“Entertainment” is generally not a word you think of in relation to the US tax code. But you’re probably quite familiar with the limitations the code places on entertainment expenses such as meals.
The tax code makes a distinction between entertainment activities, which includes meals, and entertainment facilities, which are “any item of personal or real property owned, rented, or used by a taxpayer * * * if it is used * * * for, or in connection with entertainment.” (See section 1.274-2(e)(2) of the federal income tax regulations.)
Entertainment activities are deductible when they are directly related to the active conduct of a trade or business. Expenses paid with respect to an entertainment facility are not deductible (unless an exception applies).
Examples of entertainment facilities include yachts, hunting lodges, fishing camps, swimming pools, tennis courts, bowling alleys, automobiles, airplanes, apartments, hotel suites, and homes in vacation resorts. In one case (Dodd), the tax court held that a hot air balloon was an entertainment facility. In another (Harrigan Lumber), the court concluded that lease payments for hunting rights were an item “with respect to a facility” and therefore nondeductible.
The taxpayer in T.C. Memo. 2013-293 (Austin Otology Associates), a physician specializing in the study and treatment of neurological disorders of the ear, developed a hearing protection device for shooters. He developed and refined the device while hunting on leased property. His company deducted the cost of the lease.
The taxpayer also made seven separate hunting trips to various other locations during 2007, 2008, and 2009 during which he tested his device. The company deducted the costs of these trips.
The company also deducted expenses for a vacation home and a deep sea fishing charter for the taxpayer during 2008.
Which of the four expenses do you think fit the description of entertainment activities, and which are entertainment facilities?
Note: The IRS disallowed all the expenses, and the court agreed. The expenses categorized as activities were disallowed because the principal character of those expenses was not the active conduct of business. The expenses categorized as facilities are nondeductible by statute (and in this case, do not meet any of the exceptions in the regulations).
Editorial Note: Exceptions to the nondeductibility of facility expenses are: Out of pocket expenses, expenses for non-entertainment use, otherwise deductible expenses, expenses treated as compensation, and expenses for employees.