The best way to protect your aircraft deductions is travel for business and thoroughly and consistently retain documents you can use on audit to show (1) the business reason for the travel, including the business benefit you expect from it, (2) the dates of departure and return, and the number of days away spent on business, (3) where you went, and (4) the amount of your aircraft expenses. However, sometimes even this is not enough. In such cases, the exact aircraft structure matters. This article discusses two ways the IRS has tried to disallow deductions, even if the business use is clear, based on the idea that the taxpayer failed to implement quite the right aircraft arrangement.
The first tax trap relates to the fact that many entrepreneurs are involved in multiple businesses, and use their aircraft to travel for all of them. In situations where the aircraft is operated in one company but makes trips for the benefit of other companies owned by the same person, the IRS has sought to argue that these trips do not constitute “business” because they benefit a related company, and not the operator company, which pays the cost of the trips. In other words, the IRS has sought to artificially pretend that flights undertaken purely for business purposes are not, in fact, “business” trips because, despite the economic reality, the trip is not within the narrow enterprise of the company operating the flight. Fortunately, a recent federal court ruling has chipped away at this IRS strategy. In Morton v. US, April 2011, the US Court of Claims ruled that business flights in furtherance of any of the taxpayer’s commonly owned corporations would be considered within the business of the corporation that operated the aircraft. A few notes of caution about Morton: (1) This is only one federal court; it remains possible that other courts would rule differently. And (2) tax rules and FAA rules are not always in sync. Although Morton would seem to support, for tax purposes, a structure where one company provides air transportation for the benefit of other companies, the FAA has expressed concern that such a structure would constitute an illegal charter unless the company operating the aircraft was a certificated air carrier.
The second tax trap to be wary of has taken on increased significance because it could disqualify otherwise eligible 2011 aircraft acquisitions from the 100% bonus depreciation passed in the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. The vulnerable structure is one where an individual owns an existing company that has need of an aircraft, and chooses for liability protection reasons to form another single-purpose company, also owned by that individual, to hold title to the aircraft, and then lease the plane from the single-purpose company to the existing company. Under this trap, the IRS would argue that the aircraft is used for “related party leasing,” and is therefore ineligible for any type of accelerated depreciation—including 100% bonus depreciation. The purpose of the “related party leasing” law the IRS relies on was to prevent creative tax structuring wherein aircraft owners would purchase an aircraft in a controlled company, and then, for a large portion of the usage, lease the aircraft to themselves for personal use—i.e., the intent of the law relates to the concern that the related-lessee/end-user would use the plane for personal, rather than business, purposes. Despite this narrow intent, the law is written so broadly that it technically applies not only to leases for personal use, but also to leases for business use. The IRS has recognized that the goal of the law was to discourage structures where an excessive amount of total flight hours were through related-party, personal-use leases. In the past, some experts opined that the IRS would enforce the law consistently with its purposes—that is, not use it to punish structures where the aircraft is leased between related companies for strictly business purposes. Recently, however, the IRS appears more eager to bring in any possible government revenue by catching taxpayers in traps, even if doing so follows the letter, rather than the spirit, of the law. As a result, aircraft owners must be careful to avoid the “related party lease” problem, especially if they hope to benefit from 100% bonus depreciation.
In the current climate, the need for aircraft owners to use qualified advisors has never been greater. The above represents just a summary description of two tax issues. It is not intended as an exhaustive guide. A thorough aircraft arrangement requires coordinating the federal tax requirements with state tax and FAA compliance.