Year-End Tax Planning For Aircraft Owners
Illustrating the advantages of careful planning and prudent governance- Keith Swirsky and Christopher Younger review end-of-year considerations for Board Members of companies that own business aircraft.
December can be a busy month for use of company-owned aircraft for personal flights. Board Members must be mindful that personal usage of a company aircraft can adversely impact the corporation’s ability to deduct expenses relating to aircraft ownership and operation- and tax depreciation can be compromised.
Before the company flight department schedules use of a company aircraft for upcoming personal travel- the Board should become cognizant of several key restrictions on the ability to fully utilize all available income tax deductions relating to aircraft ownership- and should develop and implement policies designed to avoid inadvertently triggering those restrictions.
QUALIFIED BUSINESS USE REQUIREMENT
One major restriction on an aircraft owner’s ability to take accelerated depreciation and/or bonus depreciation deductions are rules requiring that an aircraft be utilized in qualified business functions during the tax year in question. To depreciate a business aircraft in accordance with accelerated depreciation schedules in any given tax year- more than 50% of use of the aircraft during such tax-year must be in a “Qualified Business Use” (use in a trade or business of the taxpayer).
Qualified Business Use rules are convoluted- but critically important when considering the appropriate tax treatment for a company aircraft. In broad terms- they create three categories of common trade or business uses that may not be counted for purposes of satisfying the 50% test unless all other trade or business uses comprise at least 25 percent of the total use of an aircraft during the tax year. These are:
(1) Leasing the aircraft to any person who owns 5% or more of the taxpayer- or to any “related person”;
(2) Using the aircraft to provide compensation (personal- non business-use flights without reimbursement at fair market rates) to any person who owns 5% or more of the company- or to any related person (a flight for which income is imputed to a 5% owner under the Standard Industry Fare Level (SIFL) formula); and
(3) Using the aircraft to provide compensation to any other person unless an amount is included in the gross income of such person with respect to such use of the aircraft- and any required income tax was withheld (SIFL).
The 25% and 50% use tests must be met during (i) the company’s ownership of the aircraft; or (ii) during the straight-line (Alternate Depreciation System - ADS) depreciation period applicable to the aircraft- whichever period is shorter. The consequence of failing the tests in even a single taxable year is that the aircraft must be depreciated under the less favorable ADS method during such taxable year and all subsequent taxable years.
Note: ADS establishes a period of depreciation that is generally longer than if the more common Modified Acceleration Cost Recovery System (MACRS) were employed. If the aircraft had been depreciated using accelerated depreciation schedules in any prior taxable year- the taxpayer must recapture prior depreciation to the extent that depreciation deductions taken during prior years exceed the deductions that would have been allowed under the ADS method.
Therefore- a pre-year-end review of all flight logs and calculation of the various types of use of company aircraft is essential to ensure compliance with the rules relating to qualified business use - and most importantly to determine if any year-end vacation travel needs to be limited- or additional qualified business use needs adding before year-end.
DEDUCTION LIMITATIONS & PERSONAL USE
Aircraft owners must be aware of another major limitation on the deductible amount of trade or business expenses that result from the use of business aircraft for personal flights for a recreational or entertainment purpose at the destination location. Under these rules- to the extent a business aircraft is used for entertainment purposes- the expenses will be disallowed as a deduction- including any allocable depreciation.
Under the “flight-by-flight” hours methodology- if the aircraft was flown for 100 hours- 30% of which were for entertainment purposes- 30% of the company’s operating expense and depreciation deductions would be disallowed. (Of course- on any given flight- some passengers may be traveling for business purposes and others for entertainment purposes- so the calculations are more complicated.)
The amount treated as compensation to an individual (i.e. the recipient includes the value in their income)- may serve to reduce the disallowed portion- but this is a relatively small offset. For a company with a high tax-basis aircraft- the loss of depreciation entitlements related to this disallowance can easily push the lost tax deduction in excess of $20-000 or $30-000 per flight hour- or more for aircraft subject to bonus depreciation or aircraft purchased late in the tax year.
There are ways to mitigate the effects of these rules. It may be far less costly to schedule personal flights on charter aircraft and pay applicable fair market value charter rates- than to use the company’s aircraft for those flights and lose lucrative and beneficial depreciation as well as other deductions. These issues need consideration prior to year-end to avoid using the company aircraft in a manner that will lead to disallowance of valuable tax deductions.
Consultation with a qualified aviation tax advisor could certainly enable the business aircraft owner to avoid a painful start to the New Year!
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