Townsend Industries, Inc. v. United States

Facts

P manufactures the T-51, a product that allows offset printers to produce two-color documents in a single pass through the printing press. For the last forty years, P has gathered its salespeople for an annual, two-day meeting at its headquarters involving its corporate staff and some factory workers. After the meeting, the company has sponsored a four-day expense-paid fishing trip to a resort in Ontario, Canada. Other than at a dinner at which the company spoke about the state of the company, the employees and salespeople spent their time largely as they wished usually fishing. Business discussions were conducted on an ongoing basis during the trip. The IRS held that the per-employee cost of the trip was taxable wages. Since P did not withhold a portion of those costs the IRS penalized P. A taxpayer may exclude certain fringe benefits from his or her gross income and thereby avoid paying income tax on these benefits. Section 132(d) excludes 'working condition fringe' benefits from an individual's wages and provides that ''working condition fringe' means any property or services provided to an employee of the employer to the extent that, if the employee paid for such property or services, such payment would be allowable as a deduction under section 162 or 167.' Section162(a)(2) allows a deduction for 'traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business.' Section 274(a)(1)(A) disallows deductions for entertainment expenses for an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, unless the taxpayer establishes that the item was directly related to, or, in the case of an item directly preceding or following a substantial and bona fide business discussion (including business meetings at a convention or otherwise), that such item was associated with, the active conduct of the taxpayer's trade or business. Section 274(d) forbids deductions for entertainment expenses unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer's statement (A) the amount of such expense or other item, (B) the time and place of the travel, entertainment, amusement, recreation, or use of the facility or property, or the date and description of the gift, (C) the business purpose of the expense or other item, and (D) the business relationship to the taxpayer of persons entertained, using the facility or property, or receiving the gift. The IRS has regulations that state 'only such traveling expenses as are reasonable and necessary in the conduct of the taxpayer's business and directly attributable to it may be deducted.' 26 C.F.R. § 1.162-2(a) (emphasis added). The regulation then explains that where personal and business travel are mixed, travel expenses may only be deducted 'if the trip is related primarily to the taxpayer's trade or business.' 26 C.F.R. § 1.162-2(b)(1). However, even if the trip is not primarily business-related, expenses 'which are properly allocable to the taxpayer's trade or business' may still be deducted. Section 1.274-2(c)(3) adds four requirements that the taxpayer must meet in order to deduct entertainment and travel expenses. The expense will only be considered directly related to or associated with, the active conduct of business if: (i) . . . the taxpayer had more than a general expectation of deriving some income or other specific trade or business benefit . . . . (ii) . . . the taxpayer actively engaged in a business meeting, negotiation, discussion, or other bona fide business transaction, other than entertainment, for the purpose of obtaining such income or other specific trade or business benefit . . . .(iii) In light of all the facts and circumstances of the case, the principal character or aspect of the combined business and entertainment . . . was the active conduct of the taxpayer's trade or business . . . It is not necessary that more time be devoted to business than to entertainment to meet this requirement. The active conduct of trade or business is considered not to be the principal character or aspect of combined business and entertainment activity on hunting or fishing trips . . . unless the taxpayer clearly establishes to the contrary. (iv) The expenditure was allocable to the taxpayer and a person or persons with whom the taxpayer engaged in the active conduct of trade or business during the entertainment . . . The IRS penalized P and P paid the penalties in part and sued to get a refund of those monies. There were no other formal business meetings but employees discussed work throughout the trip. The trip was used to introduce new products as well. The District Court determined that P failed to establish a business purpose. It held that the trips were not mandatory and the one brief meeting held on the fishing trip was not an ordinary and necessary business expense. It held that P’s general expectation of P to derive uncertain future benefits, particularly in the way of improved relations among its employees and sales personnel was not enough to allow the trips to qualify as directly related under section 274(a). It held that the business conducted in Iowa right before the trip was too remote for the court to find the associated with test had been met. 

Issues

Rule of Law

Holding and Decision

Legal Analysis

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