MEAL AND ENTERTAINMENT EXPENSES – Jacobs v. C.I.R., 148 T.C. No. 24 (2017)
Why This Case is Important: This case provides a detailed explanation of the 50% limitation on business deductions for meal and entertainment expenses and an important exception to that limitation.
Facts: In Jacobs, the taxpayers were the owners of several entities, including an S corporation, that, together, own the Boston Bruins, a professional hockey team in the National Hockey League (NHL). NHL teams play a total of 82 regular season games, 41 at home and 41 on the road. On road trips, the team travels with dozens of employees, including team members, coaches, and administrative staff, many of whom spend the night prior to the game in a hotel in the city where the game is to be played. These hotels generally provide the organization’s employees with a series of meals, which are consumed in banquet rooms furnished by the hotels at no additional cost. In 2009 and 2010, the taxpayers’ S corporation filed tax returns on which it deducted over $500,000 total related to the organization’s pregame meals related to away games. The IRS disallowed 50% of these deductions, resulting in income tax deficiencies to the taxpayers of approximately $85,000. The taxpayers filed a petition with the U.S. Tax Court contesting these deficiencies.
Law and Analysis: Section 162(a) of the Internal Revenue Code allows a deduction for all necessary and ordinary expenses incurred carrying on a trade or business. Under Section 274(a)(1)(A), deductions for meal expenses related to a trade or business are limited to 50% of the actual expense, with certain exceptions. One of these exceptions is for meals that constitute a “de minimis fringe benefit.” Under Section 132(e) of the Code, for a meal to be a de minimis fringe benefit, it must be: (1) available to all employees, without discriminating in favor of highly compensated employees; (2) provided at an eating facility that is owned or leased by the employer, operated by the employer, and located on or near the business premises of the employer; and (3) provided during, or immediately before or after, the employee’s workday. Furthermore, the employer must not substantially profit from operating the facility. After reviewing these factors, the Court determined that the meals provided by the organization constituted de minimis fringe benefits. With respect to the second requirement, it found that through its contracts with the hotels, the organization leased, and for a period of time operated the banquet rooms in which meals were provided. That being the case, the Court found in favor of the taxpayers and reversed the IRS’s 50% disallowance of the organization’s meal expenses.
DEDUCTIONS FOR LEGAL FEES / ORIGIN OF CLAIM – Dulik v. C.I.R., T.C. Summ. Op. 2017-1 (2017)
Why this Case is Important: When individuals incur legal fees related to their employment or business operations, they often question whether those fees are deductible. This issue becomes more complicated when it is unclear whether the fees were incurred in a taxpayer’s individual capacity or in relation to his or her business. This case is a good example of this type of situation and explanation of the rule for deductibility.
Facts: In Dulik, the taxpayer was employed by a pharmaceutical company for approximately 30 years. In the course of his employment with the company, he signed a non-compete agreement that restricted his ability to provide services to any competitor of his employer throughout the world for two years after his employment terminated. In 2010, the taxpayer’s employer terminated his employment and provided him with a separation agreement that provided him with a severance benefit and, among other terms, incorporated the restrictions on his ability to compete with the employer. The taxpayer wanted to negotiate the terms of his separation, including the restriction on competition, and hired an attorney for assistance in doing so. After a couple months of discussions, the employer refused to negotiate any terms of the agreement and the taxpayer signed the agreement. He paid his attorneys $27,000 in legal fees for their assistance. The following month, the taxpayer incorporated an S corporation, which he intended to operate in the pharmaceutical industry. On the corporation’s 2010 income tax return, it did not report any income. It had approximately $30,000 of deductions, $27,000 of which were related to the payments to the taxpayer’s attorneys. This loss flowed through to the taxpayer’s personal income tax return. The IRS disallowed the corporate deduction for legal fees and adjusted the corporate and personal returns accordingly. The taxpayer filed a petition with the Tax Court contesting this disallowance.
Law and Conclusion: To the extent that the legal fees were incurred in carrying on the corporation’s business, they were properly deducted on the corporate tax return. If they were not incurred in carrying on that business, they were not deductible by the corporation but instead were deductible as an itemized deduction of the taxpayer to the extent they exceeded 2% of the taxpayer’s adjusted gross income (which they did not). In determining which taxpayer is entitled to deduct legal fees, the Court will look to the “origin” of the legal claim at issue. The taxpayer’s position was that the purpose of the fees was to avoid the non-compete restrictions so that the corporation could operate free of those restrictions. As the Court stated, while this may have been the case, it was not relevant to the Court’s determination because the Court was not concerned with the consequences of the legal action, but instead was concerned with the origin of the action. The Court determined that the legal action arose from the taxpayer’s personal status as a former employee of his employer, and the terms of his separation from that employer. That being the case, the legal fees were properly deducted on his personal tax return, if at all. The Court found in favor of the IRS.
LACK OF PROFIT MOTIVE – Lewis v. C.I.R., T.C. Memo. 2017-117 (2017)
Why This Case is Important: This case is a good example of a situation in which a taxpayer was not able to deduct expenses related to what he considered to be his “business” activities because he did not operate that business with a profit motive.
Facts: In Lewis, the taxpayer was a minister who occasionally performed weddings, attended meetings, and conducted seminars. On his 2011 personal income tax return, he deducted expenses related to these activities. The IRS examined the taxpayer’s return and determined that, in his capacity as a minister, he was not operating a business. Therefore, it disallowed all related deductions and assessed a tax deficiency against the taxpayer of almost $1,700 and penalties of over $300. The taxpayer filed a Tax Court petition contesting the disallowances and resulting assessments.
Law and Analysis: Section 162(a) of the Internal Revenue Code allows a deduction for all necessary and ordinary expenses incurred carrying on a trade or business. The taxpayer’s position was that he was engaged in the business of being a minister and that all expenses he incurred in his capacity as a minister were tax deductible. For a taxpayer to be engaged in a trade or business in the meaning of Section 162, his primary purpose for engaging in the activity must be for income or profit. The taxpayer was unable to provide evidence that he had a profit motive in carrying on his ministerial and related activities, or that he had profited from those activities. In fact, he testified that many of his services were provided free of charge. Not having been presented with any evidence of a profit motive, the Court found in favor of the IRS.
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