                  T.C. Memo. 2001-18



                UNITED STATES TAX COURT



       RONALD AND SUE M. LESCHKE, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 4301-99.                    Filed January 26, 2001.


     R determined that Ps were liable for income tax
deficiencies based on the disallowance of amounts
claimed as business expense deductions by an S
corporation wholly owned by P husband.

     Held: Amounts used to purchase gift certificates
for corporate customers are deductible only to the
extent of the $25 limitation set forth in sec. 274(b),
I.R.C.

     Held, further, sums paid for gift nut baskets
given to employees are fully deductible pursuant to the
language of secs. 102(c) and 274(b), I.R.C.

     Held, further, $100 bills given to employees as
Christmas bonuses are fully deductible as compensation.

Richard A. Frederick, for petitioners.

Christa A. Gruber and Mark J. Miller, for respondent.
                                - 2 -


                          MEMORANDUM OPINION

     NIMS, Judge:   Respondent determined Federal income tax

deficiencies for petitioners’ 1993 and 1994 taxable years in the

amounts of $20,446 and $37,214, respectively.     The deficiencies

are attributable in part to adjustments in the taxable income

reported by R & J Transport, Inc. (R&J), an S corporation wholly

owned by petitioner Ronald Leschke.     After concessions, this

Court is asked to decide whether, and to what extent, the

following expenditures made by R&J are deductible as business

expenses:

     (1) Amounts used to purchase gift certificates given to

corporate customers of R&J;

     (2) amounts paid for gift nut baskets given to employees of

R&J; and

     (3) $100 bills given to employees of R&J as Christmas

bonuses.

     Unless otherwise indicated, all section references are to

sections of the Internal Revenue Code in effect for the years in

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

                              Background

     This case was submitted fully stipulated pursuant to Rule

122, and the facts are so found.    The stipulations of the
                                 - 3 -

parties, with accompanying exhibits, are incorporated herein by

this reference.   At the time the petition was filed in this case,

petitioners resided in Manitowoc, Wisconsin.

     During the years at issue, petitioner Ronald Leschke was the

president and sole owner of R&J, a small trucking company

operating out of Manitowoc, Wisconsin.   R&J had in place at all

relevant times an election to be treated under subchapter S of

the Internal Revenue Code, which provides for the passthrough and

taxation to shareholders of corporate income.   See sec. 1366.

Three types of deductions claimed by R&J for the years 1993 and

1994, the disallowance of which would lead to a corresponding

increase in petitioners’ taxable income, form the subject of this

litigation.

Gift Certificates

     In 1993, R&J paid $7,606.46 to Towsley, Inc., for 36 gift

certificates.   Each gift certificate was priced at $210 and

entitled the recipient to select merchandise from a catalog

enclosed with the certificate.    Included among the wide variety

of potential choices available through the catalog were

telephones, stereos, cameras, clocks, luggage, and kitchen

appliances.

     The gift certificates were given by R&J as promotional items

to 28 corporate customers, with each such customer receiving

either one or two certificates.    R&J deducted $7,606 for the gift
                               - 4 -

certificates as an “Advertising” expense on its 1993 U.S. Income

Tax Return for an S Corporation, Form 1120S.    (Although the

record reflects corporate recipients for 37 gift certificates,

one certificate was apparently omitted by R&J in calculating the

claimed deduction.)   Upon subsequent examination, respondent

allowed a deduction of $25 per gift certificate, for a total of

$900, and disallowed the balance.

Gift Nut Baskets

     During each of the years 1993 and 1994, R&J gave gift nut

baskets to 166 nonemployees and 44 employees as promotional

Christmas gifts.   The 210 baskets for each year were purchased at

a cost of $61 apiece, for a total of $12,810.    With respect to

the baskets given in 1993, R&J paid $7,500 of the purchase price

in 1993 and deducted such amount in that year as an

“Administrative” expense.   The remaining portion of the price,

$5,310, was paid and deducted in 1994, designated as an

“Advertising” expense.   With respect to the baskets given in

1994, the full $12,810 was both paid and deducted as an

“Administrative” expense in that year.

     Pursuant to the above-mentioned examination, respondent

allowed for the 1993 year a deduction of $25 per gift for only

the 166 baskets given to nonemployees.   For 1994, a deduction of

$25 per gift was allowed for all 210 baskets.    Any additional

amounts claimed were disallowed.
                               - 5 -

Christmas Bonuses

     In 1993, R&J distributed Christmas bonuses in the form of

one $100 bill to each of 42 employees.   The $4,200 expended in

this manner was deducted by R&J in 1993 as an “Administrative”

expense and was not included in the wages of the recipients.

This deduction was disallowed in full by respondent.

                            Discussion

I.   General Rules

     Deductions are a matter of “legislative grace”, and “a

taxpayer seeking a deduction must be able to point to an

applicable statute and show that he comes within its terms.”      New

Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934); see also

Rule 142(a).   As a general rule, section 162(a) authorizes a

deduction for “all the ordinary and necessary expenses paid or

incurred during the taxable year in carrying on any trade or

business”.   An expense is ordinary for purposes of this section

if it is normal or customary within a particular trade, business,

or industry.   See Deputy v. du Pont, 308 U.S. 488, 495 (1940).

An expense is necessary if it is appropriate and helpful for the

development of the business.   See Commissioner v. Heininger, 320

U.S. 467, 471 (1943).

     In addition to the above criteria for deductibility under

section 162, certain categories of expenses must also satisfy the

strict substantiation requirements of section 274 in order for a
                               - 6 -

deduction to be allowable.   Among items within the purview of

section 274 are traveling expenses, entertainment expenses, “any

expense for gifts”, and expenses with respect to listed property

(as defined in section 280F(d)(4)).    Sec. 274(d).   Accordingly,

no deduction is allowed for gifts “unless the taxpayer

substantiates by adequate records or by sufficient evidence

corroborating the taxpayer’s own statement” the amount of the

expense, the date and description of the gift, the business

purpose of the expense, and the business relationship to the

person receiving the gift.   Id.    Moreover, the available

deduction for even a properly substantiated business gift may be

further limited if the gift is of a type subject to the

provisions of section 274(b), set forth in relevant part below:

          SEC. 274(b).   Gifts.--

                 (1) Limitation.--No deduction shall be
          allowed under section 162 or section 212 for any
          expense for gifts made directly or indirectly to
          any individual to the extent that such expense,
          when added to prior expenses of the taxpayer for
          gifts made to such individual during the same
          taxable year, exceeds $25. For purposes of this
          section, the term “gift” means any item excludable
          from gross income of the recipient under section
          102 which is not excludable from his gross income
          under any other provision of this chapter * * *

     Section 102, in turn, reads as follows:

     SEC. 102.   GIFTS AND INHERITANCES.

          (a) General Rule.--Gross income does not include
     the value of property acquired by gift, bequest,
     devise, or inheritance.
                                   - 7 -

                 *     *      *    *       *   *      *

            (c) Employee Gifts.--

                 (1) In general.--Subsection (a) shall not
            exclude from gross income any amount transferred
            by or for an employer to, or for the benefit of,
            an employee.

II.   Application

      A.   Substantiation Requirements of Sections 162 and 274(d)

      As a threshold matter, we deal briefly with the question of

whether the expenditures at issue have been substantiated as

business expenses to an extent sufficient to comply with the

requirements of sections 162 and 274(d).           Although respondent

makes reference on brief to a lack of substantiation, we are

satisfied that the stipulated facts and exhibits meet the

criteria imposed by these sections.

      First, the distributing of gifts or bonuses to customers and

employees, particularly at Christmas, has long been accepted as

an ordinary and necessary business practice, and we refuse to

find otherwise here.       See Danz v. Commissioner, 18 T.C. 454, 460,

464 (1952) (stating that bonuses described as “Christmas gifts to

employees” were ordinary and necessary expenses), affd. 231 F.2d

673 (9th Cir. 1955); Dobbe v. Commissioner, T.C. Memo. 2000-330

(holding that the cost of golf clubs given to a foreign

salesman/broker was an ordinary and necessary business expense);

Snyder v. Commissioner, T.C. Memo. 1983-692 (finding that the

cost of flowers and fruit baskets given out at Christmas time to
                                - 8 -

employees and customers, to promote goodwill, was an ordinary and

necessary business expense).    Furthermore, the evidence contained

in the record establishes the dollar amount for each of these

expenditures, indicates that the items were given at Christmas,

describes the nature of the items given, stipulates that they

were distributed either as “promotional” items or “bonuses”, and

identifies the names of the corporate customer or employee

recipients and their roles as such.     We are convinced that this

information comports with the requisites of sections 162 and

274(d).   Moreover, we believe that respondent’s allowing of a $25

deduction for each gift certificate and for the majority of the

gift baskets represents an implicit concession that the

underlying requirements for substantiation have been satisfied on

these facts.    We thus conclude that to the extent section 162 is

and section 274(d) may be applicable to the expenses at issue,

the necessary factual basis for deductibility has been shown on

this record.    We therefore turn to the question of whether other

legal principles preclude or limit the available deductions with

respect to each of the three forms of expenditure in contention.

     B.   Other Limitations on Deductibility

           1.   Gift Certificates

     Petitioners contend that the expenditures made for the gift

certificates are fully deductible and are not limited by section

274(b) to a deduction of $25.   Petitioners maintain that these
                               - 9 -

certificates were given to large corporate customers and

therefore were not gifts “made directly or indirectly to any

individual”.   Hence, in petitioners’ view, these expenses do not

come under the restrictions of section 274(b).

     Conversely, respondent asserts that the certificates were

given indirectly to individuals within the meaning of the statute

and regulations promulgated thereunder.    According to respondent,

it is reasonable to surmise from the facts presented that

petitioners intended and were aware that particular individuals

would be the beneficiaries of the gift certificates.

     Before examining the parties’ respective arguments, we pause

to note that respondent has labeled these expenditures as

“gifts”, and petitioners have not challenged whether they in fact

represent an “item excludable from gross income of the recipient

under section 102”.   Sec. 274(b)(1).   However, as a leading

commentator has observed:

          Normally, a transfer is a gift for purposes of §
     102 only if it proceeds from detached and disinterested
     generosity. Section 274(b) is mostly concerned with
     transfers that arise from motivations having to do more
     with business advantage than generosity, which are
     excluded from the recipient’s gross income under an
     unverbalized extension of the meaning of “gift,”
     covering gratuitous transfers of items of small value.
     * * * [1 Bittker & Lokken, Federal Taxation of Income,
     Estates, and Gifts, par. 21.3, at 21-52 (3d ed.
     1999)(fn. ref. omitted); see also Commissioner v.
     Duberstein, 363 U.S. 278 (1960).]

Thus, while the reach of section 102 in a business context

appears to be less than fully articulated, we decline to address
                               - 10 -

this matter where it has seemingly been conceded, even if sub

silentio, and we accept the parties’ gift characterization for

purposes of this proceeding.

     The regulations which address indirect gifts in the context

of largess to business entities provide:

     Gift to corporation or other business entity. If a
     taxpayer makes a gift to a corporation or other
     business entity intended for the eventual personal use
     or benefit of an individual who is an employee,
     stockholder, or other owner of the corporation or
     business entity, the gift generally will be considered
     as made indirectly to such individual. Thus, if a
     taxpayer provides theater tickets to a closely held
     corporation for eventual use by any one of the
     stockholders of the corporation, and if such tickets
     are gifts, the gifts will be considered as made
     indirectly to the individual who eventually uses such
     ticket. On the other hand, a gift to a business
     organization of property to be used in connection with
     the business of the organization (for example, a
     technical manual) will not be considered as a gift to
     an individual, even though, in practice, the book will
     be used principally by a readily identifiable
     individual employee. A gift for the eventual personal
     use or benefit of some undesignated member of a large
     group of individuals generally will not be considered
     as made indirectly to the individual who eventually
     uses, or benefits from, such gifts unless, under the
     circumstances of the case, it is reasonably practicable
     for the taxpayer to ascertain the ultimate recipient of
     the gift. Thus, if a taxpayer provides several
     baseball tickets to a corporation for the eventual use
     by any one of a large number of employees or customers
     of the corporation, and if such tickets are gifts, the
     gifts generally will not be treated as made indirectly
     to the individuals who use such tickets. [Sec. 1.274-
     3(e)(2), Income Tax Regs.]

     In addition, this Court has previously summarized the

standard set by the foregoing regulation as follows:
                              - 11 -

          Gifts for the use of undesignated members of a
     large group are not considered indirect gifts to
     individuals; thus, one distinguishing factor lies in
     the provider’s knowledge about the ultimate recipient
     of the gift. But the heart of the distinction being
     made is that payments for gifts to be made by and in
     the sole discretion of some other business entity are
     not treated as “gifts to individuals” by the payor in
     the first instance. * * * [World Wide Agency, Inc. v.
     Commissioner, T.C. Memo. 1981-419.]

     Applying these precepts to the matter at hand, we conclude

that petitioners have failed to establish that the gift

certificates were given to undesignated and unknown members of a

large group in the sole discretion of the receiving entity.    The

record before us lists only the name of each corporate recipient

and the corresponding sales volume generated by that customer.

We thus are unable to determine that the entities were not small,

closely held corporations with few employees.   Even a significant

sales volume tells us little about the underlying corporate

structure or relationships.   We also note that R&J chose to give

a second certificate to 9 of the 28 enumerated customers for

reasons that apparently bear no correlation to sales volume.

Those customers ranked first, fourth, fifth, seventh, eleventh,

fifteenth, seventeenth, twenty-second, and twenty-third in terms

of decreasing sales volumes were selected to receive two

certificates.   This could support an inference that R&J expected

or intended particular persons to be awarded the gift

certificates and felt that two individuals in certain
                                - 12 -

organizations were deserving.      We hold that section 274(b) limits

to $25 the deduction available for each of the 36 gift

certificates claimed to represent a deductible expenditure.

          2.    Gift Nut Baskets

     As regards the gift nut baskets, we observe as a preliminary

matter that respondent’s determinations include adjustments

reducing the deductions claimed with respect to both the baskets

given to nonemployees and those given to employees of R&J.     The

pleadings filed by petitioners also dispute disallowed amounts

related to both types of recipient.      On brief, however,

petitioners address only their entitlement to increased

deductions for sums expended to purchase the baskets given to

those stipulated as employees.     We thus assume, and deem,

petitioners to have conceded that they are allowed to deduct only

$25 for each basket given to those designated by stipulation as

nonemployees.   See Rules 142(a), 149(b).     In this connection, we

also note that respondent has pointed out on brief that conflicts

within certain documents in the record may indicate that several

recipients of baskets not identified as employees may in fact

have held that status.   However, because petitioners do not so

argue, and because any such error would be in respondent’s favor

based on our resolution below, we accept the parties’ numerical

stipulations in this regard.
                              - 13 -

     Concerning the baskets given to employees, petitioners again

assert that the related expenditures are fully deductible and are

not limited to $25 by section 274(b).   Their rationale for doing

so differs, however, from that advocated in conjunction with the

gift certificates.   Principally, petitioners maintain that

because gifts to employees are not excludable from income under

section 102, they are not “gifts” for purposes of the limitation

imposed by section 274(b).   In the alternative, petitioners argue

that the baskets should be characterized as fully deductible

compensation, rather than as gifts.

     In addition to contentions regarding lack of adequate

substantiation, which we rejected above, respondent cites section

1.274-2(b)(1)(iii)(b)(1), Income Tax Regs., in support of the

position that any deduction available to R&J is limited by

section 274(b).   This regulation establishes, for purposes of

applying the appropriate set of strict substantiation rules under

section 274, the label to be adopted in cases where an expense

might be considered either as a gift or for entertainment.

Specifically, an “expenditure for packaged food or beverages

transferred directly or indirectly to another person intended for

consumption at a later time” is deemed a gift.   Sec. 1.274-

2(b)(1)(iii)(b)(1), Income Tax Regs.    From that statement,
                              - 14 -

respondent extrapolates that any such distribution of food is a

gift within the meaning of section 274 and is thereby subject to

the $25 limitation.

     We, however, disagree with respondent’s premise.   While the

cited regulation may specify the proper characterization for an

item which falls within the section 274 criteria for both a gift

and an entertainment expense, it does not establish that the item

qualifies as either in the first instance.    For that, we must

look to the statutory definition.   Section 274(b)(1) states

expressly that “For purposes of this section, the term ‘gift’

means any item excludable from gross income of the recipient

under section 102”.   Section 102, in turn, is equally explicit in

providing that such section “shall not exclude from gross income

any amount transferred by or for an employer to, or for the

benefit of, an employee.”   Sec. 102(c)(1).   The plain language of

the sections thus appears to demand the construction advocated by

petitioners.   Additionally, we note that because this subsection

(c) was enacted as part of the Tax Reform Act of 1986, Pub. L.

99-514, sec. 122(b), 100 Stat. 2110, certain earlier cases may be

inapposite.

     We further observe that petitioners’ interpretation would

seem to do no violence to the purpose underlying the strict

substantiation rules.   The aim of these restrictions is “to

disallow as business deductions items for which there will be no
                                - 15 -

matching inclusion in the income of the recipient and generally

to prevent the deduction of personal expenditures under the guise

of business expenses.”    World Wide Agency, Inc. v. Commissioner,

T.C. Memo. 1981-419; see also H. Rept. 1447, 87th Cong., 2d Sess.

(1962), 1962-3 C.B. 405, 423.    Since section 102(c)(1) precludes

treatment of gifts to employees as tax-free gratuities, the

principle of matching income inclusion and deduction will be

protected in situations such as that now before the Court.

     We therefore hold that the gift nut baskets presented to

employees of R&J are not gifts within the meaning of section

274(b) and that deduction of amounts expended to purchase the

baskets is not subject to the $25 limitation.   Hence, a deduction

of $61 is allowed for each basket given to those stipulated as

employees.

           3.   Christmas Bonuses

     With respect to the $100 bills given to employees as

Christmas bonuses, petitioners rely primarily on the argument

that the full $4,200 is deductible under section 162(a)(1)

because it represents compensation paid to those employees.

Alternatively, if the bonuses are characterized as gifts,

petitioners aver that they are fully deductible for the same

reasons as were discussed above in connection with the nut

baskets.
                               - 16 -

     Respondent, in addition to again referencing substantiation,

counters that the bonuses may not now be deducted as compensation

because there exists no proof the payments were intended as such

at the time made.    Respondent asserts that since the amounts were

not included in the wages of the R&J employees, petitioners are

precluded from construing them as compensation at this juncture.

According to respondent, the bills must be treated as gifts and

any deductions, if substantiated, would at best be limited to $25

by section 274(b).   Furthermore, to the extent that an employee

received both a $100 bill and a gift basket, respondent maintains

that only a single $25 deduction is potentially allowable.

     Regulations promulgated under section 162 speak to the issue

of when bonuses to employees are deductible as compensation:

     Bonuses to employees will constitute allowable
     deductions from gross income when such payments are
     made in good faith and as additional compensation for
     the services actually rendered by the employees,
     provided such payments, when added to the stipulated
     salaries, do not exceed a reasonable compensation for
     the services rendered. It is immaterial whether such
     bonuses are paid in cash or in kind or partly in cash
     and partly in kind. Donations made to employees and
     others, which do not have in them the element of
     compensation or which are in excess of reasonable
     compensation for services, are not deductible from
     gross income. [Sec. 1.162-9, Income Tax Regs.]

     Whether the requisite compensatory intent has been shown in

a particular case is a factual question to be decided on the

basis of all relevant circumstances.    See Electric & Neon, Inc.

v. Commissioner, 56 T.C. 1324, 1340 (1971), affd. without
                              - 17 -

published opinion 496 F.2d 876 (5th Cir. 1974); Dobbe v.

Commissioner, T.C. Memo. 2000-330; St. John v. Commissioner, T.C.

Memo. 1970-238.   One such pertinent circumstance is whether the

employer reported the amounts as wages or compensation on income

tax returns or Forms W-2, Wage and Tax Statement, and deducted

withholding therefrom.   See Paula Constr. Co. v. Commissioner, 58

T.C. 1055, 1059 (1972), affd. without published opinion 474 F.2d

1345 (5th Cir. 1973); Electric & Neon, Inc. v. Commissioner,

supra at 1340-1341.   However, contrary to respondent’s apparent

position, failure to do so is not conclusive.   See Danz v.

Commissioner, 18 T.C. at 464; Dobbe v. Commissioner, supra.

     For instance, in Danz v. Commissioner, supra at 460, the

taxpayer designated the payments at issue as “Christmas gifts to

employees”, and the Commissioner determined that they were not

deductible as compensation.   Given these facts, we held:

          The Commissioner erred in disallowing the amounts
     paid by the trust as Christmas bonuses to employees for
     1943, 1944, 1945, and 1946. Those represented amounts
     ranging from $5 to $35 determined by the manager of the
     hotel to be suitable bonuses for various employees of
     the hotel, and a bonus to the manager ranging from $50
     to $150 per year fixed by the real estate company as
     agent for the trust in the operation of the hotel. The
     determination of the Commissioner indicates that they
     were disallowed not because in excess of reasonable
     compensation for the employees but because the trust
     had not deducted withholding or social security taxes
     from the amounts paid * * * [Id. at 464.]

     Likewise, in Dobbe v. Commissioner, supra, the company

purchased golf clubs for an overseas salesman/broker, did not
                              - 18 -

issue a Form W-2, and deducted the entire cost as an “Employee

Relations” or “Customer Ref” expense.    We nonetheless reiterated

that “Whether the golf clubs were given to Mr. Heemskerk as a

gift or for services rendered must be determined from all the

facts and circumstances.”   Id.   After pointing out that “A

voluntarily executed transfer of property by one to another,

without any consideration or compensation therefor, is not

necessarily a gift within the meaning of section 274(b)”, we

concluded that the company had “purchased the golf clubs for Mr.

Heemskerk as an incentive for future performance and in

appreciation for his past services to the company.”    Id.     A full

deduction was permitted under section 162(a).   See id.

     We are similarly convinced that the $100 bills here were in

fact given in recognition of services performed.    When relatively

small cash payments are made to a significant number of non-

shareholder employees, and only to employees, we are hard pressed

to infer that their labors for the employer were not the

underlying motivation.   This is not a case which presents a

situation of potential disguised dividends to owners, the more

typical context for challenges to the deductibility of an alleged

bonus.   See Owensby & Kritikos, Inc. v. Commissioner, 819 F.2d

1315, 1324 (5th Cir. 1987), affg. T.C. Memo. 1985-267;

Labelgraphics, Inc. v. Commissioner, T.C. Memo. 1998-343, affd.

221 F.3d 1091 (9th Cir. 2000).    We therefore hold that the
                             - 19 -

bonuses are fully deductible as compensation.   Alternatively, for

the sake of completeness, we note that even a gift

characterization would not result in application of the section

274(b) $25 limit for reasons identical to those relied upon in

resolving treatment of the nut baskets.

     To reflect the foregoing,



                                          Decision will be entered

                                   under Rule 155.
