Rev. Rul. 84-110

ISSUES

(1) Are expenses incurred by a member of a city council deductible if the expenses consistently exceed the salary and expense allowance received from the city?

(2) Are the expenses described in (1) charitable contributions deductible under section 170 of the Internal Revenue Code, and therefore subject to the limitations stated in section 162(b) or business expenses deductible under section 162(a) of the Code?

FACTS

A, an individual, was an elected member of the city council of city CI. CI furnished each city council member, including A, with office space and furniture for the member and one secretary, a salary allowance for one secretary, and legislative assistance from the staff of the city council.

The facilities furnished by CI were not adequate for A to properly perform A 's duties as a city council member. Therefore, A used A 's personal funds to obtain office space in A 's district larger than the space furnished by CI and to hire a staff of eight persons, in addition to A 's secretary, to work at the office. The additional staff members hired by A were not employees of CI.

The staff researched issues for which A believed legislation was necessary and assisted A 's constituents in resolving their problems under the laws of CI. A received from CI 25 x dollars for A 's salary and expenses, including the allowance for A 's secretary. A incurred 100 x dollars for A 's expenses as a city council member, including rent for A 's office space, the salaries for the secretary and the eight additional staff members, and office supplies for the office. These expenses were reasonable in amount, were directly related to A 's official business as a city council member, were not capital expenditures, and were not personal expenses of A or related to any private business of A.

LAW AND ANALYSIS -- ISSUE (1)

Section 162(a) of the Code allows a deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

Under section 7701(a)(26) of the Code, the term "trade or business" includes the performance of the functions of a public office.

Under section 1.162-1(a) of the Income Tax Regulations, the full amount of the allowable deduction for ordinary and necessary business expenses is deductible even though the expenses exceed the gross income derived during the taxable year from the business.

In Frank v. United States, 577 F.2d 93 (9th Cir.1978), the United States Court of Appeals held that an administrative assistant to a United States senator could deduct all expenses incurred in that capacity even though those expenses consistently exceeded the taxpayer's salary from the Senate. The court stated that the general rule is that an activity must be engaged in for profit in order to be a trade or business under section 162 of the Code. The court held, however, that section 7701(a)(26) creates an exception for holders of a public office to the general profit motive requirement, as long as the taxpayer accepts the public office in good faith and not for the purpose of avoiding taxes.

In Rev. Rul. 73-464, 1973-2 C.B. 35, a member of Congress was unable to serve constituents properly because of the limit on the amount of the member's Congressional allowance for the staff and office equipment. Accordingly, the member used the member's own funds to hire additional staff and purchase additional equipment. The ruling holds that the member could deduct the full amount expended for the additional staff salaries under section 162 of the Code and deduct depreciation on the additional equipment not included in the Congressional allowance under section 167.

In Rev. Rul. 73-464, the Congressional expenses of the member of Congress exceeded the income from Congressional activities for the first two years. In the third year and all subsequent years, the member's income from Congressional activities exceeded the expenses of these activities. The result of the ruling, however, would remain the same even if the member's Congressional expenses consistently exceeded the member's Congressional income.

In this case, A incurred expenses for staff salaries, office rent, and office supplies, which A paid from A 's personal funds. These office expenses were incurred in the trade or business of performing the functions of a public office.

LAW AND ANALYSIS -- ISSUE (2)

Section 170 of the Code provides, subject to certain limitations, a deduction for charitable contributions (as defined in section 170(c) ), payment of which is made during the taxable year. Under section 170(c)(1), the term "charitable contribution" includes a contribution or gift to or for the use of a political subdivision of a state that is made for exclusively public purpose.

Section 170(b)(1) of the Code limits the deduction for charitable contributions by individuals to a specified percentage of the taxpayer's contribution base (adjusted gross income determined without regard to any net operating loss carryover to the taxable year).

Under section 162(b) of the Code, no deduction is allowable as a trade or business expense under section 162(a) for any contribution or gift that would be deductible under section 170 were it not for the percentage limitations stated in section 170.

Section 1.162-15(a)(2) of the regulations states that the limitations in section 162(b) of the Code apply only to payments that are in fact contributions or gifts to organizations described in section 170. For example, payments by a transit company to a hospital, a charitable organization, in return for a binding obligation of the hospital to provide hospital care to the company's employees are not charitable contributions.

Furthermore, section 1.170A 1(c)(5) of the regulations states that transfers of property to an organization described in section 170(c) of the Code that bear a direct relationship to the taxpayer's trade or business and that are made with a reasonable expectation of financial return commensurate with the amount of the transfer may constitute allowable deductions as trade or business expenses rather than as charitable contributions.

In Marquis v. Commissioner, 49 T.C. 695 (1968), acq., 1971-2 C.B. 3, a travel agent made voluntary payments to charitable organizations with which the taxpayer did business, to encourage the organizations to continue doing business with the taxpayer. The Tax Court held that the payments were not charitable contributions, but were fully deductible business expenses. In Singer Co. v. United States, 449 F.2d 413 (Ct.Cl.1971), the United States Court of Claims held that discounts on a sewing machine company's sales of sewing machines to schools that were made for the purpose of encouraging the schools' students to buy the company's machines in the future were not charitable contributions. These decisions indicate that a payment or transfer to a charitable organization is not a charitable contribution if the taxpayer's business may benefit from the payment or transfer.

These cases dealt with profit making businesses and are consistent with the general rule stated in Rev. Rul. 73-113, 1973-1 C.B. 65, that when a taxpayer engaged in a trade or business makes a transfer of property with a reasonable expectation of financial return to the taxpayer in the taxpayer's trade or business commensurate with the amount of the transfer, no deduction under section 170 of the Code is allowable with respect to the transfer and the transfer may constitute an ordinary and necessary business expense under section 162 of the Code. However, under section 7701(a)(26) of the Code, a taxpayer performing the functions of a public office is engaged in a trade or business even though the taxpayer has no expectation of financial return. Thus, section 7701(a)(26) creates an exception to the general rule of section 1.170A 1(c)(5) of the regulations and Rev. Rul. 73-113 that an expectation of financial return is necessary for a deduction to be governed by section 162(a) rather than by section 170.

In this case, A 's payments for salaries, office rent, and office supplies were made to permit A to properly perform the duties of a city council member. The payments, therefore, benefited A 's trade or business as a public official. Since, as a result of section 7701(a)(26) of the Code, a public official need not have a profit motive in order to be engaged in a trade or business, A 's payments are not charitable contributions to CI even though A did not derive a monetary benefit from them.

HOLDINGS

(1) A 's expenditures for salaries, office rent, and office supplies are deductible under section 162 of the Code provided that A itemizes deductions.

(2) A 's expenditures for these items are not charitable contributions deductible under section 170 of the Code; accordingly, the limitations stated in section 162(b) do not apply to the expenses.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 59-160, 1959-1 C.B. 59, holds that mayors, council members, and other officials of municipal governments who serve without compensation may deduct as charitable contributions unreimbursable expenses directly connected with and solely attributable to the performance of their official duties. The ruling states that the deduction for these expenses are subject to the limitations imposed by section 170 of the Code. Because the position of Rev. Rul. 59-160 is inconsistent with the conclusion reached in this revenue ruling, Rev. Rul. 59-160 is revoked.

Rev. Rul. 73-464 and Rev. Rul. 73-113 are amplified.