Business/Industry: Deducting costs of flights on corporate jets.

Deducting Costs of Flights on Corporate Jets
The Internal Revenue Service has disallowed a company's deductions for the costs of using its aircraft to transport a company officer/shareholder and spouse to and from vacation sites in the United States (technical advice memorandum (TAM) 9715001). The IRS views such travel as entertainment that is nondeductible under Internal Revenue Code section 274; therefore, the company's deductions are limited to the amounts it treated as compensation to the officer.

Ninety percent of the company's use of the aircraft was for business purposes. With respect to the vacation flights, the company fully complied with income and payroll tax rules for personal flights, using the 1985 special valuation rules of section 1.61-21(g) to determine the amounts to be treated as compensation.

For more than a decade, taxpayers have assumed that the personal use of a corporate jet will not jeopardize deductions if the special valuation rules are properly followed. The IRS, however, says that while the section 274 disallowance rules may preserve the deduction for the compensation that is imputed, the rules are otherwise unaffected by the company's compliance with the special valuation rules. Therefore, the excess of the expenses incurred—dollar for dollar—over the value imputed to the employee is nondeductible.

Observation: According to the TAM, the personal flights clearly are the type of entertainment expenses Congress targeted with the enactment of the section 274. Thus the expenses should be subject to disallowance provisions regardless of the special valuation rules. Many taxpayers will argue that the 1985 compromise settled both the income and the deduction issues, and that the IRS should not be pursuing a disallowance theory inconsistent with the compromise.

It is possible that the IRS will search for other ways to disallow deductions for costs that have some relationship to fringe benefits when there is a difference between costs incurred and the value imputed to the employee. This could include company cars and spousal travel.

It would be better for such new interpretations of the tax law to be presented in proposed regulations that alert taxpayers prospectively than to be introduced as part of an IRS audit, where the application is retroactive.

—Tracy Hollingsworth, Esq., staff director of tax councils at Manufacturers Alliance, Arlington, Virginia.


Accounting Fees Limited
According to Internal Revenue Code section 7430, if the Internal Revenue Service loses its case against a taxpayer in a tax dispute in which its position was not substantially justified, that taxpayer is entitled to recover reasonable administrative and litigation costs. However, section 7430(c)(1)(B) (iii) limits the recovery of attorney fees to $110 an hour (adjusted for inflation) unless a special factor, such as the limited availability of qualified attorneys for a particular proceeding, justifies a higher rate.

In a recent Tax Court case, Robert T. Cozean v. Commissioner (109 TC no. 10), the IRS issued a $700,000 deficiency notice to a taxpayer stating that various items of income had not been reported and that certain deductions had been denied. Two weeks before the trial, the IRS conceded and settled the case. The taxpayer then filed a motion for award of litigation costs in order to recover his attorney's fees of $250 an hour and related accounting fees of $170 an hour. The taxpayer argued that these rates were reasonable because the number of attorneys qualified to handle such a case was limited. The IRS argued that the taxpayer's recovery should be limited to the statutory cap because no special factors existed.

The court ruled in favor of the government. It cited Pierce v. Underwood (487 U.S. 552, 1988) in which the U.S. Supreme Court ruled that in order to qualify for special factor treatment and recover more than the statutory limit, a taxpayer must prove that his attorney possesses a distinctive knowledge or a specialized skill needed in that particular case. In other words, limited availability of attorneys in a particular field or geographical area does not create a special factor. For special factor status to be considered, the attorney must possess some nonlegal or technical ability other than his or her tax expertise.

For example, recoveries in excess of the statutory amount might be allowed when an attorney specializes in the law of other countries and/or is literate in foreign languages.

The court cautioned that factors such as novelty and difficulty of the issues, the undesirability of the case, the work and ability of counsel, the results obtained and the customary fees and awards in other cases should not be considered in determining whether an upward adjustment of the hourly rate is warranted.

Observation: In Cozean , the taxpayer's CPA was authorized to practice before the IRS and the Tax Court. Such CPAs should advise their clients that section 7430 (c)(3) subjects accounting fees to the same limitations as legal fees and, in the absence of a special factor, are subject to the statutory cap.

—Michael Lynch, CPA, Esq., associate professor of accounting at Bryant College, Smithfield, Rhode Island.

Line Items

    Rating the Enforcers

  • According to Internal Revenue Service fact sheet 97-25, the IRS will try to change the public's perception that an agent's performance rating is based on collections by (1) no longer ranking its district offices, (2) suspending the distribution of any goals relating to revenue production in its field offices, (3) no longer including penalty amounts in its statistical results on revenue collected and (4) asking the General Accounting Office to certify that enforcement results are not used in employee performance reviews.

    Payoff for Tattlers

  • The IRS is authorized to pay rewards to informants for information that leads to the detection and punishment of any person violating the Internal Revenue Code. According to a new temporary regulation (TD 8737), the reward ceiling has been raised to 15% from 10% of the recovered money.

    Till Death Are You Liable

  • In fact sheet 97-13, the IRS discusses the meaning of joint and several liability in relation to married couples who elect to file joint federal income tax returns. The IRS points out that liability continues even after a separation or divorce and has established uniform procedures to notify one spouse of activity against the other while safeguarding the privacy rights of both.

    Yes, This Is John Doe

  • IRS employees must identify themselves by name when dealing with the public. However, if an employee believes that using only a last name is insufficient protection from harassment, that employee may register a pseudonym. According to IRS fact sheet 97-17, approximately 350 pseudonyms are registered.

    Not Out of the Hat

  • According to fact sheet 97-21, the primary method of selecting returns for audit is the computer selection program known as the discriminate function system.

    —Michael Lynch, CPA, Esq., associate professor of accounting at Bryant College, Smithfield, Rhode Island.


©1998 AICPA


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