Increased IRS Scrutiny on Personal Use of Company-Owned Aircraft

(00:00) [Music] welcome to the Cherry Bekaert tax beat a conversation about tax that [Music] matters welcome to this edition of the Cherry Bekaert tax beat podcast today we are talking about the tax rules for companies that own private aircraft in February the IR announced the program to start auditing personal use of company-owned aircraft um really targeting company owners and key Executives uh this continues IRS recent actions to step up examinations on high net worth individuals joining in today's conversation is Mike Grim Mike is

(00:52) director with our state and local tax team specializes in resolving controversy issues between taxpayers tax authorities and also has exensive experience working with company owned aircraft how you doing today Mike good Brooks um appreciate it I'm uh sitting here I'm resident in Louisville Kentucky office of of Cherry Bekaert uh and uh looking forward to today's topic and and I think you were saying earlier there might be a horse race somewhere near you in the next day or two yeah yeah there's a there's a certain two and a half minutes that is

(01:25) getting a lot of worldwide attention here for the next couple weeks or at least the rest of this week so uh it it it's a it's a lively time to be in Louisville I can tell you that all right and as always my partner in crime joining me today Miss Sarah McGregor from Greenville how's life treating you life is great uh glad it's May glad were on to uh summer topics and summer things to think about and I was just uh uh thinking about all the private planes probably F flying in in to Louisville to for that uh race and perfect time to be

(02:03) talking about uh how the the costs of all those planes might get handled I'm sure all being strictly reported in accordance with IRS regulations no doubt all right the IRS has announced a pilot program no pun intended here to examine tax returns associated with up to 48 corporate owned Jets results of these initial examinations will then determine how the IRS May focus at se on further examinations um so before we talk about all these tax issues uh let's start with some background the big picture of owning and operating a private aircraft

(02:40) so Mike how would you describe the know the overall scene for Federal Regulation and oversight of private aircraft I appreciate that Brooks whenever clients come to talk to us their first question well because we're kind of joking earlier about bourbon you know and as it aside I usually tell people I'm an aviation attorney cocktail party parties because if I say uh tax they'll snooze otherwise um but they love talking about their planes Well normally clients will come to us especially if they not experien in owning and operating an

(03:12) airplane and they've heard their buddies say you know big depreciation big tax writeoffs or I've got a big gain I need to address so I need to go buy an airplane so one of the first things that we talk about before we get into the tax issues especially federal tax issues is the inter play of the Federal Aviation Administration and their regulations uh as they're vitally important because how you operate an airplane and how you structure operations can have a tremendous impact and not not just on uh the federal tax

(03:45) benefits you're seeking to obtain but also whether you're legally operating the airplane in accordance with the applicable law so I would love to tell you Brooks that the FAA and the IRS have similar guidance on what is and is not non-commercial versus commercial operations but obviously uh at times they differ now the terms that are kind of thrown around I'm going to give you give you some of the listeners a couple of terms to kind of uh terms of art to kind of be listening for the FAA looks at operational control so at the end of

(04:16) the day FAA is about flight safety they're trying to figure out okay who legally has operational control of the airplane where the IRS looks at more what we call possession command and control and as indicated there are some differences where the FAA treats say an interchange agreement which is an agreement to two between two owners to kind of swap use of airplanes uh the FAA use looks at that as non-commercial but the IRS looks at that as commercial subject to Federal excess tax that's just one of the examples so when we're

(04:49) talking to clients and Prospects about airplanes I always want to know okay how are you going to be operating and using the airplane are you going to own it in your primary business that has certain benefits and and and disadvantages are you going to create a special purpose entity a lot of clients hear from their lawyers hey let's get let's isolate this asset right well how you then manage and and most importantly compensate or reimburse that airplane entity is vitally important on how it's structured from an FAA standpoint because we want

(05:29) to keep obviously ly we want to maximize our clients tax benefits but we want to keep them in compliance with the Federal Aviation regulations an example i g i give to some degree is that carnival game uh kids carnival game whacka okay you know you don't want to solve one problem okay we address maybe some tax benefits but create for the client FAA issues that could get them into some real serious trouble in the way that they manage and operate the airplane one other comment I'll make on the FAA side is you'll hear the comments well I'm

(06:06) part 91 or on part 135 those are references to certain federal AV Aviation regulations that determine what you can and can't do under either non-commercial or commercial operations the those are also important because the IRS does use those uh that nomenclature as well when they're talking about uh certain issues related to aircraft ownership and uh tax issues so Mike now that we've got sorted out the FAA rules about um how the plane is going to be owned and operated um then we've got to deal with the IRS issues which can be pretty complex um

(06:51) about the use of the air aircraft you want to talk about some of the key issues that the IRS looks at or focuses on in its sure compliance regul yeah even before they announced the new as Brooks said pilot program no pun intended if you got an audit with any type of aircraft activity they're uh the really big the really big thing for them has always been they want to see the control employee which is defined as a 5% or greater owner they want to see that they're paying income tax on their personal use that has always been issue

(07:22) number one but the other things that we're seeing more and more review on is things like bonus depreciation which can include accelerated depreciation whether it's bonus which right now is is 60% bonus but for several years we at 100% that includes using uh this includes using fiveyear makers as an accelerated depreciation and I'm beginning to see a ton of excise tax audits actually I had two clients earlier this year who receive federal excise Transportation tax Audits and you know it's bad when you're meeting with the auditor and

(07:58) you're trying to explain partn 1 part 135 and they're furiously writing down notes and they're like Okay can I'm sorry what is this part 91 you talked about and real quick I realized here's someone doing an excess tax audit on a client that doesn't understand Federal excess tax so the other thing I'm seeing is we've got a lot of new and inexperienced Auditors now I personally like that because I can teach them the right way to do it and get our client zal change audits um and then really the the other issue is is really looking at

(08:32) personal use versus entertainment or business use because how you use it um obviously drives how much of the tax benefits you can take uh Avail yourselves of another issue I spoke about when I talk about the FAA is that if you're going to have to use a special purpose entity then the FAA requires that that that entity lease the airplane it cannot operated out of a like a single member LLC cannot operate legally an airplane from an FAA perspective so setting up a leasing structure including a related party leasing structure

(09:12) creates passive losses and a lot of times clients don't even consider that that this could be a passive activity on the on that lease Arrangement so a lot of uh uh landmines in there to navigate through uh just to be able to use and and report that from a tax purpose so it may or may not have uh the benefits that that a company is looking for but it certainly has some other use benefits in in helping those key Executives and those owners manage their business more and their time more efficiently but you know we we've talked

(09:51) about the IRS but but those are not the only tax authorities and you work in our state and local tax team so can you fill us in a little bit about the state and local taxes that need to be considered also yeah and and if if we're brought in early enough in the deal we can also try to maximize clients uh either exemption or deferral of certain key taxes specifically sales and use taxes a lot of clients are very focused on the purchase location of the airplane which which is good for sales tax but they forget what exemptions or deferrals do I

(10:25) have in the state I'm actually going to hanger in which is where there's a use tax benefit so there's various exemptions like resale FlyAway some states like South Carolina have caps we can if brought in early enough in the transaction we can plan around some of those issues obviously tangable personal property tax continues to be an issue in certain States whether you park it in Louisville Kentucky for example or you park it across the river in Clark County at Clark County Airport in Southern Indiana could be dependent upon the

(10:57) value of the plane as much of a 100 as much of a $100,000 a year in additional property taxes so that you know maybe that drive over the river uh is wor it to save 100 Grand a year we can assist with that so let's go back and uh to the income tax side of this as you said earlier Mike there are really two major issues the IRS focuses on one is the income inclusion for for personal use of the aircraft and the other one is expense dis so let's take the first one uh what can you tell us about the income inclusion rules okay it it used to be uh

(11:42) in the Heyday pre uh tcja uh you used to be able to uh deduct the company still got a deduction for commuting expenses that were imputed to the employee so basically from the imputation of income or income inclusion any personal use so it could be personal commuting it could be going on the weekend to see your your child in college uh it could be going to get you know Medical Services uh at an out of state treatment facility or it could be personal entertainment any any personal use of a company-owned asset is going to

(12:19) result in income inclusion now the benefit uh one of the benefits is the Cil rate now Cil stands for simple uh industry fa or standard industry Fair level sffl it is a it's put out by the Department of Transportation and basically what it does is it looks at a variety of factors including the the length of the trip in terms of nautical miles size of the airplane how many passengers how many are there for for personal reasons and it basically runs a calculation that uh effectively is the cost of a first class air ticket which

(12:59) if if you've chartered a plane recently uh that the chartering of an airplane could be as much as 5,000 to 10,000 an hour where the imputed income that the control employee takes into their W2 may only be 20% of that so the the the control employee does not get imputed the entire expense associated with the use of that airplane now pre tcja the company didn't have to take a haircut on commuting they got to deduct the full expense related to commuting and we'll talk about that here at a moment now there's a couple different rules I won't

(13:40) go into these in detail but there's a there's a couple different ways you can calculate the personal versus business use you can do a predominance test is the flight predominantly business and you can do that based on occupied seats if it's an eight if it's an eight passenger airplane four seats are occupied three for business then it's a 75% of the occupied seats predominantly business then you don't have to worry about the personal use so there's a couple of different ways to to to look at that and we can assist clients in

(14:16) determining how much income inclusion there is as well as to do the simple calculation so that commuting uh now in our work from anywhere kind of world uh if you've got uh one of your your business owners living in Colorado now and they commute to the New York office uh once a month or a couple of times um a month that that commuting to that work location now um is going to be count as personal use of that aircraft um yeah it's going to be count of as personal use but the bigger issue because it historically it

(14:55) it was imputed into income the company's going to lose the corresponding deduction so this includes all of the at the end of the year you look at because we can transition into you know what about the disallowance of expense deductions so what you'll do at the end of the year is the company will look at all of the direct operating cost as well as the indirect operating cost like hanger Insurance uh maintenance programs depreciation right and look at all of the expenses and then they have to take a haircut on the personal community and

(15:30) or personal entertainment and they lose the benefit of that deduction now obviously for business purposes they get a uh full deduction for the percent related to to business uh usage so if the flight value the CLE value that's imputed to the employee is say um uh 20% of that $5,000 so $1,000 for a flight but the expenses themselves were uh up WS of 4,000 then uh the company really loses out the employee is good because they picked up $1,000 wor a value in their W2 their out- of pocket cost would be the tax on that um that, value but the

(16:14) company is losing a deduction for say that $4,000 of direct and indirect costs uh for that that's correct okay that's correct yeah there there is a there is a haircut on the expense side but it's a if it's a business flight uh and for business purpose then all of those there is no income inclusion and the expenses are all deductible at that point so correct correct so it is a it is a costly operation to the to the company owning the aircraft but it does provide a lot of benefit to the key Executives and others who are taking

(16:51) advantage of it that and there is one minor exception I'll just drop I call it the Taylor Swift exception um if if if you're traveling on a company airplane for security reasons then the company may be able to uh not lose uh the benefit of the deduction you still get imputed income um but you generally have to have a safety plan but I do want to throw that out there because we do have some high net worth individuals that you know a safety concern could be an issue so there there that's something we could look at that's also flying in and out of

(17:26) of high-risk areas as well say you've got a a manufact ing facility in in an unstable environment and you're trying to get in and out of of those places yeah yeah definitely okay all right Mike pull out your crystal ball um first tell us who's going to win the Derby and secondly tell us what the IRS is going to be doing on their pilot audits what do you think uh the Derby I haven't handicapped the race yet so I'll have to get back to you on that with regard to what they're looking for is is they're going to be looking at flight logs okay

(17:57) they're going to be looking at flight logs and and it's it's going to be a little bit late at this point but it's always a best practice is begin capturing I mean you got to maintain the flight logs anyway from an FAA perspective is begin capturing relatively contemporaneous with the flights what the business purpose is the the service will normally most clients fly between the same city pairs especially on their Community flights but if you do have business in Turks and Kos okay you you know and you're legitimately going there or you go to

(18:30) Vegas right you know cities that just sound uh to an agent like you're having fun if you're going there for business document document document and do it relatively contemporaneous with the flight but that's what they're going to be looking at they're going to be looking at flight logs and asking questions about the nature of the trip uh and that's why the rules of how you characterize a trip on a per seat basis or um you know a flight bylight basis are vitally important and why we should get why we should be involved from the

(19:06) get-go on these uh audit issues so it sounds like Mike that that if someone is thinking about this there there was a lot of administrative effort on the front end or recordkeeping uh to keep all this straight to keep the accounting for the costs and the activity straight to get the payroll straight um what questions would you suggest a business owner think about um before they move forward with acquiring a plane it is talk to a professional such as myself to to really fully understand the interplay between the FAA guidelines

(19:46) the IRS uh the IRS uh tax issues and any state and local tax concerns it really needs to be and I hate to use the word holistic I feel like it's it's overused but you really need to do a holistic review because how it is structured is vitally important to get all of the benefits and advantages possible uh and there are going to be tradeoffs so talk to talk to a professional who understands the interplay between the FAA the IRS and state and local tax issues so that they can maximize your benefits and minimize uh any any shortcomings

(20:29) wow I think you just summarized the whole podcast from that sentence but anyway let's move to final comments Mike is there anything else you would like to add I mean you just said it all very eloquently there but any add on uh my final comment is even if you're a pre-existing aircraft owner and you may have been have you may have been using airplanes for years and feel that you're fairly up to speed it's always good to to sort of have a gut check uh and and we did that with a client just earlier this week and there were a

(21:02) couple of things they could improve upon to really make uh both from an audit perspective make uh I won't say Ironclad but really improve a couple of things so even if you're a seasoned aircraft owner and operator you could still benefit from a review of the things that we discussed and Sarah I still think owning an aircraft in in a company uh has a lot of uh positives to it uh it just means that the company and its and its uh key Executives need to walk through the guidelines and make sure that they are following uh the plan and U as as Mike

(21:43) said a lot of documentation the better the documentation and the more contemporaneously it's recorded with a flight event uh the better it's going to be when and if the IRS or a state comes calling to take a look and I guess I'll just semi Echo that is we've always known if you have a company owned air plane uh you will draw a question on the IRS audit it'll be at the top of the you know list of something they're going to ask about and it's going to now it's going to be even heightened more heightened it may draw

(22:20) the whole audit on you uh just for having the plane but anyway so you got uh it's not for the faint of heart if you're going to own it and be trying to take some significant deductions on it all right okay that's a wrap on on this discussion of tax reporting issues for income inclusion and expense disallowance for company owned aircraft a quick disclaimer that we are not providing tax advice on this podcast please consult with your Tax Advisor hopefully at Cherry Bekaert with your specific tax issues or or to discuss

(22:50) information from today's podcast check out the firm's website at cbh.com for the latest guidance and materials on this and other tax and business topics uh this this concludes today's podcast please like share and subscribe thank you Mike thank you our listeners for spending your time with us we truly appreciate it let's call it a day and go forth in peace [Music]