NEW IRS TAX PROCEDURES
Category: Business Aircraft - Tax
Author: Christopher Younger
New IRS Tax Procedures
Avoiding a new potential aircraft ownership/operations-related Income Tax pitfall.
Suppose that you or your company owns an aircraft that has been, and is currently used primarily for business purposes. In connection with the ownership of that aircraft, you believe that you have carefully considered all of the complex federal income tax laws and regulations pertaining to the deduction of expenses and depreciation that relate to the ownership and operation of that aircraft from income earned from other activities you or your company have undertaken.
You have followed the advice of your tax advisors and have filed your income tax returns in accordance with that advice. One of the suggestions you have followed is to “group” your aircraft ownership and operating activities with one or more other business activities you undertake to avoid treatment of the aircraft ownership and operating activity as a “passive” activity. So far, so good… right?
Not so fast! As part of its constant efforts to improve on its job as the nation’s tax collector, the IRS recently issued Revenue Procedure 2010-13, which sets forth a new requirement regarding the grouping of aircraft ownership and operating activity with other business activities. Under Revenue Procedure 2010-13, taxpayers who group their aircraft ownership and operating activity with other business activities of the taxpayers must now file statements with their income tax returns for the periods in which those activities are grouped.
The big issue for aircraft owners and operators in connection with the issuance of this Revenue Procedure is that, if a taxpayer inadvertently neglects to file such a statement, it may now be easier for the IRS to assert that an aircraft ownership and operating activity is a separate passive activity and that any losses emanating from that activity may not be deducted against income generated from other non-passive activities because those activities have not been properly grouped.
A brief summary of the passive loss rules will assist the reader in understanding the significance of this new Revenue Procedure and the potential pitfalls surrounding the requirement for grouping statements set forth in it. An individual’s business activities that are owned either directly by that individual or through one or more pass-through entities are classified as either passive or non-passive activities.
The passive loss rules provide that net losses from a taxpayer's passive activities may not be used to offset net income from such taxpayer's non-passive activities. A passive activity includes (i) any trade or business activity in which the taxpayer does not materially participate and (ii) any rental activity regardless of whether the taxpayer materially participates in the activity. Put another way, in order for the owner of a trade or business activity to be considered ‘active’ in the trade or business, the activity must not be a “rental activity,” and the owner must materially participate in the activity. This is a very brief overview of a complex set of income tax rules and the reader is advised to consult with his or her tax advisor before deciding how best to proceed in connection with them.
A taxpayer is permitted to group activities that constitute an “appropriate economic unit.” Furthermore, the applicable tax regulations contain additional requirements that must be met for rental activities. However, once a taxpayer elects to group separate activities together, the taxpayer may not ‘ungroup’ those activities absent special circumstances.
There is no definition of the term ‘activity’ in connection with the passive loss rules. Therefore, the IRS can assert that, even when aircraft ownership or operations are conducted within an entity or by an individual, such activity is separate and distinct from other business activities conducted by such entity or individual. In the situation where the aircraft ownership and/or operating activity is conducted in a separate entity and perhaps if the aircraft is leased to another entity or individual, the IRS can potentially make a clearer distinction between those activities for purposes of applying the passive loss rules and disallowing a grouping of activities, especially if a taxpayer has not met all procedural requirements for making such a grouping.
For tax years beginning after January 25, 2010, Revenue Procedure 2010-13 requires that a taxpayer file the statement of a grouping with its annual tax return in order to group activities together for passive loss purposes. However, it appears to be the consensus among tax advisors that taxpayers should immediately begin filing such statements with their tax returns for 2009. For grouping elections in effect for prior tax years, the Revenue Procedure provides that those elections will remain effective without the need to file a statement of such grouping for those prior tax years.
Revenue Procedure 2010-13 does provide that, if a taxpayer prepares its tax returns such that they are consistent with the taxpayer’s asserted grouping of activities but such taxpayer fails to file the required statement regarding such grouping with its return, the taxpayer may file the statement with a subsequent return and the statement will be made effective retroactively to the prior returns in which the taxpayer made the grouping.
However, if the IRS discovers the failure to file the statement before it is filed the taxpayer is required to show reasonable cause for its failure to have filed the statement with a prior return in which such grouping was made.
In effect, Revenue Procedure 2010-13 does nothing for the aircraft owner/operator other than to create another hurdle to cross to ensure that such taxpayer gets the maximum benefit from the ownership and operation of its business aircraft. The problem is that the price a taxpayer could pay for failing to successfully jump this seemingly simple hurdle could be extremely high. This is one more example of the need for meticulous attention to detail when acquiring business aircraft and ensuring that your advisors are doing the same for you.
Christopher Younger is an attorney at the Law Offices of Christopher B. Younger, LLC. He is a tax and FAA specialist concentrating in the areas of corporate aircraft transactions and aviation taxation. He has extensive experience in planning and implementing unique aircraft ownership and operating structures on a global level. He has worked on numerous tax audits with the IRS and with various state taxing authorities. The firm’s services include Code Section 1031 tax-free exchanges, federal tax and regulatory planning, state sales and use tax planning, and preparation and negotiation of transactional documents commonly used in the business aviation industry, including aircraft purchase agreements, leases, joint-ownership and joint-use agreements, management and charter agreements, and fractional program documents.
Mr. Younger can be reached at the firm’s offices at 47 East All Saints Street, Frederick, Maryland 21701; telephone: (301) 696 5735; email: firstname.lastname@example.org.