Deductions for Entertainment Use of Business Aircraft, 45480-45487 [2012-18693]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 77, Number 148 (Wednesday, August 1, 2012)]
[Rules and Regulations]
[Pages 45480-45487]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-18693]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9597]
RIN 1545-BF34


Deductions for Entertainment Use of Business Aircraft

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the use 
of business aircraft for entertainment. These final regulations affect 
taxpayers that deduct expenses for entertainment, amusement, or 
recreation provided to specified individuals. The final regulations 
reflect statutory amendments under the American Jobs Creation Act of 
2004 (AJCA) and the Gulf Opportunity Zone Act of 2005 (GOZA).

DATES: Effective Date: These regulations are effective August 1, 2012.
    Applicability Date: For dates of applicability, see Sec. Sec.  
1.61-21(g)(14)(iii), 1.274-9(e), and 1.274-10(h).

FOR FURTHER INFORMATION CONTACT: Michael Nixon (section 274), (202) 
622-4930; or Lynne A. Camillo (section 61), (202) 622-6040 (not toll-
free numbers).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains final amendments to the Income Tax 
Regulations, 26 CFR part 1, relating to the disallowance under section 
274 of the Internal Revenue Code (Code) of deductions for the use of 
business aircraft for entertainment.
    On June 15, 2007, a notice of proposed rulemaking (REG-147171-05) 
regarding the use of business aircraft for entertainment was published 
in the Federal Register (72 FR 33169). Written and electronic comments 
responding to the notice of proposed rulemaking were received. A public 
hearing on the proposed regulations was held on October 25, 2007. After 
consideration of all the comments, the proposed regulations are adopted 
as amended by this Treasury decision. The comments and revisions are 
discussed in the preamble.

Explanation of Provisions and Summary of Comments

1. Determination of Costs

a. Application of Disallowance to Fixed Costs
    The proposed regulations provide that expenses subject to 
disallowance under section 274(a) include variable costs such as fuel 
and landing fees, and fixed costs such as depreciation, hangar fees, 
pilot salaries, and other items not directly related to an individual 
flight. Commentators suggested that the final regulations should limit 
expenses subject to disallowance to the direct or variable costs of a 
flight and exclude fixed costs. The final regulations do not adopt this 
comment because section 274(e)(2) does not explicitly differentiate 
between fixed and variable expenses and because such an interpretation 
is contrary to Congressional intent.
b. Charter Rate Safe Harbor
    The proposed regulations requested comments on whether, as an 
alternative to determining actual expenses, the final regulations 
should allow taxpayers to determine the amount of expenses paid or 
incurred for entertainment flights by reference to charter rates. The 
proposed regulations asked for specific comments on the availability of 
substantiated actual, published, undiscounted charter rates charged to 
the general public by companies that meet certain requirements.
    Commentators generally endorsed the inclusion of a charter rate 
safe harbor in the final regulations. They suggested that the IRS 
establish rates either by conducting a survey of average charter rates 
by region or by authorizing representatives of the industry to create a 
charter rate reporting system. One commentator suggested that if the 
IRS does not establish charter rates, individual taxpayers should be 
allowed to determine charter rates. Commentators also stated that a 
charter rate safe harbor should include rates for rentals of small 
piston aircraft, which taxpayers use extensively for business but 
normally are not chartered.
    The difficulty of determining accurate and reliable charter rates 
continues to be an impediment to establishing a charter rate safe 
harbor. Accordingly, the final regulations do not include these rules. 
However, the final regulations authorize the IRS to adopt charter rate 
or other safe harbors in future published guidance, see Sec.  
601.601(d).
c. Depreciation
    The proposed regulations permit a taxpayer to elect to compute 
depreciation expenses on a straight-line basis for all of the 
taxpayer's aircraft and all taxable years for purposes of calculating 
expenses subject to disallowance, even if the taxpayer uses another 
method to compute depreciation for other purposes. The proposed 
regulations provide a transition rule for applying the straight-line 
election to aircraft placed in service in taxable years preceding the 
election, which requires the taxpayer to apply the straight-line method 
as if it had been applied from the year the aircraft was placed in 
service.
    A commentator requested that the final regulations allow a separate 
election for each aircraft. The final regulations do not allow an 
aircraft-by-aircraft election. Requiring taxpayers to make the election 
for all aircraft appropriately balances the policies of promoting 
business investment through the allowance of additional first-year 
depreciation and denying a tax benefit for entertainment use of 
business aircraft.
    The commentator also suggested that changing depreciation methods 
under the transition rule may result in disallowing more than 100 
percent of the cost of the aircraft. In response to the comment, the 
final regulations clarify that, in any taxable year, the depreciation 
disallowance does not exceed the amount of otherwise allowable 
depreciation. Thus, the sum of the allowable depreciation and the 
depreciation disallowed will not exceed 100 percent of basis, 
regardless of the taxable year a taxpayer makes the straight-line 
election.
    The final regulations provide examples illustrating how taxpayers 
determine depreciation and basis under the election.

[[Page 45481]]

d. Interest Expense
    A commentator asked for clarification on whether interest is an 
expense that is subject to disallowance. In response to this comment, 
the final regulations clarify that interest is subject to disallowance 
if the underlying debt is secured by or properly allocable to an 
aircraft used for entertainment.
e. Aircraft Aggregation
    The proposed regulations provide that a taxpayer may aggregate 
expenses for aircraft of similar cost profiles to calculate expenses 
subject to disallowance. The proposed regulations require that aircraft 
have the same engine type and number and suggest other factors relevant 
to whether aircraft are of a similar cost profile.
    A commentator requested that the final regulations make the 
aircraft aggregation rules less restrictive. The commentator opined 
that taxpayers should be allowed to aggregate the expenses of all 
aircraft to alleviate the administrative burden of computing and 
allocating expenses to entertainment use of the aircraft. The 
commentator stated that, alternatively, the rules inappropriately 
require similar cost profiles to include the same number of engines and 
require an unduly detailed analysis of the aircraft characteristics.
    The final regulations retain the aircraft aggregation rules. 
Aggregating the expenses of all aircraft regardless of cost 
characteristics would create unacceptable distortions in the amount of 
expenses allocated to the use of each aircraft. The rules are 
sufficiently broad and flexible for taxpayers to easily apply them.

2. Allocation of Costs to Flights

a. Primary Purpose Test
    The proposed regulations provide two alternative methods for 
allocating the costs associated with the use of an aircraft to provide 
entertainment to specified individuals. The occupied seat hours or 
miles allocation method divides the total expenses for the year by the 
number of occupied seat hours or occupied seat miles to determine a per 
seat or per mile rate, and it applies the rate to the number of hours 
or miles of entertainment use. The flight-by-flight method allocates 
expenses to a flight and then to the passengers on the flight according 
to the entertainment or nonentertainment character of the travel.
    Commentators suggested that the final regulations adopt a primary 
purpose test for identifying disallowed expenses. Under a primary 
purpose test, the primary purpose of a flight would determine whether 
any costs associated with specified individuals traveling for 
entertainment on that flight are disallowed. Generally, if the primary 
purpose of a flight is business, no more than the additional or 
incidental costs associated with specified individuals traveling for 
entertainment aboard that flight would be disallowed. Some commentators 
suggested that if the primary purpose of a flight is business, no costs 
should be allocated to entertainment. One commentator advocated that 
the final regulations include a primary purpose test as a safe harbor 
for smaller aircraft.
    The final regulations do not adopt a primary purpose test. Section 
274(e)(2) applies if a taxpayer provides entertainment, amusement, or 
recreation to a specified individual and does not depend on either the 
reason the taxpayer provides the entertainment or the overall use of 
the aircraft. Disregarding entertainment use by a specified individual 
is contrary to Congressional intent in amending section 274(e)(2) to 
disallow expenses allocable to entertainment use of aircraft by 
specified individuals.
b. Effect of Allocation Rules
    Commentators suggested the passenger-by-passenger allocation of 
costs in the proposed regulations imposes an undue administrative 
burden on taxpayers. One commentator stated that the regulations result 
in excess disallowance and are unworkable due to their inconsistency 
with the primary purpose test. Another commentator said that 
determination of the character of each passenger's use could be 
difficult and asked for more examples illustrating when a use is 
entertainment.
    The final regulations retain the occupied seat hours or miles and 
flight-by-flight allocation rules. Before the amendment of section 
274(e)(2), taxpayers were required to maintain records of the character 
of the use of aircraft by employees to comply with the income inclusion 
rules of section 61 and Sec.  1.61-21. Any additional administrative 
burden resulting from the requirement to identify, and allocate 
expenses to, entertainment use of aircraft is limited and is inherent 
in the statutory requirement to allocate expenses to entertainment use. 
The final regulations do not include additional examples of 
entertainment use because entertainment use is defined for purposes of 
section 274 in Sec.  1.274-2(b)(1) and is therefore beyond the scope of 
this regulation.

3. Allocation of Disallowance to Expenses

    The proposed regulations provide that the disallowance provisions 
are applied on a pro rata basis to all disallowed expenses. A 
commentator requested clarification of how an amount that is treated as 
compensation to or reimbursed by a specified individual is allocated to 
disallowed expenses. The commentator noted that it is necessary to 
determine the amount of disallowed expenses that represents 
depreciation to properly adjust an aircraft's basis.
    In response to this comment, the final regulations clarify that any 
amounts disallowed and any amounts reimbursed or treated as 
compensation are applied to total expenses subject to disallowance on a 
pro rata basis. The final regulations include an example illustrating 
this rule.

4. Bona Fide Security Concerns

    The proposed regulations do not exempt expenses for entertainment 
travel from disallowance under section 274 when there is a business 
need to use the aircraft to provide security pursuant to Sec.  1.132-
5(m). A commentator argued that the final regulations should provide 
that the excess cost of using a private aircraft for bona fide security 
concerns should not be subject to disallowance. Section 1.132-5(m) 
reduces the amount of income inclusion for the fringe benefit under 
circumstances in which a bona fide security concern exists, but does 
not convert an entertainment flight into a business flight. Because 
section 274(e) does not provide an exception to disallowance for 
expenses related to the use of a private aircraft for bona fide 
security concerns, the final regulations do not adopt this comment.

5. Aircraft as Entertainment Facilities

    The proposed regulations do not address the use of aircraft as 
entertainment facilities, but requested comments on whether additional 
guidance on this question should be issued. Commentators suggested that 
the same rules in the proposed regulations should apply to the use of 
aircraft as entertainment facilities and requested that the final 
regulations clarify when and how the rules apply to entertainment 
facilities.
    These regulations interpret section 274(e)(2). Section 274(e)(2) is 
an exception to the disallowance provisions of section 274(a). Expenses 
for entertainment facilities are disallowed under section 274(a)(1)(B). 
Therefore, the final regulations clarify that section 274(e)(2) and the 
associated regulations apply to expenses for

[[Page 45482]]

entertainment facilities as well as entertainment activities. However, 
the final regulations do not include specific rules for the use of 
aircraft as entertainment facilities, which are addressed elsewhere in 
the section 274 regulations.

6. Deadhead Flights

    The proposed regulations provide that an aircraft flying without 
passengers en route to pick up, or after having discharged, passengers 
(deadhead flight) is generally treated as having the same number and 
character of passengers as the leg of the trip on which passengers are 
on board. A commentator suggested that the final regulations allow any 
reasonable method to determine expenses related to deadhead flights. 
The final regulations do not adopt this rule because it would be 
difficult to administer.
    Another commentator asked that the final regulations provide 
examples including mathematical computations for expenses for deadhead 
flights. In response to this comment, the final regulations include 
examples illustrating the computation of expenses for a deadhead 
flight.

7. Leases to Third Parties

    The proposed regulations provide that expenses allocable to a lease 
or charter of an aircraft to an unrelated third party in a bona-fide 
business transaction for the charter period are not subject to the 
expense disallowance. A commentator suggested that the rules for leases 
and charters to third parties should clarify that ``charter period'' 
includes ``lease period,'' that not only expenses but also flight hours 
or miles attributable to a charter period are removed from the seat/
hour or seat/mile calculation, and that a taxpayer may use any 
reasonable method to allocate expenses to a charter period.
    The seat hour or seat mile calculation is a method of allocating 
expenses to entertainment use. If expenses are not subject to the 
expense disallowance, then no allocation is required, and seat hours or 
miles attributable to a charter period are not included in that 
calculation. The final regulations change the term charter period to 
the term lease or charter period. The final regulations also clarify 
that whether a third party is unrelated to the taxpayer is determined 
under section 267(b) or 707(b).

8. Section 274(e)(8) Exception

    A commentator asked for clarification on whether the proposed 
regulations modify the section 274(e)(8) exception for ``entertainment 
sold to customers.'' Another commentator asked for clarification on 
what constitutes ``adequate and full consideration'' for purposes of 
the section 274(e)(8) exception.
    The proposed and final regulations, which provide guidance on the 
section 274(e)(2) exception, state that the section 274(a) disallowance 
for the use of a taxpayer-provided aircraft for entertainment does not 
apply to expenses that meet the exceptions of section 274(e). 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. However, the 
final regulations do not provide additional rules on the section 
274(e)(8) exception, which is outside the scope of the regulations.

9. Travel on Regularly Scheduled Commercial Airlines

    A commentator requested that the final regulations include an 
exception for entertainment flights by employees of commercial 
passenger or cargo airlines on flights operated by their employers. The 
commentator also noted that identifying entertainment use by specified 
individuals on these flights and allocating expenses to this use would 
be extremely burdensome. While the final regulations do not provide a 
general exception to the disallowance rules for taxpayers that are 
commercial passenger or cargo airlines because a general exception is 
not supported by the statute, the final regulations provide a special 
rule for specified individuals on regularly scheduled flights of 
taxpayers that are commercial passenger airlines. This rule treats 
expenses of entertainment flights by specified individuals in the same 
manner as expenses of entertainment flights by non-specified 
individuals under certain circumstances.

10. Charitable Contribution Deduction

    A commentator suggested that the final regulations should include 
rules on charitable contribution deductions for the fixed costs of 
using aircraft for charitable purposes. These rules are outside the 
scope of the regulations; therefore, the final regulations do not adopt 
this comment.

11. Income Inclusion and Compensation

    Section 274(e)(2) and the proposed regulations provide, in general, 
that expenses are not disallowed to the extent of the amount a taxpayer 
treats as compensation to, or includes in the income of, a specified 
individual. A commentator requested that the final regulations include 
a ``safe harbor deduction'' of the amount of compensation claimed for 
the specified individual. The final regulations do not adopt this 
comment because section 274(e)(2) already operates as a safe harbor 
deduction to the extent of amounts treated as compensation and income, 
up to the amount of expenses properly allocable to that entertainment 
use.
    The proposed regulations additionally provide, in effect, that 
expenses are not disallowed to the extent of the amount a specified 
individual reimburses the taxpayer. A commentator asked that the final 
regulations include examples of how these rules apply when an employee 
pays for a flight and that the regulations specify that the taxpayer 
has income in that circumstance. The final regulations retain examples 
from the proposed regulations that illustrate the amount of expenses 
disallowed when amounts are treated as compensation or when an employee 
reimburses the taxpayer. The circumstances under which the taxpayer has 
income from reimbursements is beyond the scope of these regulations.

Effective/Applicability Date

    The final regulations apply to taxable years beginning after August 
1, 2012.

Effect on Other Documents

    Notice 2005-45 (2005-1 CB 1228) is obsoleted as of August 1, 2012.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866, as 
supplemented by Executive Order 13563. Therefore, a regulatory 
assessment is not required. Section 553(b) of the Administrative 
Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. 
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, the notice of 
proposed rulemaking that preceded these final regulations was submitted 
to the Chief Counsel for Advocacy of the Small Business Administration 
for comment on its impact on small business, and no comments were 
received.

Drafting Information

    The principal authors of these regulations are Michael Nixon of the 
Office of Associate Chief Counsel (Income Tax and Accounting) and Lynne 
A. Camillo of the Office of

[[Page 45483]]

Division Counsel/Associate Chief Counsel (Tax Exempt and 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.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
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).* * *


0
Par. 2. Section 1.61-21 is amended by revising paragraphs (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 paragraph (b) of this section to value the 
entertainment use of an aircraft provided after October 22, 2004, to a 
specified individual. An employer who uses the general valuation rules 
of paragraph (b) of this section to value any entertainment use of an 
aircraft by a specified individual in a calendar year must use the 
general valuation rules of paragraph (b) of this section 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).
* * * * *

0
Par. 3. Section 1.274-9 is added to read as follows:


Sec.  1.274-9  Entertainment provided to specified individuals.

    (a) In general. Paragraphs (e)(2) and (e)(9) of section 274 provide 
exceptions to the disallowance of section 274(a) for expenses for 
entertainment, amusement, or recreation activities, or for an 
entertainment facility. In the case of a specified individual (as 
defined in paragraph (b) of this section), the exceptions of paragraphs 
(e)(2) and (e)(9) of section 274 apply only to the extent that the 
expenses do not exceed the amount of the expenses treated as 
compensation (under section 274(e)(2)) or as income (under section 
274(e)(9)) to the specified individual. 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 in relation 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).
    (c) Specified individual treated as recipient of entertainment 
provided to others. For purposes of section 274(a), a specified 
individual is treated as the recipient of entertainment provided to 
another individual because of the relationship of the other individual 
to the specified individual if the entertainment is a fringe benefit to 
the specified individual under section 61(a)(1) (without regard to any 
exclusions from gross income). Thus, expenses allocable to 
entertainment provided to the other individual are attributed to the 
specified individual for purposes of determining the amount of 
disallowed expenses.
    (d) Entertainment use of aircraft by specified individuals. For 
rules relating to entertainment use of aircraft by specified 
individuals, see Sec.  1.274-10.
    (e) Effective/applicability date. This section applies to taxable 
years beginning after August 1, 2012.

0
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. Section 
274(a) disallows a deduction for certain expenses for entertainment, 
amusement, or recreation activities, or for an entertainment facility. 
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. Section 274(e)(2) 
and (e)(9) provides certain exceptions to the disallowance of section 
274(a) for expenses for goods, services, and facilities for 
entertainment, recreation, or amusement.
    (ii) Expenses treated as compensation--(A) Employees who are not 
specified individuals. Section

[[Page 45484]]

274(a), Sec.  1.274-2(a) through (d), and paragraph (a)(1) of this 
section, in accordance with section 274(e)(2)(A), do not apply to 
expenses for entertainment air travel provided to an employee who is 
not a specified individual to the extent that a taxpayer--
    (1) Properly treats the expenses relating 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) Treats the proper amount as compensation to the employee under 
Sec.  1.61-21.
    (B) Persons who are not employees and are not specified 
individuals. Section 274(a), Sec.  1.274-2(a) through (d), and 
paragraph (a)(1) of this section, in accordance with section 274(e)(9), 
do not apply to expenses for entertainment air travel provided to a 
person who is not an employee and is not a specified individual to the 
extent that the expenses are includible in the income of that person. 
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), Sec.  1.274-2(a) through 
(d), and paragraph (a)(1) of this section, 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 amount of the expenses do 
not exceed the sum of--
    (1) The amount treated as compensation to or included in the income 
of the specified individual in the manner specified under paragraph 
(a)(2)(ii)(A)(1) of this section (if the specified individual is an 
employee) or under paragraph (a)(2)(ii)(B) of this section (if the 
specified individual is not an employee); and
    (2) Any amount the specified individual reimburses the taxpayer.
    (iii) Travel on regularly scheduled commercial airlines. Section 
274(a), Sec.  1.274-2(a) through (d), and paragraph (a)(1) of this 
section do not apply to expenses for entertainment air travel that a 
taxpayer that is a commercial passenger airline provides to specified 
individuals of the taxpayer on the taxpayer's regularly scheduled 
flights on which at least 90 percent of the seats are available for 
sale to the public to the extent the expenses are includible in the 
income of the recipient of the entertainment in the manner specified 
under paragraph (a)(2)(ii)(A)(1) of this section (if the specified 
individual is an employee) or under paragraph (a)(2)(ii)(B) of this 
section (if the specified individual is not an employee).
    (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. Except as otherwise provided, 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), (e)(3), or (f)(3) of this section, reduced (but not below zero) 
by the amount the taxpayer treats as compensation or reports as income 
under paragraph (a)(2)(ii)(C)(1) of this section to the specified 
individual, plus any amount the specified individual reimburses the 
taxpayer.
    (d) Expenses subject to disallowance under this section--(1) 
Definition of expenses. In determining the amount of expenses subject 
to disallowance under this section, a taxpayer must include all of the 
expenses of operating the aircraft, including all fixed and 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; interest on debt secured by or properly 
allocated (within the meaning of Sec.  1.163-8T) to an aircraft; and 
all costs paid or incurred for aircraft leased or chartered to the 
taxpayer.
    (2) Leases or charters to third parties. Expenses allocable to a 
lease or charter of a taxpayer's aircraft to an unrelated (as 
determined under section 267(b) or 707(b)) third-party in a bona-fide 
business transaction for adequate and full consideration are excluded 
from the definition of expenses in paragraph (d)(1) of this section. 
Only expenses allocable to the lease or charter period are excluded 
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(i)(1) and using the applicable convention under section 
168(d)) of an aircraft, even if the taxpayer uses a different 
methodology to calculate depreciation for the aircraft under other 
sections of the Internal Revenue Code (for example, section 168). If 
the property qualifies for the additional first-year depreciation 
deduction provided by, for example, section 168(k), 168(n), 1400L(b), 
or 1400N(d), depreciation for purposes of this straight-line election 
is determined on the unadjusted depreciable basis (as defined in Sec.  
1.168(b)-1(a)(3)) of the property. However, the amount of depreciation 
disallowed as a result of this paragraph (d)(3) for any taxable year 
cannot exceed a taxpayer's allowable depreciation for that taxable 
year. 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 methodology for all depreciable 
aircraft it operates and must continue to use the methodology for the 
entire period the taxpayer uses any depreciable aircraft.
    (ii) Aircraft placed in service in earlier taxable years. The 
amount of depreciation for purposes of this paragraph (d)(3) for 
aircraft placed in service in taxable years before the

[[Page 45485]]

taxable year of the election is determined by applying the straight-
line method of depreciation to the unadjusted depreciable basis (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 (using 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 computing depreciation under 
this paragraph (d)(3). A taxpayer may revoke an election 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, maximum take-off weight, payload, 
passenger capacity, fuel consumption rate, age, maintenance costs, and 
depreciable basis.
    (5) Authority for establishing safe harbors for determining 
expenses. The Commissioner may establish in published guidance, see 
Sec.  601.601(d)(2) of this chapter, one or more safe harbor methods 
under which a taxpayer may determine the amount of expenses paid or 
incurred for entertainment flights.
    (e) Allocation of expenses--(1) General rule. 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 of all aircraft for the taxable year.
    (ii) Computation under the occupied seat hours or miles method. The 
amount of expenses allocated to an entertainment flight taken by a 
specified individual is computed under the occupied seat hours or miles 
method by determining--
    (A) The total expenses for the year under paragraph (d) of this 
section for the aircraft or group of aircraft (if aggregated under 
paragraph (d)(4) of this section), as applicable;
    (B) The 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 6 hours with three passengers results in 18 occupied seat 
hours;
    (C) The cost per occupied seat hour or mile for the aircraft or 
group of aircraft, as applicable, by dividing the total expenses under 
paragraph (e)(2)(ii)(A) of this section by the total number of occupied 
seat hours or miles under paragraph (e)(2)(ii)(B) of this section; and
    (D) 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 under 
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 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) minus 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 hours, and 4 hours, respectively, during 
the Taxpayer's taxable year. Each flight carries four passengers. On 
Flight 1, none of the passengers is a specified individual. On 
Flight 2, passengers A and B are specified individuals traveling for 
entertainment purposes and passengers C and D are not specified 
individuals. For Flight 2, 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. For Flight 3, 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 (20 occupied seat hours) for Flight 1, plus 
four passengers times 5 hours (20 occupied seat hours) for Flight 2, 
plus four passengers times 4 hours (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) for entertainment 
provided to specified individuals, $5,000 ($1,000 x 5 hours) each is 
allocable to A and B for Flight 2, and $4,000 ($1,000 x 4 hours) 
each is allocable 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 (for A, $5,000 less 
the $1,200 treated as compensation, and for 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 that makes three flights. First, G travels 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

[[Page 45486]]

allocable to G's entertainment (nine total occupied seat hours minus 
the four occupied seat hours 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 to G's entertainment use of the aircraft 
($1,000 x five occupied seat hours). The amount disallowed is $5,000 
minus the total of any amount the Taxpayer treats as compensation to 
G plus any amount 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 combine all expenses (as defined in paragraph (d)(1) of 
this section) for the taxable year for the aircraft or group of 
aircraft (if aggregated 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 for the flight by the cost per mile or the number of hours for 
the flight by the cost per hour. The expenses for the flight then are 
allocated to the passengers on the flight per capita. Thus, if five 
passengers are traveling on a flight, and the total expense allocated 
to the flight is $10,000, the expense allocable to each passenger is 
$2,000.
    (f) Special rules--(1) Determination of basis. (i) If any deduction 
for depreciation is disallowed under 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.
    (ii) The provisions of this paragraph (f)(1) are illustrated by the 
following examples:

    Example 1. (i) B Co. is a calendar-year taxpayer that owns an 
aircraft not used in commercial or contract carrying of passengers 
or freight. The aircraft is placed in service on July 1 of Year 1 
and has an unadjusted depreciable basis of $1,000,000. The class 
life of the aircraft for depreciation purposes is 6 years. For 
determining depreciation under section 168, B Co. uses the optional 
depreciation table that corresponds with the general depreciation 
system, the 200 percent declining balance method of depreciation, a 
5-year recovery period, and the half-year convention. For 
determining the depreciation disallowance for each year under 
paragraph (d)(3) of this section, B Co. elects to use the straight-
line method of depreciation and the class life of 6 years and, 
therefore, uses the optional depreciation table for purposes of 
section 168 that corresponds with the straight-line method of 
depreciation, a recovery period of 6 years, and the half-year 
convention. In each year, the aircraft entertainment use subject to 
disallowance under this section is 10 percent of the total use.
    (ii) B Co. calculates the depreciation and basis of the aircraft 
as follows:

--------------------------------------------------------------------------------------------------------------------------------------------------------
                         200 Percent
                          declining     Straight line        Depreciation
                           balance      depreciation      disallowance under    Depreciation  deduction  Sec.   1.274-7 Basis of     Suspended basis.
                        depreciation       amount            section 274                                         aircraft
                           amount
--------------------------------------------------------------------------------------------------------------------------------------------------------
Year 1...............         200,000          83,300  8,330. (.10 x 83,300)..  191,670 (200,000 minus   808,330 (1,000,000       8,330.
                                                                                 8,330).                  minus 191,670).
Year 2...............         320,000         166,700  16,670 (.10 x 166,700).  303,330 (320,000 minus   505,000 (808,330 minus   25,000 (8,300 plus
                                                                                 16,670).                 303,330).                16,670).
Year 3...............         192,000         166,700  16,670 (.10 x 166,700).  175,330 (192,000 minus   329,670 (505,000 minus   41,670 (25,000 plus
                                                                                 16,670).                 175,330).                16,670).
Year 4...............         115,200         166,700  16,670 (.10 x 166,700).  98,530 (115,200 minus    231,140 (329,670 minus   58,340 (41,670 plus
                                                                                 16,670).                 98,530).                 16,670).
Year 5...............         115,200         166,600  16,660 (.10 x 166,600).  98,540 (115,200 minus    132,600 (231,140 minus   75,000 (58,340 plus
                                                                                 16,660).                 98,540).                 16,660).
Year 6...............          57,600         166,700  16,670 (.10 x 166,700).  40,930 (57,600 minus     91,670 (132,600 minus    91,670 (75,000 plus
                                                                                 16,670).                 40,930).                 16,670).
Year 7...............  ..............          83,300  8,330 (.10 x 83,300)...  .......................  91,670.................  91,670.
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (iii) In Year 7, there is no further deduction for depreciation 
of the aircraft, therefore, under paragraph (d)(3) of this section, 
no depreciation expense is disallowed. Under Sec.  1.274-7 and this 
paragraph (f)(1), basis is not reduced for disallowed depreciation. 
Therefore, at the end of Year 7, the basis of the aircraft for 
purposes of Sec.  1.274-7 is $91,670, which is the total amount of 
disallowed depreciation in Years 1 through 6. B Co.'s deductions for 
depreciation total $908,330, which added to $91,670 equals 
$1,000,000.
    Example 2. (i) The facts are the same as in Example 1, except 
that B Co. does not elect to use the straight-line method of 
depreciation under paragraph (d)(3) of this section until Year 3.
    (ii) B Co. calculates the depreciation and basis of the aircraft 
as follows:

--------------------------------------------------------------------------------------------------------------------------------------------------------
                         200 Percent
                          declining     Straight line        Depreciation
                           balance      depreciation      disallowance under    Depreciation  deduction   Sec.   1.274 Basis of      Suspended basis.
                        depreciation       amount            section 274                                         aircraft
                           amount
--------------------------------------------------------------------------------------------------------------------------------------------------------
Year 1...............         200,000  ..............  20,000 (.10 x 200,000).  180,000................  820,000 (1,000,000       20,000.
                                                                                                          minus 180,000).
Year 2...............         320,000  ..............  32,000 (.10 x 320,000).  288,000 (320,000 minus   532,000 (820,000 minus   52,000 (20,000 plus
                                                                                 32,000).                 288,000).                32,000).
Year 3...............         192,000         166,700  16,670 (.10 x 166,700).  175,330 (192,000 minus   356,670 (532,000 minus   68,670 (52,000 plus
                                                                                 16,670).                 175,330).                16,670).
Year 4...............         115,200         166,700  16,670 (.10 x 166,700).  98,530 (115,200 minus    258,140 (356,670 minus   85,340 (68,670 plus
                                                                                 16,670).                 98,530).                 16,670).
Year 5...............         115,200         166,600  16,660 (.10 x 166,600).  98,540 (115,200 minus    159,600 (258,140 minus   102,000 (85,340 plus
                                                                                 16,660).                 98,540).                 16,660).

[[Page 45487]]

 
Year 6...............          57,600         166,700  16,670 (.10 x 166,700).  40,930 (57,600 minus     118,670 (159,600 minus   118,670 (102,000 plus
                                                                                 16,670).                 40,930).                 16,670).
Year 7...............  ..............          83,300  8,330 (.10 x 83,300)...  0......................  118,670................  118,670.
--------------------------------------------------------------------------------------------------------------------------------------------------------

    (iii) In Year 7, there is no further deduction for depreciation 
of the aircraft, therefore, under paragraph (d)(3) of this section, 
no depreciation expense is disallowed. Under Sec.  1.274-7 and this 
paragraph (f)(1), basis is not reduced for disallowed depreciation. 
Therefore, at the end of Year 7, the basis of the aircraft for 
purposes of Sec.  1.274-7 is $118,670, which is the total amount of 
disallowed depreciation in Years 1 through 6. B Co.'s deductions for 
depreciation total $881,330, which added to $118,670 equals 
$1,000,000.
    (2) Pro rata disallowance. (i) The amount of disallowed expenses, 
and any amounts reimbursed or treated as compensation, under this 
section are applied on a pro rata basis to all of the categories of 
expenses subject to disallowance under this section.
    (ii) The provisions of this paragraph (f)(2) are illustrated by the 
following example:

    Example. (i) C Co. owns an aircraft that it uses for business 
and other purposes. The expenses of operating the aircraft in the 
current year total $1,000,000. This amount includes $250,000 for 
depreciation (25 percent of total expenses).
    (ii) In the same year, the aircraft entertainment use subject to 
disallowance under this section is 20 percent of the total use and C 
Co. treats $80,000 as compensation to specified individuals. Thus, 
the amount of the disallowance under this section is $120,000 
($1,000,000 x 20 percent ($200,000) less $80,000).
    (iii) Under paragraph (f)(2) of this section, C Co. may 
calculate the amount by which a category of expense, such as 
depreciation, is disallowed by multiplying the total disallowance of 
$120,000 by the ratio of the amount of the expense to total 
expenses. Thus, $30,000 of the $120,000 total disallowed expenses is 
depreciation ($250,000/$1,000,000 (25 percent) x $120,000).
    (iv) The result is the same if C Co. separately calculates the 
amount of depreciation in total disallowed expenses and in the 
amount treated as compensation and nets the result. Depreciation is 
25 percent of total expenses, thus, the amount of depreciation in 
disallowed expenses is $50,000 (25 percent x $200,000 total 
disallowed expenses) and the amount of depreciation treated as 
compensation is $20,000 (25 percent x $80,000). Disallowed 
depreciation is $50,000 less $20,000, or $30,000.

    (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 allocating 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 must be based solely on the number of passengers on board for the 
two occupied legs of the flight, the character of the travel of the 
passengers on board (entertainment or nonentertainment) and the length 
in hours or miles of the two occupied legs of the flight.
    (iii) The provisions of this paragraph (f)(3) are illustrated by 
the following examples:

    Example 1. (i) Aircraft flies from City A to City B, a 6-hour 
trip, with 12 passengers aboard. Eight of the passengers are 
traveling for business and four of the passengers are specified 
individuals traveling for entertainment purposes. The aircraft flies 
empty (deadheads) from City B to City C, a 4-hour trip. At City C it 
picks up 12 passengers, six of whom are traveling for business and 
six of whom are specified individuals traveling for entertainment 
purposes, for a 2-hour trip to City A. The taxpayer uses the 
occupied seat hour method of allocating expenses.
    (ii) The two legs of the trip on which the aircraft is occupied 
comprise 96 occupied seat hours (12 passengers x 6 hours (72) for 
the first leg plus 12 passengers x 2 hours (24) for the third leg). 
Sixty occupied seat hours are for business (8 passengers x 6 hours 
(48) for the first leg plus 6 passengers x 2 (12) hours for the 
third leg) and 36 occupied seat hours are for entertainment purposes 
(4 passengers x 6 hours (24) for the first leg plus 6 passengers x 2 
(12) hours for the third leg). Dividing the 36 occupied seat 
entertainment hours by 96 total occupied seat hours, 37.5 percent of 
the total occupied seat hours of the two occupied flights are for 
entertainment.
    (iii) The 4-hour deadhead leg comprises one-third of the total 
flight time of 12 hours. Therefore, the deadhead flight is deemed to 
have provided one-third of the total 96 occupied seat hours, or 32 
occupied seat hours (96 x \1/3\ = 32). Of the 32 deemed occupied 
seat hours, 37.5 percent, or 12 deemed occupied seat hours, are 
treated as entertainment under paragraph (f)(3)(ii) of this section. 
The 32 deemed occupied seat hours for the deadhead flight are 
included in the calculation under paragraph (e)(2)(ii)(B) of this 
section and expenses are allocated under paragraph (e)(2)(ii)(D) of 
this section to the 12 deemed occupied seat hours treated as 
entertainment.
    Example 2. (i) The facts are the same as for Example 1, but the 
taxpayer uses the flight-by-flight method of allocation.
    (ii) Of the 24 passengers on the occupied flights, 10 
passengers, or 41.7 percent, are traveling for entertainment 
purposes. If the annual cost per flight hour calculated under 
paragraph (e)(3)(ii) of this section is $1,000, $4,000 is allocated 
to the 4-hour deadhead leg. Under paragraph (f)(3)(ii) of this 
section, 41.7 percent of the $4,000, or $1,667, is treated as an 
expense for entertainment. The calculation of the cost per mile or 
hour for the year under paragraph (e)(3)(ii) of this section 
includes the expenses and number of miles or hours flown for the 
deadhead leg.

    (g) Effective/applicability date. This section applies to taxable 
years beginning after August 1, 2012.

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.

    Approved: July 25, 2012.
Emily S. McMahon,
Acting Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2012-18693 Filed 7-31-12; 8:45 am]
BILLING CODE 4830-01-P