Comm'r of Internal Revenue

Tax Court of the United States.Feb 20, 1951
16 T.C. 401 (U.S.T.C. 1951)
16 T.C. 401T.C.

Docket No. 22281.



Eli T. Scott, Esq., and Herbert G. Bantz, Esq., for the petitioner. Michael Waris, Esq., for the respondent.

Eli T. Scott, Esq., and Herbert G. Bantz, Esq., for the petitioner. Michael Waris, Esq., for the respondent.

Entertainment expenses are deductible only if they are in fact ordinary and necessary expenses for carrying on a trade or business and to the extent that they are primarily social and personal in nature and bear no direct relation to the operation of a business, such expenditures may not be deducted.

The respondent has determined a deficiency in petitioner's 1945 income tax in the amount of $8,928.05. The deficiency results from the disallowance of deductions in the sums of $9,304.40 and $400 claimed by petitioner as entertainment and advertising expenses, respectively, incurred in that year.

Respondent has abandoned an issue raised by way of amended answer relating to certain salary expense deducted by the petitioner in 1945.


Petitioner, a resident of Greenwich, Connecticut, filed his individual income tax return for the calendar year 1945 with the collector of internal revenue for third district of New York.

Petitioner is engaged in the business of manufacturing and importing fine watches and jewelry. He conducts his business at 304 East 45th Street, New York, N.Y., in a loft factory covering 4,000 or 5,000 square feet, which contains a tool and die shop, several milling machines and various kinds of lathes, drilling machines and presses. During 1945 the petitioner employed between 25 and 30 people.

The petitioner buys gold, diamonds, rubies, and other precious stones, imports watch crystals from England and France and watch movements from Switzerland, and then puts them together in the form of bracelets and watches. The petitioner occupies a unique position in the jewelry and watch manufacturing business. He is a craftsman whose work requires a high degree of skill, and some of the watches he manufactures have been sold by him for as much as $10,000 each.

The petitioner sells only to stores and wholesale houses. He keeps merchandise on hand for sale to his customers and also fills special orders placed by them. The wholesale price of his watches ranges from $100 to $10,000 and averages about $200 each. The average order during 1945 was between $2,000 and $4,000. His firm is patronized by stores handling expensive jewelry. The buyers for these stores frequently come to New York and often bring their wives and families with them. It is customary in the petitioner's business to entertain such buyers in order to gain and hold their patronage.

During the year 1945, petitioner could not produce enough merchandise to fill his customer's orders, and such unfilled orders amounted to several hundred thousand dollars in 1945. Buyers came for all over the country and from as far away as the Philippines and Honolulu begging for merchandise and offered ‘bonuses‘ to the petitioner if he would sell to them. Because of this shortage of supply, the buyers came to New York City more frequently than usual. During 1945 petitioner entertained customers to maintain or promote good will, not to ‘drum up‘ business.

In earlier years the petitioner had employed salesmen, paying them a salary and commission, but during 1945 he could not make enough merchandise to fill the orders his customers had placed with him and employed no salesmen.

The petitioner claimed a deduction for entertainment expense in the amount of $9,304.40 on his 1945 income tax return. That amount was arrived at by the petitioner through the use of three types of records, hereinafter referred to as chits, petty cash vouchers and checks. The chits represented $6,150.08 of the total $9,304.40 and were made up as follows: The petitioner's wife, who worked in his office as bookkeeper and office manager, would draw checks payable to cash and place the proceeds thereof in a safe in the office. Such checks totaled $6,350.08 for year 1945. When a check for this cash fund was drawn, a charge therefor was made at the end of the month to the entertainment account in the general ledger. The petitioner would advise his wife that he had expended a certain sum for entertainment, and she would then make out a chit, setting forth the amount given to her by the petitioner and a brief description of the purpose of the expenditure. The information given to her by the petitioner was also recorded by him in a book which he carried. Sometimes he would tell her what he had spent on the day he spent it, but sometimes as much as a week would elapse before he would inform her of the expenditure. When his wife had made out the chit, she would give the petitioner cash from the aforementioned fund in the amount reported as spent. When the fund began to get low, she would replenish it by cashing another check. The checks were drawn in varied amounts.

$200 of this amount was not expended in 1945.

In all of the chits for the year 1945 there was included the cost of the petitioner's own entertainment and food, and in the chits relating to the evening entertainment there was also included the cost of his wife's entertainment and food. The petitioner had known many of the people referred to on the chits for a long time. Some of those people also entertained the petitioner.

Of the total expenditures recorded on the chits, approximately $3,400 was spent for suppers, theaters and nightclubs. The balance was spent mainly on luncheons. The following table shows the information contained on the chits for the months of January, June, September and October, 1945. Each date represents an individual chit and the numbers following the written notation show the number of people entertained. Chits set forth in this table are typical of those for the other months of 1945.

+-----------------------------------------------------------------------------+ ¦Date ¦January ¦Amount ¦ +------+-------------------------------------------------------------+--------¦ ¦1945 ¦ ¦ ¦ +------+-------------------------------------------------------------+--------¦ ¦1-5 ¦For luncheon, Myron Everts—3 ¦$12.45 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-6 ¦For Brotherhood luncheon—Keller, Schaeffer, Kelly ¦24.25 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-6 ¦For cocktails & supper, Brecht plus 4 ¦37.00 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-8 ¦Pay to luncheon, for Hausmann (New Orleans) ¦8.50 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-9 ¦Pay to JS, for luncheon, Al Schulz—3 ¦16.40 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-9 ¦Pay to Woods, for luncheon, Elebash—4 ¦22.50 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-9 ¦For theater, Fri. Jan. 12, Red Mill ¦75.20 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-10 ¦For luncheon, Hy Schliessman—2 ¦8.75 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-12 ¦Pay to tips—Wivels ¦28.00 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-12 ¦For 16 at Wivel's after theater ¦135.00 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-12 ¦Pay to tips N. Y. A. C., Julius ¦20.00 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-12 ¦Pay to Waldorf, for luncheon—Leon Binard ¦12.50 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-12 ¦For tips—Waters ¦15.00 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-12 ¦For theater, Sat. matinee—4 ¦11.00 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-12 ¦For Garden tickets, Sonja Henie ¦14.40 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-13 ¦Pay to Sat. luncheon, for Simard, McCayne, Vogt, ELS ¦18.85 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-13 ¦Pay to Sat. supper, Simard, Lyons, ELS ¦32.25 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-13 ¦Pay to tips, Waldorf, for banquet dept., hat check, etc., ¦ ¦ ¦ ¦Hans ¦ ¦ +------+-------------------------------------------------------------+--------¦ ¦ ¦& waiters ¦95.00 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-14 ¦For M. J. Lyons, Barclay reservation ¦66.20 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-17 ¦Pay to supper & theater, for Vogt—4 ¦56.00 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-22 ¦For luncheon, Grauat ¦22.50 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-22 ¦For supper & theater Laykin—4 ¦43.75 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-25 ¦Pay to luncheon, for Helzberg ¦18.00 ¦ +------+-------------------------------------------------------------+--------¦ ¦1-26 ¦For supper & evening, Reingold & Maurice ¦93.50 ¦ +------+-------------------------------------------------------------+--------¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+

June 6-1 For Memorial Day & weekend, Detroit 316.00 6-4 For cocktails, Commodore 14.00 6-7 For theater & Wivels—7 155.00 6-7 For overnight, N.Y 34.00 6-11 For luncheon 31.00 6-15 For theater & “21” club 180.50 6-20 For luncheon, Oberman 7.50 6-21 For luncheon, Lichtey 12.00

September 9-5 For cocktails & supper, Higginbotham 47.00 9-9 For Labor Day weekend 225.00 9-14 For luncheon, Hansen 13.00 9-17 For Helzberg, cocktails 15.00 9-18 For luncheon, Chris Brodersen 7.00 9-20 For lunch, Bud Tobias 17.00 9-21 For supper, Clawson 18.00 9-24 For supper—Habe, Chicago 42.00

October 10-1 For luncheon—M. Caplan 11.00 10-5 For luncheon—Pongrace 9.00 10-6 For supper & theater—4 63.00 10-8 For theater & supper, Lichtenstein 129.00 10-15 For luncheon—Kleska & Gutowitz 35.00 10-18 For supper—Stegmeier 84.00 10-31 For luncheon—M. Wethered 18.00

Two chits, one for $34 and the other for $25, represented the cost to the petitioner of a hotel room, meals, and tips when, after a night of entertaining customers, he missed his train home and remained overnight in New York.

The second type of records kept by the petitioner was petty cash vouchers, which represented $1,870.97 of the total $9,304.40 claimed as entertainment expenses. Such vouchers were small memoranda similar to the chits.

The expenditures by petitioner's wife and employees for the entertainment of customers were recorded on these vouchers. Thereafter, they were listed in a ‘Petty Cash‘ disbursements journal where they were consolidated by months and recorded in the entertainment expense account in the general ledger. The cash so expended was drawn from the petty cash fund, a fund separate from the previously mentioned revolving fund from which petitioner was reimbursed.

The third type of record of entertainment expense kept by the petitioner was cancelled checks. Such checks were made payable to the persons who provided the entertainment, and the amount thereof, which totaled $1,083.35 for 1945, was charged to the entertainment account. Included in these checks were checks payable to the New York Athletic Club, checks for bon voyage baskets that petitioner sent to customers leaving on a steamer, and checks representing the cost of tickets and entertainment at jewelers' conventions. Among the cancelled checks was one for $25.40 in payment of repairs on the petitioner's automobile.

Gross profits of the petitioner's business for the years 1943, 1944, and 1945 were $67,523.68, $120,007.56, and $204,483.37, respectively. Petitioner claimed entertainment and traveling expenses in 1943 in the amount of $4,490.24, and entertainment expenses in 1944 in the amount of $8,256.64.

The petitioner's advertising account was charged with the amount of $400 representing money expended by the petitioner for entering a horse named ‘Schulztime‘ which he owned in horse shows, for horse show programs, and for trophies for certain classes of shows. This expenditure was not an ordinary and necessary business advertising expense.

Petitioner's ordinary and necessary business expense for entertainment in the taxable year 1945 totaled $5,500.



The respondent has disallowed as a deduction from the petitioner's 1945 taxable income the sum of $9,304.40 claimed as entertainment expense, and a $400 item claimed as advertising ex expense. There is no serious dispute as to whether either of these sums was spent; the issue is whether they are deductible.

Entertainment expenses are allowed as a deduction from gross income only to the extent that they are ‘ordinary and necessary‘ in carrying on a trade or business. Section 23(a)(1) of the Internal Revenue Code. The requirements that the expense must be both ordinary and necessary must be strictly complied with, Helvering v. Welch 290 U.S. 111, and whether contested expenditures are ordinary and necessary is primarily a question of fact. Commissioner v. Heininger, 320 U.S. 467. Proof is required that the purpose of the expenditure was primarily business rather than social or personal, and that the business in which taxpayer is engaged benefited or was intended to be benefited thereby. Louis Boehm, 35 B.T.A. 1106.

SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(a) EXPENSES.—(1) TRADE OR BUSINESS EXPENSES.—(A) IN GENERAL.— All the ordinary and necessary expenses paid during the taxable year in carrying on any trade or business * * *

During 1945 petitioner elaborately entertained buyers and others connected with the jewelry business, personally spending about $7,000. In addition thereto approximately $2,000 was expended by his wife and employees on luncheons, drinks, weekend visits, conventions, suppers, theaters, and nightclubs. Approximately $3,400 of the $7,000 expended by petitioner personally was spent on suppers, theaters and nightclubs and other forms of evening entertainment. On these occasions petitioner would bring his wife and the party or parties he was entertaining would also bring their wives. There is little to distinguish these occasions from the usual social gatherings among friends to renew acquaintanceship and enjoy a pleasant evening. They bear little semblance to the usual gatherings of business people at restaurants or other places of entertainment which serve primarily as congenial meeting places for the discussion or negotiation of business matters. Petitioner made no attempt to show that the evening entertainment he offered his guests served this purpose or that all of it was directly related to the operations of his business.

These gatherings may have been desirable and helpful to the present and future success of petitioner's business, but this is usually true of all entertaining done by business or professional people for the purpose of acquiring or retaining the favor of patrons and clients. Such expenditures are nonetheless nondeductible absent a showing that they were ordinary and necessary to the taxpayer's business within the meaning of section 23 of the Internal Revenue Code. In Louis Boehm, supra, we stated:

We do not think the burden of proof is met by the petitioner's argument that in general, membership in social, political, and fraternal organizations is helpful in obtaining clients through contracts made thereby or the citing of one instance of gaining a client through acquaintance made at a political club. No evidence has been introduced to show that any part or all of the expenditures in question were so closely related to the conduct of the petitioner's business as to have been appropriate, helpful, usual, or necessary. It is noted that in cases where expenditures of a social nature have been held to be deductible business expenses proof was presented to show that such expenditures had a direct relation to the conduct of a business or the business benefits expected. Such proof has not been presented here to show that the expenditures are deductible under section 23(a).

After taking into consideration the nature of the entertainment provided by the petitioner and the fact that it was undertaken at a time when he had more business than he could handle, we are not convinced that all of the expenditures in issue were made for purely business reasons or that the entire cost of such entertainment may be characterized as ordinary and necessary expense incident to the carrying on of the petitioners's business. An expense is deductible only if it complies with the strict requirements of section 23 and does not constitute a personal expense expressly disallowed by section 24.

SEC. 24. ITEMS NOT DEDUCTIBLE.(a) GENERAL RULE.— In computing net income no deduction shall in any case be allowed in respect of— (1) Personal, living, or family expenses, except extraordinary medical expenses deductible under section 23(x);

Moreover, the petitioner's attempt to deduct such nondeductible items as the cost of repairing an automobile, the cost of hotel room, tips, and meals on two occasions when, after a night of entertaining customers, he remained in New York after missing the train home, and the inclusion of $200 which had been placed in the petty cash fund but was not expended on entertainment, all create doubt as to the accuracy of the total deduction.

On the other hand, we are convinced that some part of the expenditures was prompted by strictly business considerations and should be characterized as ordinary and necessary expenses. Applying the rule of Cohan v. Commissioner, 39 Fed.(2d) 540, we have reached an approximation after a careful consideration of the testimony of petitioner and his wife and a close examination of the memoranda and other exhibits received in evidence. From all this evidence, we have concluded that $5,500 fairly represents the amount spent by the petitioner for ordinary and necessary business entertainment in 1945 and that amount is properly deductible under section 23(a)(1) of the Internal Revenue Code.

The petitioner has included in his advertising expense the sum of $400 spent in entering his horse named ‘Schulztime‘ in a horse show and for such items as horse show programs and trophies. Petitioner has not satisfactorily shown how these expenditures were calculated to advertise or publicize his business. There is no evidence that the petitioner called the attention of those persons attending the horse shows to the fact that he was a dealer in watches by advertising in the horse show program. Cf. Rodgers Dairy Co., 14 T.C. 66. There is an inference in the record that the name ‘Schulztime‘ was relied on by petitioner to publicize his business but if this be true the name chosen was so subtle and the entry of a horse in a show so far removed from the petitioner's business that it could not reasonably have been expected to publicize the business. In our opinion, the $400 so expended was not an ordinary and necessary business expense within the meaning of section 23(a)(1) of the Code and the Commissioner's disallowance of the deduction is sustained.

Decision will be entered under Rule 50.