S corp. cannot deduct cost of leasing entertainment facility.

• Author: Silvio, Michael S.

In Patrick E. Catalano, TC Memo 1998-447, an S corporation could not deduct any amounts paid to its sole shareholder for the lease of his powerboats used to provide entertainment for his clients. Catalano reported the S corporation's lease payments for the boats as rental income on Schedule E of his individual Federal income tax returns; he also deducted expenses relating to the boats on these Schedules E. (These expenses included depreciation, repairs and maintenance, property taxes, interest, insurance and slip fees.) For 1990, 1991 and 1992, Catalano's corporation deducted 80% of the lease payments on its Federal corporate income tax return under Sec. 274(n).

Facts

Catalano was the sole shareholder of an S corporation. He owned three powerboats, which he leased to his corporation for various periods in accordance with written lease agreements executed by Catalano, as an individual lessor and on behalf of his corporation, as lessee. Catalano invited clients, potential clients and their spouses aboard his boats, mostly on the weekends. While on board, Catalano and his clients (or potential clients) did have business discussions.

The Tax Court held that Catalano's treatment of the lease payments and related expenses on his individual returns was correct; however, it denied a deduction to the S corporation for the lease payments, because these payments were related to the use of an entertainment facility.

Entertainment Facilities

Under Sec. 274(a)(1), no deduction shall be allowed for any item with respect to an activity, or entertainment facility used in connection with such activity, considered to constitute entertainment, amusement or recreation, unless it is established that the item was directly related to (or, in the case of an item directly preceding or following a substantial and bona fide business discussion, that such item was associated with) the conduct of the taxpayer's trade or business. The term "entertainment facility" encompasses any real or personal property owned, rented or used by a taxpayer. This includes boats, automobiles, aircraft and homes in vacation resorts. Any entertainment use of the property, no matter how minimal, will result in the property being characterized as an entertainment facility.

According to Regs. Sec. 1.274-2 (e)(3)(i), nondeductible expenditures for an entertainment facility generally include depreciation and operating costs, such as rent and utility charges, expenses for maintenance...