Midland Fin. Co. v. Comm'r

T.C. Memo. 2001-203

UNITED STATES TAX COURT

MIDLAND FINANCIAL CO. AND SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 12302-99, 4574-00. Filed August 1, 2001.

Steven T. Ledgerwood and Alan G. Holloway, for petitioner.

Ann L. Darnold and Michael J. O’Brien, for respondent.

MEMORANDUM OPINION

RUWE, Judge: Respondent determined the following

deficiencies in petitioner’s Federal income taxes:

TYE Deficiency

July 31, 1995 $132,164
July 31, 1996 123,604
Dec. 31, 1996 52,851

After taking into consideration the agreed adjustments contained

in the notice of deficiency for the years ending July 31, 1995
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and 1996, the issue for decision is whether petitioner’s

deductions for expenses incurred in providing officers with

nonbusiness flights on a company-owned airplane are limited by

section 2741 to the amount reported as imputed income to the

recipient officers.

Background

The parties submitted this case fully stipulated. The

stipulation of facts and the attached exhibits are incorporated

herein by this reference. Petitioner is a corporation that had

its principal place of business in Oklahoma City, Oklahoma, at

the time it filed its petition.

For the period in issue, petitioner had fiscal years ending

July 31, 1995 and 1996. Petitioner also had a short taxable year

beginning August 1 and ending December 31, 1996. Petitioner

timely filed its Forms 1120, U.S. Corporation Income Tax Return,

for the years in issue. Petitioner uses the accrual method of

accounting for tax purposes.

Petitioner is principally engaged in the business of

providing financial services. Petitioner’s headquarters are

located in Oklahoma City, and, through its subsidiaries,

petitioner has retail bank locations throughout Oklahoma.

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

Petitioner originates and services commercial, consumer, and

residential loans throughout the country.

Midland Aviation Co. (Aviation) was a subsidiary of

petitioner and filed consolidated Federal income tax returns with

petitioner. On April 20, 1995, Aviation was liquidated and a

Falcon 200 aircraft (the Falcon) owned by Aviation was

transferred to petitioner. During the years in issue, petitioner

used the Falcon predominantly for business travel, but it was

occasionally used for personal travel by George and Jeff Records

(the Recordses), two corporate officers of petitioner.

Petitioner kept accurate records that indicate the nature of the

flights of the Falcon.2

The personal use of the Falcon was treated as compensation

to the Recordses. On the basis of the valuation rules set forth

in section 1.61-21(g), Income Tax Regs., petitioner properly

determined that the value of the personal use to the Recordses

was $48,424, $45,076.57, and $14,916, respectively, for the

taxable years ending July 31, 1995, July 31, 1996, and the short

taxable year ending December 31, 1996. Petitioner reported these

2
On the basis of an allocation according to flight miles,
the percentages attributable to business use and personal use
during the years in issue were as follows:

TYE Business Personal

July 31, 1995 80% 20%
July 31, 1996 69 31
Dec. 31, 1996 68 32
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amounts on the Recordses’ respective Forms W-2, Wage and Tax

Statement, as wages subject to withholding, and the Recordses

reported these amounts as compensation on their respective

individual income tax returns. The personal use of the Falcon

served to compensate the Recordses for their services as

employees of petitioner and did not constitute constructive

dividends to them. The amounts of compensation paid to the

Recordses during the years in issue, including the value of the

personal use of the Falcon, were reasonable.

On its Federal income tax returns, petitioner deducted the

following amounts with respect to the operation of the Falcon:

TYE Amount

July 31, 1995 $2,126,223.00
July 31, 1996 1,282,081.52
Dec. 31, 1996 530,957.18
Total 3,939,261.70

The amounts deducted by petitioner include the amounts treated as

compensation to the Recordses for the personal use of the Falcon.

Respondent disallowed petitioner’s deductions related to the

Falcon to the extent that the portion of the deduction amounts

attributable to the personal use of the Falcon exceeded the

amounts treated as compensation to the Recordses for such use.3

3
Respondent determined the disallowed amount for each year
in issue by multiplying the total amount deducted by the
percentage attributable to personal use and then subtracting the
amounts included on the Recordses’ respective Forms W-2.
 - 5 -

Discussion

The parties agree that the value of the personal use of the

Falcon is reportable by the Recordses as compensation and that

petitioner is entitled to deduct some amount in connection with

that use. Respondent argues that the amounts of petitioner’s

deductions attributable to the personal use of the Falcon are

limited to the amounts reported as wages to the Recordses for

such use. Petitioner argues that the portion of petitioner’s

deduction attributable to the personal use of the Falcon is not

limited to the amounts reported as wages to the Recordses in

connection with the personal use.

Section 162(a) generally provides that a taxpayer may deduct

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 it is directly connected with, or

proximately related to, the taxpayer’s trade or business

activities. Bingham’s Trust v. Commissioner, 325 U.S. 365, 370

(1945).

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

taxpayer/employer may deduct expenses paid as compensation for

personal services. Sec. 162(a)(1). If the compensation is in

the form of a noncash fringe benefit, the employer may take a

deduction for expenses incurred in providing the benefit if the

value of the noncash fringe benefit is includable in the
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recipient employee’s gross income. Sec. 1.162-25T, Temporary

Income Tax Regs., 50 Fed. Reg. 755 (Jan. 7, 1985), amended 50

Fed. Reg. 46013 (Nov. 6, 1985); see 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

value reported to an employee as compensation; rather, the

employer is required to deduct its costs incurred in providing

the benefit to the employee. Sec. 1.162-25T, Temporary Income

Tax Regs., supra.

Some deductions previously allowable under section 162 were

disallowed by the enactment of section 274. Section 274(a)(1)(A)

generally provides for the disallowance of deductions 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 activity. However, section 274(e)(2) provides that the

general 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).
 - 7 -

Respondent argues that section 274 limits the amounts of

petitioner’s deductions attributable to the personal use of the

Falcon to the amounts reported by petitioner as wages

attributable to that personal use.

This is not an issue of first impression. In Sutherland

Lumber-Southwest, Inc. v. Commissioner, 114 T.C. 197, 206 (2000),

affd. per curiam __ F.3d __ (8th Cir., July 3, 2001), we held

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.” Respondent

recognizes that Sutherland Lumber-Southwest, Inc. precludes us

from limiting petitioner’s deduction to the amount treated as

compensation to the Recordses, unless we choose to overrule our

prior opinion. Respondent urges us to do just that.

In Sutherland Lumber-Southwest, Inc., we provided an

extensive analysis of the statute, the context in which it

appears, its legislative history, and relevant regulations. In

affirming our opinion, the Court of Appeals for the Eighth

Circuit stated:

After a complete review de novo, we agree with the Tax
Court’s well-reasoned opinion, and affirm on the basis
of the analysis set forth therein. * * * Because we
have nothing of substance to add to the Tax Court’s
thorough analysis, further discussion is superfluous.
[Sutherland Lumber-Southwest, Inc. v. Commissioner, __
F.3d at __.]
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The above quote applies to the case before us. No purpose would

be served by repeating the statutory analysis that led us to hold

that an employer’s deduction is not limited to the amount

reportable by its employees.

The doctrine of stare decisis generally requires that we

follow the holding of a previously decided case, absent special

justification. Sec. State Bank v. Commissioner, 111 T.C. 210,

213 (1998), affd. 214 F.3d 1254 (10th Cir. 2000). While

respondent has thoroughly rearticulated his arguments in support

of a different interpretation of the statute, we find nothing

therein that would cause us to refrain from applying the doctrine

of stare decisis in the instant case. Accordingly, we hold that

petitioner’s deductions for operation of the Falcon are in no way

limited by the value reportable by the Recordses.

Decisions will be entered

under Rule 155.