When the IRS audited Winter Corporation’s current year tax return, the IRS disallowed $10,000 of travel and entertainment expenses incurred by Charles, an officer-shareholder, because of inadequate documentation. The IRS asserted that the $10,000 expenditure was a constructive dividend to Charles, who maintained that the expense was business related. Charles argued that he derived no personal benefit from the expenditure and therefore received no constructive dividend. Prepare a memorandum for your tax manager explaining whether the IRS’s assertion or Charles’s assertion is correct. Your manager has suggested that, at a minimum, you consult the following resources:
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According to Internal Revenue Code section 274(d):
“No deduction or credit shall be allowed under section 162 or 212 for any traveling expense, for any item with respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, or with respect to a facility used in connect with such an activity, unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer’s own 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 requirements to deduct a travel and entertainment expense include substantial adequate documentation. Without this, the IRS will continue assert this $10,000 expenditure as a constructive dividend to Charles, even though he maintained it is business-related and claims no personal benefit. Oral testimony is not enough—written substantial documentation is necessary.
As per sec.162.(a)In generalThere shall be allowed as a
deduction all the ordinary and necessary expenses paid or incurred
during the taxable year in carrying on any trade or business,
including—
(1) a reasonable allowance for salaries or other compensation for
personal services actually rendered;
(2) 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; and
(3) rentals or other payments required to be made as a condition to
the continued use or possession, for purposes of the trade or
business, of property to which the taxpayer has not taken or is not
taking title or in which he has no equity.
In addition there should be proper evidence for the expense
incurred.
1.274-1 Disallowance of certain entertainment, gift and travel
expenses.
Section 274 disallows in whole, or in part, certain expenditures
for entertainment, gifts and travel which would otherwise be
allowable under Chapter 1 of the Code. The requirements imposed by
section 274 are in addition to the requirements for deductibility
imposed by other provisions of the Code. If a deduction is claimed
for an expenditure for entertainment, gifts, or travel, the
taxpayer must first establish that it is otherwise allowable as a
deduction under Chapter 1 of the Code before the provisions of
section 274 become applicable. An expenditure for entertainment, to
the extent it is lavish or extravagant, shall not be allowable as a
deduction. The taxpayer should then substantiate such an
expenditure in accordance with the rules under section 274(d). See
§ 1.274-5. Section 274 is a disallowance provision exclusively, and
does not make deductible any expense which is disallowed under any
other provision of the Code. Similarly, section 274 does not affect
the includability of an item in, or the excludability of an item
from, the gross income of any taxpayer. For specific provisions
with respect to the deductibility of expenditures: for an activity
of a type generally considered to constitute entertainment,
amusement, or recreation, and for a facility used in connection
with such an activity, as well as certain travel expenses of a
spouse, etc.,With the help of these provisions we can conclude that
IRS’s assertion is correct.
This is because it is clearly given that IRS disallowed due to
inadequate documentation.
Conclusion - Without adequate documentation, the IRS will continue to assert the $10,000 travel and entertainment expenditure Charles to be classified as a constructive dividend. He must report this amount as income, rather than a deduction.
When the IRS audited Winter Corporation’s current year tax return, the IRS disallowed $10,000 of travel...
When the IRS audited Winter Corporation’s current year tax return, the IRS disallowed $10,000 of travel and entertainment expenses incurred by Charles, an officer-shareholder, because of inadequate documentation. The IRS asserted that the $10,000 expenditure was a constructive dividend to Charles, who maintained that the expense was business related. Charles argued that he derived no personal benefit from the expenditure and therefore received no constructive dividend. Prepare a memorandum for your tax manager explaining whether the IRS’s assertion or Charles’s...