Deductions for Entertainment Use of Business Aircraft, 33169-33177 [E7-11445]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 72, Number 115 (Friday, June 15, 2007)]
[Proposed Rules]
[Pages 33169-33177]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-11445]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-147171-05]
RIN 1545-BF34


Deductions for Entertainment Use of Business Aircraft

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations relating to the 
use of business aircraft for entertainment. These proposed regulations 
affect taxpayers that deduct expenses for entertainment, amusement, or 
recreation provided to specified individuals. This document also 
provides notice of a public hearing on these proposed regulations. The 
proposed regulations reflect amendments under the American

[[Page 33170]]

Jobs Creation Act of 2004 (AJCA) and the Gulf Opportunity Zone Act of 
2005 (GOZA).

DATES: Written comments must be received by September 13, 2007. 
Requests to speak and outlines of topics to be discussed at the public 
hearing scheduled for October 25, 2007, at 10 a.m., must be received by 
October 4, 2007.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-147171-05), room 
5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand delivered between the 
hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-147171-05), courier's 
desk, Internal Revenue Service, 1111 Constitution Avenue, NW., 
Washington, DC. Alternatively, taxpayers may submit electronic comments 
via the internet at the Federal eRulemaking Portal at 
www.regulations.gov (IRS-REG-147171-05). The public hearing will be 
held in the auditorium, Internal Revenue Building, 1111 Constitution 
Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations under 
section 274, Michael A. Nixon of the Office of Associate Chief Counsel 
(Income Tax & Accounting), (202) 622-4930; concerning the regulations 
under section 61, Lynne A. Camillo of the Office of Division Counsel/
Associate Chief Counsel (Tax Exempt & Government Entities), (202) 622-
6040 (not toll-free numbers); concerning submissions of comments, the 
hearing, and/or to be placed on the building access list to attend the 
hearing, Richard Hurst at Richard.A.Hurst@irscounsel.treas.gov.

SUPPLEMENTARY INFORMATION: 

Background

    This document contains proposed regulations under section 274(e)(2) 
of the Internal Revenue Code (Code). Section 274(e)(2) was amended by 
section 907 of the AJCA, Public Law 108-357, and by section 403(mm) of 
the GOZA, Public Law 109-135. Both amendments are effective for certain 
expenses incurred after October 22, 2004. On May 27, 2005, the IRS and 
Treasury Department issued Notice 2005-45 (2005-24 IRB 1228) providing 
interim guidance on amended section 274(e)(2) and inviting comments. 
Notice 2005-45 is effective for expenses incurred after June 30, 2005. 
Commentators submitted written and electronic comments responding to 
Notice 2005-45. The IRS and Treasury Department have reviewed and 
considered all the comments in the process of preparing these proposed 
regulations. See Sec.  601.601(d)(2)(ii)(b) of this chapter.
    Generally, section 162(a) allows as a deduction all the ordinary 
and necessary expenses paid or incurred during the taxable year in 
carrying on any trade or business. Under section 274(a)(1)(A), no 
deduction is allowed for an activity generally considered to be 
entertainment, amusement, or recreation, unless the taxpayer 
establishes that the activity is directly related to or (in certain 
cases) associated with the active conduct of the taxpayer's trade or 
business.
    Section 1.274-2(b)(1) of the Income Tax Regulations provides that 
entertainment means any activity of a type generally considered to 
constitute entertainment, amusement, or recreation, such as 
entertaining at night clubs, cocktail lounges, theaters, country clubs, 
golf and athletic clubs, sporting events, and on hunting, fishing, 
vacation and similar trips. Similar activities relating solely to the 
taxpayer's family also may constitute entertainment. Entertainment may 
include an activity that satisfies the personal, living, or family 
needs of an individual, such as providing food and beverages or a hotel 
suite to a business customer or the customer's family. Entertainment 
does not include activities, however, that are clearly not regarded as 
constituting entertainment, such as the provision of supper money by an 
employer to an employee working overtime, the maintenance of a hotel 
room by an employer for lodging of an employee while in business travel 
status, or the use of an automobile in the active conduct of a trade or 
business even though also used for routine personal purposes such as 
commuting to and from work. Under Sec.  1.274-2(b)(1)(ii), an objective 
test is used to determine whether an activity is of a type generally 
considered to constitute entertainment.
    Section 274(e) provides exceptions to the general disallowance 
provisions of section 274(a). Prior to amendment by the AJCA, section 
274(e)(2) excepted expenses from section 274(a) ``to the extent that 
the expenses are treated by the taxpayer'' as compensation to the 
employee. Under prior law, section 274(e)(9) similarly excepted 
expenses to the extent that the expenses are treated by the taxpayer as 
income to persons who are not employees.
    Section 274(o) provides that the Secretary shall prescribe 
regulations necessary to carry out the purposes of the section.
    Generally, Sec.  1.61-21(b)(1) requires an employee to include in 
gross income the fair market value of a fringe benefit, such as an 
entertainment flight, after subtracting amounts paid, by or on behalf 
of the employee, for the fringe benefit, as well as amounts excluded 
from income by another section of the Code. If an employee takes a 
personal flight on an employer's aircraft, and the employer also 
provides a pilot, the general rule under Sec.  1.61-21(b)(6) is that 
the fair market value of the flight is equal to the amount that an 
individual would have to pay in an arm's-length transaction to charter 
the same or a comparable piloted aircraft for that period for the same 
or a comparable flight. If the employer does not provide a pilot, the 
general rule under Sec.  1.61-21(b)(7) is that the fair market value of 
the flight is equal to the amount that an individual would have to pay 
in an arm's-length transaction to rent a comparable aircraft for that 
period in the geographic area in which the aircraft is used. The 
regulations do not permit valuation of a flight by reference to the 
employer's costs.
    As an alternative to the general valuation rules just described, 
Sec.  1.61-21(g) provides that an employee's personal flights on an 
employer's aircraft may be valued using an optional special valuation 
rule, the non-commercial flight valuation rule. In order to use the 
non-commercial flight valuation rule, applying the applicable aircraft 
multiple from Sec.  1.61-21(g)(7), it is necessary to know the weight 
of the employer's aircraft, the number of miles for the flight being 
valued, and whether the employee receiving the benefit is a control 
employee within the meaning of Sec.  1.61-21(g)(8) or (9). The value of 
an employee's personal use of a company aircraft is computed by 
multiplying the Standard Industry Fare Level (SIFL) by the terminal 
charge to arrive at the value of the flight (the SIFL formula). SIFL is 
a cents-per-mile factor that, taken with the aircraft multiple and the 
terminal charge, is intended to approximate coach and first class fares 
on commercial aircraft.
    The consistency rule set forth in Sec.  1.61-21(g)(14)(i) provides 
that a taxpayer who uses the SIFL formula in a calendar year to value 
any flight provided to an employee must use the SIFL formula to value 
all flights provided to employees during that calendar year. Notice 
2005-45 advised taxpayers that the consistency rule in the regulations 
would be amended to permit taxpayers to value the entertainment use of 
aircraft by specified individuals (within the meaning of section 
274(e)(2)(B)) under

[[Page 33171]]

the fair market value rules of Sec.  1.61-21(b) but continue to value 
flights for other employees and for specified individuals not traveling 
for entertainment purposes using the SIFL formula.
    In Sutherland Lumber-Southwest, Inc. v. Comm'r, 114 T.C. 197 
(2000), aff'd 255 F.3d 495 (8th Cir. 2001), acq. 2002-1 CB xvii, the 
Tax Court held that the amount a taxpayer may deduct for the cost of 
entertainment-related flights under the section 274(e)(2) exception is 
not limited to the amount included in the income of the employees and 
corporate officers who took the flights. Rather, the court held that a 
taxpayer may deduct the full cost of an employee's or officer's non-
business flight on the taxpayer's aircraft if the taxpayer includes in 
the recipient's income the value of the flights computed under the non-
commercial flight valuation rule of Sec.  1.61-21. As a result, a 
deduction greater than the amount included in the recipient's income 
was allowable.
    Section 907 of the AJCA was intended to overturn Sutherland Lumber 
in certain cases. H. Conf. Rept. No. 108-755, at 798 (2004). 
Specifically, as amended by the AJCA, the section 274(e)(2) and (9) 
exceptions to the section 274(a) disallowance apply in the case of a 
specified individual only ``to the extent that the expenses do not 
exceed the amount of expenses'' that are treated as compensation to the 
specified individual. A specified individual is any individual who is 
subject to the requirements of section 16(a) of the Securities Exchange 
Act of 1934 (15 U.S.C. 78p(a)) with respect to the taxpayer, or who 
would be subject to those requirements if the taxpayer were an issuer 
of equity securities referred to in that section. Section 274(e)(2)(B).
    Thus, in the case of a specified individual, the section 274(e)(2) 
and (9) disallowance exceptions apply only to the extent that a 
taxpayer treats as compensation to the specified individual an amount 
equal to or greater than the amount of deductible entertainment 
expenses allocable to entertainment provided to the specified 
individual. Expenses allocable to entertainment provided to the 
specified individual that the taxpayer does not treat as compensation 
to the specified individual are disallowed.

Explanation of Provisions and Summary of Comments

1. Definition of Entertainment

a. Distinction Between Entertainment and Other Personal Use
    Notice 2005-45 references Sec.  1.274-2(b)(1) in defining 
entertainment. Commentators suggested that the proposed regulations 
should provide additional guidance on the meaning of ``entertainment'' 
in order to assist taxpayers in delineating between entertainment use 
and ``nonentertainment'' personal use. The proposed regulations do not 
adopt these comments because these rules are addressed in the existing 
regulations at Sec.  1.274-2(b)(1). Consistent with those regulations, 
entertainment does not include travel for reasons such as attending to 
business other than that of the employer, medical purposes, attending 
funerals, and participating in charitable activities.
b. Primary Purpose Test
    Several commentators recommended that the proposed regulations 
adopt a purpose of the flight test that would characterize a flight as 
a business flight for all purposes if the primary purpose of the flight 
is business. Thus, under the recommendation, if the primary purpose of 
the flight were business, no amount would be disallowed for 
entertainment provided to specified individuals who are traveling for 
entertainment purposes. Conversely, if the primary purpose of the 
flight were entertainment, no amount would be allowed as an expense 
deduction with respect to individuals traveling for business. The 
proposed regulations do not adopt these comments. The IRS and Treasury 
Department believe that disregarding entertainment use by a specified 
individual would be contrary to Congressional intent in amending 
section 274(e)(2) to disallow expenses allocable to entertainment use 
of aircraft by specified individuals. Section 274(e)(2)(B) focuses on 
the recipient of the entertainment, amusement, or recreation, not the 
purpose of the employer providing the entertainment or the overall use 
of the aircraft.
c. Use of Aircraft for Bona Fide Security Purposes
    Several commentators suggested that entertainment use by a 
specified individual of an aircraft should not be treated as 
entertainment within the meaning of section 274 or subject to section 
274(e)(2)(B) if there is a business need to use the aircraft to provide 
security, pursuant to Sec.  1.132-5(m). The proposed regulations do not 
adopt this comment. Section 1.132-5(m) merely computes the income 
inclusion for a fringe benefit. It reduces the income inclusion amount 
rather than eliminates it. It does not convert entertainment flights 
into business flights.

2. Definition of Expenses

a. Fixed Costs
    To calculate the amount of expenses for entertainment use of an 
aircraft, Notice 2005-45 provides that taxpayers must take into account 
all of the expenses of maintaining and operating the aircraft. 
Commentators recommended that entertainment expenses should not include 
fixed costs such as depreciation. Commentators noted that the 
legislative history refers to ``aircraft operating costs'' and ``actual 
cost'' and interpreted this language to mean that costs should be 
limited to variable costs. H. Conf. Rept. 108-755 at 798. Some 
commentators have suggested that incremental costs are the only costs 
that should be disallowed.
    The proposed regulations do not adopt these comments. Industry use 
of the term ``operating costs'' generally refers to all costs, fixed 
and variable, including depreciation claimed on the taxpayer's tax 
return. Therefore, the IRS and Treasury Department believe that the use 
of the term ``operating costs'' in the legislative history does not 
reflect Congressional intent to apply section 274(e)(2) to variable 
costs only. Moreover, the term ``aircraft operating costs'' in the 
legislative history is consistent with use of that term in Sutherland 
Lumber, in which it referred to fixed and variable costs for purposes 
of section 274(e)(2).
b. Depreciation
    Commentators suggested that disallowing accelerated depreciation 
(including the additional first-year depreciation under, for example, 
sections 168(k), 1400L(b), and 1400N(d)) would result in excessive 
amounts disallowed in early years and is inconsistent with 
Congressional intent to provide incentives for purchasing aircraft. In 
response to these comments, the proposed regulations permit a taxpayer 
to elect to calculate depreciation on a straight-line basis over the 
class life of an aircraft for all of the taxpayer's aircraft for the 
current year and all future years when calculating the amount of 
disallowed expenses.
c. Aggregation of Aircraft
    Notice 2005-45 permits taxpayers to calculate expenses separately 
for each aircraft or to aggregate the expenses of

[[Page 33172]]

aircraft of similar cost profiles. For example, the expenses of 
turboprop aircraft may be aggregated (but may not be aggregated with 
the expenses of a jet aircraft) and the expenses of a two-engine jet 
aircraft may be aggregated (but may not be aggregated with the expenses 
of a four-engine jet aircraft).
    Commentators requested that the proposed regulations provide more 
details on the definition of cost profile. In response to these 
comments, the proposed regulations provide additional characteristics 
that define similar cost profiles. Specific comments are requested on 
the appropriateness of these characteristics in defining similar cost 
profiles and on other characteristics that may be useful in determining 
criteria for aggregating aircraft.

3. Allocation Methods

    Notice 2005-45 provides an occupied seat hour or mile formula to 
allocate expenses to entertainment flights provided to specified 
individuals. The formula multiplies the hours or miles flown by an 
aircraft by the number of occupied seats. Then a taxpayer aggregates 
all fixed and variable expenses to determine the total expenses paid or 
incurred during the taxable year with respect to an aircraft (or 
aggregated aircraft) and divides the amount of total expenses by total 
occupied seat hours or miles to determine the cost per occupied seat 
hour or mile. Once a taxpayer determines this cost, the taxpayer uses 
the cost to determine the expenses allocable to each specified 
individual's entertainment flight.
    Commentators expressed concern that this formula may not produce 
accurate results and is administratively burdensome. The proposed 
regulations retain the occupied seat hour or mile formula, which allows 
averaging of fixed and variable costs and yields a simple formula for 
determining the cost of one occupied seat hour or mile. It does not 
require a determination of whether a flight is for entertainment of 
specified individuals or other uses or an allocation of entertainment 
and other costs for a particular flight. Once the taxpayer determines 
the cost per occupied seat hour or mile, the disallowance calculation 
is relatively easy and results in a cost for each occupied seat hour or 
mile allocable to each entertainment flight taken by a specified 
individual.
    Nevertheless, in response to commentators' concerns, the proposed 
regulations provide the option of allocating expenses on a flight-by-
flight basis as an alternative to using the occupied seat mile or hour 
formula. Under the flight-by-flight method, a taxpayer may aggregate 
all expenses for the taxable year and divide the amount of total 
expenses by the number of flight hours or miles for the taxable year to 
determine the cost per hour or mile. The taxpayer allocates expenses to 
each flight by multiplying the number of miles or hours for the flight 
by the expense per hour or mile and allocates expenses for the flight 
to the passengers on the flight per capita.

4. Specified Individuals

    Notice 2005-45 applies to entertainment use of an aircraft provided 
to a specified individual of a taxpayer by a party related to the 
taxpayer within the meaning of sections 267(b) or 707(b). The notice 
also defines a specified individual as the recipient of entertainment 
provided to a spouse or family member of the specified individual or to 
another person because of the person's relationship to the specified 
individual, cf. Sec.  1.61-21(a)(4), and includes those entertainment 
flights within the potential disallowance of costs to the taxpayer. 
Commentators expressed concern that these provisions defined specified 
individual too broadly, exceeding the authority of the IRS and Treasury 
Department, and suggested that the definition be narrowed.
    The proposed regulations do not adopt these comments. In the GOZA, 
Congress enacted technical corrections that clarify that the related 
party rules of sections 267(b) and 707(b) apply to section 274(e)(2). 
The IRS and Treasury Department conclude that Congress intended all 
entertainment flights to be subject to the section 274(e)(2) 
requirements. However, comments on how the regulations could define 
passengers aboard by virtue of a relationship with a specified 
individual are welcome. Finally, the proposed regulations define 
officer by reference to regulations at 17 CFR 240.16a-1(f) that 
implement section 16(a) of the Securities Exchange Act of 1934.

5. Other

a. Determination of Basis
    The proposed regulations provide that, if an amount disallowed is 
allocable to depreciation, Sec.  1.274-7 applies and the basis of the 
aircraft is not reduced for the amount of depreciation disallowed.
b. Allocation of Expenses Pro Rata
    Numerous commentators inquired how taxpayers should allocate 
disallowed expenses between fixed and variable expenses. In response to 
these comments, the proposed regulations provide that the expense 
disallowance provisions apply to expenses on a pro rata basis.
c. Deadhead Flights
    Notice 2005-45 provides that an aircraft returning empty from a 
flight after discharging passengers or traveling empty to pick up 
passengers (deadheading) is treated as having the same number and 
character of occupied seat hours or miles as the leg or legs of the 
trip on which passengers are aboard.
    Commentators, citing confusion on the treatment of deadhead 
flights, have requested additional guidance, including safe harbors 
such as treating the empty flight as if it had the same composition as 
the prior or subsequent flight. The proposed regulations adopt these 
comments by providing more detail on how taxpayers should treat 
deadhead flights.
d. Leasing of Taxpayer Aircraft
    Commentators requested guidance on the leasing of aircraft to 
unrelated third parties. In response to these requests, the proposed 
regulations provide guidance on the treatment of expenses allocable to 
taxpayers that charter their aircraft.
e. Aircraft as Entertainment Facilities
    Notice 2005-45 addressed the treatment of expenses for the 
entertainment use of aircraft and did not address the effect of the 
amendment to section 274(e)(2) on the treatment of aircraft as 
entertainment facilities. Commentators asked how the entertainment 
facility disallowance under section 274(a)(1)(B) interacts with rules 
on aircraft used to provide specified individuals with entertainment.
    Section 274(a)(1)(B) disallows all the expenses, direct and 
indirect, associated with the ownership and operation of an aircraft 
that is an entertainment facility, except for expenses for business 
travel and expenses that meet the exceptions of section 274(e). Thus, 
expenses for personal, nonentertainment travel (such as for medical 
purposes or attending funerals), as well as for entertainment travel, 
are disallowed, unless an exception such as 274(e)(2) applies.
    The IRS and Treasury Department believe that Congress, in adding 
section 274(e)(2)(B), contemplated entertainment use of aircraft by 
specified individuals without specifically considering circumstances in 
which aircraft may be regarded as entertainment facilities. Therefore, 
these proposed regulations are limited to use of taxpayer-provided 
aircraft in

[[Page 33173]]

entertainment activities under section 274(a)(1)(A), and do not provide 
rules relating to the application of section 274(e)(2)(B) in 
circumstances under which aircraft may be regarded as entertainment 
facilities under section 274(a)(1)(B). Comments are requested on 
whether the IRS and Treasury Department should issue guidance on 
aircraft as entertainment facilities and the content of the guidance.
f. Fringe Benefit Consistency Rules
    The proposed regulations relax the consistency rule of Sec.  1.61-
21(g)(14)(i) to permit taxpayers to value the entertainment use of 
aircraft by specified individuals under the fair market value rules of 
Sec.  1.61-21(b), but continue to value flights for other employees and 
for specified individuals not traveling for entertainment using either 
the SIFL formula of Sec.  1.61-21(g) or the general (fair market value) 
rule of Sec.  1.61-21(b).
    The proposed regulations preserve the consistency rule of Sec.  
1.61-21(g)(14)(i) with respect to particular groups of employees 
(specified and non-specified individuals) and with respect to non-
entertainment flights. Thus, if an employer values the entertainment 
use of aircraft by one specified individual under the fair market value 
rules of Sec.  1.61-21(b) in a calendar year, the employer must use the 
fair market value rules to value the entertainment use of aircraft by 
all specified individuals during that calendar year.
    The existing consistency rules of Sec.  1.61-21(g)(14)(i) continue 
to apply for valuing the entertainment use of aircraft for other 
employees (non-specified individuals) and for valuing the personal use 
of aircraft by specified individuals not traveling for entertainment 
purposes. Thus, if an employer values the personal use of aircraft by 
any other employee or the non-entertainment personal use of aircraft by 
any specified individual using the SIFL formula of Sec.  1.61-21(g) in 
a calendar year, the employer must use the SIFL formula to value the 
personal use of aircraft by all other employees and the non-
entertainment personal use of aircraft by all specified individuals 
during that calendar year. Similarly, if the employer values the 
personal use of aircraft by any other employee or the non-entertainment 
personal use of aircraft by any specified individual using the fair 
market value rules of Sec.  1.61-21(b) in a calendar year, the employer 
must use the fair market value rules to value the personal use of 
aircraft by all other employees and the non-entertainment personal use 
of aircraft by all specified individuals during that calendar year.
g. Treatment as Compensation to Non-Specified Individuals
    The proposed regulations clarify that in order for a taxpayer to 
meet the requirements of section 274(e)(2) for expenses treated as 
compensation, the taxpayer must include the proper amount as 
compensation to an employee on the taxpayer's return.
h. Section 162(m)
    Notice 2005-45 provides that any amount for the entertainment use 
of an aircraft that is treated by the taxpayer as compensation to a 
specified individual who is also a covered employee is subject to 
section 162(m). Commentators disagreed with this conclusion. They 
opined that the deduction disallowance of section 274 relates to the 
expenses of the aircraft, not amounts treated as income to the 
employee, and that, under Sec.  1.162-25T, the expenses associated with 
providing the aircraft are not deducted by the employer as 
compensation. Thus, according to the commentators, expenses treated as 
compensation for purposes of section 274(e)(2) should not be subject to 
the deduction limitation of section 162(m). However, the IRS and 
Treasury Department believe that the deduction limitation of section 
162(m) applies to amounts treated as compensation for purposes of 
section 274(e)(2). The legislative history of section 162(m) provides 
that the deduction limitation of section 162(m) applies to all 
remuneration for services, including cash and the cash value of all 
remuneration (including benefits) paid in a medium other than cash 
regardless of whether the remuneration is deducted as compensation. 
H.R. Conf. Rep. No. 103-213 (1993) at 585 (993-3 CB 463). Any amount 
included in an employee's income for entertainment flights is 
remuneration for services and therefore is subject to section 162(m).
i. Entertainment Sold to Customers
    Commentators requested clarification on whether section 274(e)(8), 
the exception to section 274(a) for entertainment sold to customers, 
applies to a taxpayer's expenses for providing an aircraft for the 
entertainment use of specified individuals. A commentator asserted that 
section 274(e)(8) excepts expenses of a flight from the section 274(a) 
disallowance to the extent a passenger pays full and fair 
consideration. The commentator suggested that expenses are excepted 
from the section 274(a) disallowance under section 274(e)(8) in three 
circumstances common in business aviation: (1) A lease of an aircraft 
without a pilot at a fair market value lease rate; (2) payment of a 
fair market value charter rate for an aircraft the taxpayer has 
enrolled under a charter certificate held by a charter company; and (3) 
payment of expenses allowed to be reimbursed in a time-sharing 
agreement under Federal Aviation Regulation 91.501(d), 14 CFR 
91.501(d).
    The proposed regulations do not address these issues, as rules 
implementing the section 274(e)(8) exception are provided in Sec.  
1.274-2(f)(2)(ix). Therefore, it is outside the scope of these proposed 
regulations on the exceptions under section 274(e)(2) and (9). As 
stated in Sec.  1.274-2(f)(2)(ix), section 274(e)(8) applies only to 
taxpayers that are in the trade or business of providing entertainment 
to customers, and only to entertainment sold to customers. Therefore, 
the exception does not apply to expenses paid or incurred for 
entertainment provided to individuals by taxpayers that are not in the 
trade or business of providing entertainment.
j. Charter Rate Safe Harbor
    As an alternative to determining actual expenses, the IRS and 
Treasury Department are considering whether the regulations should 
permit taxpayers to determine the amount of their expenses paid or 
incurred for entertainment flights by reference to charter rates. Under 
such a safe harbor, taxpayers could elect to treat as the amount of 
expenses for entertainment flights an undiscounted charter rate for 
each flight in lieu of calculating the actual expenses of each 
entertainment flight provided to specified individuals. Under the safe 
harbor, the undiscounted charter rate for the flight would be allocated 
to the individuals on the flight in lieu of the occupied seat or 
flight-by-flight allocation methods.
    Under the charter rate method being considered, an undiscounted 
charter rate would be based on the amount that a person would pay in an 
arms-length transaction to charter the same or comparable aircraft for 
the same or comparable flight. A taxpayer would have to show that a 
charter rate used to value flights is a substantiated actual, 
published, undiscounted charter rate charged to the general public 
within 10 days before or after the taxpayer's flight by a qualified 
chartering company. A qualified chartering company would be a 
chartering company unrelated to the taxpayer (within the meaning of 
section 267(b) or 707(b)) that is in the trade or business of 
chartering aircraft and that operates and charters 10 or more aircraft

[[Page 33174]]

to the general public during the taxable year. Leaseback arrangements 
or rates charged for off-peak usage, aircraft downtime, or by employers 
to their employees would not qualify under the safe harbor. A qualified 
chartering company would not include a chartering company that charters 
any aircraft to or for the use of a person (or an employee of the 
person) that owns any aircraft used by the chartering company. If a 
taxpayer elects the safe harbor, the taxpayer would have to use it for 
all entertainment flights on all of the taxpayer's aircraft for the 
current and all subsequent taxable years unless the taxpayer makes a 
proper revocation.
    The proposed regulations do not include the safe harbor. 
Nonetheless, comments are requested on whether such a safe harbor, or 
other safe harbors, should be adopted. Comments are also requested on 
the availability of substantiated actual, published, undiscounted 
charter rates charged to the general public by companies that meet the 
requirements of a qualified chartering company.
    Taxpayers may not use a charter rate to determine expenses 
allocable to entertainment flights unless and until a rule is adopted 
in final regulations.

Proposed Effective Date

    The regulations, as proposed, apply to any taxable year beginning 
on or after the date of publication of a Treasury decision adopting 
these rules as final regulations in the Federal Register. However, 
taxpayers may rely on the rules in these proposed regulations or those 
provided in Notice 2005-45 for taxable years beginning before the 
publication of the Treasury decision. If Notice 2005-45 and the 
proposed regulations include different rules for the same particular 
issue, then the taxpayer may rely on either the rule set forth in 
Notice 2005-45 or the rule set forth in the proposed regulations. 
However, if the proposed regulations include a rule that was not 
included in Notice 2005-45, taxpayers may not rely on the absence of a 
rule in Notice 2005-45 to apply a rule contrary to the proposed 
regulations.

Special Analyses

    This notice of proposed rulemaking is not a significant regulatory 
action as defined in Executive Order 12866. Therefore, a regulatory 
assessment is not required. It has also been determined that section 
553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does 
not apply to these regulations and, because the regulations do not 
impose a collection of information on small entities, the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to 
section 7805(f) of the Code, this notice of proposed rulemaking will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any electronic or written comments (a 
signed original and eight (8) copies) that are submitted timely to the 
IRS. The IRS and Treasury Department specifically request comments on 
the clarity of the proposed regulations and how they may be made easier 
to understand.
    A public hearing has been scheduled for October 25, 2007, at 10 
a.m., in the auditorium, Internal Revenue Building, 1111 Constitution 
Avenue, NW., Washington, DC. Due to building security procedures, 
visitors must enter through the Constitution Avenue entrance. In 
addition, all visitors must present photo identification to enter the 
building. Because of access restrictions, visitors will not be admitted 
beyond the immediate entrance more than 30 minutes before the hearing 
starts. For information about having your name placed on the building 
access list to attend the hearing, see the FOR FURTHER INFORMATION 
CONTACT section of this preamble.

Drafting Information

    The principal authors of these proposed regulations are Michael A. 
Nixon and Christian T. Wood of the Office of Associate Chief Counsel 
(Income Tax & Accounting) and Lynne A. Camillo of the Office of the 
Division Counsel/Associate Chief Counsel (Tax Exempt & Government 
Entities). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, under the authority of 26 U.S.C. 7805, 26 CFR Part 1 
is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical order to read, in part, as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.274-9 also issued under 26 U.S.C. 274(o).* * *
    Section 1.274-10 also issued under 26 U.S.C. 274(o).* * *

    Par. 2. Section 1.61-21 is amended by revising paragraph (g)(14)(i) 
and (ii) and adding paragraph (g)(14)(iii) to read as follows:


Sec.  1.61-21  Taxation of fringe benefits.

* * * * *
    (g) * * *
    (14) * * *
    (i) Use by employer. Except as otherwise provided in paragraph 
(g)(13) or paragraph (g)(14)(iii) of this section or in Sec.  1.132-
5(m)(4), if the non-commercial flight valuation rule of this paragraph 
(g) is used by an employer to value any flight provided in a calendar 
year, the rule must be used to value all flights provided to all 
employees in the calendar year.
    (ii) Use by employee. Except as otherwise provided in paragraph 
(g)(13) or (g)(14)(iii) of this section or in Sec.  1.132-5(m)(4), if 
the non-commercial flight valuation rule of this paragraph (g) is used 
by an employee to value a flight provided by an employer in a calendar 
year, the rule must be used to value all flights provided to the 
employee by that employer in the calendar year.
    (iii) Exception for entertainment flights provided to specified 
individuals after October 22, 2004. Notwithstanding the provisions of 
paragraph (g)(14)(i) of this section, an employer may use the general 
valuation rules of Sec.  1.61-21(b) to value the entertainment use of 
an aircraft by a specified individual. An employer who uses the general 
valuation rules of Sec.  1.61-21(b) to value any entertainment use of 
an aircraft by a specified individual in a calendar year must use the 
general valuation rules of Sec.  1.61-21(b) to value all entertainment 
use of aircraft provided to all specified individuals during that 
calendar year.
    (A) Specified individuals defined. For purposes of paragraph 
(g)(14)(iii) of this section, specified individual is defined in 
section 274(e)(2)(B) and Sec.  1.274-9(b).
    (B) Entertainment defined. For purposes of paragraph (g)(14)(iii) 
of this section, entertainment is defined in Sec.  1.274-2(b)(1).
* * * * *
    Par. 3. Section 1.274-9 is added to read as follows:


Sec.  1.274-9  Entertainment provided to specified individuals.

    (a) In general. No deduction is allowed for expenses for 
entertainment provided to a specified individual (as defined in 
paragraph (b) of this section) except to the extent that the expenses 
do not exceed the amount of the expenses treated as compensation to the 
specified individual, as provided in section

[[Page 33175]]

274(e)(2)(B) and (9) and Sec.  1.274-10. The amount disallowed is 
reduced by any amount that the specified individual reimburses a 
taxpayer for the entertainment.
    (b) Specified individual defined. (1) A specified individual is an 
individual who is subject to section 16(a) of the Securities Act of 
1934 with respect to the taxpayer, or an individual who would be 
subject to section 16(a) if the taxpayer were an issuer of equity 
securities referred to in that section. Thus, for example, a specified 
individual is an officer, director, or more than 10 percent owner of a 
corporation taxed under subchapter C or subchapter S, or a personal 
service corporation. A specified individual includes every individual 
who--
    (i) Is the direct or indirect beneficial owner of more than 10 
percent of any class of any registered equity (other than an exempted 
security);
    (ii) Is a director or officer of the issuer of the security;
    (iii) Would be the direct or indirect beneficial owner of more than 
10 percent of any class of a registered security if the taxpayer were 
an issuer of equity securities; or
    (iv) Is comparable to an officer or director of an issuer of equity 
securities.
    (2) For partnership purposes, a specified individual includes any 
partner that holds more than a 10 percent equity interest in the 
partnership, or any general partner, officer, or managing partner of a 
partnership.
    (3) For purposes of this section, officer has the same meaning as 
in 17 CFR Sec.  240.16a-1(f).
    (4) A specified individual includes a director or officer of a tax-
exempt entity.
    (5) A specified individual of a taxpayer includes a specified 
individual of a party related to the taxpayer within the meaning of 
section 267(b) or section 707(b).
    (6) For purposes of section 274(a), a specified individual is 
treated as the recipient of entertainment provided to a spouse or 
family member of the specified individual or to another individual 
because of the relationship of the spouse, family member or other 
individual to the specified individual. Thus, expenses allocable to 
entertainment provided to the spouse, family member, or other 
individual are attributed to the specified individual for purposes of 
determining the amount of disallowed expenses.
    (c) Entertainment use of aircraft by specified individuals. For 
rules relating to entertainment use of aircraft by specified 
individuals, see Sec.  1.274-10.
    (d) Effective/applicability date. This section applies to taxable 
years beginning after the date these regulations are published as final 
regulations in the Federal Register.
    Par. 4. Section 1.274-10 is added to read as follows:


Sec.  1.274-10  Special rules for aircraft used for entertainment.

    (a) Use of an aircraft for entertainment--(1) In general. Under 
section 274(a) and this section, no deduction otherwise allowable under 
chapter 1 is allowed for expenses for the use of a taxpayer-provided 
aircraft for entertainment, except as provided in paragraph (a)(2) of 
this section.
    (2) Exceptions--(i) In general. Paragraph (a)(1) of this section 
does not apply to deductions for expenses for business entertainment 
air travel or to deductions for expenses that meet the exceptions of 
section 274(e), Sec.  1.274-2(f), and this section.
    (ii) Expenses treated as compensation--(A) Employees. Section 
274(a), paragraphs (a) through (d) of Sec.  1.274-2, and paragraph 
(a)(1) of this section, in accordance with section 274(e)(2), do not 
apply (in the case of specified individuals, as provided in paragraph 
(a)(2)(ii)(C) of this section), to expenses for entertainment air 
travel provided to employees to the extent that a taxpayer--
    (1) Properly treats the expenses with respect to the recipient of 
entertainment as compensation to an employee under chapter 1 and as 
wages to the employee for purposes of chapter 24; and
    (2) Includes the proper amount in the employee's income under Sec.  
1.61-21.
    (B) Persons who are not employees. Section 274(a), paragraphs (a) 
through (e) of Sec.  1.274-2, and paragraph (a)(1) of this section, in 
accordance with section 274(e)(9), do not apply (in the case of 
specified individuals, as provided in paragraph (a)(2)(ii)(C) of this 
section), to expenses for entertainment air travel provided to persons 
who are not employees to the extent the expenses are includible in the 
income of those persons. This exception does not apply to any amount 
paid or incurred by the taxpayer that is required to be included in any 
information return filed by the taxpayer under part III of subchapter A 
of chapter 61 and is not so included.
    (C) Specified individuals. Section 274(a) and paragraphs (a) 
through (d) of Sec.  1.274-2, in accordance with section 274(e)(2)(B), 
do not apply to expenses for entertainment air travel of a specified 
individual to the extent that the expenses do not exceed the sum of--
    (1) The amount treated as compensation under paragraph 
(a)(2)(ii)(A) of this section or reported as income under paragraph 
(a)(2)(ii)(B) of this section to the specified individual; and
    (2) Any amount the specified individual reimburses the taxpayer.
    (b) Definitions. The definitions in this paragraph (b) apply for 
purposes of this section.
    (1) Entertainment. For the definition of entertainment for purposes 
of this section, see Sec.  1.274-2(b)(1). Entertainment does not 
include personal travel that is not for entertainment purposes. For 
example, travel to attend a family member's funeral is not 
entertainment.
    (2) Entertainment air travel. Entertainment air travel is any 
travel aboard a taxpayer-provided aircraft for entertainment purposes.
    (3) Business entertainment air travel. Business entertainment air 
travel is any entertainment air travel aboard a taxpayer-provided 
aircraft that is directly related to the active conduct of the 
taxpayer's trade or business or related to an expenditure directly 
preceding or following a substantial and bona fide business discussion 
and associated with the active conduct of the taxpayer's trade or 
business. See Sec.  1.274-2(a)(1)(i) and (ii). Air travel is not 
business entertainment air travel merely because a taxpayer-provided 
aircraft is used for the travel as a result of a bona fide security 
concern under Sec.  1.132-5(m).
    (4) Taxpayer-provided aircraft. A taxpayer-provided aircraft is any 
aircraft owned by, leased to, or chartered to, a taxpayer or any party 
related to the taxpayer (within the meaning of section 267(b) or 
section 707(b)).
    (5) Specified individual. For rules relating to the definition of a 
specified individual, see Sec.  1.274-9.
    (c) Amount disallowed. The amount disallowed under this section for 
an entertainment flight by a specified individual is the amount of 
expenses allocable to the entertainment flight of the specified 
individual under paragraph (e)(2)(ii)(D), (e)(3)(ii), or (f)(3) of this 
section, reduced (but not below zero) by the amount the taxpayer treats 
as compensation under paragraph (a)(2)(ii)(A) of this section or 
reports as income under paragraph (a)(2)(ii)(B) of this section to the 
specified individual, plus any amount the specified individual 
reimburses the taxpayer.
    (d) Expenses taken into account under this section--(1) Definition 
of expenses. In determining the amount of expenses taken into account 
under this section, a taxpayer must take into account all of the 
expenses of operating the aircraft, including all fixed and

[[Page 33176]]

variable expenses the taxpayer deducts in the taxable year. These 
expenses include, but are not limited to, salaries for pilots, 
maintenance personnel, and other personnel assigned to the aircraft; 
meal and lodging expenses of flight personnel; take-off and landing 
fees; costs for maintenance flights; costs of on-board refreshments, 
amenities and gifts; hangar fees (at home or away); management fees; 
costs of fuel, tires, maintenance, insurance, registration, certificate 
of title, inspection, and depreciation; and all costs paid or incurred 
for aircraft leased, or chartered, to or by the taxpayer.
    (2) Leases or charters to third parties. Expenses allocable to a 
lease or charter of a taxpayer's aircraft to an unrelated third-party 
in a bona-fide business transaction for adequate and full consideration 
are not taken into account for purposes of the definition of expenses 
in paragraph (d)(1) of this section. Only expenses allocable to the 
charter period are not taken into account under this paragraph (d)(2).
    (3) Straight-line method permitted for determining depreciation 
disallowance under this section--(i) In general. In lieu of the amount 
of depreciation deducted in the taxable year, solely for purposes of 
paragraph (d)(1) of this section, a taxpayer may elect to treat as its 
depreciation deduction the amount that would result from using the 
straight-line method of depreciation over the class life (as defined by 
section 168(g)(2) and taking into account the applicable convention 
under section 168(d)) of an aircraft, although the taxpayer uses 
another methodology to calculate depreciation for the aircraft under 
other sections of the Internal Revenue Code (for example, section 168). 
If the property is qualified property or 50-percent bonus depreciation 
property under section 168(k), qualified New York Liberty Zone property 
under section 1400L(b), or qualified Gulf Opportunity Zone property 
under section 1400N(d), depreciation for purposes of this straight-line 
election is determined on the unadjusted depreciable basis of the 
property. For purposes of this section, a taxpayer that elects to use 
the straight-line method and class life under this paragraph (d)(3) for 
any aircraft it operates must use that method for all taxpayer-provided 
aircraft it operates and must continue to use the method for the entire 
period the taxpayer uses any taxpayer-provided aircraft.
    (ii) Aircraft placed in service in earlier taxable years. If the 
taxpayer elects to use this paragraph (d)(3) with respect to aircraft 
placed in service in taxable years before the current taxable year, the 
amount of depreciation is determined by applying the straight-line 
method of depreciation to the original cost (or, for property acquired 
in an exchange to which section 1031 applies, the basis of the aircraft 
as determined under section 1031(d)) and over the class life (taking 
into account the applicable convention under section 168(d)) of the 
aircraft as though the taxpayer used that methodology from the year the 
aircraft was placed in service.
    (iii) Manner of making and revoking election. A taxpayer makes the 
election under this paragraph (d)(3) by filing an income tax return for 
the taxable year that determines the taxpayer's expenses for purposes 
of paragraph (d)(1) of this section by including depreciation as 
determined under this paragraph (d)(3). An election may be revoked only 
for compelling circumstances upon consent of the Commissioner by 
private letter ruling.
    (4) Aggregation of aircraft--(i) In general. A taxpayer may 
aggregate the expenses of aircraft of similar cost profiles for 
purposes of calculating disallowed expenses under paragraph (c) of this 
section.
    (ii) Similar cost profiles. Aircraft are of similar cost profiles 
if their operating costs per mile or per hour of flight are comparable. 
Aircraft must have the same engine type (jet or propeller) and the same 
number of engines to have similar cost profiles. Other factors to be 
considered in determining whether aircraft have similar cost profiles 
include, but are not limited to, payload, passenger capacity, fuel 
consumption rate, age, maintenance costs, and depreciable basis.
    (e) Allocation of expenses--(1) General rule. Except as provided in 
paragraph (f)(4) of this section, for purposes of determining the 
expenses allocated to entertainment air travel of a specified 
individual under paragraph (a)(2)(ii)(C) of this section, a taxpayer 
must use either the occupied seat hours or miles method of paragraph 
(e)(2) of this section or the flight-by-flight method of paragraph 
(e)(3) of this section. A taxpayer must use the chosen method for all 
flights of all aircraft for the taxable year.
    (2) Occupied seat hours or miles method--(i) In general. The 
occupied seat hours or miles method determines the amount of expenses 
allocated to a particular entertainment flight of a specified 
individual based on the occupied seat hours or miles for an aircraft 
for the taxable year. Under this method, a taxpayer may choose to use 
either occupied seat hours or miles for the taxable year to determine 
the amount of expenses allocated to entertainment flights of specified 
individuals, but must use occupied seat hours or miles consistently for 
all flights for the taxable year.
    (ii) Computation of the occupied seat hours or miles method. The 
amount of expenses allocated to an entertainment flight taken by a 
specified individual is determined under the occupied seat hours or 
miles method by--
    (A) Determining the total expenses for the year under paragraph 
(d)(1) of this section for the aircraft or group of aircraft (as 
determined under paragraph (d)(4) of this section), as applicable;
    (B) Determining the total number of occupied seat hours or miles 
for the taxable year for the aircraft or group of aircraft by totaling 
the occupied seat hours or miles of all flights in the taxable year 
flown by the aircraft or group of aircraft, as applicable. The occupied 
seat hours or miles for a flight is the number of hours or miles flown 
for the flight multiplied by the number of seats occupied on that 
flight. For example, a flight of six hours with three passengers 
results in 18 occupied seat hours;
    (C) Determining the cost per occupied seat hour or mile for the 
aircraft or group of aircraft, as applicable, by dividing the total 
expenses in paragraph (e)(2)(ii)(A) of this section by the total number 
of occupied seat hours or miles determined in paragraph (e)(2)(ii)(B) 
of this section; and
    (D) Determining the amount of expenses allocated to an 
entertainment flight taken by a specified individual by multiplying the 
number of hours or miles of the flight by the cost per occupied hour or 
mile for that aircraft or group of aircraft, as applicable, as 
determined in paragraph (e)(2)(ii)(C) of this section.
    (iii) Allocation of expenses of multi-leg trips involving both 
business and entertainment legs. A taxpayer that uses the occupied seat 
hours or miles allocation method must allocate the expenses of a trip 
by a specified individual that involves at least one segment for 
business and one segment for entertainment purposes between the 
business travel and the entertainment travel unless none of the 
expenses for the entertainment segment are disallowed. The 
entertainment cost of a multi-leg trip is the total cost of the flights 
(by occupied seat hours or miles) over the cost of the flights that 
would have been taken without the entertainment segment or segments.
    (iv) Examples. The following examples illustrate the provisions of 
this paragraph (e)(2):

    Example 1. (i) A taxpayer-provided aircraft is used for Flights 
1, 2, and 3, of 5 hours, 5

[[Page 33177]]

hours, and 4 hours, respectively, during the Taxpayer's taxable 
year. On Flight 1, there are four passengers, none of whom are 
specified individuals. On Flight 2, passengers A and B are specified 
individuals traveling for entertainment purposes and passengers C 
and D are not specified individuals. Taxpayer treats $1,200 as 
compensation to A, and B reimburses Taxpayer $500. On Flight 3, all 
four passengers (A, B, E, and F) are specified individuals traveling 
for entertainment purposes. The Taxpayer treats $1,300 each as 
compensation to A, B, E, and F. Taxpayer incurs $56,000 in expenses 
for the operation of the aircraft for the taxable year. The aircraft 
is operated for 56 occupied seat hours for the period (four 
passengers times 5 hours or 20 occupied seat hours for Flight 1, 
plus four passengers times 5 hours or 20 occupied seat hours for 
Flight 2, plus four passengers times 4 hours or 16 occupied seat 
hours for Flight 3). The cost per occupied seat hour is $1,000 
($56,000/56 hours).
    (ii) For purposes of determining the amount disallowed (to the 
extent not treated as compensation or reimbursed), $5,000 ($1,000 x 
5 hours) each is allocable with respect to A and B for Flight 2, and 
$4,000 ($1,000 x 4 hours) each is allocable with respect to A, B, E, 
and F for Flight 3.
    (iii) For Flight 2, because Taxpayer treats $1,200 as 
compensation to A, and B reimburses Taxpayer $500, Taxpayer may 
deduct $1,700 of the cost of Flight 2 allocable to A and B. The 
deduction for the remaining $8,300 cost allocable to entertainment 
provided to A and B on Flight 2 is disallowed (with respect to A, 
$5,000 less the $1,200 treated as compensation, and with respect to 
B, $5,000 less the $500 reimbursed).
    (iv) For Flight 3, because Taxpayer treats $1,300 each as 
compensation to A, B, E, and F, Taxpayer may deduct $5,200 of the 
cost of Flight 3. The deduction for the remaining $10,800 cost 
allocable to entertainment provided to A, B, E, and F on Flight 3 is 
disallowed ($4,000 less the $1,300 treated as compensation to each 
specified individual).
    Example 2. (i) G, a specified individual, is the sole passenger 
on an aircraft on a two-hour flight from City A to City B for 
business purposes. G then travels on a three-hour flight from City B 
to City C for entertainment purposes, and returns from City C to 
City A on a four-hour flight. G's flights have resulted in nine 
occupied seat hours (two for the first segment, plus three for the 
second segment, plus four for the third segment). If G had returned 
directly to City A from City B, the flights would have resulted in 
four occupied seat hours.
    (ii) Under paragraph (e)(2)(iii) of this section, five occupied 
seat hours are allocable with respect to G's entertainment (nine 
total occupied seat hours minus the four occupied seat miles that 
would have resulted if the travel had been a roundtrip business trip 
without the entertainment segment). If Taxpayer's cost per occupied 
seat hour for the year is $1,000, $5,000 is allocated with respect 
to G's entertainment use of the aircraft ($1,000 x five occupied 
seat hours). The amount disallowed is $5,000 minus any amount the 
Taxpayer treats as compensation to G or that G reimburses Taxpayer.

    (3) Flight-by-flight method--(i) In general. The flight-by-flight 
method determines the amount of expenses allocated to a particular 
entertainment flight of a specified individual on a flight-by-flight 
basis by allocating expenses to individual flights and then to a 
specified individual traveling for entertainment purposes on that 
flight.
    (ii) Allocation of expenses. A taxpayer using the flight-by-flight 
method must aggregate all expenses (as defined in paragraph (d)(1) of 
this section) for the taxable year for the aircraft or group of 
aircraft (as determined under paragraph (d)(4) of this section), as 
applicable, and divide the total amount of expenses by the number of 
flight hours or miles for the taxable year for that aircraft or group 
of aircraft, as applicable, to determine the cost per hour or mile. 
Expenses are allocated to each flight by multiplying the number of 
miles or hours for the flight by the cost per hour or mile. The 
expenses for the flight are then allocated to the passengers on the 
flight per capita. Thus, if three of five passengers are traveling for 
business and two passengers are specified individuals traveling for 
entertainment purposes, and the total expense allocated to the flight 
is $10,000, the expense allocable to each specified individual is 
$2,000.
    (f) Special rules--(1) Determination of basis. If an amount 
disallowed is allocable to depreciation under paragraph (f)(2) of this 
section, the rules of Sec.  1.274-7 apply. In that case, the basis of 
an aircraft is not reduced for the amount of depreciation disallowed 
under this section.
    (2) Pro rata disallowance. The expense disallowance provisions of 
this section are applied on a pro rata basis to all of the expenses 
disallowed by this section.
    (3) Deadhead flights. (i) For purposes of this section, an aircraft 
returning without passengers after discharging passengers or flying 
without passengers to pick up passengers (deadheading) is treated as 
having the same number and character of passengers as the leg of the 
trip on which passengers are aboard for purposes of the allocation of 
expenses under paragraphs (e)(2) or (e)(3) of this section. For 
example, when an aircraft travels from point A to point B and then back 
to point A, and one of the legs is a deadhead flight, for determination 
of disallowed expenses, the aircraft is treated as having made both 
legs of the trip with the same passengers aboard for the same purposes.
    (ii) When a deadhead flight does not occur within a roundtrip 
flight, but occurs between two unrelated flights involving more than 
two destinations (such as an occupied flight from point A to point B, 
followed by a deadhead flight from point B to point C, and then an 
occupied flight from point C to point A), the allocation of passengers 
and expenses to the deadhead flight occurring between the two occupied 
trips is based on the number of passengers on board for the two 
occupied legs of the flight, the character of the passengers on board 
(entertainment or nonentertainment purpose) and the length in hours or 
miles of the two occupied legs of the flight.
    (g) Effective/applicability date. This section applies to taxable 
years beginning after the date these regulations are published as final 
regulations in the Federal Register.

Kevin M. Brown,
Deputy Commissioner for Services and Enforcement.
 [FR Doc. E7-11445 Filed 6-14-07; 8:45 am]
BILLING CODE 4830-01-P