UNITED STATES TAX COURT



   SUTHERLAND LUMBER-SOUTHWEST, INC., Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 23936-97.     Filed March 28, 2000.


     P provided its employees with the use of the
company-owned aircraft for nonbusiness flights. P
notified its employees to report the value of the
flights as imputed income. P deducted the expenses
incurred in providing the flights. R, relying on sec.
274(e)(2), I.R.C., determined that deductions for
expenses incurred in providing employees with
nonbusiness flights on a company-owned airplane are
limited to the amount reported as imputed income to the
recipient employees. P contends that its expense
deductions are not subject to sec. 274, I.R.C., or, in
the alternative, if subject to sec. 274, I.R.C., are
excepted from the restriction of sec. 274, I.R.C., by
application of sec. 274(e)(2), I.R.C.
     Held: Sec. 274(e)(2), I.R.C., excepts from the
effect of sec. 274, I.R.C., deductions of an employer’s
expenses in connection with an entertainment facility
and does not limit or peg the amount deductible to the
amount reportable by employees; i.e., the value of the
benefit received.
                                - 2 -



     Anne G. Batter, for petitioner.

     Robert M. Fowler, for respondent.



                               OPINION

     GERBER, Judge:   The parties filed cross-motions for partial

summary judgment, seeking resolution of whether petitioner is

allowed to deduct its expenses in operating its company aircraft

for the benefit of employees or whether the deduction is limited

to the value of the use of the aircraft--the amount reportable by

petitioner’s employees.   The parties’ controversy raises the

question of whether and how section 2741 applies for petitioner’s

1992 and 1993 taxable years.

                            Background

     Petitioner is a corporation with its principal place of

business in Kansas City, Missouri.      Petitioner’s president and

vice president are Dwight Sutherland (Dwight) and Perry

Sutherland (Perry), respectively.    Petitioner is principally

engaged in the retail lumber business with outlets located in

eight Texas cities.   In addition to the retail lumber business,

petitioner owned a 1976 Model 25 Lear Jet, which was used for

travel related to the lumber business and for its air charter

     1
       Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the taxable years under
consideration, and Rule references are to the Tax Court’s Rules
of Practice and Procedure.
                              - 3 -


service business operated out of Kansas City.   Dwight and Perry

also used the plane for travel related to their positions as

directors of other businesses (director’s flights), for other

business and charitable purposes (nonvacation flights), and for

vacation travel (vacation flights).   In 1992, the plane was used

approximately 30 percent for charter business, 23 percent for

director’s flights, 18 percent for nonvacation flights, 24

percent for vacation flights, and 5 percent for other purposes.

In 1993, the plane was used approximately 16 percent of the time

for charter business, 16 percent for director’s flights, 32

percent for nonvacation flights, 24 percent for vacation flights,

and 11 percent for other purposes.

     Use of the aircraft for director’s flights, nonvacation

flights, and vacation flights was reported by Dwight and Perry as

compensation in connection with their employment with petitioner.

Petitioner calculated and reported the amount of imputed income

for Dwight and Perry in accord with the valuation formula

provided in section 1.61-21(g), Income Tax Regs.   Petitioner, in

accord with section 162, deducted its costs incurred in operating

the aircraft, including those flights taken for director’s

flights, nonvacation flights, and vacation flights.   Respondent

agrees that petitioner correctly applied and calculated the

imputed income and associated deduction figures pursuant to
                                - 4 -


sections 61 and 162, leaving the applicability of section 274 as

the only matter in controversy.

     Respondent determined income tax deficiencies of $341,631

and $119,558 for petitioner’s 1992 and 1993 tax years,

respectively.    The deficiency determinations were based on

adjustments to deductions involving airplane expenses, net

operating loss, environmental tax, alternative minimum tax, and

contributions.    Petitioner moved for partial summary judgment

solely with respect to the disallowance of a portion of its

claimed deduction for expenses to operate the aircraft, asking

the Court to hold either that section 274 does not apply or, if

section 274 applies, that section 274(e)(2) excepts petitioner

from the provisions of section 274.     If we decide that petitioner

is correct with respect to either contention, petitioner’s

partial summary judgment motion will be granted.

     Respondent, in his cross-motion for partial summary

judgment, asks the Court to hold that section 274 is applicable

and, further, that section 274(e)(2) limits petitioner’s

deduction to the value of the benefits received by employees with

respect to the vacation flights.    Likewise, if respondent’s

position is incorrect with respect to either contention,

petitioner’s partial summary judgment motion will be granted and

respondent’s denied.
                               - 5 -


     Respondent conceded that petitioner is entitled to deduct

the expenses for operating the aircraft for flights attributable

to the lumber business, the air charter business, the nonvacation

flights, and the director’s flights.

                          Discussion

     The parties’ cross-motions for partial summary judgment2

involve employee fringe benefits.   Normally, answers to such

matters may be found in sections 61, 162, 132, and related

sections.   Here, however, we are confronted with the more vexing

combination of those sections with section 274, which provides

special rules for disallowance of certain deductions in

connection with entertainment, amusement, or recreation

activities.   Simplifying matters, the parties agree that the

value of the vacation use of the aircraft is reportable by the

employees as compensation and that petitioner is entitled to

     2
       Rule 121(b) provides that summary adjudication upon all or
any part of the legal issues in controversy may be rendered if
the pleadings and admissions show that no genuine issue exists as
to any material fact and that a decision may be rendered as a
matter of law. See Sundstrand Corp. v. Commissioner, 

, 520 (1992), affd. 

(7th Cir. 1994); Zaentz v.
Commissioner, 

, 754 (1988); Naftel v. Commissioner, 

, 529 (1985). The moving party bears the burden of
proving that there is no genuine issue of material fact, and
factual inferences will be read in a manner most favorable to the
party opposing summary judgment. See Dahlstrom v. Commissioner,

, 821 (1985); Marshall v. Commissioner, 

,
271 (1985). The facts necessary to consider the questions
presented here by each motion are contained in pleadings and
other documents in the record and are not controverted.
Consequently, the issue herein is ripe for partial summary
judgment.
                               - 6 -


deduct some amount in connection with that same use.    We consider

whether petitioner, under section 274, may deduct its aircraft

operating costs in full or whether petitioner’s deduction is

limited to the amount reportable as compensation by the

employees.   In that regard, the parties agree that, without

considering section 274, petitioner has correctly deducted its

expenses incurred in operating the aircraft and notified its

employees to report the value of the use of the aircraft.

      Section 162(a) generally provides that a taxpayer is

allowed a deduction for all ordinary and necessary expenses paid

or incurred by the taxpayer in carrying on a trade or business.

An expenditure is “ordinary and necessary” if the taxpayer

establishes that it is directly connected with, or proximately

related to, the taxpayer’s activities.     See Bingham’s Trust v.

Commissioner, 

, 370 (1945).     Deductions are a matter

of legislative grace, and petitioner must prove that it is

entitled to the claimed deductions.    See Rule 142(a); INDOPCO,

Inc. v. Commissioner, 

, 84 (1992); New Colonial Ice

Co. v. Helvering, 

(1934).

     As an ordinary expense of carrying on a trade or business, a

taxpayer/employer may deduct expenses paid as compensation for

personal services.   See sec. 162(a)(1).   If the compensation is

paid in the form of noncash fringe benefits, section 1.162-25T,

Temporary Income Tax Regs., 50 Fed. Reg. 747, 755 (Jan. 7, 1985),
                                 - 7 -


amended 50 Fed. Reg. 46006, 46013 (Nov. 6, 1985), provides that

an employer may take a deduction for expenses incurred in

providing the benefit if the value of the noncash fringe benefit

is includable in the recipient employee’s gross income.   See also

sec. 1.61-21(b), Income Tax Regs. (employee is required to

include in gross income the value of any fringe benefit

received).   The employer may not deduct the amount included by

the employee as compensation but is required to deduct the

employer’s costs incurred in providing the benefit to the

employee.    See sec. 1.162-25T, Temporary Income Tax 

.

     Some deductions previously allowable under section 162 were

disallowed by the enactment of section 274, among other sections.

Section 274 was enacted to eliminate or curb perceived abuses

with respect to business expense deductions for entertainment and

travel expenses and for gifts.    See H. Rept. 1447, 87th Cong., 2d

Sess. (1962), 1962-3 C.B. 402, 423; S. Rept. 1881, 87th Cong., 2d

Sess. (1962), 1962-3 C.B. 703, 730-731.   Section 274(a)(1)(A)

generally provides for the disallowance of deductions, otherwise

allowable under chapter 1 of the Internal Revenue Code, involving

an entertainment, amusement, or recreation activity.   Section

274(a)(1)(B) disallows the deduction of otherwise allowable

expenses incurred with respect to a facility used in connection

with such an activity.   See Harrigan Lumber Co. v. Commissioner,
                                 - 8 -

, 1564-1565 (1987), affd. without published opinion

(11th Cir. 1988).

     Although section 274(a) is designed generally to prohibit

deductions for certain entertainment-related expenses, section

274(e)(2) provides that the deduction disallowance provision of

section 274(a) will not apply to:

     Expenses treated as compensation.--Expenses for goods,
     services, and facilities, to the extent that the
     expenses are treated by the taxpayer, with respect to
     the recipient of the entertainment, amusement, or
     recreation, as compensation to an employee on the
     taxpayer’s return of tax under this chapter and as
     wages to such employee for purposes of chapter 24
     (relating to withholding of income tax at source on
     wages). [Emphasis added.]

Petitioner argues that the “to the extent” language acts to

except its deduction, as claimed, from the reach of section 274.

Conversely, respondent argues that the “to the extent” language

acts to limit petitioner’s deduction to the amount includable as

income by its employees.

     Respondent agrees that, but for section 274, petitioner’s

claimed deduction would be allowable in full.    In addition,

respondent does not challenge petitioner’s fringe benefit income

value calculations under section 61.     Even on the assumption that

section 274 applies, if we hold that subsection 274(e)(2) removes

petitioner’s deduction from the reach of section 274, then
                               - 9 -


petitioner prevails.3   Accordingly, we first address the parties’

arguments that focus on section 274(e)(2); i.e., whether it acts

as an exception or a limitation.

     The section 274(e)(2) question is whether Congress intended

the words “to the extent that” to except taxpayers from section

274(a) or whether it limits a taxpayer’s deduction to the amount

of income includable by the employee.   Generally, for purposes of

imputed employee fringe benefit income, the value of a benefit

received from use of corporate property is the fair rental value

of such property less any reimbursement.   See Ireland v. United

States, 

, 737-739 (5th Cir. 1980); Loftin & Woodard,

Inc. v.   United States, 

, 1219 (5th Cir. 1978); Dole

v. Commissioner, 

, 707 (1965), affd. 

(1st

Cir. 1965); Levy v. Commissioner, T.C. Memo. 1984-306.   Congress,

however, has provided specific valuation rates for certain

benefits, including employer-provided flights on noncommercial


     3
       Because of our holding on the sec. 274(e) issue, we need
not and do not decide whether the aircraft in this case is a
“facility” used in connection with “an activity which is of a
type generally considered to constitute entertainment, amusement,
or recreation”. Sec. 274(a)(1)(A) and (B). It would also
include deciding whether an aircraft, or the aircraft in this
case, is a transportation facility and/or which type of facility
it may primarily be. The answer to that question would be
transitory in nature because the use could change on a year-by-
year basis. Because of our holding on the sec. 274(e) issue, the
outcome in this case would be the same irrespective of our
holding on the broader question of whether sec. 274 applies. In
addition, our holding in the context of sec. 274(e) provides a
universal answer to the controversy between the parties here.
                              - 10 -


aircraft, for purposes of computing the amount of income taxable

to the employee.   See sec. 1.61-21(g), Income Tax Regs.   Such

rates do not bear a correlation to the actual costs incurred by

the aircraft’s owner/operator.   Instead, the rates are derived

from use of a percentage of commercial flight fares.   “[T]he

multiples used are intended to approximate coach and first-class

fares on commercial airlines (e.g., 125 percent of the SIFL

[Standard Industry Fare Level] rates approximates coach fare and

200 percent of the SIFL rates approximates first-class fare).”

50 Fed. Reg. 52281, 52283 (Dec. 23, 1985) (prefatory language to

sec. 1.61-2T, Temporary Income Tax Regs.).   The use of this

bright-line approach can result in uneven or differing

treatment.4   As a result, in some cases, such as the one under

consideration, it is possible that an employee would be required

to report a lower value as income while the employer would be

allowed to deduct a higher cost amount.   The opposite result

could also occur; i.e., the value of an employee’s use or benefit

is greater than the cost to the employer.    In that setting, the

employer would be limited to deducting cost, even though the

employee would be required to report income in excess of the

allowable deduction.

     4
       See 131 Cong. Rec. 7305-7310 (1985), wherein Senator
Metzenbaum discussed the differences in the cost of travel in a
small plane, which could be less than the SIFL value imputed as
income, and in a luxury plane, which could be greater than the
SIFL value imputed as income.
                               - 11 -


       Section 274(e) is entitled “Specific Exceptions to

Application of Subsection (a)”.    (Emphasis supplied.)   Likewise,

the legislative history contains references to “exceptions” in

describing section 274(e)’s subsections.    See H. Rept. 

, 1962-3 C.B. at 428; S. Rept. 

, 1962-3 C.B. at

742.    More particularly, in connection with section 274(e), the

legislative history contains the following statement:

       The bill contains nine exceptions to the general
       disallowance provision * * *. Where an expense falls
       within one of the enumerated exceptions, the item will
       continue to be deductible to the same extent as allowed
       by existing law.

H. Rept. 

, 1962-3 C.B. at 428; S. Rept. 

,

1962-3 C.B. at 742.    Accordingly, section 274(e) was intended to

except certain categories of deduction from the effect of section

274.    Subsequent legislative history also references subsection

274(e) as providing for exceptions.     See H. Rept. 99-426 (1985),

1986-3 C.B. (Vol. 2) 1, 118. (“If an exception [from subsection

274(e)] applies, the entertainment expenditure is deductible if

it is ordinary and necessary and if any applicable section 274(d)

substantiation requirements are satisfied.”)

       Collaterally, and by way of comparison, section 274(e)(9),

concerning deductions for expenses for nonemployees, contains the

“to the extent that” language.    The legislative history

concerning that subsection references subsection (e)(9) as an

exception.    See S. Rept. 96-498 (1979), 1980-1 C.B. 517, 545-546.
                               - 12 -


Those same congressional materials also contain an example of a

manufacturer’s allowing use of an entertainment facility by a

nonemployee dealer.   It provides that, as long as all reporting

requirements are met, “the manufacturer will not be subject to

these [deduction] limitations if the value of the entertainment

facilities are includible in income of the dealer”.    

In other words, section 274 does not apply, and any restrictions

are removed with respect to otherwise allowable deductions by

employers as long as the value of the benefit is included in the

nonemployee dealer’s income.

     Respondent also seeks support in the legislative history.

Respondent contends that his interpretation of section 274(e) is

supported by the purpose stated for section 274.    We have already

pointed out that section 274 was intended to curb the perceived

abuses occurring with expense accounts and the resulting

substantial tax-free benefits conferred on the recipients.      H.

Rept. 

, 1962-3 C.B. at 423.    Respondent argues that

the difference between the value and cost here confers benefits

not intended by the enactment of section 274.    Respondent’s

argument misses the mark for several reasons.    Firstly,

irrespective of section 274, the employees are being taxed in

accord with the Internal Revenue Code for the benefits received,

a fact with which respondent agrees.    Secondly, petitioner, as

employer, received no tax-free benefit.    Thirdly, although
                               - 13 -


petitioner has deducted its expenses of operating the aircraft,

that is no more or less than it was entitled to under section 162

and pertinent regulations.   Finally, the application of the

benefit provisions requiring the reporting of the value of the

benefit to the employee may result in the employee’s reporting

more imputed income than the employer is entitled to deduct.

With little support for respondent’s position, we find

petitioner’s interpretation of the “to the extent” language of

section 274(e)(2) is more appropriate and more likely the one

intended.

     We also note that the section 274(e) regulations also refer

to the section 274(e) subsections as exceptions.   See, e.g., sec.

1.274-2(f)(2), Income Tax Regs., listing the nine categories of

expenditures similar to those listed in section 274(e).   One of

those categories includes travel and entertainment expenses “to

the extent that” they are treated as compensation.   Sec. 1.274-

2(f)(2)(iii), Income Tax Regs.   Section 1.274-2(f)(1), Income Tax

Regs., provides that the limitations on deductions for

entertainment expenses are not applicable to the listed

categories.   That regulation also provides that the expenditures

in those categories shall be deductible to the extent allowable

under chapter I of the Code.   See 

also support

petitioner’s interpretation of the subsection as an exception.
                              - 14 -


     Other portions of section 274 have obvious caps or

limitations on the amount of deduction available to taxpayers.

For example, section 274(b)(1) limits deductions for gifts “to

the extent that such expense * * * exceeds $25.”    Therefore,

section 274(e)(2) could have been phrased “expenses are

deductible to the extent that they do not exceed the amount of

expenses treated as compensation” or “to the extent of the amount

includible in an employee’s income”.   Congress, however, did not

use language that limits the amount deductible to the amounts

includable.

     There exist numerous other examples in the Internal Revenue

Code where Congress intended to place limitations on particular

items.   Some are obvious and some more subtle.   By means of

slight yet significant modification to section 274(e)(2), a

limitation, as opposed to an exception, could have been

articulated.   By changing “to the extent that” to “to the extent

of”, a limitation could have more unambiguously been placed.     See

secs. 119(d)(2), 125(d)(2)(B), 136(b), 165(d), 165(h)(2)(A),

170(d)(1)(A), 277(a), and 306(d)(2).

     Section 83 is another example of a section expressly

limiting the amount of an employer’s deduction.    Addressing the

deduction available for property transferred for the performance

of services, Congress restricted the amount of the deduction to

“an amount equal to the amount included * * * in the gross income
                               - 15 -


of the person who performed such services”.   Sec. 83(h).   These

examples, the legislative history, and the above analysis

convince us that Congress did not intend a limitation in section

274(e)(2).

     As a final comment, we note that while respondent is

critical of the mismatch of income and expense that could occur

under petitioner’s interpretation, respondent does not comment on

the mismatch possible under his scenario if the costs associated

with providing the flight are less than the SIFL value dictated

by the Code.   Moreover, respondent does acknowledge that the

interaction of sections 61 and 162 in the benefits area already

permits the possibility for mismatched income and deductions.

There is no indication that Congress was attempting to fix any

such possible mismatch by enacting section 274.   To the contrary,

the legislative history seems to indicate otherwise.

     For the reasons outlined above, we hold that section

274(e)(2) acts to except the deductions in controversy from the

effect of section 274, and, accordingly, petitioner’s deduction

for operation of the aircraft is not limited to the value

reportable by its employees.   In view of the foregoing, it is

unnecessary to decide the general applicability of section 274(a)

to the expenses of company-owned aircraft used for personal

travel.
                        - 16 -




In light of the foregoing,


                         An appropriate order will be

                    issued.