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Business Aviation & The Boardroom - New Taxes Levied By The IRS

Last month- Keith Swirsky established that the IRS’s audit position on managed corporate aircraft is alarming. In this article- he asserts why the IRS position is wrong- since a management company merely serves as an outsourced version of an in-house flight department.

AvBuyer   |   1st August 2011
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New Taxes Levied by the IRS on Corporate Aircraft Operations (continued)
Last month- Keith Swirsky established that the IRS’s audit position on managed corporate aircraft is alarming. In this article- he asserts why the IRS position is wrong- since a management company merely serves as an outsourced version of an in-house flight department.

Aircraft management services most often include interviewing and hiring crew- negotiating a fleet insurance policy on more comprehensive terms and with competitive pricing- and coordinating and managing all maintenance related to the aircraft.

Regardless of whether these services are obtained from an in-house flight department or are outsourced to a management company- when operations are conducted under Part 91 regulations- the aircraft owner is the operator of the aircraft and remains legally responsible for its own flight operations.

An aircraft owner’s decision to outsource the management of these functions rather than perform them in-house should not convert an otherwise non-taxable- non-commercial flight operation to a taxable commercial flight operation. Simply put- the IRS has created guidelines for its auditors that are illogical and have significant ramifications for the aircraft industry.

Furthermore- the IRS does not provide its auditors with adequate training in aviation-related matters- and the auditors are “thrown into the deep end” with little understanding of the rules they are supposed to enforce.

As set forth in applicable law- when an aircraft owner engages a management company to provide aviation services on behalf of the aircraft owner- the management company is doing so as the owner’s “agent.” The management company does not acquire any independent right to dictate which crew members fly the aircraft- to mandate that the aircraft owner continue using the fleet insurance policy offered by the management company- or to agree to have maintenance performed at the maintenance facility designated by the management company. Rather- the management company offers its guidance and expertise and wants to be as flexible and cooperative as possible.

It is inherent in the relationship between an aircraft owner and a management company that the aircraft owner has the right to require that the crew be replaced- to provide its own insurance and to choose to have aircraft maintenance performed at the authorized maintenance facility of its choice rather than the facility recommended by the management company.

The entire relationship is fluid because an aircraft owner can terminate its relationship with a management company at any time pursuant to the terms of the management agreement if it is not satisfied with the management services it receives. So- at no time does the management company act as an independent principal that somehow obtains possession- command and control of the aircraft.

Further- the IRS has a misguided understanding with respect to aircraft that are placed on charter certificates. The IRS contends that if an aircraft owner gives up the right to cancel a scheduled charter flight- then the aircraft owner has transferred possession- command and control of the aircraft to the management company. The IRS fails to understand the nature of the business relationship between the aircraft owner and the management company.

In particular- in order for a management company to schedule a charter flight and to commit the aircraft for charter to the public- it needs the aircraft owner’s consent to schedule the aircraft. Once the aircraft owner gives its consent- it is commercially unreasonable to expect the aircraft owner to have unlimited rights to cancel the scheduled charter flight at a moment’s notice.

The IRS’s audit guidelines would require the aircraft owner to be able to cancel the scheduled charter flight up to the actual point in time that the aircraft is ready to take off. While this is an idealistic objective- it is not practical. The aircraft owner wants to maximize revenue from chartering- and if the owner could cancel a flight up until take-off- the management company would be hampered in marketing the aircraft for charter. It is a lose/lose scenario. The IRS guidelines would force an aircraft owner to have an unprofitable and therefore undesirable business relationship with the management company. It is clear that the IRS’s position is unsustainable.

It is simply a matter of time before the right case goes to trial and the courts recognize that the IRS’s audit guidelines are unsupported by the law and common sense. Until this happens- the industry should be fully alerted that the IRS is now paying particular attention to aircraft management companies- and assessing federal transportation excise taxes on the management companies’ revenues relating to aircraft owners’ operations in private carriage.

In many cases- the unpaid federal excise tax can be quite significant. As an example- a large cabin-class aircraft (Falcon 900LX- for example) being operated by an owner for 300-400 hours a year could have a $1.5 million annual budget- and with a federal transportation excise tax of 7.5% the tax liability alone (before interest and penalties) would exceed $100-000 for just one year’s operations. Since the IRS would generally audit three years of tax filings- on a single aircraft a management company could be assessed over $300-000 plus penalties and interest.

The federal excise tax on fuel purchased for the aircraft owner’s operations could provide a small offset against this liability. In addition- the management company would be entitled to claim that the aircraft owner’s international flights would be exempt from the 7.5% excise tax- and instead a de minimis international facilities tax would be due.

It also seems that an aircraft management company could argue that fixed costs should be prorated between owner usage and charter usage- in the event that the aircraft was also used in charter operations.

Unfortunately- what has been described above is simply a quagmire. Thoughtful planning can be of only limited benefit until the IRS audit guidelines are revised.

Do you have any questions or opinions on the above topic? Get it answered/published in World Aircraft Sales Magazine. Email feedback to Jack@avbuyer.com

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