COMPENSATORY PERSONAL USE - Non-business use of a business aircraft results in a pro rata disallowance of all fixed and variable expenses. However, business use may include personal use by employees provided it is taxed to them as compensation, and their aggregate compensation is ordinary, necessary and reasonable in amount. When a taxpayer owns a business, he often has the opportunity to structure his personal use as either subject to a pro rata disallowance or as compensation. Because the employee is taxed under a valuation method prescribed by the Internal Revenue Code Regulation 1.61(21)(g), and the employer is generally allowed to deduct actual costs, it is important for the taxpayer to consider the disparity between the deduction allowed his company and his personal income charge. Particularly during the initial five years of ownership, the taxpayer will often find that the compensation charge is less than the corresponding deduction allowed to his company.
When personal use is taxed as compensation, the regulations impute income in two steps; a mileage charge, and a terminal charge. The mileage charge is based on the gross take-off weight of the aircraft and the distance traveled. Both the mileage charge and the terminal charge are adjusted every six months. Nonetheless, the following table provides a reasonable estimate of the per passenger compensation charge that may be used for tax planning purposes:
Weight Charge per mile
> 6000 lbs. - example: all single engine piston aircraft, light piston
twins, Piper Meridian, TBM 700, Eclipse 500 $.12
6001 - 10,000 lbs. - example: Cessna 402, Piper Navajo, Cessna
Caravan, Pilatus PC12, Citation Mustang, Embraer Phenom 100 $.25
10,001 - 25,000 lbs. - example: Beech King Air, Citation CJ
Citation X, Learjets $.60
< 25,000 lbs. - example: Gulfstreams, Challengers, Falcons $.75
The terminal fee does not vary based on size of the aircraft and is approximately $40 per leg per person.
When personal use is primarily personal entertainment use of a specified individual, (generally a 10% greater stockholder or officer); special rules limit the employer?s deduction to the amount taxed to the employee. However, these regulations do not limit the amount taxed to the employee to the deduction of the employer. It is therefore imperative first to determine if the employee is a specified individual; and second, is his use primarily entertainment or other personal use. Entertainment use would include travel to sporting events, theater, and vacations. Common examples of non-entertainment use include commuting, visiting family members, visiting the sick and the like.
The compensatory structure is likely to result in significant savings during its depreciable life. The table below illustrates the potential savings to both the single engine piston aircraft and a large jet. For purposes of the illustration, assume that the single engine piston aircraft cost $500,000 and the large jet cost $30,000,000. Each airplane flies 150 hours a year, 50 of which is personal non-entertainment use. The flights are each for two-hour legs, and carry two passengers. The table below illustrates the difference between a pro rata disallowance and a compensatory charge.
Piper Saratoga $500,000 Gulfstream G400 $30,000,000
Depreciation (5-year average) $100,000 Depreciation (5-year average) $6,000,000
Variable cost (150 hours) $ 28,000 Variable cost (150 hours) $ 600,000
Fixed cost $ 15,000 Fixed cost $ 600,000
Interest cost (90% financing @ 6%) $ 27,000 Interest cost (90% financing @ 6%) $1,620,000
Total deductions $170,000 Total deductions $8,820,000
1/3 potential disallowance $ 56,667 1/3 potential disallowance $2,940,000
Mileage charge $ 40 Mileage charge $ 750
Departure charge $ 40 Departure charge $ 40
Total per person charge $ 80 Total per person charge $ 790
Two passengers $ 160 Two passengers $ 1,580
Imputed income for 50 hrs (25 trips) $ 4,000 Imputed income for 50 hrs (25 trips) $ 39,500
Potential tax savings $ 52,667 Potential tax savings $2,900,500
% deductible 93% % deductible 99%
The Internal Revenue Service has issued proposed regulations that deal with entertainment flights by specified individuals. These regulations contain significant guidance, but hint of substantial potential changes. All aircraft operators have a duty to keep contemporaneous records as to the business purpose of the trip; who traveled on the aircraft, and any person visited during the trip. These records should also clearly indicate the nature of the personal use of the business aircraft; deductibility may be determined by documentation.
For additional information on the IRS proposed rules see - Webinar - Proposed Rules on Personal Entertainment
IRS Circular 230 Disclosure. New IRS rules impose requirements concerning any written federal tax advice from attorneys. To ensure compliance with those rules, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under federal tax laws, specifically including the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
