Recent press coverage of Internal Revenue Service and U.S. Securities and Exchange Commission problems with executive travel on company aircraft makes continued use challenging. The known benefits of business-owned aircraft include security, privacy and efficiency, particularly in light of delays inherent in commercial travel. This newsletter describes in plain English the basic requirements and strategies for dealing with the myriad rules presented with respect to executive and guest travel on company aircraft, and recommends as a solution the adoption of a carefully drafted executive aircraft use policy.
Traveling on business-owned aircraft allows executives to fly to more remote locations, work in privacy during travel, avoid long waits at the airport and travel with more security. Many companies also allow executives to use the aircraft for personal travel. However, such travel on company aircraft requires compliance with requirements of multiple government agencies, including the U.S. Securities and Exchange Commission (SEC), Internal Revenue Service (IRS) and Federal Aviation Administration (FAA). Noncompliance with these rules can lead to adverse publicity or fines. For example, The Wall Street Journal reported suspect personal use of corporate aircraft to executive vacation homes. Also, the SEC recently challenged erroneously reported flights, settling these charges for $2.8 million for under-reported perks.
Personal, as contrasted to business, travel by an executive on a company-owned or -chartered aircraft is considered a "perquisite" for SEC proxy reporting purposes for public companies. The SEC requires the quantitative reporting for the principal executive officer, the principal financial officer and the other named executive officers of all "perquisites" valued at the greater of $25,000 and 10 percent of all perquisites. For example, if total perquisites are valued at $100,000, then yearly executive travel on the company aircraft valued at $25,000 would need to be reported. Each perquisite must be valued on the basis of the aggregate incremental cost to the company and, for each perquisite for which footnote quantification is required, the company must explain its methodology for computing the aggregate incremental cost.
The company can use either actual aggregate incremental costs or obtain estimates. Such costs include fuel costs, landing and parking fees, customs and handling charges, per hour accruals of maintenance service plans, passenger caterings and ground transportation, crew travel expenses and other trip-related variable costs (including fees for contract crew members and the use of a fractional jet interest or charter costs). Depreciation and fixed pilot salaries generally do not need to be included. Important to note is that a personal guest “hitch-hiking” on a business trip typically does not result in SEC reporting because there is no aggregate incremental cost added to that business trip. On the other hand, if the executive travels for personal reasons on a given flight, the aggregate incremental costs can be significant, and are generally higher than the amount reported as income to the IRS for such travel. The SEC has not provided any details on exactly what items should be included in aggregate incremental costs for reported personal travel, but an examination of 2011 proxy statements reveals that a minority of public companies include in “aggregate incremental costs” the tax cost to the company for the deduction disallowance for flights that are considered "entertainment, amusement, or recreation" as well as fuel, pilot costs and other expenses (see below).
Example: A CEO flies from New York (company headquarters) to San Francisco for company business every month, and the CEO’s spouse joins on these trips. Generally, no SEC quantitative reporting is required because there is no aggregate incremental costs incurred as a result of the additional personal passenger.
IRS Rules on Individual Income
Compared to the SEC, the IRS uses very different rules for determining taxable income to the executive for personal travel. Each passenger on each leg must be judged as traveling primarily for business or primarily for personal reasons. For example, an executive traveling from New York to San Francisco for three days of business meetings and staying for an additional day or two would have no imputed income; imputed income would result however if a spouse accompanied the executive on the flight. The amount included for personal travel can be determined under special cents per mile rules referred to as the "SIFL" rates, but if not used properly, the IRS could require the use of a full charter equivalent amount. Executives and other control employees and their guests generally have imputed income of approximately $1 per mile, but non-control employees have imputed income of only around 10 cents per mile. If the 50 percent seating capacity rule is met, which is rare, there can be "0" imputed income, and certain security-related travel can result in a lower rate for heavy aircraft. Children under age 2 do not result in imputed income, presumably because they are not occupying a seat.
Example: A CEO flies from New York to San Francisco for business in April 2012, and the CEO’s spouse and 1-year-old son accompanies. The CEO’s spouse results in $2,048.44 of imputed income to the CEO, but there is no imputed income for the CEO’s business flight or for the 1-year-old son.
IRS Rules on Company Deductions
Starting in 2004, a subset of personal travel deemed to constitute "entertainment, amusement, or recreation," can result in hundreds of thousands and often millions of lost tax deductions on the company's tax return. Careful planning and knowledge of the rules can significantly reduce this tax detriment. The IRS has issued detailed guidance on how to calculate the disallowed deductions and has made clear that all costs are disallowed, including depreciation and other fixed costs.
Example: A CEO flies from New York to San Francisco for business frequently, and the CEO’s spouse accompanies to attend weddings, go sightseeing and other entertainment activities. The CEO’s spouse results in SIFL imputed income for each flight of $2,084.44. Assuming these are the only flights on the aircraft and the total costs of the aircraft are $4,000,000, the Company has a deduction disallowance of $2,000,000, reduced by the SIFL amount included in income by the CEO for the spousal travel. In contrast, if the accompanying spouse had not been engaging in entertainment activities, and was simply attending for routine personal reasons, then the airplane costs would be fully deductible. Note that in addition to the “entertainment” disallowance, the SIFL imputed income to the CEO may be subject to disallowance under §162(m) for compensation over $1,000,000.
A prudent and reasonable method of eliminating both SEC reporting and IRS imputed income is to permit the executive to reimburse the company for any personal aircraft use. Generally for reimbursed travel, if the aircraft is not flying under a part 135 certificate, the executive and company must enter in to a simple timeshare agreement and file it with the FAA. Note that reimbursement by executives in this fashion does result in imposition of an excise tax under §4261 of 7.5 percent, plus a small leg charge.
Companies with aircraft used for company business by executives should adopt a detailed use policy that complies with applicable SEC, IRS and FAA requirements. This policy should clearly set forth the terms and conditions for any occasional personal aircraft use, as well as financial implications to both the executive and the company. In addition, detailed records should be maintained so as to substantiate and validate compliance with the company policy.