                      115 T.C. No. 20



                UNITED STATES TAX COURT



CHURCHILL DOWNS, INC. AND SUBSIDIARIES, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 8140-99.                 Filed September 26, 2000.

     P conducts horse races, including the Kentucky
Derby, at its facilities. The races produce revenues
through pari-mutuel wagering (including simulcast pari-
mutuel wagering), admissions and seating, concession
commissions, sponsorship revenues, licensing rights,
and broadcast fees. P’s largest source of revenues is
wagers placed on horse races. P incurred entertainment
expenses that were ordinary and necessary expenses
under sec. 162, I.R.C. The expenses at issue included
P’s cost of holding the Sport of Kings Gala, a brunch
following the post position drawing for the Derby race,
a week-long, hospitality tent for the press, Kentucky
Derby Winner’s Party, Breeders’ Cup press-reception
cocktail party and dinner, and the Breeders’ Cup press
breakfast.

     P deducted the full amount of expenses incurred in
holding the above events. R determined the expenses
were only partially deductible pursuant to sec. 274(n),
I.R.C.
                                  - 2 -


          Held: P’s claimed deductions are limited by sec.
     274(n)(1), I.R.C., as determined by R.

          Held, further: In incurring the expenses at issue
     P neither provided goods and services to the general
     public nor received adequate and full consideration for
     the goods and services provided. Therefore, P’s
     expenses are not excluded from the operation of sec.
     274(n)(1) by sec. 274(n)(2) or (e)(7) or (8), I.R.C.


     Paul J. Cox, for petitioners.

     Andrew M. Winkler, for respondent.



                                 OPINION


     LARO, Judge:    This case is before the Court fully

stipulated.    See Rule 122.1    Respondent determined deficiencies

in petitioners’ 1994 and 1995 Federal income tax of $51,872 and

$20,658, respectively.    The sole issue we must decide2 is whether

petitioners’ claimed deductions for expenses for parties and

other entertainment are limited by section 274(n)(1).      We hold

they are.     The stipulation of facts and the attached exhibits are

incorporated herein.     The stipulated facts are hereby found.

                                Background

     Petitioners are corporations which file a consolidated


     1
       Rule references are to the Tax Court Rules of Practice and
Procedure. Unless otherwise indicated, section references are to
the Internal Revenue Code in effect for the years in issue.
     2
       The parties had settled all other outstanding issues
before the case was submitted.
                                - 3 -

Federal corporate income tax return.    When the petition was

filed, petitioners’ principal place of business was located in

Louisville, Kentucky.   Petitioners own the Churchill Downs

racetrack in Louisville, Kentucky, and three other race tracks.

     Petitioners conduct live horse races, including the Kentucky

Derby, at their facilities.    The races produce revenues through

pari-mutuel wagering (including simulcast pari-mutuel wagering),

admissions and seating, concession commissions, sponsorship

revenues, licensing rights, and broadcast fees.    The main source

of petitioners’ revenues is wagers placed on horse races.

     Petitioners do not directly compete with other racetracks

for local patrons because of the separation of facilities and the

differences in the seasonal timing of meets.    However,

petitioners operate in a highly competitive industry.      They

compete for patrons with other sports, entertainment, and gaming

operations, including land-based, riverboat, and cruise ship

casinos and State lotteries.

     Petitioners’ biggest race is the Kentucky Derby.      The

Kentucky Derby is held each year on the first Saturday in May.

Petitioners’ Kentucky Derby events include:    The Sport of Kings

Gala, a brunch following the post position drawing for the Derby

race, a week long hospitality tent with coffee, orange juice, and

donuts for the press open from 4 a.m. to 9 a.m., the Derby race,

and the Kentucky Derby Winner’s Party.
                               - 4 -

     The Sport of Kings Gala includes a press-reception cocktail

party followed by a dinner and entertainment on the Thursday

evening of Derby week.   The costs of the Sport of Kings Gala,

including those for food, beverages, and entertainment, are borne

by petitioners.   Petitioners’ employees were in attendance at the

Sport of Kings Gala in 1994 and in 1995.   In 1994, the Sport of

Kings Gala was held at the Sports Spectrum, an off-track betting

facility located in Louisville, Kentucky, and owned by

petitioners.   In 1995, the Sport of Kings Gala was held at the

Kentucky State Fair and Exposition Center in Louisville,

Kentucky.

     The Breeders’ Cup race rotates among several racetracks.

In 1994, petitioners hosted the Breeders’ Cup race, the Breeders’

Cup press-reception cocktail party and dinner, and the Breeders’

Cup press breakfast.   Under petitioners’ contract with Breeders’

Cup Limited (BCL) they were obligated to conduct certain

promotional activities designed to enhance the significance of

the Breeders’ Cup day of races as a national and international

championship event for the sport of racing.   Included in these

required promotional activities are the Breeders’ Cup press-

reception cocktail party and dinner and the Breeders’ Cup press

breakfast.

     The 1994 Breeders’ Cup press-reception cocktail party and

dinner were held at the Galt House Hotel in Louisville, Kentucky,
                                - 5 -

and sponsored by petitioners.    Attendance at the Breeders’ Cup

press-reception cocktail party and dinner is by invitation only,

and the expenses for food, beverages, and entertainment were

borne by petitioners.    Employees of petitioners were in

attendance at the dinner.    Attendance at the Breeders’ Cup press

breakfast is by invitation only, and the expenses for food,

beverages, and entertainment were borne by petitioners.

Employees of petitioners were also in attendance at the

breakfast.

     Petitioners have found that the key to their success is

their ability to present quality races.    Critical to the ability

to present quality races is the ability to offer high purse

levels to attract the best available horses, trainers, and

jockeys.

     Petitioners allocated blocks of tickets to the Sport of

Kings parties to horsemen, sponsors, staff, city/county VIP’s,

racing VIP’s, racing officials, media representatives, and

others.    More tickets were allocated to the media than to any

other category.

     The Kentucky Derby items and amounts in issue are:

                                       Amounts in Issue
           Item                        1994        1995
    Sport of Kings Gala              $114,375    $85,571
    Press hospitality tent              -0-        7,803
    Derby winner’s party               17,500       -0-
       Total                          131,875     93,374

collectively referred to as Derby expenses.
                               - 6 -

     The Breeders’ Cup items and amounts in issue are:

           Item                        Amounts in Issue
    Breeders’ Cup party                    $116,000
    Post-draw brunch                         21,885
    Press breakfast                           7,500
       Total                                145,385

collectively referred to as Breeders’ Cup expenses.

     The miscellaneous items and amounts in issue are:

                                          Amounts in Issue
             Item                         1994        1995
     Kentucky thoroughbred
      owners’ & trainers’ dinner        $2,310      $2,150
     Cummings reception                  1,630        -0-
     Farewell party                      1,000        -0-
     Stakes day buffet                    -0-       13,132
     Music theatre - derby
      eve gala table                      -0-        2,500
     U.S. Senate restaurant               -0-          538
     Dinner for twenty-five
      at $19.36 per person                -0-             484
     Dinner for fifty-five
      at $20.35 per person                -0-        1,119
     Louisville Chamber of
       Commerce dinner                    -0-          500
     Green Herb cocktail party            -0-        1,196
         Total                           4,940      21,619

collectively referred to as miscellaneous expenses.


                            Discussion

     Respondent concedes that all of the expenses at issue meet

the requirements for deductions as ordinary and necessary

business expenses of petitioner under section 162 for the years

in issue.   However, respondent argues that these deduction are

limited by section 274.

     Petitioners argue they are in the entertainment business,
                                - 7 -

and accordingly, they should not be subject to the restrictions

of section 274(n) with respect to expenses they incur in the

course of providing that entertainment.    Alternatively,

petitioners argue the expenses at issue are excluded from the

provisions of section 274 by application of section 274(e),

paragraphs (7) and (8), and section 274(n)(2)(A).3

     Section 162(a) allows a deduction for all ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on a trade or business.    Section 274 disallows a

deduction in certain instances for expenses which would otherwise

be deductible under section 162.    Section 274(a) provides in

part:

          SEC. 274(a). Entertainment, Amusement, or
     Recreation.--

                 (1) In general.--No deduction otherwise
            allowable under this chapter shall be allowed
            for any item--

                 (A) Activity.--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, or, in the case
            of an item directly preceding or following a
            substantial and bona fide business discussion


     3
         Sec. 274(n)(2) provides:

     Exceptions.--Paragraph (1) shall not apply to any
     expense if--

                 (A) such expense is described in paragraph (2),
            (3), (4), (7), (8), or (9) of subsection (e).
                                - 8 -

            (including business meetings at a convention or
            otherwise), that such item was associated with,
            the active conduct of the taxpayer’s trade or
            business, * * *

     Respondent does not dispute that the expenses at issue are

directly related to the active conduct of petitioners’ business.

There is also no dispute that the events were critical to the

success of the Kentucky Derby and the Breeders’ Cup.    Some of the

expenses at issue were required to be provided under the contract

between petitioners and BCL.

     Respondent argues that the deductions of the expenses at

issue are limited by section 274(n).    Section 274(n) allows only

a portion of entertainment expense to be deducted.    That section

provides:

          SEC. 274(n). Only 50 Percent of Meal and
     Entertainment Expenses Allowed as Deduction.--

          (1) In general.--The amount allowable as a
     deduction under this chapter for--

                 (A) any expense for food or beverages, and

                 (B) any item with respect to an activity
            which is of a type generally considered to
            constitute entertainment, amusement, or
            recreation, or with respect to a facility used
            in connection with such activity,

     shall not exceed 50 percent of the amount of such
     expense or item which would (but for this paragraph) be
     allowable as a deduction under this chapter.

     The Secretary was granted authority to promulgate

regulations to carry out the purposes of section 274.    See sec.

274(o).   Regulations were promulgated to clarify what type of
                               - 9 -

activity would be considered entertainment.   In pertinent part

they provide:

     Objective test. An objective test shall be used to
     determine whether an activity is of a type generally
     considered to constitute entertainment. Thus, if an
     activity is generally considered to be entertainment,
     it will constitute entertainment for purposes of this
     section and section 274(a) regardless of whether the
     expenditure can also be described otherwise, and even
     though the expenditure relates to the taxpayer alone.
     This objective test precludes arguments such as that
     “entertainment” means only entertainment of others or
     that an expenditure for entertainment should be
     characterized as an expenditure for advertising or
     public relations. However, in applying this test the
     taxpayer’s trade or business shall be considered.
     Thus, although attending a theatrical performance would
     generally be considered entertainment, it would not be
     so considered in the case of a professional theater
     critic, attending in his professional capacity.
     Similarly, if a manufacturer of dresses conducts a
     fashion show to introduce his products to a group of
     store buyers, the show would not be generally
     considered to constitute entertainment. However, if an
     appliance distributor conducts a fashion show for the
     wives of his retailers, the fashion show would be
     generally considered to constitute entertainment. [Sec.
     1.274-2(b)(1)(ii), Income Tax Regs.]

     Petitioners argue that they are in the entertainment

business and that the Derby expenses, Breeders’ Cup expenses, and

miscellaneous expenses are all part of their entertainment

product and therefore should be fully deductible.   Petitioners

conduct live horse races, including the Kentucky Derby, at their

facilities.   The races produce revenues through pari-mutuel

wagering (including simulcast pari-mutuel wagering), admissions

and seating, concession commissions, sponsorship revenues,

licensing rights, and broadcast fees.   Petitioners’ main source
                                - 10 -

of revenues is wagers placed on horse races.

     In determining whether the expenses in question are

entertainment expenses petitioners’ trade or business must be

considered.   We would agree petitioners are in the entertainment

business.   However, applying the objective test mandated by

section 1.274-2(b)(1)(ii), Income Tax Regs., the Derby, Breeders’

Cup, and miscellaneous expenses all constitute entertainment

expenses and cannot be properly categorized as “part of the

entertainment product”.   Thus the Derby, Breeders’ Cup, and

miscellaneous expenses are subject to the restrictions imposed by

section 274(n)(1) unless they fall within one of the exceptions

set out in section 274(n)(2).

     Petitioners alternatively argue that the Derby, Breeders’

Cup, and miscellaneous expenses are excluded from the operation

of section 274(n)(1) by paragraphs (7) and (8) of section 274(e).

Those paragraphs provide as follows:

          (7) Items available to public.--Expenses for goods,
     services, and facilities made available by the taxpayer to
     the general public.

          (8) Entertainment sold to customers.--Expenses for
     goods or services (including the use of facilities) which
     are sold by the taxpayer in a bona fide transaction for an
     adequate and full consideration in money or money’s worth.

     Petitioners provide entertainment to all of the public

through their different events.    The Kentucky Derby and the

Breeders’ Cup Championship are open to the general public as are

other races during Derby Week and Breeders’ Cup week.    In
                              - 11 -

contrast, the events that give rise to the Derby, Breeders’ Cup,

and miscellaneous expenses are invitation-only events that are

attended by selected horsemen, petitioners’ employees, media

officials, and local dignitaries.    They may be entertainment

events designed to make the Derby and Breeders’ Cup more

prestigious events and to heighten public awareness of the

upcoming events as petitioners claim.    However, we can see no

meaningful difference between the expenses at issue here and

normal entertainment of selected clients and suppliers, which is

limited by section 274(n).   The expenses at issue are not

expenses for goods, services, and facilities made available by

petitioners to the general public.     The events at issue provide

goods and services to persons petitioner selects to entertain.4


     4
       Sec. 1.274-2(f)(2)(viii), Income Tax Regs., provides
useful guidance on the difference between providing goods and
services to the general public and providing them to a selected
clientele. Those regulations provide:

          (viii) Items available to the public. Any
     expenditure by a taxpayer for entertainment (or for a
     facility in connection therewith) to the extent the
     entertainment is made available to the general public
     is not subject to the limitations on allowability of
     deductions provided for in paragraphs (a) through (e)
     of this section. Expenditures for entertainment of the
     general public by means of television, radio,
     newspapers and the like, will come within this
     exception, as will expenditures for distributing
     samples to the general public. Similarly, expenditures
     for maintaining private parks, golf courses and similar
     facilities, to the extent that they are available for
     public use, will come within this exception. For
     example, if a corporation maintains a swimming pool
                                                    (continued...)
                              - 12 -

We therefore hold that the Derby, Breeders’ Cup, and

miscellaneous expenses are not excluded by section 274(e)(7) and

(n)(2).

     We find no evidence in the record that the Derby, Breeders’

Cup, and miscellaneous expenses for goods and services were sold

by petitioners in a bona fide transaction for an adequate and

full consideration in money or money’s worth.    Indeed, the record

indicates that the expenses were borne by petitioner and goods

and services were given without cost to the parties that were

entertained.   We therefore hold that the Derby, Breeders’ Cup,

and miscellaneous expenses are not excluded by section 274(e)(8)

and(n)(2).5

     We hold that petitioners’ claimed deductions for Derby,

Breeders’ Cup, and miscellaneous expenses are limited by

section 274(n)(1) as determined by respondent.   In reaching the


     4
      (...continued)
     which it makes available for a period of time each week
     to children participating in a local public
     recreational program, the portion of the expense
     relating to such public use of the pool will come
     within this exception.
     5
       Petitioners place reliance on the treatment afforded a
casino that provided comps to selected members of the general
public in Priv. Ltr. Rul. 96-41-005 (June 27, 1996). Based on
the letter ruling petitioners argue that the Derby, Breeders’
Cup, and miscellaneous expenses should be deductible in full. We
are unpersuaded that the reasoning used therein is applicable to
the present situation. We also note that the precedential value
of letter rulings is specified in sec. 6110(k)(3), which provides
in pertinent part: “a written determination may not be used or
cited as precedent.”
                             - 13 -

holdings in this opinion, we have considered all arguments for

contrary holdings, and have rejected all arguments not discussed

as without merit or irrelevant.

     To reflect the foregoing,

                                         Decision will be entered

                                      under Rule 155.
