Townsend Industries Inc. (“Townsend”) manufactures and sells T-51 printing press attachments that enable presses to print multi-color documents. For more than forty years, Townsend conducted an annual sales meeting at its Iowa headquarters, followed by a company-paid fishing trip to a five-star resort in Ontario, Canada. After the 1996 and 1997 fishing trips, the IRS assessed employment taxes against Townsend based on its determination that the costs of the trips were includible as wages subject to employment taxes. While the federal district court agreed with the IRS, the Eighth Circuit Court of Appeals overruled its decision.
According to the Court of Appeals, “[t]he question of whether the per-employee cost of the trip amounted to taxable wages and whether Townsend should have withheld a portion of these costs turns on whether each employee could have deducted these costs as business expenses.” Answering this question requires review and application of Internal Revenue Code Sections 132 and 162, which address exclusion or deduction of fringe benefits and traveling expenses, as well as Section 274, which imposes certain substantiation requirements.
According to these Code Sections, costs associated with an entertainment, amusement or recreational activity generally may be excluded or deducted only if they were directly related to a taxpayer’s trade or business. If incurred for an item directly preceding or following a substantial and bona fide business discussion, the exclusion or deduction is allowed if the item was associated with the active conduct of the taxpayer’s trade or business. The taxpayer must substantiate the costs with documentation identifying the amount and item expensed, the time and place of the transaction, the business purpose, and the relationship of the persons entertained.
To prove that the fishing trip expenses were reasonable and necessary business expenses directly related to its business, Townsend had to show that: it had more than a general expectation of deriving some income or business benefit; its employees actively engaged in business meetings, discussions and other activities; the principal character of the trips was business related; and adequate records were maintained.
Townsend met this burden of proof by showing that during the trips there were substantial discussions regarding new products and repair and maintenance issues relating to existing products. Evidence was presented to show the trips provided interaction between factory and sales personnel which promoted a better understanding of Townsend’s business. Personnel in the company’s plastics division, who were engaged in a different product line and who were thought to initiate inflammatory discussions on T-51 issues, were not invited on the trips. The lack of an invitation to those personnel was taken as further evidence the trips were intended to provide a forum to focus on T-51 business concerns. As the Court of Appeals noted, “If Townsend was merely providing a free vacation to its salespeople and employees, it would not have mattered if they continued to include the plastics division.”
The Townsend decision provides a primer on taxation of fringe benefits and travel expenses. Any employer with substantial fringe benefit and travel expense deductions related to business conferences or meetings should carefully review the decision, and related Internal Revenue Code Sections, to avoid being caught in the IRS’s net. We would be pleased to provide you a copy of the decision and related Internal Revenue Code Sections, and to discuss the procedures to be employed to assure deductions in the future.