Rev. Rul. 78-373

Advice has been requested concerning the deductibility of expenses paid by Members of the Congress of the United States in the situations described below.

Situation 1. A, a Member of Congress, pays for the lunch of a constituent whom A takes to a restaurant in order that A might have the time and opportunity to discuss a problem the constituent is having with an agency of the Government. A had no other time to discuss the constituent's problem.

Situation 2. B, a Member of Congress, pays for the cost of a party for B's staff members, secretaries, and aides, all of whom are compensated out of B's annual congressional allowance.

Situation 3. C, a Member of Congress, pays the cost of a cocktail party and buffet to which a few of C's constituents are invited. The stated purpose of the party is to enable C to meet with these constituents, to solicit their views, and to exchange opinions about general issues and matters relating to Governmental affairs and policy. The surroundings at the party are not conductive to the discussion of business.

Section 162(a) of the Internal Revenue Code of 1954 provides that there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

Section 7701(a)(26) of the Code provides that the term "trade or business" includes the performance of the functions of a public office.

Section 274(a) of the Code provides, in part, that no deduction otherwise allowable shall be allowed for any item with respect to an activity which is of a type generally considered to constitute entertainment, amusement, or recreation, unless the taxpayer establishes that the item was directly related to the active conduct of the taxpayer's trade or business.

Section 274(e)(1) of the Code provides, in regard to business meals, that section 274(a) shall not apply to expenses for food and beverages furnished to any individual under circumstances which (taking into account the surroundings in which furnished, the taxpayer's trade, business, or income-producing activity and the relationship to such trade, business, or activity of the persons to whom the food and beverages are furnished) are of a type generally considered to be conducive to a business discussion.

Section 274(e)(5) of the Code provides, in part, that section 274(a) shall not apply to expenses for recreational, social, or similar activities (including facilities therefor) primarily for the benefit of employees (other than employees who are officers, shareholders or other owners, or highly compensated employees).

Section 1.274-2(f)(2) of the Income Tax Regulations provides, in part, that with respect to the specific exception of section 274(e)(1) of the Code, there is no requirement that business actually be discussed. However, the surroundings in which the food or beverages are furnished must be such as would provide an atmosphere where there are no substantial distractions to discussion.

Section 1.274-2(c)(3)(i) of the regulations provides that, in order to meet the "directly related to the active conduct of the taxpayer's trade or business" requirement, at the time the taxpayer made the entertainment expenditure (or was committed to make the expenditure), the taxpayer must have had more than a general expectation of deriving some income or other specific trade or business benefit (other than the goodwill of the persons entertained) at some indefinite future time from the making of the expenditure.

Section 1.274-2(c)(7) of the regulations provides, in part, that expenditures for entertainment, even if connected with the taxpayer's trade or business, will generally be considered not directly related to the active conduct of the taxpayer's trade or business, if the entertainment occurred under circumstances where there was little or no possibility of engaging in the active conduct of trade or business. Meetings or discussions at night clubs, theaters, and sporting events, or during essentially social gatherings such as cocktail parties are examples of circumstances where there is little or no possibility of engaging in the active conduct of trade or business.

With respect to whether an expense is incurred in carrying on a "trade or business" by a public official, it is necessary to distinguish the deductible ordinary and necessary expenses in carrying on a trade or business, and those nondeductible expenses that are more properly described as campaign expenses incurred in order to retain the office or to become elected to the office. See section 162(e)(2) of the Code and sections 1.162-20(c)(1) and 1.212-1(f) of the regulations. In McDonald v. Commissioner, 323 U.S. 57 (1944), 1944 C.B. 94, the Supreme Court of the United States held that the amount paid by a judge as an assessment to the party fund by all the party's candidates running for election, was not a deductible business expense. The Court stated that the judge would be allowed a deduction for expenses incurred in performing the duties of a judge, but would not be allowed a deduction for expenses incurred in seeking a judgeship.

In Situation 1, A's constituent is discussing a particular problem the constituent is having with an agency of the Government. A's expenditure is neither a campaign expense in order to retain A's office nor a personal expense.

Accordingly, in Situation 1, the expense incurred by A in buying lunch for the constituent is an ordinary and necessary business expense and is deductible by A pursuant to section 162 of the Code, subject to the provisions of section 274 and the regulations thereunder. However, if the constituent meets with A on essentially a social visit or on campaign matters, the expense for such meal would not be deductible.

In Situation 2, the employee-employer relationship that is necessary in order to be covered by the section 274(e)(5) exception is absent. B's staff members, secretaries, and aides are not employees of B, but rather are employees of the United States who are compensated out of B's annual congressional allowance for hiring employees. Compare Case 1 in Rev. Rul. 61-21, 1961-1 C.B. 431. Further, section 1.274-2(c)(3)(i) of the regulations states that one of the requirements of meeting the "directly related to the active conduct of the taxpayer's trade or business" requirement of section 274, is that at the time the taxpayer made the entertainment expenditure, the taxpayer had more than a general expectation of deriving some income or other specific trade or business benefit (other than the goodwill of the person or persons entertained) at some indefinite future time from the making of the expenditure. B could not have had more than a general expectation of deriving a trade or business benefit from the expenditure. The expenses incurred are in the nature of expenses incurred to develop goodwill.

Accordingly, in Situation 2, the expenses incurred by B in providing a party for B's staff, secretaries, and aides are not directly related to the active conduct of the taxpayer's trade or business and therefore are not deductible pursuant to section 1.274-2(c)(3)(i) of the regulations.

In Situation 3, the surroundings at the cocktail party and buffet are not conducive to the discussion of business, so that it cannot be considered to be a business meal. Entertainment of this kind generally occurs under circumstances where there is little or no possibility of conducting business.

Accordingly, in Situation 3, the expenses incurred by C in providing a cocktail party and buffet for a few of C's constituents to solicit their views and exchange opinions regarding general issues and matters relating to governmental affairs and policy are not deductible pursuant to section 1.274-2(c)(7) of the regulations.