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Tax Trap for 2011 – Failure to Elect Grouping of Aircraft Company and Operating Company

Second in a series of articles on “How to Survive an IRS Audit of your Aircraft”

There are many valid business reasons to separate aircraft ownership from the operating companies it serves. These often include liability protection, ownership differences, and managerial issues to name a few. Although it is often beneficial to segregate ownership for non-tax reasons, it is important to avoid inadvertently causing the aircraft entity to be treated on a “stand-alone” basis for passive activity income tax purposes.

IRS PASSIVE ACTIVITY RULES: PROVING THE TIME DEDICATED IN YOUR BUSINESS

All tax practitioners are aware how unyielding the tax code can be to those who lack sufficient planning and learn of the law’s arcane requirements only after the fact. One recent tax court case re-affirming this lesson is Williams v. Commissioner, TC Memo 2014-158 (August 2014), where a taxpayer lost out on deductions from his aircraft business due to his failure to provide the court with sufficient proof of his day-to-day work.

UNDERSTANDING AND PLANNING FOR TAX RISKS OF OVERLAPPING LOAN GUARANTIES

When a financed aircraft is owned in a special-purpose company, which lacks assets other than the aircraft, it is typical and understandable for the financing bank to insist that, in order to extend this special-purpose company a loan to purchase the aircraft, that loan must be guarantied by another, more solvent person or company. In fact, banks will often seek multiple, overlapping guaranties—for example, from both spouses a couple, or from an individual and another company owned by that individual.

KEY TAX EXPOSURE AREA: PASSIVE ACTIVITY PROTECT YOURSELF WITH PROPERLY FILED ELECTIONS

A notable milestone in the cat-and-mouse game of individuals seeking to minimize tax burden and Congress making new laws to end potential shelter activity is the Passive Activity Rule, which was originally enacted as part of the Tax Reform Act of 1986, and which recent developments have brought prominently to the minds of tax advisors. In particular, an important one-time opportunity to avoid being trapped under this rule arises from new IRS regulations issued in November 2013 due to the new net-investment income tax passed as part of the 2010 Patient Protection and Affordable Care Act (a/k/a “Obamacare”).

NEW IRS REGULATIONS: IMPACTS ON OWNERS, LESSEES, AND CHARTER CUSTOMERS

Deducting Aircraft Expenses? Detailed Tax Calculations Now Mandatory

New IRS regulations effective in 2013 and forward require taxpayers claiming deductions for aircraft to undertake detailed calculations to determine what fraction of total expenses may be rendered non-deductible due to personal entertainment use of the plane. These calculations are necessary not only for aircraft owners, but also for lessees and charter customers; they apply to any company seeking deduction of expenses for use or ownership of business aircraft.