The Commissioner determined a deficiency in petitioner's income tax for the year 1963 of $2,753.12. Petitioner disputes in this proceeding only the adjustment made by the Commissioner disallowing a deduction for certain entertainment expenses allegedly incurred by petitioner in 1963 and not reimbursed by his employer. Petitioner's nonreimbursed expenses were recorded in a desk calendar or "diary" which purported to list certain information relating to each expenditure claimed, but he did not keep any supporting receipts or other documentary proof of the making of these expenditures. The Commissioner disallowed a deduction for petitioner's entertainment expenditures of $25 or more, but not those of less than $25. It is the correctness of this determination which constitutes the only issue in this case.
FINDINGS OF FACT
Some of the facts have been stipulated and, as stipulated, are incorporated herein by this reference along with accompanying exhibits.
William F. Sanford (hereinafter referred to as petitioner) filed his Federal income tax return for the calendar year 1963 with the district director of internal revenue, Manhattan District, New York, N.Y., using the cash method of accounting. This return was filed and the tax payable indicated thereon was computed on the basis that the petitioner qualified as an unmarried head of household. During the tax year and at the time the petition herein was filed petitioner resided in Chicago, Ill.
Petitioner was employed during 1963 by RKO General Broadcasting, Inc. (hereinafter referred to as RKO), as an outside salesman of television-advertising time on RKO's five television stations. Most of his sales were made through the presentation of recommendations to buy television-advertising time, and these "presentations" were often made at luncheons or dinners, either at restaurants or at his home. He was reimbursed by RKO for some of these expenditures, generally on the average of $50 to $60 per week, but it was understood that, for the most part, he would have to bear all entertainment expenses above this weekly amount. Petitioner worked primarily on a commission basis, and his rate of compensation took into account the fact that he occasionally incurred expenses in obtaining and keeping accounts for which he was not reimbursed.
On his Federal income tax return for the year 1963, petitioner listed "outside salesman expenses" totaling $13,950.35, less reimbursement from his employer, RKO, of $4,431.93, and deducted the difference of $9,518.42 as nonreimbursed employee business expenses. In his notice of deficiency, the Commissioner disallowed as a deduction $5,800.05 of the $9,518.42 claimed as business expenses, as well as $614.43 of petitioner's claimed deduction for medical expenses. In his petition to this Court, petitioner assigned as error only the disallowance of employee business expenses in the amount of $4,984.31.
Among the "outside salesman expenses" listed by petitioner was an item for "Entertainment, from my record" in the amount of $8,853.35. Petitioner had been reimbursed by RKO for a portion of these expenses in the amount of $3,186.18, so that his claimed nonreimbursed entertainment expenses came to $5,667.17. The Commissioner disallowed a deduction for all alleged entertainment expenditures of $25 or more, a total of $4,984.31, which is the amount disputed by petitioner
As to those entertainment expenses for which he sought and obtained reimbursement from his employer — which are not involved herein — petitioner filed a detailed expense account with his employer every Tuesday in respect of the expenses incurred during the preceding calendar week. A number of those expenses were supported by receipts or other documentary evidence. Most of these expenses represented the cost of lunches, and most of them ranged from about $10 to $25 each. Petitioner also maintained a desk calendar or "diary," on which he recorded those entertainment expenses for which he did not seek reimbursement. Most of the items recorded on this calendar, or diary, represented the alleged cost of dinners, and most of these involved claimed expenditures in excess of $25. The entries on this calendar identified the names of the persons entertained, the amount allegedly spent, and, by abbreviation or code, the restaurant, the advertising agency, and the alleged reason for the entertainment. However, in contrast to the expense accounts submitted to petitioner's employer, the particular client or account involved in the alleged business discussion was not identified, and in respect of none of the items recorded on the calendar did petitioner either obtain or retain any supporting receipt or other documentary evidence. No item for which petitioner sought reimbursement from his employer was recorded on the calendar.
Although the Commissioner did not disturb the deduction as to the items under $25 on the calendar, he disallowed the deduction in respect of all such items of $25 or more for want of proper substantiation, as required by section 274 of the 1954 Code and accompanying regulations. In this Court he makes the additional argument that the alleged expenses are in any event not deductible under section 162(a).
Petitioner, an outside salesman of television-advertising time, claimed $8,853.35 entertainment expenses on Form 2106 — "Statement of Employee Business Expenses," which was made part of his 1963 income tax return (Form 1040). This sum, according to petitioner's testimony, represented the cost of luncheons and dinners during 1963 at which petitioner discussed business with "advertising agency people." He was either advanced or reimbursed for the cost of some of those meals by his employer, and the Commissioner does not challenge the propriety of such expenses here. The remaining expenditures, those for which petitioner neither sought nor received reimbursement, were claimed by petitioner as a deduction from his gross income
The requirements imposed by section 274 were added to the Internal Revenue Code of 1954 by the Revenue Act of 1962, 76 Stat. 974. They are in addition to the requirements imposed by section 162, and petitioner still has the burden of proving initially that his expenditures were ordinary and necessary expenses, proximately related to his trade or business. H.Rept. No. 1447, 87th Cong., 2d Sess., p. 19 (1962); S. Rept. No. 1881, 87th Cong., 2d Sess., p. 27 (1962). Cf. Welch v. Helvering, 290 U.S. 111. We are by no means convinced that petitioner has carried this initial burden with respect to every expenditure disallowed by the Commissioner. To be sure, petitioner submitted in evidence a "diary," consisting of pages from his desk calendar bound together, which purported to show the time, place, and amount of each of his nonreimbursed expenditures along with the persons entertained, the advertising agencies they represented, and the type of business discussed. But the large number of dinners claimed by petitioner as deductible expenses, approximately three per week, and the fact that the cost of petitioner's entertainment at luncheons was usually reimbursed by his employer, along with a relatively small number of dinners, suggests that at least some of his claimed nonreimbursed expenses
Nevertheless, though petitioner's proof was deficient in some important respects and left us with the definite impression that the amount of entertainment expenses claimed by him was excessive, this might have been an appropriate case for application of the rule of Cohan v. Commissioner, 39 F.2d 540 (C.A. 2), and we might have made an approximation of petitioner's allowable expenses were it not for section 274(d). That subsection, however, provides, in part, that "no deduction shall be allowed —"
(2) for any item with respect to an activity which is of a type generally considered to constitute entertainment * * *
* * * * * * *
unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating his own statement (A) the amount of such expense * * * (B) the time and place of the * * * entertainment * * * (C) the business purpose of the expense * * *, and (D) the business relationship to the taxpayer of persons entertained * * *. The Secretary or his delegate may by regulations provide
Under this provision, a taxpayer must substantiate every expenditure claimed as a deduction by either "adequate records" or other "sufficient evidence," for such expenditures as are not thus substantiated will be disallowed in full.
As the House and Senate committee reports make abundantly clear, section 274(d) was "intended to overrule, with respect to * * * [entertainment] expenses, the so-called Cohan rule." Where, under Cohan, a court was not only permitted but required to make as close an approximation as it could when the evidence indicated that a taxpayer had incurred deductible expenses but their exact amount could not be determined, under section 274(d), "the entertainment, etc., expenses in such a case * * * [will] be disallowed entirely." H.Rept. No. 1447, supra at 23; S.Rept. No. 1881, supra at 35. Our opinion that petitioner has failed to substantiate his expenditures of $25 and over in the manner contemplated by the statute thus compels the conclusion that the Commissioner correctly disallowed a deduction for all such expenditures.
Terms such as "adequate" and "sufficient" obviously contemplate and require further elucidation, and the regulations promulgated under section 274(d) spell out their meaning in a carefully detailed explanation of the substantiation rules. Supported not only by the general rule-making power under section 7805 of the 1954 Code, but also by the specific provisions of section 274(h)
Section 1.274-5(c) Rules for substantiation —
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(2) Substantiation by adequate records — (i) In general. To meet the "adequate records" requirements of section 274(d), a taxpayer shall maintain an account book, diary, statement of expense or similar record (as provided in subdivision (ii) of this subparagraph) and documentary evidence (as provided in subdivision (iii) of this subparagraph) which, in combination, are sufficient to establish each element of an expenditure specified in paragraph (b)
* * * * * * *
(iii) Documentary evidence. Documentary evidence, such as receipts, paid bills, or similar evidence sufficient to support an expenditure shall be required for —
(a) Any expenditure for lodging while traveling away from home, and
provided, however, that the Commissioner, in his discretion, may prescribe rules waiving such requirements in circumstances where he determines it is impracticable for such documentary evidence to be required. Ordinarily, documentary evidence will be considered adequate to support an expenditure if it includes sufficient information to establish the amount, date, place, and the essential character of the expenditure. For example, a hotel receipt is sufficient to support expenditures for business travel if it contains the following: name, location, date, and separate amounts for charges such as for lodging, meals, and telephone. Similarly, a restaurant receipt is sufficient to support an expenditure for a business meal if it contains the following: name and location of the restaurant, the date and amount of the expenditure, and, if a charge is made for an item other than meals and beverages, an indication that such is the case. A document may be indicative of only one (or part of one) element of an expenditure. Thus, a cancelled check, together with a bill from the payee, ordinarily would establish the element of cost. In contrast, a cancelled check drawn payable to a named payee would not by itself support a business expenditure without other evidence showing that the check was used for a certain business purpose.
Thus, an "adequate" record of an expenditure is defined as an entry in an account book, diary, or similar record, made "at or near the time of the expenditure," and documentary evidence such as a receipt, paid bill, or similar evidence (unless the expenditure is less than $25), which in combination are sufficient to establish each of the elements of the expenditure (amount, time, place, business purpose, and business relationship) for which substantiation is required by section 274(d). Moreover, in the absence of "adequate records," section 1.274-5(c)(3), Income Tax Regs., provides that the taxpayer may alternatively satisfy the substantiation requirements by coming forward with "corroborative evidence sufficient" to support his own statement containing specific information in detail as to each element of the expenditure, or such elements as have not been substantiated by adequate records. And these provisions go on to state that where the unsubstantiated element is the cost, time, place, or date of the expenditure "the corroborative evidence shall be direct evidence, such as a statement in writing or oral testimony of persons entertained or other witness." Less stringent rules are provided, however, where the taxpayer is able to show that, because of the inherent nature of the situation in which the expenditure was made, he was unable to meet either the "adequate records" or the alternative "sufficient evidence" requirements, or where his failure to produce adequate records is due to the loss of such records through circumstances beyond his control. Sec. 1.274-5(c)(4) and (5), Income Tax Regs.
In the present case, it is clear that petitioner has failed to substantiate his claimed expenditures for entertainment in excess of $25 by either "adequate records" or other "sufficient evidence" as those terms
The only reason suggested for his failure to obtain or retain receipts for unreimbursed entertainment expenses of $25 or more was the advice of his lawyer, which appears to have been based on the lawyer's conclusion that the regulations were invalid. That the regulations plainly support the Commissioner's position
In arguing that the regulations are contrary to law, petitioner's counsel points out that section 274(b) places a $25 limit on deductible business gifts, that no such limit was prescribed by statute in connection with deductible entertainment expenses, and he contends that the Commissioner's regulations here under consideration were therefore unauthorized. The point is without merit. The regulations do not, first of all, flatly disallow a deduction for entertainment expenditures above $25 as does section 274(b) in connection with business gifts; to the contrary, they merely provide that the documentary proof ordinarily required as part of an "adequate record" of an expenditure need not be obtained in the case of expenditures below $25. Moreover, Congress deliberately refused to fix any dollar limit in connection with the substantiation requirements of section 274(d), involved herein, and expressly left the matter to be governed by regulations. After
The Secretary or his delegate may by regulations provide that some or all of the requirements of the preceding sentence shall not apply in the case of an expense which does not exceed an amount prescribed pursuant to such regulations.
This conferred ample authority to draw the line at $25.
Nor is there any compelling reason to disapprove these regulations because they require that diary entries be corroborated by documentary proof such as receipts. The history of the underlying statutory provisions, demonstrating the potential for abuse in the case of entertainment expenses,
However, receipts, cancelled checks, paid bills, stubs, or other similar records may be required in certain cases, as, for example, to substantiate the amount expended for lodging and transportation while traveling on business.
Cf. H.Rept. No. 1447, 87th Cong., 2d Sess., p. A32. This suggests that "receipts, cancelled checks, paid bills, stubs, or other similar records" may be required for larger expenditures like lodging and transportation. At best, from petitioner's point of view, the committee reports are inconclusive in this respect, and we must conclude that in appropriate cases, involving larger expenditures, there was no intention to preclude the Commissioner from demanding that diary entries (self-serving statements) be supported by corroborating documentary evidence. Certainly, the Commissioner had some discretion in
Moreover, nothing in the plain language of the statute is inconsistent with the regulations and we must take heed of the Supreme Court's admonition that "Treasury regulations must be sustained unless unreasonable and plainly inconsistent with the revenue statutes and that they constitute contemporaneous constructions by those charged with administration of these statutes which should not be overruled except for weighty reasons." Commissioner v. South Texas Co., 333 U.S. 496, 501. See also Fawcus Machine Co. v. United States, 282 U.S. 375, 378; Boske v. Comingore, 177 U.S. 459, 470; Brewster v. Gage, 280 U.S. 327, 336; Textile Mills Corp. v. Commissioner, 314 U.S. 326, 336-339; Colgate Co. v. United States, 320 U.S. 422, 426. Here, the Secretary or his delegate had authority to promulgate regulations clarifying the substantiation requirements of section 274(d) and its ambiguous terms such as "adequate" records and "sufficient" evidence, not only under the general rule-making power granted in section 7805, I.R.C. 1954, but also under the mandate of section 274(h), which provides that "The Secretary or his delegate shall prescribe such regulations as he may deem necessary to carry out the purposes of this section." This gives "added reasons why interpretations of the Act and regulations under it should not be overruled by the courts unless clearly contrary to the will of Congress." Commissioner v. South Texas Co., 333 U.S. 496, 503. Far from being contrary to the will of Congress, we think the regulations under consideration reflect a faithful observance of the congressional intent.
The regulations setting forth the substantiation rules and incorporating the requirement of documentary proof were first proposed on November 8, 1962, 27 Fed. Reg. 10894 (which proposal required documentary proof of expenditures of $10 or more), and was adopted in its present form on December 27, 1962 (T.D. 6630), sec. 1.274-5, Income Tax Regs., so that it was available to petitioner throughout the year 1963 here in issue. The Internal Revenue Service, in two published revenue procedures, allowed taxpayers a grace period until March 31, 1963, extended to July 31, 1963, in which to conform their accounting systems to the requirements of the new regulations if their accounting systems already conformed to the requirements of Rev. Rul. 60-120, 1960-1 C.B. 83, and if "good faith efforts" were made to comply with the new requirements in the interim. Rev. Proc. 63-3, 1963-1 C.B. 473; Rev. Proc. 63-18, 1963-1 C.B. 506-507. The Commissioner has not, however, relaxed his application of the documentary proof requirement in petitioner's case with respect to any of the expenditures of $25 or more incurred by petitioner during 1963, and we will not disturb his determination in this matter. An obvious reason for refusing to extend the benefits of these
Finally, petitioner has made some reference to section 274(e), but those provisions have no bearing on section 274(d), involved herein. In general, section 274 as a whole provides for the disallowance of certain types of deductions, whereas subsection (d) spells out the substantiation requirements that must be met where the deduction is otherwise allowable. Subsection (e) lists certain exceptions to subsection (a), which deals with the disallowance of specified entertainment, amusement or recreation deductions, and one of those exceptions is found in paragraph (1) of subsection (e) dealing with "business meals." Thus, (e)(1) makes clear that subsection (a) may not be relied upon to disallow deductions for "business meals" that qualify under (e)(1). But nothing in (e) relieves the taxpayer of complying with the substantiation requirements of (d), which come into play only with respect to deductions otherwise allowable. The committee reports make clear that even though an expenditure is covered by one of the exceptions to (a), the "substantiation requirements" must nevertheless "be fulfilled." H.Rept. No. 1447, 87th Cong., 2d Sess., p. A33. See also S.Rept. No. 1881, 87th Cong., 2d Sess., p. 36 ("the new substantiation requirements * * * will have to be satisfied with respect to any such expense"). The same thought is set forth in section 1.274-5(a)(2), Income Tax Regs., which explicitly states that the substantiation requirements must be met in connection with any expense for entertainment, amusement, or recreation "including the items specified in section 274(e)." There is no merit to petitioner's argument based upon section 274(e).
Reviewed by the Court.
Decision will be entered for the respondent.
(h) REGULATORY AUTHORITY. — The Secretary or his delegate shall prescribe such regulations as he may deem necessary to carry out the purposes of this section, * * *