accounting) and Lynne
A. Camillo of the Office of
[[Page 45483]]
Division Counsel/Associate Chief Counsel (Tax Exempt and Government
Entities). However, other personnel from the IRS and Treasury
Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 is amended by adding
entries in numerical order to read, in part, as follows:
Authority: 26 U.S.C. 7805* * *
Section 1.274-9 also issued under 26 U.S.C. 274(o).* * *
Section 1.274-10 also issued under 26 U.S.C. 274(o).* * *
0
Par. 2. Section 1.61-21 is amended by revising paragraphs (g)(14)(i)
and (ii) and adding paragraph (g)(14)(iii) to read as follows:
Sec. 1.61-21 Taxation of fringe benefits.
* * * * *
(g) * * *
(14) * * *
(i) Use by employer. Except as otherwise provided in paragraph
(g)(13) or paragraph (g)(14)(iii) of this section or in Sec. 1.132-
5(m)(4), if the non-commercial flight valuation rule of this paragraph
(g) is used by an employer to value any flight provided in a calendar
year, the rule must be used to value all flights provided to all
employees in the calendar year.
(ii) Use by employee. Except as otherwise provided in paragraph
(g)(13) or (g)(14)(iii) of this section or in Sec. 1.132-5(m)(4), if
the non-commercial flight valuation rule of this paragraph (g) is used
by an employee to value a flight provided by an employer in a calendar
year, the rule must be used to value all flights provided to the
employee by that employer in the calendar year.
(iii) Exception for entertainment flights provided to specified
individuals after October 22, 2004. Notwithstanding the provisions of
paragraph (g)(14)(i) of this section, an employer may use the general
valuation rules of paragraph (b) of this section to value the
entertainment use of an aircraft provided after October 22, 2004, to a
specified individual. An employer who uses the general valuation rules
of paragraph (b) of this section to value any entertainment use of an
aircraft by a specified individual in a calendar year must use the
general valuation rules of paragraph (b) of this section to value all
entertainment use of aircraft provided to all specified individuals
during that calendar year.
(A) Specified individuals defined. For purposes of paragraph
(g)(14)(iii) of this section, specified individual is defined in
section 274(e)(2)(B) and Sec. 1.274-9(b).
(B) Entertainment defined. For purposes of paragraph (g)(14)(iii)
of this section, entertainment is defined in Sec. 1.274-2(b)(1).
* * * * *
0
Par. 3. Section 1.274-9 is added to read as follows:
Sec. 1.274-9 Entertainment provided to specified individuals.
(a) In general. Paragraphs (e)(2) and (e)(9) of section 274 provide
exceptions to the disallowance of section 274(a) for expenses for
entertainment, amusement, or recreation activities, or for an
entertainment facility. In the case of a specified individual (as
defined in paragraph (b) of this section), the exceptions of paragraphs
(e)(2) and (e)(9) of section 274 apply only to the extent that the
expenses do not exceed the amount of the expenses treated as
compensation (under section 274(e)(2)) or as income (under section
274(e)(9)) to the specified individual. The amount disallowed is
reduced by any amount that the specified individual reimburses a
taxpayer for the entertainment.
(b) Specified individual defined. (1) A specified individual is an
individual who is subject to section 16(a) of the Securities Act of
1934 in relation to the taxpayer, or an individual who would be subject
to section 16(a) if the taxpayer were an issuer of equity securities
referred to in that section. Thus, for example, a specified individual
is an officer, director, or more than 10 percent owner of a corporation
taxed under subchapter C or subchapter S or a personal service
corporation. A specified individual includes every individual who--
(i) Is the direct or indirect beneficial owner of more than 10
percent of any class of any registered equity (other than an exempted
security);
(ii) Is a director or officer of the issuer of the security;
(iii) Would be the direct or indirect beneficial owner of more than
10 percent of any class of a registered security if the taxpayer were
an issuer of equity securities; or
(iv) Is comparable to an officer or director of an issuer of equity
securities.
(2) For partnership purposes, a specified individual includes any
partner that holds more than a 10 percent equity interest in the
partnership, or any general partner, officer, or managing partner of a
partnership.
(3) For purposes of this section, officer has the same meaning as
in 17 CFR Sec. 240.16a-1(f).
(4) A specified individual includes a director or officer of a tax-
exempt entity.
(5) A specified individual of a taxpayer includes a specified
individual of a party related to the taxpayer within the meaning of
section 267(b) or section 707(b).
(c) Specified individual treated as recipient of entertainment
provided to others. For purposes of section 274(a), a specified
individual is treated as the recipient of entertainment provided to
another individual because of the relationship of the other individual
to the specified individual if the entertainment is a fringe benefit to
the specified individual under section 61(a)(1) (without regard to any
exclusions from gross income). Thus, expenses allocable to
entertainment provided to the other individual are attributed to the
specified individual for purposes of determining the amount of
disallowed expenses.
(d) Entertainment use of aircraft by specified individuals. For
rules relating to entertainment use of aircraft by specified
individuals, see Sec. 1.274-10.
(e) Effective/applicability date. This section applies to taxable
years beginning after August 1, 2012.
0
Par. 4. Section 1.274-10 is added to read as follows:
Sec. 1.274-10 Special rules for aircraft used for entertainment.
(a) Use of an aircraft for entertainment--(1) In general. Section
274(a) disallows a deduction for certain expenses for entertainment,
amusement, or recreation activities, or for an entertainment facility.
Under section 274(a) and this section, no deduction otherwise allowable
under chapter 1 is allowed for expenses for the use of a taxpayer-
provided aircraft for entertainment, except as provided in paragraph
(a)(2) of this section.
(2) Exceptions--(i) In general. Paragraph (a)(1) of this section
does not apply to deductions for expenses for business entertainment
air travel or to deductions for expenses that meet the exceptions of
section 274(e), Sec. 1.274-2(f), and this section. Section 274(e)(2)
and (e)(9) provides certain exceptions to the disallowance of section
274(a) for expenses for goods, services, and facilities for
entertainment, recreation, or amusement.
(ii) Expenses treated as compensation--(A) Employees who are not
specified individuals. Section
[[Page 45484]]
274(a), Sec. 1.274-2(a) through (d), and paragraph (a)(1) of this
section, in accordance with section 274(e)(2)(A), do not apply to
expenses for entertainment air travel provided to an employee who is
not a specified individual to the extent that a taxpayer--
(1) Properly treats the expenses relating to the recipient of
entertainment as compensation to an employee under chapter 1 and as
wages to the employee for purposes of chapter 24; and
(2) Treats the proper amount as compensation to the employee under
Sec. 1.61-21.
(B) Persons who are not employees and are not specified
individuals. Section 274(a), Sec. 1.274-2(a) through (d), and
paragraph (a)(1) of this section, in accordance with section 274(e)(9),
do not apply to expenses for entertainment air travel provided to a
person who is not an employee and is not a specified individual to the
extent that the expenses are includible in the income of that person.
This exception does not apply to any amount paid or incurred by the
taxpayer that is required to be included in any information return
filed by the taxpayer under part III of subchapter A of chapter 61 and
is not so included.
(C) Specified individuals. Section 274(a), Sec. 1.274-2(a) through
(d), and paragraph (a)(1) of this section, in accordance with section
274(e)(2)(B), do not apply to expenses for entertainment air travel of
a specified individual to the extent that the amount of the expenses do
not exceed the sum of--
(1) The amount treated as compensation to or included in the income
of the specified individual in the manner specified under paragraph
(a)(2)(ii)(A)(1) of this section (if the specified individual is an
employee) or under paragraph (a)(2)(ii)(B) of this section (if the
specified individual is not an employee); and
(2) Any amount the specified individual reimburses the taxpayer.
(iii) Travel on regularly scheduled commercial airlines. Section
274(a), Sec. 1.274-2(a) through (d), and paragraph (a)(1) of this
section do not apply to expenses for entertainment air travel that a
taxpayer that is a commercial passenger airline provides to specified
individuals of the taxpayer on the taxpayer's regularly scheduled
flights on which at least 90 percent of the seats are available for
sale to the public to the extent the expenses are includible in the
income of the recipient of the entertainment in the manner specified
under paragraph (a)(2)(ii)(A)(1) of this section (if the specified
individual is an employee) or under paragraph (a)(2)(ii)(B) of this
section (if the specified individual is not an employee).
(b) Definitions. The definitions in this paragraph (b) apply for
purposes of this section.
(1) Entertainment. For the definition of entertainment for purposes
of this section, see Sec. 1.274-2(b)(1). Entertainment does not
include personal travel that is not for entertainment purposes. For
example, travel to attend a family member's funeral is not
entertainment.
(2) Entertainment air travel. Entertainment air travel is any
travel aboard a taxpayer-provided aircraft for entertainment purposes.
(3) Business entertainment air travel. Business entertainment air
travel is any entertainment air travel aboard a taxpayer-provided
aircraft that is directly related to the active conduct of the
taxpayer's trade or business or related to an expenditure directly
preceding or following a substantial and bona fide business discussion
and associated with the active conduct of the taxpayer's trade or
business. See Sec. 1.274-2(a)(1)(i) and (ii). Air travel is not
business entertainment air travel merely because a taxpayer-provided
aircraft is used for the travel as a result of a bona fide security
concern under Sec. 1.132-5(m).
(4) Taxpayer-provided aircraft. A taxpayer-provided aircraft is any
aircraft owned by, leased to, or chartered to, a taxpayer or any party
related to the taxpayer (within the meaning of section 267(b) or
section 707(b)).
(5) Specified individual. For rules relating to the definition of a
specified individual, see Sec. 1.274-9.
(c) Amount disallowed. Except as otherwise provided, the amount
disallowed under this section for an entertainment flight by a
specified individual is the amount of expenses allocable to the
entertainment flight of the specified individual under paragraph
(e)(2), (e)(3), or (f)(3) of this section, reduced (but not below zero)
by the amount the taxpayer treats as compensation or reports as income
under paragraph (a)(2)(ii)(C)(1) of this section to the specified
individual, plus any amount the specified individual reimburses the
taxpayer.
(d) Expenses subject to disallowance under this section--(1)
Definition of expenses. In determining the amount of expenses subject
to disallowance under this section, a taxpayer must include all of the
expenses of operating the aircraft, including all fixed and variable
expenses the taxpayer deducts in the taxable year. These expenses
include, but are not limited to, salaries for pilots, maintenance
personnel, and other personnel assigned to the aircraft; meal and
lodging expenses of flight personnel; take-off and landing fees; costs
for maintenance flights; costs of on-board refreshments, amenities and
gifts; hangar fees (at home or away); management fees; costs of fuel,
tires, maintenance, insurance, registration, certificate of title,
inspection, and depreciation; interest on debt secured by or properly
allocated (within the meaning of Sec. 1.163-8T) to an aircraft; and
all costs paid or incurred for aircraft leased or chartered to the
taxpayer.
(2) Leases or charters to third parties. Expenses allocable to a
lease or charter of a taxpayer's aircraft to an unrelated (as
determined under section 267(b) or 707(b)) third-party in a bona-fide
business transaction for adequate and full consideration are excluded
from the definition of expenses in paragraph (d)(1) of this section.
Only expenses allocable to the lease or charter period are excluded
under this paragraph (d)(2).
(3) Straight-line method permitted for determining depreciation
disallowance under this section--(i) In general. In lieu of the amount
of depreciation deducted in the taxable year, solely for purposes of
paragraph (d)(1) of this section, a taxpayer may elect to treat as its
depreciation deduction the amount that would result from using the
straight-line method of depreciation over the class life (as defined by
section 168(i)(1) and using the applicable convention under section
168(d)) of an aircraft, even if the taxpayer uses a different
methodology to calculate depreciation for the aircraft under other
sections of the Internal Revenue Code (for example, section 168). If
the property qualifies for the additional first-year depreciation
deduction provided by, for example, section 168(k), 168(n), 1400L(b),
or 1400N(d), depreciation for purposes of this straight-line election
is determined on the unadjusted depreciable basis (as defined in Sec.
1.168(b)-1(a)(3)) of the property. However, the amount of depreciation
disallowed as a result of this paragraph (d)(3) for any taxable year
cannot exceed a taxpayer's allowable depreciation for that taxable
year. For purposes of this section, a taxpayer that elects to use the
straight-line method and class life under this paragraph (d)(3) for any
aircraft it operates must use that methodology for all depreciable
aircraft it operates and must continue to use the methodology for the
entire period the taxpayer uses any depreciable aircraft.
(ii) Aircraft placed in service in earlier taxable years. The
amount of depreciation for purposes of this paragraph (d)(3) for
aircraft placed in service in taxable years before the
[[Page 45485]]
taxable year of the election is determined by applying the straight-
line method of depreciation to the unadjusted depreciable basis (or,
for property acquired in an exchange to which section 1031 applies, the
basis of the aircraft as determined under section 1031(d)) and over the
class life (using the applicable convention under section 168(d)) of
the aircraft as though the taxpayer used that methodology from the year
the aircraft was placed in service.
(iii) Manner of making and revoking election. A taxpayer makes the
election under this paragraph (d)(3) by filing an income tax return for
the taxable year that determines the taxpayer's expenses for purposes
of paragraph (d)(1) of this section by computing depreciation under
this paragraph (d)(3). A taxpayer may revoke an election only for
compelling circumstances upon consent of the Commissioner by private
letter ruling.
(4) Aggregation of aircraft--(i) In general. A taxpayer may
aggregate the expenses of aircraft of similar cost profiles for
purposes of calculating disallowed expenses under paragraph (c) of this
section.
(ii) Similar cost profiles. Aircraft are of similar cost profiles
if their operating costs per mile or per hour of flight are comparable.
Aircraft must have the same engine type (jet or propeller) and the same
number of engines to have similar cost profiles. Other factors to be
considered in determining whether aircraft have similar cost profiles
include, but are not limited to, maximum take-off weight, payload,
passenger capacity, fuel consumption rate, age, maintenance costs, and
depreciable basis.
(5) Authority for establishing safe harbors for determining
expenses. The Commissioner may establish in published guidance, see
Sec. 601.601(d)(2) of this chapter, one or more safe harbor methods
under which a taxpayer may determine the amount of expenses paid or
incurred for entertainment flights.
(e) Allocation of expenses--(1) General rule. For purposes of
determining the expenses allocated to entertainment air travel of a
specified individual under paragraph (a)(2)(ii)(C) of this section, a
taxpayer must use either the occupied seat hours or miles method of
paragraph (e)(2) of this section or the flight-by-flight method of
paragraph (e)(3) of this section. A taxpayer must use the chosen method
for all flights of all aircraft for the taxable year.
(2) Occupied seat hours or miles method--(i) In general. The
occupied seat hours or miles method determines the amount of expenses
allocated to a particular entertainment flight of a specified
individual based on the occupied seat hours or miles for an aircraft
for the taxable year. Under this method, a taxpayer may choose to use
either occupied seat hours or miles for the taxable year to determine
the amount of expenses allocated to entertainment flights of specified
individuals, but must use occupied seat hours or miles consistently for
all flights of all aircraft for the taxable year.
(ii) Computation under the occupied seat hours or miles method. The
amount of expenses allocated to an entertainment flight taken by a
specified individual is computed under the occupied seat hours or miles
method by determining--
(A) The total expenses for the year under paragraph (d) of this
section for the aircraft or group of aircraft (if aggregated under
paragraph (d)(4) of this section), as applicable;
(B) The number of occupied seat hours or miles for the taxable year
for the aircraft or group of aircraft by totaling the occupied seat
hours or miles of all flights in the taxable year flown by the aircraft
or group of aircraft, as applicable. The occupied seat hours or miles
for a flight is the number of hours or miles flown for the flight
multiplied by the number of seats occupied on that flight. For example,
a flight of 6 hours with three passengers results in 18 occupied seat
hours;
(C) The cost per occupied seat hour or mile for the aircraft or
group of aircraft, as applicable, by dividing the total expenses under
paragraph (e)(2)(ii)(A) of this section by the total number of occupied
seat hours or miles under paragraph (e)(2)(ii)(B) of this section; and
(D) The amount of expenses allocated to an entertainment flight
taken by a specified individual by multiplying the number of hours or
miles of the flight by the cost per occupied hour or mile for that
aircraft or group of aircraft, as applicable, as determined under
paragraph (e)(2)(ii)(C) of this section.
(iii) Allocation of expenses of multi-leg trips involving both
business and entertainment legs. A taxpayer that uses the occupied seat
hours or miles allocation method must allocate the expenses of a trip
by a specified individual that involves at least one segment for
business and one segment for entertainment between the business travel
and the entertainment travel unless none of the expenses for the
entertainment segment are disallowed. The entertainment cost of a
multi-leg trip is the total cost of the flights (by occupied seat hours
or miles) minus the cost of the flights that would have been taken
without the entertainment segment or segments.
(iv) Examples. The following examples illustrate the provisions of
this paragraph (e)(2):
Example 1. (i) A taxpayer-provided aircraft is used for Flights
1, 2, and 3, of 5 hours, 5 hours, and 4 hours, respectively, during
the Taxpayer's taxable year. Each flight carries four passengers. On
Flight 1, none of the passengers is a specified individual. On
Flight 2, passengers A and B are specified individuals traveling for
entertainment purposes and passengers C and D are not specified
individuals. For Flight 2, Taxpayer treats $1,200 as compensation to
A, and B reimburses Taxpayer $500. On Flight 3, all four passengers
(A, B, E, and F) are specified individuals traveling for
entertainment purposes. For Flight 3, Taxpayer treats $1,300 each as
compensation to A, B, E, and F. Taxpayer incurs $56,000 in expenses
for the operation of the aircraft for the taxable year. The aircraft
is operated for 56 occupied seat hours for the period (four
passengers times 5 hours (20 occupied seat hours) for Flight 1, plus
four passengers times 5 hours (20 occupied seat hours) for Flight 2,
plus four passengers times 4 hours (16 occupied seat hours) for
Flight 3. The cost per occupied seat hour is $1,000 ($56,000/56
hours).
(ii) For purposes of determining the amount disallowed (to the
extent not treated as compensation or reimbursed) for entertainment
provided to specified individuals, $5,000 ($1,000 x 5 hours) each is
allocable to A and B for Flight 2, and $4,000 ($1,000 x 4 hours)
each is allocable to A, B, E, and F for Flight 3.
(iii) For Flight 2, because Taxpayer treats $1,200 as
compensation to A, and B reimburses Taxpayer $500, Taxpayer may
deduct $1,700 of the cost of Flight 2 allocable to A and B. The
deduction for the remaining $8,300 cost allocable to entertainment
provided to A and B on Flight 2 is disallowed (for A, $5,000 less
the $1,200 treated as compensation, and for B, $5,000 less the $500
reimbursed).
(iv) For Flight 3, because Taxpayer treats $1,300 each as
compensation to A, B, E, and F, Taxpayer may deduct $5,200 of the
cost of Flight 3. The deduction for the remaining $10,800 cost
allocable to entertainment provided to A, B, E, and F on Flight 3 is
disallowed ($4,000 less the $1,300 treated as compensation to each
specified individual).
Example 2. (i) G, a specified individual, is the sole passenger
on an aircraft that makes three flights. First, G travels on a two-
hour flight from City A to City B for business purposes. G then
travels on a three-hour flight from City B to City C for
entertainment purposes, and returns from City C to City A on a four-
hour flight. G's flights have resulted in nine occupied seat hours
(two for the first segment, plus three for the second segment, plus
four for the third segment). If G had returned directly to City A
from City B, the flights would have resulted in four occupied seat
hours.
(ii) Under paragraph (e)(2)(iii) of this section, five occupied
seat hours are
[[Page 45486]]
allocable to G's entertainment (nine total occupied seat hours minus
the four occupied seat hours that would have resulted if the travel
had been a roundtrip business trip without the entertainment
segment). If Taxpayer's cost per occupied seat hour for the year is
$1,000, $5,000 is allocated to G's entertainment use of the aircraft
($1,000 x five occupied seat hours). The amount disallowed is $5,000
minus the total of any amount the Taxpayer treats as compensation to
G plus any amount that G reimburses Taxpayer.
(3) Flight-by-flight method--(i) In general. The flight-by-flight
method determines the amount of expenses allocated to a particular
entertainment flight of a specified individual on a flight-by-flight
basis by allocating expenses to individual flights and then to a
specified individual traveling for entertainment purposes on that
flight.
(ii) Allocation of expenses. A taxpayer using the flight-by-flight
method must combine all expenses (as defined in paragraph (d)(1) of
this section) for the taxable year for the aircraft or group of
aircraft (if aggregated under paragraph (d)(4) of this section), as
applicable, and divide the total amount of expenses by the number of
flight hours or miles for the taxable year for that aircraft or group
of aircraft, as applicable, to determine the cost per hour or mile.
Expenses are allocated to each flight by multiplying the number of
miles for the flight by the cost per mile or the number of hours for
the flight by the cost per hour. The expenses for the flight then are
allocated to the passengers on the flight per capita. Thus, if five
passengers are traveling on a flight, and the total expense allocated
to the flight is $10,000, the expense allocable to each passenger is
$2,000.
(f) Special rules--(1) Determination of basis. (i) If any deduction
for depreciation is disallowed under this section, the rules of Sec.
1.274-7 apply. In that case, the basis of an aircraft is not reduced
for the amount of depreciation disallowed under this section.
(ii) The provisions of this paragraph (f)(1) are illustrated by the
following examples:
Example 1. (i) B Co. is a calendar-year taxpayer that owns an
aircraft not used in commercial or contract carrying of passengers
or freight. The aircraft is placed in service on July 1 of Year 1
and has an unadjusted depreciable basis of $1,000,000. The class
life of the aircraft for depreciation purposes is 6 years. For
determining depreciation under section 168, B Co. uses the optional
depreciation table that corresponds with the general depreciation
system, the 200 percent declining balance method of depreciation, a
5-year recovery period, and the half-year convention. For
determining the depreciation disallowance for each year under
paragraph (d)(3) of this section, B Co. elects to use the straight-
line method of depreciation and the class life of 6 years and,
therefore, uses the optional depreciation table for purposes of
section 168 that corresponds with the straight-line method of
depreciation, a recovery period of 6 years, and the half-year
convention. In each year, the aircraft entertainment use subject to
disallowance under this section is 10 percent of the total use.
(ii) B Co. calculates the depreciation and basis of the aircraft
as follows:
--------------------------------------------------------------------------------------------------------------------------------------------------------
200 Percent
declining Straight line Depreciation
balance depreciation disallowance under Depreciation deduction Sec. 1.274-7 Basis of Suspended basis.
depreciation amount section 274 aircraft
amount
--------------------------------------------------------------------------------------------------------------------------------------------------------
Year 1............... 200,000 83,300 8,330. (.10 x 83,300).. 191,670 (200,000 minus 808,330 (1,000,000 8,330.
8,330). minus 191,670).
Year 2............... 320,000 166,700 16,670 (.10 x 166,700). 303,330 (320,000 minus 505,000 (808,330 minus 25,000 (8,300 plus
16,670). 303,330). 16,670).
Year 3............... 192,000 166,700 16,670 (.10 x 166,700). 175,330 (192,000 minus 329,670 (505,000 minus 41,670 (25,000 plus
16,670). 175,330). 16,670).
Year 4............... 115,200 166,700 16,670 (.10 x 166,700). 98,530 (115,200 minus 231,140 (329,670 minus 58,340 (41,670 plus
16,670). 98,530). 16,670).
Year 5............... 115,200 166,600 16,660 (.10 x 166,600). 98,540 (115,200 minus 132,600 (231,140 minus 75,000 (58,340 plus
16,660). 98,540). 16,660).
Year 6............... 57,600 166,700 16,670 (.10 x 166,700). 40,930 (57,600 minus 91,670 (132,600 minus 91,670 (75,000 plus
16,670). 40,930). 16,670).
Year 7............... .............. 83,300 8,330 (.10 x 83,300)... ....................... 91,670................. 91,670.
--------------------------------------------------------------------------------------------------------------------------------------------------------
(iii) In Year 7, there is no further deduction for depreciation
of the aircraft, therefore, under paragraph (d)(3) of this section,
no depreciation expense is disallowed. Under Sec. 1.274-7 and this
paragraph (f)(1), basis is not reduced for disallowed depreciation.
Therefore, at the end of Year 7, the basis of the aircraft for
purposes of Sec. 1.274-7 is $91,670, which is the total amount of
disallowed depreciation in Years 1 through 6. B Co.'s deductions for
depreciation total $908,330, which added to $91,670 equals
$1,000,000.
Example 2. (i) The facts are the same as in Example 1, except
that B Co. does not elect to use the straight-line method of
depreciation under paragraph (d)(3) of this section until Year 3.
(ii) B Co. calculates the depreciation and basis of the aircraft
as follows:
--------------------------------------------------------------------------------------------------------------------------------------------------------
200 Percent
declining Straight line Depreciation
balance depreciation disallowance under Depreciation deduction Sec. 1.274 Basis of Suspended basis.
depreciation amount section 274 aircraft
amount
--------------------------------------------------------------------------------------------------------------------------------------------------------
Year 1............... 200,000 .............. 20,000 (.10 x 200,000). 180,000................ 820,000 (1,000,000 20,000.
minus 180,000).
Year 2............... 320,000 .............. 32,000 (.10 x 320,000). 288,000 (320,000 minus 532,000 (820,000 minus 52,000 (20,000 plus
32,000). 288,000). 32,000).
Year 3............... 192,000 166,700 16,670 (.10 x 166,700). 175,330 (192,000 minus 356,670 (532,000 minus 68,670 (52,000 plus
16,670). 175,330). 16,670).
Year 4............... 115,200 166,700 16,670 (.10 x 166,700). 98,530 (115,200 minus 258,140 (356,670 minus 85,340 (68,670 plus
16,670). 98,530). 16,670).
Year 5............... 115,200 166,600 16,660 (.10 x 166,600). 98,540 (115,200 minus 159,600 (258,140 minus 102,000 (85,340 plus
16,660). 98,540). 16,660).
[[Page 45487]]
Year 6............... 57,600 166,700 16,670 (.10 x 166,700). 40,930 (57,600 minus 118,670 (159,600 minus 118,670 (102,000 plus
16,670). 40,930). 16,670).
Year 7............... .............. 83,300 8,330 (.10 x 83,300)... 0...................... 118,670................ 118,670.
--------------------------------------------------------------------------------------------------------------------------------------------------------
(iii) In Year 7, there is no further deduction for depreciation
of the aircraft, therefore, under paragraph (d)(3) of this section,
no depreciation expense is disallowed. Under Sec. 1.274-7 and this
paragraph (f)(1), basis is not reduced for disallowed depreciation.
Therefore, at the end of Year 7, the basis of the aircraft for
purposes of Sec. 1.274-7 is $118,670, which is the total amount of
disallowed depreciation in Years 1 through 6. B Co.'s deductions for
depreciation total $881,330, which added to $118,670 equals
$1,000,000.
(2) Pro rata disallowance. (i) The amount of disallowed expenses,
and any amounts reimbursed or treated as compensation, under this
section are applied on a pro rata basis to all of the categories of
expenses subject to disallowance under this section.
(ii) The provisions of this paragraph (f)(2) are illustrated by the
following example:
Example. (i) C Co. owns an aircraft that it uses for business
and other purposes. The expenses of operating the aircraft in the
current year total $1,000,000. This amount includes $250,000 for
depreciation (25 percent of total expenses).
(ii) In the same year, the aircraft entertainment use subject to
disallowance under this section is 20 percent of the total use and C
Co. treats $80,000 as compensation to specified individuals. Thus,
the amount of the disallowance under this section is $120,000
($1,000,000 x 20 percent ($200,000) less $80,000).
(iii) Under paragraph (f)(2) of this section, C Co. may
calculate the amount by which a category of expense, such as
depreciation, is disallowed by multiplying the total disallowance of
$120,000 by the ratio of the amount of the expense to total
expenses. Thus, $30,000 of the $120,000 total disallowed expenses is
depreciation ($250,000/$1,000,000 (25 percent) x $120,000).
(iv) The result is the same if C Co. separately calculates the
amount of depreciation in total disallowed expenses and in the
amount treated as compensation and nets the result. Depreciation is
25 percent of total expenses, thus, the amount of depreciation in
disallowed expenses is $50,000 (25 percent x $200,000 total
disallowed expenses) and the amount of depreciation treated as
compensation is $20,000 (25 percent x $80,000). Disallowed
depreciation is $50,000 less $20,000, or $30,000.
(3) Deadhead flights. (i) For purposes of this section, an aircraft
returning without passengers after discharging passengers or flying
without passengers to pick up passengers (deadheading) is treated as
having the same number and character of passengers as the leg of the
trip on which passengers are aboard for purposes of allocating expenses
under paragraphs (e)(2) or (e)(3) of this section. For example, when an
aircraft travels from point A to point B and then back to point A, and
one of the legs is a deadhead flight, for determination of disallowed
expenses, the aircraft is treated as having made both legs of the trip
with the same passengers aboard for the same purposes.
(ii) When a deadhead flight does not occur within a roundtrip
flight, but occurs between two unrelated flights involving more than
two destinations (such as an occupied flight from point A to point B,
followed by a deadhead flight from point B to point C, and then an
occupied flight from point C to point A), the allocation of passengers
and expenses to the deadhead flight occurring between the two occupied
trips must be based solely on the number of passengers on board for the
two occupied legs of the flight, the character of the travel of the
passengers on board (entertainment or nonentertainment) and the length
in hours or miles of the two occupied legs of the flight.
(iii) The provisions of this paragraph (f)(3) are illustrated by
the following examples:
Example 1. (i) Aircraft flies from City A to City B, a 6-hour
trip, with 12 passengers aboard. Eight of the passengers are
traveling for business and four of the passengers are specified
individuals traveling for entertainment purposes. The aircraft flies
empty (deadheads) from City B to City C, a 4-hour trip. At City C it
picks up 12 passengers, six of whom are traveling for business and
six of whom are specified individuals traveling for entertainment
purposes, for a 2-hour trip to City A. The taxpayer uses the
occupied seat hour method of allocating expenses.
(ii) The two legs of the trip on which the aircraft is occupied
comprise 96 occupied seat hours (12 passengers x 6 hours (72) for
the first leg plus 12 passengers x 2 hours (24) for the third leg).
Sixty occupied seat hours are for business (8 passengers x 6 hours
(48) for the first leg plus 6 passengers x 2 (12) hours for the
third leg) and 36 occupied seat hours are for entertainment purposes
(4 passengers x 6 hours (24) for the first leg plus 6 passengers x 2
(12) hours for the third leg). Dividing the 36 occupied seat
entertainment hours by 96 total occupied seat hours, 37.5 percent of
the total occupied seat hours of the two occupied flights are for
entertainment.
(iii) The 4-hour deadhead leg comprises one-third of the total
flight time of 12 hours. Therefore, the deadhead flight is deemed to
have provided one-third of the total 96 occupied seat hours, or 32
occupied seat hours (96 x \1/3\ = 32). Of the 32 deemed occupied
seat hours, 37.5 percent, or 12 deemed occupied seat hours, are
treated as entertainment under paragraph (f)(3)(ii) of this section.
The 32 deemed occupied seat hours for the deadhead flight are
included in the calculation under paragraph (e)(2)(ii)(B) of this
section and expenses are allocated under paragraph (e)(2)(ii)(D) of
this section to the 12 deemed occupied seat hours treated as
entertainment.
Example 2. (i) The facts are the same as for Example 1, but the
taxpayer uses the flight-by-flight method of allocation.
(ii) Of the 24 passengers on the occupied flights, 10
passengers, or 41.7 percent, are traveling for entertainment
purposes. If the annual cost per flight hour calculated under
paragraph (e)(3)(ii) of this section is $1,000, $4,000 is allocated
to the 4-hour deadhead leg. Under paragraph (f)(3)(ii) of this
section, 41.7 percent of the $4,000, or $1,667, is treated as an
expense for entertainment. The calculation of the cost per mile or
hour for the year under paragraph (e)(3)(ii) of this section
includes the expenses and number of miles or hours flown for the
deadhead leg.
(g) Effective/applicability date. This section applies to taxable
years beginning after August 1, 2012.
Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
Approved: July 25, 2012.
Emily S. McMahon,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2012-18693 Filed 7-31-12; 8:45 am]
BILLING CODE 4830-01-P