PERSONAL USE UPDATE
Category: Business Aircraft - Tax
Author: Edward H. Kammerer
Personal Use Update
FAA relaxes personal travel rules for company aircraft.
It’s a fact of modern economic life that corporate executives and owners sometimes utilize company aircraft for personal travel. In many cases, companies that own business aircraft encourage their executives to use the company airplane for personal travel. Some companies even insist (citing security, productivity, communications, flexibility and lifestyle as reasons for their mandating that their executives fly privately).
For the past several decades, corporate aircraft owners have faced a difficult task when trying to make their company aircraft available to their senior executives and principals for personal travel. Personal use of company aircraft has come under increasing scrutiny in recent years. Congressional oversight, 24-hour news cycles and popular fascination have all conspired to bring personal use under increased examination.
The Internal Revenue Service (IRS) takes the position that if an individual receives anything of value - for example use of a company aircraft - that person must either pay fair value in return, or be deemed to have received income equivalent to the value of the goods or services received. In response, companies and executives have entered into agreements allowing the executive to use the company aircraft in return for payment.
However, the Federal Aviation Regulations governing non-commercial transportation, FAR Part 91, make it very difficult, if not impossible for an aircraft owner to allow third parties, including their own executives and owners, to utilize and pay for their company’s aircraft. If any sort of compensation is exchanged for the use of an aircraft, the Federal Aviation Administration (FAA) is likely to deem the transportation to be “commercial” and classify the use of the aircraft as a charter operation requiring certification under Part 135. Unfortunately, it is not unusual for the FAA and IRS to come down on opposite sides of an issue!
There are limited exceptions to this rule against providing air transportation for hire without an air carrier certificate. Some of the most useful are set forth in FAR Subpart 91.501. Included among these is an exception to the general rule against reimbursed air transportation. Said exception allows for the “carriage of officials, employees, guests and property on an airplane operated by [a] company… when the carriage is within the scope of, and incidental to, the business of the company…” (emphasis added) - see FAR Subpart 91.501 (b) (5).
When transportation provided to an employee is “within the scope of, and incidental to, the business of the company,” reimbursement is limited to the cost of “owning, operating and maintaining the airplane.”
THE SCHWAB INTERPRETATION
In 1993, the FAA considered the case of Charles Schwab. Mr. Schwab’s employer, Charles Schwab & Co., wanted Mr. Schwab to use the company aircraft for all business and personal transportation. It wanted Mr. Schwab to be in constant communication with the company while traveling. The company also wanted Mr. Schwab to be able to pay for his personal transportation.
The FAA, however, refused to allow Mr. Schwab to reimburse the company for his personal transportation. The rationale of the FAA was that providing a company aircraft for an executive’s personal travel was not “within the scope of, and incidental to” the business of the company, but rather the mere provision of a perk to the employee. Thus, according to the FAA, the company could not provide the aircraft to Mr. Schwab and receive payment in return, and as a result of the ‘Schwab Interpretation’, many companies simply allowed their principals and executives to use company aircraft without payment.
Nevertheless, the IRS position with respect to providing a company aircraft to an executive did not change. In the eyes of the Service, either the executive must pay for the use of the aircraft, or they would be deemed to have received income equal to the fair market value of the transportation provided.
Fast-forward to 2004. In response to public criticism of “excessive executive perks,” Congress changed the tax code to limit the ability of an aircraft owner to deduct expenses associated with an aircraft’s use for personal trips by certain officers, directors and 10% owners.
Personal use by these “Specified Individuals” now resulted in a disallowance of tax benefits otherwise allowed with respect to the ownership, use and operation of the aircraft to the extent that the cost of such use exceeds the amount paid for the transportation by the Specified Individual. Disallowed expenses include all direct operating costs, fixed costs and depreciation expenses.
Under the new law, the cost of providing “free transportation” to Specified Individuals became quite prohibitive. The personal traveler incurred imputed income and the aircraft owner lost valuable deductions associated with the personal travel provided to their executives. Thus, in this new-world order each of the executive, the company and the company’s shareholders were losers.
For a variety of compelling reasons, including industrial and personal security, the need to keep in constant contact with executives, and the need to maintain maximum flexibility in executive’s travel itineraries personal use of company aircraft continued (and in fact grew) in spite of the seeming contradiction between the requirements of the FAA and the IRS. Personal use of company aircraft by key executives remains a “fact of life” even though some might consider it a “necessary evil.”
THE ‘SCHWAB REINTERPRETATION’
Fortunately, the FAA recently agreed to revisit its earlier Schwab Interpretation. In March 2011, it issued a new interpretation of the 91.501 (b) (5) exemption which opens up some new avenues for the personal use of company aircraft. The so-called ‘Schwab Reinterpretation’ came about as a result of a request by the NBAA that the FAA reconsider its broad prohibition against reimbursement by certain high-level employees and officials using company aircraft for personal travel.
NBAA made a persuasive case for allowing reimbursement, citing the need for key company personnel to be in “constant communication” with their companies during personal travel time, and also argued that high-level executives may be recalled at any time during their personal travels due to company emergencies and other business requirements.
The FAA was not persuaded by NBAA’s “need for constant communications” argument. However, the FAA agreed that key executives “might be recalled at any time during personal travel” and required to change their personal travel plans. The need for flexibility in schedule could form a sufficient basis for allowing such key executives to utilize company aircraft and to permit reimbursement for the cost of owning, operating and maintaining the aircraft.
The new flexibility offered under the Schwab Reinterpretation is only available to specified key executives and certain procedures must be followed in order to take advantage. First, the ability to reimburse for personal travel is restricted to “limited, high-level employees and officials…whose position merits such a high level of interference into his or her travel plans.”
The FAA also places limits on the types of travel that may be reimbursed. Only “routine personal travel, such as vacations [which] could be cancelled up to the last moment because of compelling business concerns” is reimbursable. The FAA noted that certain personal trips “such as a wedding or funeral of a close family member” or a trip for “necessary or urgent medical treatment” are not likely to be cancelled. Absent compelling business circumstances or perhaps an actual change in travel plans, such trips would not qualify for reimbursement.
The Schwab Reinterpretation includes guidelines for compliance. Companies and personal travelers should pay close attention:
First, the company must maintain, and regularly update a list of individuals whose position within the company requires that person to routinely change travel plans within a short time period. The company should be prepared to share this list with the FAA if requested. Note that this requirement calls for the identification of “individuals” by name and not by title. Note also that the FAA has made it very clear that the list of eligible individuals should be both short and selective.
Second, the list of eligible personal travelers should be approved by the company Board of Directors or equivalent governing body. It is also a good idea to revise the company aircraft use policy and employee handbooks to conform to any Board resolutions.
Companies might consider revising employment contracts with eligible key employees to reflect the fact that their personal travel is subject to interruptions and changes as needed by the company or to provide that they are granted access to the company aircraft for personal travel with the express understanding that personal travel plans may be interrupted or changed due to the business needs of the company.
Finally, the company is required to keep records for all covered flights. The records should identify and describe the “routine personal” nature of the trip. Records which can satisfy this requirement include flight logs, schedulers and dispatchers entries and invoices to the employee.
In summary, the FAA has set forth new ground-rules governing reimbursement by key executives for their personal use of company aircraft. The rules are relatively easy to follow, but it is important to follow the rules closely, and to keep good records of compliance.
Good record-keeping is essential. Companies and personal travelers should continue to monitor their compliance with other regulatory bodies such as the IRS and the Securities and Exchange Commission. Now, with careful planning, it is possible to accommodate the personal travel needs of key executives and owners without the loss of tax benefits to the aircraft-owning company and its shareholders. Following the guidelines of the Schwab Reinterpretation offers business aircraft owners and their key executives the opportunity for a true “win-win” personal travel operating strategy.
Edward Kammerer is a Partner at Hinckley, Allen & Snyder LLP. Edward can be contacted via telephone: +1 401 274 2000; or email: firstname.lastname@example.org. More information from www.haslaw.com