Increased IRS Scrutiny on Personal Use of Company-Owned Aircraft

HOST: Welcome to the Cherry Bekaert Tax Beat, a conversation about tax that matters. Today we are talking about the tax rules for companies that own private aircraft.

HOST: In February the IRS announced a program to start auditing personal use of company-owned aircraft, targeting company owners and key executives. This continues the IRS's recent actions to step up examinations of high-net-worth individuals.

MIKE GRIM: Mike Grim, director with our State and Local Tax team, specializes in resolving controversy issues between taxpayers and tax authorities and has extensive experience working with company-owned aircraft.

HOST: How are you doing today, Mike?

MIKE GRIM: Doing well. I'm resident in the Louisville, Kentucky, office of Cherry Bekaert and looking forward to today's topic. There might be a horse race nearby in the next day or two.

HOST: There's a certain two-and-a-half-minute event getting a lot of worldwide attention this week. It's a lively time to be in Louisville.

HOST: As always, my partner in crime joining me today is Sarah McGregor from Greenville. How's life treating you, Sarah?

SARAH MCGREGOR: Life is great. I'm glad it's May and we're on to summer topics. I was thinking about all the private planes probably flying into Louisville for that race, a perfect time to talk about how the costs of all those planes might be handled.

HOST: The IRS has announced a pilot program to examine tax returns associated with up to 48 corporate-owned jets. Results of these initial examinations will determine how the IRS may focus subsequent examinations.

HOST: Before we talk about tax issues, let's start with some background: the big picture of owning and operating a private aircraft. Mike, how would you describe the overall scene for federal regulation and oversight of private aircraft?

MIKE GRIM: Whenever clients come to talk to us, their first questions are about depreciation and tax writeoffs. One of the first things we discuss before tax issues is the interplay of the Federal Aviation Administration and their regulations. How you operate an aircraft and how you structure operations can have a tremendous impact not just on federal tax benefits, but also on whether you're legally operating the aircraft in accordance with applicable law.

MIKE GRIM: The FAA and the IRS do not always have similar guidance on what is and is not non-commercial versus commercial operations. The FAA looks at operational control—who legally has operational control of the aircraft—because the FAA is about flight safety. The IRS looks more at possession, command, and control.

MIKE GRIM: For example, the FAA treats an interchange agreement—an agreement between two owners to swap use of aircraft—as non-commercial, while the IRS may treat that arrangement as commercial and subject to federal excise tax. How you manage and compensate or reimburse the aircraft entity is vitally important from an FAA standpoint.

MIKE GRIM: When clients ask whether to own an aircraft in their primary business or create a special purpose entity, those choices have benefits and disadvantages. An improperly structured solution can solve a tax problem but create FAA issues that could get the client into serious trouble.

MIKE GRIM: You'll also hear references to Part 91 or Part 135. Those are federal aviation regulations that determine what you can and cannot do under non-commercial or commercial operations. The IRS uses that nomenclature as well when talking about certain aircraft ownership and tax issues.

HOST: Now that we've reviewed FAA rules about how the aircraft will be owned and operated, we need to deal with IRS issues, which can be complex. Mike, what are some of the key issues the IRS focuses on in its compliance reviews?

MIKE GRIM: Even before the IRS announced the new pilot program, the primary issue in any aircraft audit has been the control employee, defined as a 5% or greater owner. The IRS wants to see that the control employee is paying tax on their personal use. That has always been issue number one.

MIKE GRIM: We're also seeing more review of bonus depreciation, which can include accelerated depreciation. Bonus depreciation is currently 60%, though for several years it was 100%. I'm also seeing many excise tax audits; earlier this year I had two clients who received federal excise transportation tax audits.

MIKE GRIM: Another issue is personal use versus entertainment or business use, because how you use the aircraft drives how much of the tax benefits you can take. If you use a special purpose entity, the FAA may require that entity to lease the aircraft; a single-member LLC cannot operate an aircraft from an FAA perspective. Setting up a leasing structure, including related-party leasing, can create passive losses that clients often do not consider.

MIKE GRIM: There are many landmines to navigate to use and report the aircraft for tax purposes. It may or may not deliver the benefits a company is seeking, but it can provide other use benefits in helping key executives manage business and time.

HOST: Those are the IRS issues, but you work in the State and Local Tax team. Can you fill us in on state and local taxes that need to be considered?

MIKE GRIM: If we're brought in early, we can try to maximize a client's exemption or deferral of certain taxes, specifically sales and use taxes. Clients are often focused on the purchase location of the aircraft, which is good for sales tax, but they forget exemptions or deferrals available where they hangar the aircraft.

MIKE GRIM: There are exemptions like resale or Flyaway; some states like South Carolina have caps. If brought in early, we can plan around those issues. Tangible personal property tax remains an issue in certain states. Where you hangar the aircraft, for example in Louisville, Kentucky, or across the river in Clark County, Southern Indiana, could affect annual property taxes by as much as $100,000 a year.

HOST: Let's go back to the income tax side. There are two major IRS focuses: income inclusion for personal use of the aircraft and expense disallowance. Take the first one—what can you tell us about the income inclusion rules?

MIKE GRIM: Pre-TCJA, companies could deduct commuting expenses that were imputed to the employee. Any personal use of a company-owned asset—commuting, weekend trips, medical travel, or personal entertainment—results in income inclusion.

MIKE GRIM: One of the benefits is the SIFL rate. SIFL stands for Standard Industry Fare Level; it is published by the Department of Transportation. SIFL looks at factors including the length of the trip in nautical miles, size of the aircraft, number of passengers, and the number of passengers traveling for personal reasons. It effectively calculates the cost of a first-class air ticket.

MIKE GRIM: Chartering an aircraft can be extremely expensive—$5,000 to $10,000 an hour—while the imputed income that the control employee must report on their W-2 may be only a fraction of that. The control employee does not get imputed the entire expense associated with the use of the aircraft.

MIKE GRIM: There are different ways to calculate personal versus business use, such as a predominance test based on occupied seats. For example, in an eight-passenger aircraft, if four seats are occupied and three are for business, that may be considered predominantly business. We can assist clients in determining income inclusion and performing the SIFL calculation.

MIKE GRIM: In a work-from-anywhere world, if an owner lives in Colorado and commutes to the New York office once or twice a month, that commuting is personal use of the aircraft. Historically, personal use has been imputed into income and the company loses the corresponding deduction.

MIKE GRIM: At year-end, the company will look at all direct operating costs and indirect operating costs—hangar, insurance, maintenance programs, depreciation—and must take a haircut on personal commuting or entertainment. The company loses the deduction for the portion attributable to personal use.

MIKE GRIM: For business-purpose flights, there is no income inclusion and the related expenses are deductible. But if there is personal use, the company loses the associated deduction even though the employee picks up imputed income on their W-2.

MIKE GRIM: There is one exception for security reasons. If you travel on a company aircraft for documented safety reasons, the company may be able to preserve the deduction, although the employee generally still has imputed income. You generally need a safety plan to support that position.

HOST: Pull out your crystal ball. What will the IRS look for in their pilot audits?

MIKE GRIM: They will be looking at flight logs. Maintain flight logs contemporaneously with flights and document the business purpose. Clients often fly between the same city pairs, and trips to places like Turks and Caicos or Las Vegas can sound like pleasure to an auditor, so document the business purpose contemporaneously. Auditors will ask about the nature of the trip and how you characterize it, whether on a per-seat basis or a flight-by-flight basis.

HOST: If someone is thinking about acquiring an aircraft, there is a lot of administrative effort up front for recordkeeping, accounting, and payroll. What questions should a business owner ask before acquiring a plane?

MIKE GRIM: Talk to a professional who understands the interplay between FAA guidelines, the IRS, and state and local tax issues. Structure matters. A holistic review is essential to maximize benefits and minimize shortcomings. There will be tradeoffs.

HOST: Final comments, Mike?

MIKE GRIM: Even if you're a preexisting aircraft owner and have been using aircraft for years, it's good to have a review. We did that with a client recently and found a couple of improvements that strengthened their audit posture. Seasoned owners can still benefit from a review of documentation and processes.

SARAH MCGREGOR: Owning an aircraft in a company has many positives, but companies and key executives need to follow the guidelines. The better the documentation and the more contemporaneously it's recorded with a flight event, the stronger the position when the IRS or a state comes calling.

SARAH MCGREGOR: We've always known that company-owned aircraft draw audit attention, and that will be heightened now. Owning an aircraft and taking significant deductions is not for the faint of heart.

HOST: That concludes this discussion of tax reporting issues for income inclusion and expense disallowance for company-owned aircraft.

HOST: We are not providing tax advice on this podcast. Please consult with your tax advisor, hopefully at Cherry Bekaert, to discuss your specific tax issues.

HOST: For more information from today's podcast, check the firm's website at cbh.com for the latest guidance and materials on this and other tax and business topics. This concludes today's podcast. Thank you, Mike, and thank you to our listeners for spending time with us.