The "Word" Is... Operating Cost

Dictionary Definition: The expense of maintaining property; it does not include depreciation or the cost of financing or income taxes.

Aviation Usage: In the business aviation industry, the term "direct operating cost" refers to variable costs incurred when operating an aircraft, such as fuel, hourly pilot charges, landing fees, and catering. The term "direct operating costs" excludes fixed costs associated with aircraft ownership, such as insurance, depreciation, scheduled maintenance and management fees.

IRS Usage: For purposes of determining the tax deduction disallowance that applies to the entertainment use of a business aircraft, Proposed Tax Regulations require that a taxpayer must take into account all of the expenses of operating the aircraft, including all fixed and variable expenses. According to the IRS, these expenses include, but are not limited to, salaries for pilots, maintenance personnel, and other personnel assigned to the aircraft; meal and lodging expenses of flight personnel; takeoff and landing fees; costs for maintenance flights; costs of on-board refreshments, amenities and gifts; hangar fees (at home or away); management fees; costs of fuel, tires, maintenance, insurance, registration, certificate of title, inspection, and depreciation; and all costs paid or incurred for aircraft leased, or chartered, to or by the taxpayer.

What It Really Means: By defining "operating costs" broadly, the Proposed Tax Regulations dramatically increase the amount of any tax deduction disallowance caused by the entertainment use of a business aircraft. The National Business Aviation Association (NBAA) has objected to the broad use of this term by the IRS. The NBAA argues that the use of the aviation term "direct operating cost" is consistent with the SEC's reporting requirements for the aggregate incremental cost of executive perquisites and that only variable costs should be included because the relevant legislative history refers to "aircraft operating costs" and "actual cost." The IRS and the Treasury Department believe that industry use of the term "operating costs" generally refers to all costs, fixed and variable, including depreciation claimed on a taxpayer's tax return. Therefore, the Federal taxing authorities do not believe that the use of the term "operating costs" in the legislative history reflects Congressional intent to apply the tax deduction disallowance to variable costs only.

Playing It Smart: Although the NBAA is correct in its use of the term "direct operating costs," the IRS and the Treasury Department write the Tax Regulations, and they are using the broadest terms possible to capture the most tax revenue that they can. If the proposed Tax Regulations become final, the government's definition will need to be followed unless overturned by legislation or judicial determination (and the latter is highly unlikely). For more information and planning ideas on the personal use of business aircraft, click here.