Three recent developments have negatively impacted the deductibility of expenses associated with the use of business aircraft. The American Jobs Creation Act of 2004 contained a provision that limited the deductibility of expenses related to use by “Specified Individuals” of a company aircraft for purposes of “entertainment, amusement and recreation” (collectively, “Entertainment Use”).
IRS Notice 2005-45 sets forth the methodology for allocating costs of operation between deductible business use and non-deductible Entertainment Use by Specified Individuals. Costs are to be allocated on a “seat-hour / seatmile” basis. In many instances as a result of higher passenger load factors on Entertainment Use flights, the “seat-hour / seat-mile” method of calculating expenses results in a disproportionate level of disallowed expenses.
On June 14, 2007, the Service published Proposed Regulations dealing with Deductions for Entertainment Use of Business Aircraft (the “Proposed Regulations”). The Proposed Regulations provide some limited relief from the provisions of Notice 2005-45. The above developments are referred to collectively as the “Entertainment Use Rules.”
As a practical matter, continued use of business aircraft for Entertainment Use has become more expensive for both the aircraft owner and for most executives and shareholders using the aircraft. With careful planning, the increased expense, although not completely avoidable, can be minimized. The following checklist outlines some possible ways of minimizing the impact of the Entertainment Use Rules.
Please note that the utility of the following suggestions will vary on a company-to-company and individual-to-individual basis. Because your situation is unique, it is strongly recommended that all aircraft owners, operators and users consult a tax adviser before employing any of the following strategies. Please also note that the Service continues to actively review the issue of Entertainment Use and that the Proposed Regulations are subject to further revisions and interpretation by the Service. The tips noted herein may be impacted or negated by any new pronouncements by the Service.
Step 1: Understand the Scope and Application of the Entertainment Use Rules.
- The Entertainment Use Rules apply to Entertainment Use by “Specified Individuals.”
- “Specified Individuals” include certain officers, directors and 10% shareholders as well as their family members.
- Travel by other employees for Entertainment Use is not currently impacted.
- The Entertainment Use Rules apply only to Entertainment Use.
- Distinguish between:
- Business Flights which remain fully deductible.
- Entertainment Use which are never deductible.
- “Personal Business” and “Routine Personal” flights may still be deductible.
- Personal Use does not equal Entertainment Use.
Step 2: Strategies for Operations under the Entertainment Use Rules
- Recharacterize Entertainment Use missions as deductible “Revenue Flights”
- Place company aircraft on third-party charter certificate.
- Allow Specified Individuals to utilize the company aircraft as fare paying charter customers at rates approximating fair market charter value.
- Caution: The Proposed Regulations do not explicitly endorse the notion that chartering a company aircraft to a Specified Individual on an arms-length, fair market value basis is a deductible business use of the aircraft. Charter use by Specified Individuals at less than fair market value or on preferred terms is more likely to result in disallowance of expenses associated with such flights.
- Dry lease the company aircraft (without pilots or crew) to Specified Individuals.
- Useful tactic for “employee / pilots”
- For Specified Individuals who are not pilots: Contract pilots should be obtained from independent third party sources. As a general rule, use of the aircraft owner’s pilots on a contract basis by Specified Individuals may raise issues under the Federal Aviation Regulations in addition to the Entertainment Use Rules.
- Enter into Timesharing Agreements with Specified Individuals for Entertainment Use.
- Caution: Use of Timesharing Agreements in an effort to reduce disallowance due to Entertainment Use may be an aggressive tactic. In addition, the limited amounts of expenses that may be reimbursed under FAR 91.501 (d) for use of an aircraft under a Timesharing Agreement generally do not equal the fully allocated costs of ownership and operation subject to disallowance under the Entertainment Use Rules.
Step 3: Tactical Solutions for Operations under the Entertainment Use Rules
- IRS Regulations continue to allow personal use of a company aircraft for officers, employees and owners so long as the personal traveler has income imputed to them on a 1099 or W-2 equal to the value of the transportation received. IRS Regulations also specify levels of income to be imputed (the Standard Industry Fare Levels or "SIFL" rates. Imputed income at SIFL rates continues to be a bargain for the personal traveler but will likely result in significant disallowances of associated expenses for the company.
- Minimize SIFL reimbursement as a means of conducting Entertainment Use missions.
- Where SIFL reimbursement is utilized, imputing income to Specified Individuals at the higher “fair market charter rate” rather than the artificially low SIFL-Table rates reduces the amount of disallowed expenses.
- Avoid tainting the plane. Segregate all Entertainment Use to limit disallowance.
- Encourage use of “non-company” aircraft as “supplemental lift” for Entertainment Use:
- Charter Aircraft.
- Fractional Interests.
- Jet Cards.
- Encourage use of older, fully depreciated aircraft to minimize disallowances due to depreciation. (See note on depreciation in Step 4 below.)
- Manage passenger load factors:
- Minimize number of Entertainment Use passengers on each trip.
- Maximize number of business travelers on each trip.
- Combine contemporaneous business trips.
- Encourage business use of the aircraft.
- Utilize commercial airlines for transporting non-family members (such as nannies, nurses, etc.) in connection with Entertainment Use flights.
- Minimize deadhead and ferry flight activity before and after Entertainment Use flights.
- Make deadhead flights before and after Entertainment Use available to business travelers who otherwise would travel on the airlines.
- Make deadhead aircraft available to charter operators for deductible “return revenue flights.”
Step 4: Tactical Tax and Accounting Solutions
- Utilize like-kind exchanges in connection with aircraft acquisitions. Like kind exchanges result in a lower depreciable taxable basis in the aircraft creating smaller amounts of depreciation expenses subject to disallowance.
- Explore the use of the longer straight-line aircraft class-life depreciation methods authorized by the Proposed Regulations. Longer depreciation periods yield lower depreciation amounts subject to disallowance.
- Calculate expenses utilizing both the “seathour / seat-mile” method provided for in Notice 2005-45 and on the “flight-by-flight” basis provided for in the Proposed Regulations. Depending on passenger load factors, the flight-by-flight method may result in lower disallowed expenses.
- The Preamble to the Proposed Regulations suggests that the Service may in the future permit an aircraft owner to calculate expenses associated with Entertainment Use in an amount equal to an “undiscounted charter rate charged to the general public ” for such a flight. The resulting disallowance may be less than the disallowed expenses utilizing either the “seat-hour / seatmile” or “flight-by-flight” methods currently set forth in the Proposed Regulations. In the event that this “Charter Rate Safe Harbor” methodology is adopted by the Service in future regulations, the Taxpayer will need to be able to provide documentation of the fair market charter rate in effect at the time that the Entertainment Use flight occurred. As such, in the event that the Charter Rate Safe Harbor is adopted it is recommended that Taxpayer’s keep contemporaneous written records of applicable charter rates for all Entertainment Use as evidence of prevailing rates.
- Utilize compensation gross-ups for Entertainment Use travelers to minimize aftertax consequences of revised travel payment methods.
- Keep accurate and contemporaneous records of all business, “personal business,” “routine personal business” and Entertainment Use.