Section 274 Entertainment Disallowance Rules
Section 274(a) disallows a deduction for certain expenses for entertainment, amusement, or recreation activities, or for an entertainment facility. Under section 274, no deduction otherwise allowable under chapter 1 is allowed for expenses for the use of a taxpayer-provided aircraft for entertainment The regulations provide only limited guidance on what "entertainment", "amusement" or "recreation" means for this purpose. The regulations provide that the term "entertainment means any activity which is of a type generally considered to constitute entertainment, amusement, or recreation, such as entertaining at night clubs, cocktail lounges, theaters, country clubs, golf and athletic clubs, sporting events, and on hunting, fishing, vacation and similar trips, including such activity relating solely to the taxpayer or the taxpayer's family." See Treas. Reg. §1.274-2(b)(1). Travel to and from vacation locations have been treated by the IRS as entertainment. See TAM 9715001 (4/11/1997). The Regulations do provide that "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." Treas. Reg. § 1.274-10(b)(1).
At one time, a distinction was drawn between business entertainment (that could be deducted) and personal entertainment (which could not be deducted). However, after passage of the Tax Cuts and Jobs Act in 2017, all entertainment expenses became non-deductible.
The Regulations permit the computation of the disallowance percentages for entertainment use under 4 methods: Flight by flight hours, flight by flight miles, occupied seat miles and occupied set hours. 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. 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. 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. These methods are further adjusted to provide that empty or deadhead flights are characterized based on the flight to which they are associated. In addition, special rules also exist for multi-leg flights that have business and entertainment legs.
Notwithstanding the blanket prohibition against the deduction of of expenses for entertainment, amusement or recreation, Section 274(e) carves out an exception. Specifically, Section 274(e) provides that except with respect to such items provided to specified individuals, the general Sectin 274(a) prohibition does not apply 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 as wages to such employee for purposes of chapter 24 (relating to withholding of income tax at source on wages). With repect to specified individuals, the exception only applies to the extent of the amount included in the income of the specified individual. A specified individual is defined as any individual who is subject to the requirements of Section 16(a) of the Securities Exchange Act of 1934 with respect to a corporation or any subsidiaries as well as any individual who would be subject to the Section 16 reporting rules if the corporation (or any of its subsidiaries) were subject to these reporting rules. This would generally include officers, directors, and 10% shareholders. In the case of a partnership, a specified individual includes any partner that holds more than a 10% equity interest in the partnership and any general partner, officer, or managing partner of the partnership.
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