Monday, December 26, 2011

Missing Whatever

LAFA 20115002F



Number: 20115002F

Release Date: 12/16/2011


date: September 27, 2011


Revenue Agent [Redacted Text] (LB&I), Waukesha


Associate Area Counsel (LB&I), Chicago


Deduction for Cost of [Redacted Text] to [Redacted Text] *** Taxpayer

This memorandum is in response to your request for advice in the examination of ***

Taxpayer for the tax years ended *** a-through *** b. At issue is whether the taxpayer can deduct the [Redacted Text] to *** c by major shareholders to recover a [Redacted Text] [Redacted Text] . In our opinion, the costs are not deductible on the corporate return.

This memorandum was coordinated with the National Office, Associate Chief Counsel for Income Tax and Accounting, Branch 2. This advice may not be used or cited as precedent.


Taxpayer = [Redacted Text]

a = [Redacted Text]

b = [Redacted Text]

c = [Redacted Text]

d = [Redacted Text]

e = [Redacted Text]

f = [Redacted Text]

g = [Redacted Text]

h = [Redacted Text]

i = [Redacted Text]

j = [Redacted Text]

k = [Redacted Text]

l = [Redacted Text]

m = [Redacted Text]

n = [Redacted Text]

o = [Redacted Text]

p = [Redacted Text]

q = [Redacted Text]

r = [Redacted Text]

s = [Redacted Text]

t = [Redacted Text]

u = [Redacted Text]

v = [Redacted Text]

w = [Redacted Text]

x = [Redacted Text]

y = [Redacted Text]

z = [Redacted Text]

aa = [Redacted Text]

ab = [Redacted Text]

ac = [Redacted Text]

ad = [Redacted Text]

ae = [Redacted Text]

af = [Redacted Text]

ag = [Redacted Text]

ah = [Redacted Text]

a i= [Redacted Text]

aj = [Redacted Text]

ak = [Redacted Text]

al = [Redacted Text]

am = [Redacted Text]

an = [Redacted Text]

ao = [Redacted Text]

ap = [Redacted Text]


*** Taxpayer (hereinafter “the taxpayer” or “the company”) is a major manufacturer of *** d. The company was founded in *** e as *** f and, by the [Redacted Text] , was a successful manufacturer of *** g, with subsidiaries in *** h, *** i, and *** j.

In [Redacted Text] the president and principal stockholder, *** k, led an [Redacted Text] to the *** l area of *** m in search of a reliable supply of *** n. *** n was, at that time, *** o and was derived from *** p. The company purchased a *** q [Redacted Text] for the [Redacted Text] . The [Redacted Text] was successful and the company established a [Redacted Text] in *** m. In [Redacted Text] , the [Redacted Text] was sold to *** r, which used it for an [Redacted Text] to *** c, where the [Redacted Text] [Redacted Text].

In [Redacted Text] , *** s, son of *** k and the principal shareholder of the company, and his two sons, *** t and *** u [Redacted Text] of the *** q to *** m in a [Redacted Text] of the [Redacted Text]. The expenses of the trip were currently deducted on the corporate return and the costs of building the [Redacted Text] and of making a [Redacted Text] *** v were capitalized and depreciated. The Service did not challenge this treatment. The company displayed the [Redacted Text]. [Redacted Text] in the *** w's [Redacted Text] in *** x, along with an exhibit describing the original and the commemorative [Redacted Text] . The [Redacted Text] was not donated to the *** w; the [Redacted Text] and the exhibit were later transferred to the taxpayer's [Redacted Text] at its headquarters campus. The company [Redacted Text] is not an organization exempt from tax under I.R.C. §§ 501(a) and 501(c)(3).

Also in fiscal year [Redacted Text] , *** s led an [Redacted Text] to *** c to locate the remains of the original [Redacted Text] . The [Redacted Text] was not successful. The cost of this [Redacted Text] was deducted on the corporate return for [Redacted Text] . Upon examination, the Service did not challenge this deduction.

*** s was described by *** y in [Redacted Text] as *** z. His donations to the *** aa, the *** ab, and *** ac are [Redacted Text], legendary. *** v was favorably reviewed by *** ad, which called it *** ae. The [Redacted Text] has been [Redacted Text] for invited audiences, at [Redacted Text] , and on the *** af [Redacted Text] *** ag. *** k died in [Redacted Text] ; *** s died in [Redacted Text] 4. *** s's sons *** t and *** u are currently major shareholders in the company. *** s is chairman and chief executive officer of the company. The company is [Redacted Text]; all shares are owned by members of the *** ah family or by family trusts.

In fiscal year [Redacted Text] , *** t, *** u, and several family members travelled to *** c after hearing rumors that the *** q [Redacted Text] had been located in a different area than previously suspected. The [Redacted Text] found and positively identified the [Redacted Text] and investigated the possibility of [Redacted Text], returning it to the [Redacted Text], and displaying it in the company [Redacted Text]. Expenses were incurred for travel, [Redacted Text] rental, [Redacted Text], [Redacted Text], security, public relations, and related items. Filming costs totaled approximately $[Redacted Text] and travel costs were calculated at approximately $ [Redacted Text]. Some $[Redacted Text] was paid to experts at *** ai for a study on recovering and transporting the [Redacted Text]. The company eventually decided not to remove the [Redacted Text] and a [Redacted Text][Redacted Text]was erected at the site.

An exhibit at the company [Redacted Text] *** aj displays photographs, video, and artifacts of the [Redacted Text], along with the reproduction [Redacted Text] and displays describing the original and commemorative [Redacted Text] to *** m. The taxpayer states that the original and [Redacted Text][Redacted Text] are “company icons holding particular significance to [the company], company employees and the surrounding community” and are “vital elements of [the company's]culture” that “enhance and create opportunities for [the company] to tell its story and promote the company.” The [Redacted Text] was mentioned in the company's [Redacted Text] “public report” but, as the company is [Redacted Text], the extent to which this report is distributed is not clear.

The company deducted the above-mentioned costs of the *** ak [Redacted Text] on its tax return for fiscal year [Redacted Text]. Travel costs of $————- for the widow of *** s, two of her grandsons, and *** t were paid for by the *** ah family and were not deducted by the corporation.

Currently, the corporate returns for the years ended *** a through *** b are under examination. At issue is whether the costs of the *** al [Redacted Text] of [Redacted Text](fiscal year [Redacted Text] ) (hereinafter “the *** al [Redacted Text]”) are deductible.


Are the costs of an [Redacted Text], led by a corporate president/shareholder, to recover the remains of an [Redacted Text] prominent in the history of the corporation deductible on the corporate return?


I.R.C. § 162(a) allows as a deduction “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”

Reg. § 1.162-2 allows a taxpayer to deducted travel expenses that are “reasonable and necessary in the conduct of the taxpayer's business and directly attributable to it.” It further states that “if the trip is undertaken for other than business purposes, the travel fares and expenses incident to travel are personal expenses...”

“Necessary,” as it is used in § 162(a), means that the expense is appropriate and helpful, rather than absolutely essential. Welch v. Helvering, 290 U.S. 111, 113 (1933). But if there are other, more economical and practical means of attaining a result, the expense is not reasonable and, therefore, not necessary. A.S. Barber, Inc. v. United States, 85-1 USTC P 9138 (D. Mo. 1984); Sherman v. Commissioner, 44 TCM 1324, 1326 (1982); Ciaravella v. Commissioner, T.C. Memo. 1998-31. Under Reg. § 1.162-1(a), a corporation may deduct expenses for advertising and promotion. In determining the extent to which advertising expenses are reasonable, the court will compare the amount expended for the activity in question with the amount of benefit reasonably expected to be derived. Ciaravella v. Commissioner, T.C. Memo. 1998-31; Mathes v. Commissioner, T.C. Memo. 1990-483.

An expenditure that benefits employees in a private setting does not promote or advertise the taxpayer's business to the world of customers and is therefore not deductible. Quarrier Diner, Inc. v. Commissioner, 22 TCM 276, 279 (1963). The advertising must be directed toward those constituting the taxpayer's market or business environment. U.S. Equipment Co. v. Commissioner, 22 TCM 1309, 1321 (1963). The lack of exposure to groups from whom the taxpayer's business contacts or customers are likely to emerge precludes deduction of the expense. W.D. Gale, Inc. v. Commissioner, 297 F.2d 270, 271 (6th Cir. 1961).

The payment by one taxpayer of an expense of another taxpayer's trade or business is not deductible. Deputy v. DuPont, 308 U.S. 488, 494 (1940). As a general rule, the trade or business of a corporation is not also a trade or business of its share-holders. Whipple v. Commissioner, 373 U.S. 193, 202 (1963).

I.R.C. § 262(a) states that “except as otherwise expressly provided in this chapter, no deduction shall be allowed for personal, living, or family expenses.”

I.R.C. § 170(a) allows as a deduction “any charitable contribution . . . payment of which is made within the taxable year.” Under § 170(b)(2), in the case of a taxpayer-corporation, the deduction “shall not exceed 10 percent of the taxpayer's taxable income.” Under § 170(c), in order to be deductible, the contribution must be made to certain units of government, or to organizations organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competition, or for the prevention of cruelty to children or animals, provided the organization is not disqualified under § 501(c)(3).


In our opinion, the expenditures at issue are not deductible by the taxpayer as they are not ordinary and necessary expenses of the taxpayer's trade or business. In order for an expenditure to be deductible as advertising, the taxpayer has the burden of proving a proximate relationship between the expenditure and the corporation's business, that the activity “was reasonably calculated to call public attention to its business in some manner that might reasonably be expected to produce some patronage benefit,” and that the expenditure was reasonable in amount compared to the reasonably expected benefits. W.D. Gale v. Commissioner, T.C. Memo. 1960-191.

For example, in W.D. Gale v. Commissioner, T.C. Memo. 1960-191, the principal shareholder of an electrical contracting business was prominent in motor boat racing. The expenses of that activity were held not deductible by the corporation as the corporation was rarely mentioned in connection with the activity and, therefore, the business “received no substantial publicity” from the racing program.

Similarly, in Sieber v. Commissioner, T.C. Memo. 1979-15, the taxpayer claimed that his polo-playing activities were expenditures for the advertising and promotion of his building construction business. The court stated that

Petitioner has the burden of proof that his costs of playing polo were ordinary and necessary expenses of that business under section 162 . To carry his burden, it is incumbent upon petitioner to show affirmatively that the expenditures were undertaken primarily for a business, not a social or personal, purpose and that there was a proximate, rather than merely a remote or incidental, relationship between the expenditures and petitioner's business — essentially a question of fact. His burden is not made easier by the fact that the expenses involved are of a character which are normally personal and, therefore, may fall within the ambit of section 262, which takes precedence over section 162 . We conclude that petitioner has not carried his burden of proof. The weight of the evidence strongly suggests that petitioner played polo primarily because it gave him personal satisfaction and helped him maintain a close relationship with his family.[citations omitted.]

As the court stated in Mathes v. Commissioner, T.C. Memo. 1990-483,

Section 162(a) is not a carte blanche grant by the Government for the right to deduct all expenses which arguably are somewhat related to an income-producing activity, no matter how unreasonable in amount. The element of reasonableness is inherent in the phrase “ordinary and necessary” ... whether the amount of the deduction claimed is reasonable is determined under the facts and circumstances of each case. The burden of proving that such amounts are reasonable rests with petitioner. In determining whether the amount expended is reasonable, the amount of the expenditure has been compared with the benefit to be derived. [citations omitted.]

Admittedly, it is not for the Service to decide whether a taxpayer's expenditure is the best possible use of the company's funds, only whether it was ordinary and necessary in pursuit of the business. Expenditures for advertising are deductible whether or not the advertising is effective; they are even deductible if the advertising completely misfires and has disastrous results for the company's sales and reputation. The deduction depends primarily on whether the expenditure, at the time it was authorized, “might reasonably be expected to produce some patronage benefit.” On the other hand, the expenditure cannot have merely a remote or tangential connection with promoting the company; and the expense must be reasonable in amount compared to the reasonably expected benefits. Extravagant expenditures from which a reasonable person could expect only minimal benefits are not deductible. As the court stated in Helstoski v. Commissioner, T.C. Memo. 1990-382:

We do not intend to suggest that we should, as a matter of course, second-guess taxpayers' business decisions or restrict taxpayers to deduction of only the least expensive method of conducting their businesses. Nevertheless, when the individuals involved are major owners and ranking officers of the business in question, and when the issue is whether the travel expenses were primarily the personal expenses of those controlling individuals or primarily business expenses, one factor that may bear upon that issue is whether there are less expensive alternatives that would have been practical ways to conduct the business activities without so much, or so costly, travel.

In your examination, the taxpayer has not demonstrated that the *** al [Redacted Text] was intended to benefit the reputation or increase the sales of the corporation. It has not demonstrated that the results of the [Redacted Text] were disclosed to customers or potential customers (or were intended to be so disclosed) in any manner beyond the [Redacted Text] exhibit, public report, and perhaps some other minimal publications. It has not proven that the large expenses of the [Redacted Text] were reasonable in relation to the corporate benefits that could reasonably be expected.

We note also that, even if it could be established that the [Redacted Text] improved the reputation and goodwill of the *** ah family, such an accomplishment is not necessarily a promotion of the corporation itself and thus not deductible by the corporation. Brown v. Commissioner, T.C. Memo. 1970-253. Only the promotion of the company and its products qualify for deduction under § 162(a). The company has attempted to link the two, stating that the company:

projects an image of a unique family culture founded on principles and values... [that] the *** aj represents the spirit of family, the spirit of adventure, and the spirit of leadership—all values that are part of who we are as a company... it highlights *** Taxpayer's family company message and celebrates its history... *** Taxpayer has qualified research showing that consumers would rather buy from a family-owned business...

Creating an environment where emotional connections with the *** ah family and a sense of pride among employees are also very helpful in creating a stronger, more vibrant company.

We believe that any promotion of the good reputation of the *** ah family that may have resulted from the *** al [Redacted Text] is too remote from the promotion of the company and its products to qualify as a corporate advertising deduction.

The taxpayer has refe rred to Poletti v. Commissioner, 330 F.2d 818 (8 th Cir. 1964), in support of its deduction. In that case, the taxpayer ran an employment agency and gave free gifts, both to individuals who sought placement through the agency and to companies where it placed employees. The court held such expenditures deductible, noting that a taxpayer “should not be penalized taxwise for business ingenuity in utilizing advertising techniques which do not conform to the practices of one whom he is naturally trying to surpass in profits.”

Though this precedent no doubt endorses creativity in advertising, we do not believe it supports the deduction at issue. Unlike Poletti, where it was obvious that the expenditure, though unconventional, benefitted the company, the taxpayer here has not proven that the expenditure resulted in any useful promotional communication to potential customers, or was intended to do so, at least not on a scale commensurate to the size of the expenditure.

Furthermore, the elements of personal pleasure cannot be ignored. Although we do not doubt that the *** al [Redacted Text] had some historic element, the photographs and descriptions of the [Redacted Text], as provided to the Service by the taxpayer, indicate that the president of the company, his mother, and other relatives enjoyed many recreational amenities on this [Redacted Text], including diving, sailing, swimming, and other diversions. As numerous judicial opinions indicate, these factors weigh in favor of a finding that the expenses are non-deductible as “personal, living, or family expenses” under § 262 and against a finding of a business purpose under § 162(a). The fact that the expenses of five 1 family members who travelled on the expedition were not deducted on the corporate return suggests that the expedition was primarily a family recreational event and not primarily business-related.

The Regulations under § 162 envision three types of travel: (1) “Solely on business,” in which case all reasonable and necessary travel expenses, including meals and lodging, are deductible ( Reg. § 1.162-2(a)); (2) travel that mixes personal and business, in which case the expenses of travel to the destination are deductible if the trip is “primarily” for business ( Reg. § 1.162-2(b)(1)); and (3) travel “primarily personal in nature“, in which case the “traveling expenses to and from the destination are not deductible even though the taxpayer engages in business activities while at such destination” but “expenses while at the destination which are properly allocable to the taxpayer's trade or business are deductible” ( Reg. § 1.162-2(b)(1)). In your examination the *** al expedition appears to be primarily personal. The company has not established (and cannot establish) that any part of the expenses are business, because the only potentially business-related activity would be advertising-related which (as explained above) is too insufficient to qualify as ordinary and necessary.

As we do not believe the expenditures qualify under § 162, we do not reach the issue of whether they would be capitalized and amortized (rather than deducted currently) as discussed in Reg. § 1.162-20(a).

Neither are the expenses deductible as a charitable contribution. Although a small [Redacted Text] documenting the *** al [Redacted Text] was placed in the taxpayer's [Redacted Text], that [Redacted Text] is not a tax-exempt entity as defined in I.R.C. §§ 170 and 501(c)(3). In connection with the *** al [Redacted Text], no cash or other thing of value was transferred to a tax-exempt entity, nor did the company pay any expenses that were the legal obligation of a tax-exempt entity. A charitable contribution deduction is thus not an appropriate alternative.

As you have noted, the Service examined this taxpayer in previous years and did not disallow deductions arising from a previous [Redacted Text] (in [Redacted Text]) for the [Redacted Text][Redacted Text]. We note that, as a matter of law, the Service is not required to treat a taxpayer consistently from year to year; the fact that the Service allows a deduction in one year does not bar the Service from disallowing a similar deduction in a later year. Each year stands on its own. United States v. Skelly Oil Co., 394 U.S. 678, 684 (1969);Knights of Columbus Council #3660 v. United States , 783 F.2d 69 (7 th Cir 1986); Rose v. Commissioner, 55 T.C. 28, 32 (1970); Rooney v. Commissioner, T.C. Memo. 2011-14. Even if justification were needed for treating the two years differently, there may be factual distinctions between the two [Redacted Text] which justify the deduction of one but not the other. For example, the earlier [Redacted Text] is included in the [Redacted Text] *** v which may be of legitimate advertising value; the second [Redacted Text] took place after the making of the [Redacted Text] and does not appear to have been given any significant exposure to the public. The first [Redacted Text] may have lacked the family vacation factors prominent in the second [Redacted Text]. It is also possible that the earlier deduction simply escaped the Service's attention, or the amount was deemed insignificant, or the pursuit of a deficiency was judged to be an unjustified use of the Service's limited resources. Of course, we cannot now (on the grounds of consistency) disallow the [Redacted Text] deduction, as the statute of limitations on assessment has expired for that fiscal year. But the Service need not allow a similar deduction in [Redacted Text] on the grounds of consistency.

Consistency objections could also be raised due to the Service disallowing the costs of the *** al [Redacted Text] of [Redacted Text] while allowing other contributions to or expenses of the company [Redacted Text] in that year. Again, we note that the Service is not obliged to disallow every deduction that could conceivably be challenged; the Service can allow some questionable deductions while disallowing others. In this case, the Service does not choose to question whether the entire [Redacted Text] and all of its costs are defensible as an advertising and promotional expense in the years under examination. The taxpayer states (without citation to any authority) that the deduction of the costs of company [Redacted Text] on the grounds that they promote the company and its products is not unheard of. It is entirely possible that the taxpayer in this case can justify and substantiate that the [Redacted Text] in general (and the [Redacted Text] *** v are legitimate advertising expenses; we maintain, however, that the taxpayer has not proven that the costs of the [Redacted Text] were primarily business rather than personal under §§ 162(a) and 262, and that the [Redacted Text] resulted in any useful promotional communication to potential customers, or was intended to do so, at least not on a scale commensurate to the size of the [Redacted Text].

Of course, consistent with the expense not being deductible on the corporate return, that part of the cost of the [Redacted Text] which is a personal benefit to the president of the company is income to him not reported on his return. It is at the discretion of the Compliance Division, however, whether an examination of the president's individual return should be opened and an adjustment proposed; this decision involves matters regarding the allocation of IRS time and resources that are beyond the scope of Counsel's knowledge and authority.


We conclude that there is no legal basis for deducting the costs of the fiscal year [Redacted Text] to locate the [Redacted Text] of the [Redacted Text].

If you have any questions, please contact the undersigned at 414-231-2807.

Steven R. Guest

Associate Area Counsel (LB&I)

By: [Redacted Text]



*** am, *** at, *** an, *** ao, and *** ap.

1 comment:

  1. This is interesting. I know what company, and what family, and almost all the other "blanks" involved in this decision......