## Facts

- The Williamses acquired two contiguous parcels near Palo Alto, California: a 9-acre parcel and a 42-acre parcel, through transactions culminating in written agreements setting prices.
- The agreements allocated $400,000 to the 9-acre parcel and $200,000 to a one-half interest in the 42-acre parcel.
- After selling a portion of the 42-acre parcel, taxpayers asserted the written allocations were reversed by mistake and sought a higher basis for gain computation.
- Palo Alto Town & Country Village, Inc. (a shopping-center corporation) and related parties rented an airplane from Commander Aviation, Inc., a company owned by Ronald Williams and family.
- Palo Alto paid an allocable share of the plane’s operating costs based on business-use hours; the plane was kept available on standby for business needs such as transporting officers and prospective tenants.
- Taxpayers claimed deductions for airplane costs under I.R.C. § 162 and for promotion, entertainment, and travel, portions of which were disallowed by the Tax Court for inadequate substantiation under I.R.C. § 274(d).
- The Commissioner treated certain disallowed corporate expenses as constructive dividends to Ronald Williams.
- The Tax Court sustained deficiencies in substantial part; taxpayers appealed.

## Issues

1. Whether taxpayers could disregard the written purchase-price allocations between the two parcels to increase basis.
2. Whether airplane standby and operating costs paid to a related corporation were deductible as ordinary and necessary business expenses under I.R.C. § 162 beyond actual flight-time usage.
3. Whether the Tax Court properly applied I.R.C. § 274(d) substantiation rules to the challenged promotion, entertainment, and travel expenses, including whether it applied § 274(d) to noncovered items.
4. Whether disallowed corporate deductions could be treated automatically as constructive dividends to the shareholder-officer.

## Decision

- The court affirmed the Tax Court’s acceptance of the contractual land-price allocations and resulting basis computations.
- The court reversed the Tax Court’s limitation of deductible airplane expenses to in-flight hours, holding the disallowance of standby availability costs was clearly erroneous.
- The court held § 274(d) applied only to specified categories and remanded for the Tax Court to separate § 274(d)-covered items from those subject to ordinary substantiation rules.
- The court rejected the automatic treatment of disallowed corporate expenses as constructive dividends and remanded for item-by-item findings on personal benefit.
- The case was affirmed in part, reversed in part, and remanded.

## Legal Principles

- Taxpayers are generally bound by price allocations set out in voluntary, fraud-free written agreements and cannot later recharacterize those allocations solely to obtain different tax results.
- Under I.R.C. § 162, expenses for maintaining business resources on standby can be ordinary and necessary when reasonable in light of the business, even if use is intermittent.
- I.R.C. § 274(d) imposes heightened substantiation only for enumerated expense categories; courts must not extend those requirements to other expenses.
- Disallowed corporate deductions do not become constructive dividends automatically; dividend treatment requires a showing that the expenditure primarily conferred a personal benefit on the shareholder, determined item by item.

## Conclusion

The Ninth Circuit enforced the taxpayers’ written land-price allocations, expanded allowable § 162 deductions to include reasonable standby aircraft costs, limited § 274(d) substantiation to covered categories, and required individualized proof before disallowed corporate expenses could be taxed as constructive dividends, remanding for recalculations and further findings.


Palo Alto Town & Country Village, Inc. v. Commissioner, 565 F.2d 1388 (9th Cir. 1977)