n-05-45.pdf

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Part III - Administrative, Procedural, and Miscellaneous

Deductions for Entertainment Use of Business Aircraft

Notice 2005-45

This notice provides interim guidance to taxpayers on the limitation under
§ 274(e) of the Internal Revenue Code on the deductible amount of trade or business
expenses for use of a business aircraft for entertainment. Section 274(e) was amended
by § 907 of the American Jobs Creation Act of 2004 (AJCA), effective for amounts
incurred after October 22, 2004. The rules provided in this notice apply until regulations
are effective.
A. BACKGROUND
Under § 274(a)(1)(A), no deduction is allowed for an activity generally considered
to be entertainment, amusement, or recreation, unless the taxpayer establishes that the
activity is directly related to or (in certain cases) associated with the active conduct of
the taxpayer’s trade or business. Section 274(a)(1)(B) disallows deductions for facilities
used in connection with entertainment, amusement, or recreational activity, regardless
of connection to the taxpayer’s trade or business.
Section 1.274-2(b)(1) of the Income Tax Regulations provides that entertainment
means any activity 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,

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vacation and similar trips. Similar activities relating solely to the taxpayer's family also
may constitute entertainment. Entertainment may include an activity that satisfies the
personal, living, or family needs of an individual, such as providing food and beverages
or a hotel suite to a business customer or the customer’s family. Entertainment does
not include activities, however, that are clearly not regarded as constituting
entertainment, such as the provision of supper money by an employer to an employee
working overtime, the maintenance of a hotel room by an employer for lodging of
employees while in business travel status, or the use of an automobile in the active
conduct of a trade or business even though also used for routine personal purposes
such as commuting to and from work. Under § 1.274-2(b)(1)(ii), an objective test is
used to determine whether an activity is of a type generally considered to constitute
entertainment.
Section 274(e) provides exceptions to the general disallowance provisions of
§ 274(a). Prior to amendment by the AJCA, § 274(e)(2) excepted expenses from §
274(a) “to the extent that the expenses are treated by the taxpayer” as compensation to
the employee/recipient of the entertainment activity. Section 274(e)(9) similarly
excepted expenses to the extent that the expenses are treated by the taxpayer as
income to persons who are not employees.
Section 274(o) provides that the Secretary shall prescribe regulations necessary
to carry out the purposes of the section.
Generally, § 1.61-21(b) requires an employee to include in gross income the fair
market value of a fringe benefit, such as an entertainment flight (reduced by any

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reimbursement or statutory exclusion). For employee flights on employer-provided
noncommercial aircraft, § 1.61-21(g) provides that an employer may value such flights
using the Standard Industry Fare Level (SIFL) formula. Under § 1.61-21(g)(14)(i), an
employer that uses the SIFL formula in a calendar year to value any flight provided to
an employee during a calendar year must use the SIFL formula to value all flights
provided to employees during that calendar year. The fringe benefit rules under § 1.61-
21(g) generally apply to all service providers, including employees, independent
contractors, partners, and directors. The regulations do not permit valuation of a flight
by reference to the employer’s costs.
Ann. 85-113, 1985-31 IRB 31, allows an employer to elect the frequency at which
in-kind fringe benefits are treated as paid. The benefits must be treated as paid no later
than the end of each calendar year, but in-kind fringe benefits provided during the last
two months of a calendar year may be treated as paid during the subsequent calendar
year. See Ann. 85-113, sections 1 and 5(a).
In Sutherland Lumber-Southwest, Inc. v. Comm’r, 114 T.C. 197 (2000), aff’d 255
F.3d 495 (8
th
Cir. 2001), acq. AOD 2002-02 (Feb. 11, 2002), the Tax Court held that the
amount a taxpayer may deduct for the cost of entertainment-related flights under the §
274(e)(2) exception is not limited to the amount included in the income of the
employees and corporate officers who took the flights. Rather, the court held that a
taxpayer may deduct the full cost of an employee’s or officer’s non-business flight on
the taxpayer’s aircraft if the taxpayer includes in the recipient’s income the value of the
flights computed under the rules of § 1.61-21. As a result, a deduction greater than the

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amount included in the recipient’s income was allowable.
The ACJA amendment to § 274(e)(2) and (9) is intended to overturn Sutherland
Lumber-Southwest, Inc. v. Comm’r. H.R. Conf. Rep.
No. 108-755, at 798 (2004).
Specifically, as amended by § 907 of the AJCA, the § 274(e)(2) and (9) exceptions to
the § 274(a) disallowance apply in the case of a “specified individual” only “to the extent
that the expenses do not exceed the amount of expenses” that are treated as
compensation to the specified individual. A specified individual is any individual who is
subject to the requirements of § 16(a) of the Securities Exchange Act of 1934 (15
U.S.C. § 78p(a)) with respect to the taxpayer, or who would be subject to those
requirements if the taxpayer were an issuer of equity securities referred to in that
section. Section 274(e)(2)(B).
Thus, in the case of a specified individual, the § 274(e)(2) and (9) exceptions
apply only to the extent that a taxpayer treats as compensation to the specified
individual an amount equal to or greater than the amount of deductible entertainment
expenses allocable to entertainment provided to the specified individual. Expenses
allocable to entertainment provided to the specified individual that are not treated as
compensation to the specified individual are disallowed.
This notice specifically addresses expenses paid or incurred in connection with
the use of aircraft as entertainment. Section 274 (e)(2) and (9), however, apply to all
expenses subject to § 274(a). Taxpayers may apply the principles of this notice to
expenses paid or incurred in connection with other entertainment activities.
B. APPLICATION

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(1) In general
In general, the use of an aircraft for an employee’s or other recipient’s
entertainment, amusement, or recreation is subject to § 274(a) unless excepted by §
274(e). Expenses for entertainment use of an aircraft by a specified individual are
disallowed except to the extent of the amount treated as compensation to the specified
individual, as provided in this notice. The amount disallowed with regard to a specific
flight also is reduced by any amount that a specified individual reimburses the taxpayer
for that flight.
(2) Use of aircraft for entertainment

Whether an aircraft is used for entertainment of a specified individual is
determined without regard to the ownership of the aircraft. Therefore, the costs of
leased or chartered aircraft are subject to disallowance under § 274(a) (unless excepted
by § 274(e)) and this notice. Furthermore, § 274(a) and (e) and this notice apply to the
costs of aircraft operated on a regular schedule or used for bona fide security concerns
(as provided in § 1.132-5(m)).
(3) Specified individuals

A “specified individual” is either an individual who is subject to § 16(a) of the
Securities Exchange Act of 1934 with respect to the taxpayer, or an individual who
would be subject to § 16(a) if the taxpayer were an issuer of equity securities referred to
in that section. “Specified individual” includes every person who (a) is the direct or
indirect beneficial owner of more than 10 percent of any class of any registered equity
security (other than an exempted security), (b) is a director or officer of the issuer of the

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security, (c) would be the direct or indirect beneficial owner of more than 10 percent of
any class of a registered equity security if the taxpayer were an issuer of equity
securities, or (d) is comparable to an officer or director of an issuer of equity securities.
Thus, a “specified individual” is an officer, director, or more than 10% owner of a
corporation taxed under subchapter C or subchapter S, or a personal service
corporation. For partnership purposes, “specified individual” includes any partner that
holds a more than 10% equity interest in the partnership, general partner, officer, or
managing member of a partnership. "Specified individual" also includes a director or
officer of a tax-exempt entity.
The provisions of this notice apply to the use of an aircraft for the entertainment
of a specified individual of a party related to the taxpayer within the meaning of § 267(b)
or § 707(b). Thus, if X and Y are related corporations within the meaning of § 267(b)
and Y provides entertainment use of an aircraft to A, who is a specified individual as to
X, Y’s costs are disallowed (except to the extent treated as compensation to A or
reimbursed by A) under § 274(e)(2)(B).
For purposes of this notice, a specified individual is the recipient of entertainment
provided to a spouse or family member of the specified individual or to another person
because of the person’s relationship to the specified individual. See § 1.61-21(a)(4).
Thus, costs allocable to entertainment provided to a spouse, family member, or other
person are attributed to the specified individual for purposes of determining the amount
of disallowed costs. As used hereafter in this notice, the term “specified individual”
includes any person to whom a taxpayer has provided entertainment that is attributable

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to a specified individual under this paragraph.
(4) Expenses of aircraft subject to disallowance

For purposes of calculating the amount of expenses for entertainment use of an
aircraft that are disallowed (except to the extent treated as compensation to or
reimbursed by a specified individual) under § 274(e)(2)(B) or (9), taxpayers must take
into account all of the expenses of maintaining and operating the aircraft (all fixed and
operating costs). These expenses include, but are not limited to, fuel costs; salaries for
pilots, maintenance personnel, and other personnel assigned to the aircraft; meal and
lodging expenses of flight personnel; take-off and landing fees; costs for maintenance
and maintenance flights; costs of on board refreshments, amenities, or gifts; hangar
fees (at home or away); management fees; depreciation; amounts deductible under §
179 ; in the case of chartered aircraft, all costs billed for the charter (including amounts
for flight time, waiting time, fuel, and overnight expenses); and, in the case of leased
aircraft or other leased equipment, lease payments.
(5) Method of allocating expenses to flights

For purposes of § 274(e)(2)(B) and (9), the total deductible expenses attributable
to the aircraft must be allocated to expenses for use of the aircraft for entertainment of
specified individuals and expenses for all other uses. A taxpayer must allocate
expenses for each taxable year using either occupied seat hours or occupied seat miles
flown by the aircraft and must apply the chosen method consistently for all usage for the
taxable year. Occupied seat hours or miles is the sum of the hours or miles flown by an
aircraft multiplied by the number of seats occupied for each hour or mile. For example,

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a flight of 6 hours with three passengers aboard results in 18 occupied seat hours. See
the special rule for “deadhead” flights, below.
Taxpayers must aggregate all fixed and variable expenses to determine the total
expenses paid or incurred during the taxable year and divide the amount of total
expenses by total occupied seat hours or occupied seat miles flown to determine the
cost per occupied seat hour or occupied seat mile. Taxpayers may calculate the cost
per occupied seat hour or occupied seat mile separately for each aircraft or may
aggregate the costs of aircraft of similar cost profiles. For example, the costs of a
turboprop aircraft may not be aggregated with the costs of a jet aircraft and the costs of
a two-engine jet aircraft may not be aggregated with the costs of a four-engine jet
aircraft.
The amount disallowed under § 274 is the sum of (a) the cost of each occupied
seat hour (or mile) flown by a specified individual for entertainment purposes, less (b)
the sum of the amount treated as compensation and the amount reimbursed for each
specified individual and each flight. Therefore, to determine the amount subject to
disallowance, taxpayers must allocate the costs to the specific entertainment flight
provided to a specified individual and compare the cost of each flight to the amount
treated as compensation to or reimbursed by the specified individual for that flight.
Example

A taxpayer’s aircraft is used for Flights 1, 2, and 3, of 5 hours, 5 hours, and 4
hours, respectively, during the taxpayer’s taxable year. On Flight 1, there are four
passengers, none of whom are specified individuals or traveling for entertainment. On

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Flight 2, passengers A and B are specified individuals traveling for entertainment and
passengers C and D are not
specified individuals or are not traveling for entertainment.
On Flight 3, all four passengers (A, B, E, and F) are specified individuals traveling for
entertainment. The taxpayer incurs $56,000 in expenses for the operation of the aircraft
for the taxable year.
The aircraft is operated for a total of 56 occupied seat hours for the period (four
passengers times 5 hours or 20 occupied seat hours for Flight 1, plus four passengers
times 5 hours or 20 occupied seat hours for Flight 2, plus four passengers times 4 hours
or 16 occupied seat hours for Flight 3). The cost per occupied seat hour is $1,000
($56,000/56 hours). The total entertainment usage of the aircraft for specified
individuals subject to disallowance is 26 occupied seat hours (two passengers for 5
hours each on Flight 2 and four passengers for 4 hours each on Flight 3) and the total
cost subject to disallowance is $26,000 (26 occupied seat hours X $1,000).
For purposes of determining the amount disallowed (to the extent not treated as
compensation or reimbursed), $5,000 ($1,000 X 5 hours) each is allocable to A and B
for Flight 2, and $4,000 ($1,000 X 4 hours) each is allocable to A, B, E, and F for Flight
3.
For Flight 2, the taxpayer treats $1,200 (the fair market value of the flight) as
compensation to A, and B reimburses the taxpayer $500. The taxpayer may deduct
$1,700 of the cost of Flight 2 allocable to A and B. The deduction for the remaining
$8,300 cost allocable to entertainment provided to A and B on Flight 2 is disallowed
(with respect to A, $5,000 less the $1,200 treated as compensation, and with respect to

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B, $5,000 less the $500 reimbursed). For Flight 3, the taxpayer treats $1,300 (the fair
market value of the flight) each as compensation to A, B, E, and F. The taxpayer may
deduct $5,200 of the cost of Flight 3. The deduction for the remaining $10,800 cost
allocable to entertainment provided to A, B, E, and F on Flight 3 is disallowed ($4,000
less the $1,300 treated as compensation to each specified individual).
(6) Special rule for “deadhead” flights

For purposes of this notice, an aircraft returning empty from a flight after
discharging passengers or traveling empty to pick up passengers (deadheading) is
treated as having the same number and character of occupied seat miles or hours as
the leg or legs of the trip on which passengers are aboard.
(7) Allocation of expenses on trips of a specified individual involving both business and
entertainment
The costs of a flight provided to a specified individual that includes a segment or
segments for business and for entertainment must be allocated to the business and
entertainment use. The entertainment cost is the excess of the total cost of the flights
(by occupied seat hours or miles) over the cost of the flights that would have been taken
without the entertainment segment or segments.
Example
. G, a specified individual, is the sole passenger on an aircraft on a two-
hour flight from City A to City B. The flight from City A to City B is for business. G then
travels on a three-hour flight from City B to City C for entertainment purposes, and
returns from City C to City A on a four-hour flight. G’s flights have resulted in nine
occupied seat hours (two for the first segment, plus three for the second segment, plus

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four for the third segment). If G had returned directly to City A from City B, the flights
would have resulted in four occupied seat hours. Five occupied seat hours are
allocable to G’s entertainment use of the aircraft (nine total occupied seat hours less
four occupied seat hours). If the taxpayer’s cost per occupied seat hour is $1,000,
$5,000 must be allocated to G’s entertainment use of the aircraft ($1,000 X five
occupied seat hours). The amount disallowed is $5,000 less any amount the taxpayer
treats as compensation to G or G reimburses the taxpayer for this flight.
(8) Non-commercial flight valuation consistency rule

Under § 1.61-21(g)(14)(i), a taxpayer who uses the SIFL formula in a calendar
year to value any flight provided to an employee must use the SIFL formula to value all
flights provided to employees during that calendar year. The Internal Revenue Service
and the Treasury Department plan to amend these regulations to permit taxpayers to
value the entertainment use of aircraft by specified individuals under the fair market
value rules of § 1.61-21(b), but continue to value flights for other employees and for
specified individuals not traveling for entertainment using the SIFL formula. Until
regulations are published, taxpayers may rely on this notice to allow this inconsistency
in the treatment of specified and non-specified individuals for income inclusion
purposes. If the amount treated as compensation is greater than the amount of the
taxpayer’s costs (as determined under this notice) for a flight, however, the taxpayer’s
deduction is limited to the taxpayer’s costs.
(9) Interaction with § 162(m)

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Any amount for the entertainment use of an aircraft that is treated by the
taxpayer as compensation to a specified individual who is also a "covered employee"
(as defined in § 162(m)(3)) is subject to § 162(m). Thus, to the extent the covered
employee's "applicable employee remuneration" (as defined in § 162(m)(4)), including
remuneration related to entertainment, exceeds $1,000,000, the taxpayer's deduction is
disallowed under § 162(m).
(10) Costs treated as compensation

The amount of costs to which this notice applies is reduced by an amount treated
as compensation to a specified individual who is an employee of the taxpayer if the
amount is treated as compensation for the flight on the taxpayer’s income tax return as
originally filed and as wages for purposes of chapter 24 (relating to withholding of
income tax at the source on wages). See § 1.274-2(f)(2)(iii)(A) and Ann. 85-113. For a
specified individual who is not the taxpayer’s employee, costs are treated as
compensation if the amount for the flight is included in an information return under Part
III of subchapter A of chapter 61 (unless not required to be reported under those
provisions). See § 1.274-2(f)(2)(iii)(B).
C. REQUEST FOR COMMENTS
The Service and the Treasury Department request comments on issues arising
under this notice. Comments should be submitted in writing on or before August 1,
2005, and should include a reference to Notice 2005-45. Comments may be submitted
to CC:PA:LPD:PR (Notice 2005-45), Room 5203, Internal Revenue Service, P.O. Box
7604, Ben Franklin Station, Washington, DC 20044. Alternatively, comments may be

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submitted electronically via the following e-mail address:
Notice.Comments@irscounsel.treas.gov. Please include “Notice 2005-45” in the
subject line of any electronic communications.
Submissions may be hand delivered Monday through Friday between the hours
of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (Notice 2005-45), Courier’s Desk, Internal
Revenue Service, 1111 Constitution Avenue, NW, Washington, DC 20224. All
comments are available for public inspection and copying.
D. EFFECTIVE DATE
This notice applies to expenses incurred after June 30, 2005. The Service will
not challenge a reasonable method of determining disallowed expenses incurred after
October 22, 2004, and before July 1, 2005. Application of this notice to determine
disallowed expenses is a reasonable method.
E. TRANSITION RULE FOR REPORTING DISALLOWED EXPENSES
A taxpayer that incurs expenses to which § 274(e), as amended by the AJCA,
applies in a taxable year ending after October 22, 2004, but on or before May 27, 2005,
may apply the disallowance of expenses for that taxable year against expenses incurred
in the taxpayer’s first taxable year ending after May 27, 2005. Thus, for example, a
calendar year taxpayer may choose to adjust its taxable income either (a) for its 2005
taxable year to reflect the disallowance of expenses to which this notice applies that are
incurred after October 22, 2004, and before January 1, 2006, or (b) for its 2004 taxable
year to reflect the disallowance of the portion of the expenses incurred after October 22,
2004, and before January 1, 2005, and for its 2005 taxable year to reflect the

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disallowance of the portion of the expenses incurred after December 31, 2004, and
before January 1, 2006.
DRAFTING INFORMATION
The principal author of this notice is Michael A. Nixon of the Office of the
Associate Chief Counsel (Income Tax & Accounting). For further information regarding
this notice, contact Mr. Nixon or Christian Wood at (202) 622-4930 (not a toll-free call).