On December 20, the Congress passed the Tax Cuts and Jobs Act (the “Tax Act”), a $1.5 trillion tax package that cuts individual income tax rates for eight years and reduces top corporate tax rate to 21 percent permanently. The bill is now awaiting President Trump’s (fully expected) signature.
The Tax Act contains major provisions that affect business aviation. Here are a few major highlights:
a. Elimination of Like-Kind Exchanges
One of the most recognizable changes is that the Tax Act eliminates the ability to use the “like-kind exchange” (commonly short-handed to “LKE”) under Section 1031 of the Internal Revenue Code (“IRC”) in aircraft transactions.
Current Section 1031 allows taxpayers to defer any gain on the sale of an aircraft, if that aircraft is held for productive use in a trade or business or for investment, and if it is exchanged solely for another aircraft of a like kind that is also held for productive use in a trade or business or for investment.
b. Bonus Depreciation
The Tax Act, however, will only allow like-kind exchanges for real property. This means that aircraft owners would no longer be able to rely on Section 1031 to defer any taxable gain on the sale of their aircraft when they upgrade. Instead, aircraft owners will pay income tax — at “ordinary income” rates — on any gains realized on the sale of their aircraft even if the taxpayer replaces that aircraft.
Nevertheless, Aircraft owners who either disposed of the relinquished property or acquired an upgrade property on or before December 31, 2017 may still take advantage of the current Section 1031 rule pursuant to a transition rule provided by the Tax Act.
The Tax Act provides for 100 percent expensing, allowing immediate write off of the entire cost of property placed in service after September 27, 2017 and before January 1, 2023 (commonly known as “bonus depreciation”). Currently, the law allows for 50 percent bonus depreciation for qualified properties (among other things, only newly manufactured aircraft qualify).
This new bonus depreciation rule could significantly alleviate the negative impact on business aircraft buyers caused by the elimination of LKEs for aircraft. Buyers of both new and pre-owned business aircrafts are eligible for this bonus depreciation rule as long as it is the buyer’s first use of the acquired aircraft.
From January 1, 2023 through December 31, 2026, the Tax Act provides for a phase down of bonus depreciation in increments of 20 percent each year for qualified business aircraft acquired and placed in service during that period. For properties with longer production periods, including certain aircrafts, the last day is December 31, 2027.
c. No Deduction for Transportation and Commuting Benefits
The Tax Act does not allow deductions for any expense incurred for providing any transportation, or any payment or reimbursement to an employee in connection with travel between the employee’s residence and place of employment, unless it is necessary to ensure employee safety. It is not clear whether commuting expenses included in income may be deductible under this new provision.
d. Disallowance of All Entertainment Expenditures
Currently, Section 274 of the IRC does not allow deductions of entertainment expenses unless they are directly related to or associated with the active conduct of business. The Tax Act changes this long-standing rule by disallowing deduction of all entertainment expenses, regardless of their connection to the tax payer’s business activities.
e. Ticket Tax Does Not Apply to Owner Flights on Managed Aircraft
The Tax Act amended Section 4261 of the IRC to provide that owner flights on managed aircrafts are not subject to Federal Transportation Excise Tax (FET) as imposed by Section 4261 and Section 4271. Instead, they are subject to the non-commercial fuel tax. This added provision confirms that the law is consistent with the common understanding in the business aviation industry.
Payments by the aircraft owner (or lessee of a qualified lease) for aircraft management services related to maintenance, support or flights on the aircraft are not subject to the FET. The owner or lessee does not need to be on the flight as long as the owner (or lessee of a qualified lease) pays for the aircraft management services. The term “aircraft management services” is defined broadly under this new provision. Lessees who lease an aircraft from a management company or person providing aircraft management services for a term of 31 days or less do not qualify as “lessee” for purpose of the FET exception.
Note that the FET exception only applies for flights paid by the owner or lessee. Therefore, if an owner leases the aircraft to a management company and an affiliate of this owner pays for the flight, the exception may not apply.