BUSINESS AIRCRAFT EXPENSE DEDUCTIONS
Category: Business Aircraft - Tax
Author: Rex Reese
Section 103(b) of the U.S. Senate’s recently passed Jumpstart Our Business Strength Act (S. 1637, passed May 11, 2004); the "Act" would curtail the employer’s deduction under Section 162 of the Internal Revenue Code ("IRC") of expenses incurred in providing the use of company aircraft for certain executives, to the extent the expense amount exceeds the amount of income included by the executive upon such use.
On June 17, 2004, the U.S. House of Representative passed the American Jobs Creation Act (H.R. 4520), which is similar to the Act in scope and intent. The House measure did not include a provision similar to Section 103(b) of the Act. The Senate must now act on the House passed bill before a Senate-House conference can convene to reconcile differences between the two bills. If the Senate-House conference agreement includes Act Section 103(b) verbatim, the excess expense would not be deductible through December 31, 2005.
For "covered employees" (discussed below), the effect of Section 103(b) of the Act is to close, in favor of the government, the mismatching of employee income and employer expense deduction which is currently permitted under Sutherland Lumber-Southwest Inc. v. Commissioner (114 T.C. 197 (2000), aff'd 255 F.3d 495 (8th Cir. 2001)). In Sutherland Lumber, the Tax Court ruled that IRC 274(e)(2) allows the employer to deduct the actual cost of providing company aircraft for the personal use of an employee, provided that the employee includes the value thereof in income. Because under Treas. Reg. 1.61-21(g) the employee may use the "SIFL rules" to determine such value, the amount of income included by the employee is normally much less than the employer’s actual cost, thus producing potentially significant mismatching.
IRC 274(a) disallows as an entertainment expense an employer’s deduction of the costs of providing company aircraft for an employee’s personal use. However, IRC 274(e)(2) provides an exception to subsection (a) "to the extent" the expenses are treated by the employee and employer as compensation to the employee. The IRS had argued unsuccessfully in Sutherland Lumber that the phrase "to the extent" in IRC 274(e)(2) calls for a dollar-for-dollar matching of employee income and employer expense.
In holding that IRC 274(e)(2) provides an absolute exception to the applicability of IRC 274(a), and that no implied matching requirement exists, the Tax Court in Sutherland Lumber noted that in the context of various rules providing for the valuation of fringe benefits for imputed income purposes, whether in the context of a general fair rental value rule or a special valuation rule such as the SIFL rules, the valuation rate generally does not bear a correlation to the actual costs incurred by the company providing the fringe benefit, and that in some situations the amount imputed to an employee for a fringe benefit may exceed the cost incurred by the employer.
Section 103(b) of the Act would create subsections (A) and (B) under IRC 274(e)(2), with the former subsection applicable to "covered employee[s] (within the meaning of Section 162(m)(3))" and the latter applicable to "any other employee." For covered employees, the employer’s deduction would be limited under subsection (A) to "the amount of the expense" included in the employee’s income.
For other employees, subsection (B) uses the same language currently in Section 274(e)(2), which was held by the Tax Court and the court of appeals in Sutherland Lumber to permit mismatching of the amounts of the employee’s income and the employer’s expense deduction. By amending IRC 274(e)(2) in this manner, it is arguable that the Senate implicitly endorses the courts’ construction in Sutherland Lumber of the current section’s phrase "to the extent."
There is a potential ambiguity in Section 103(b) of the Act with respect to the definition of "covered employee." Under IRC 162(m)(3), which defines the term for purposes of IRC 162(m)(1), an employee is a "covered employee" if: (A) at the end of the taxable year the employee is the chief executive officer (CEO) in title or substance, or (B) the total compensation of such employee for the tax year is required to be reported to shareholders under the Securities Exchange Act of 1934 (the "1934 Act") by reason of such employee being among the four (4) highest paid officers for the tax year. Taken out of the context of IRC 162(m)(1), which deals only with public companies, IRC 162(m)(3)(A) would include CEOs of public and non-public companies alike.
However, it is arguable that the phrase "within the meaning of section 162(m)(3)" [emphasis supplied] in IRC 274(e)(2)(A) calls for a contextual, rather than abstract, reading of IRC 162(m)(3). Moreover, the IRS has interpreted the term "covered employees" to include only those employees who are both employed on the last day of the year and listed on the summary compensation table required under the 1934 Act for the year. Although not crystal clear, it is probable that IRC 274(e)(2)(A) would not apply to CEOs (or any other employees) of non-public companies.
The author is a partner in the Aviation Practice of Galland, Kharasch, Greenberg Fellman & Swirsky, P.C., in Washington, D.C. (www.gkglaw.com). Please forward comments and questions to Mr. Reese at firstname.lastname@example.org; or Tel: +1 202.342.5268; Fax +1 202.342.5219.
TO READ MORE AVIATION ARTICLES RELATING TO THIS FEATURE SEE BELOW:
CORPORATE AIRCRAFT TAX DEDUCTIONS - November 2005
BUSINESS AIRCRAFT EXPENSE DEDUCTIONS - July 2004