The U.S. Department of the Treasury (Treasury) and the U.S. Internal Revenue Service (IRS) released their 2013-2014 Priority Guidance Plan, which identifies and prioritizes the tax issues requiring administrative guidance. The plan includes two critical business aviation issues: (1) guidance on the application of the air transportation excise tax to aircraft management fees, and (2) guidance on whetherm, the business use of an aircraft by a lessee who is a 5% owner or related party of the aircraft’s lessor is “qualified business use” for purposes of tax depreciation. Recent action by the IRS has caused great confusion on these tax issues—at a cost to taxpayers—that now require clear, accurate guidance.
Air Transportation Excise Taxes on Aircraft Management Company Fees
The Internal Revenue Code imposes a federal excise tax (FET) of 7.5% on the amount paid for domestic air transportation services provided by aircraft charter operators. FET can also be imposed by the IRS on non-commercial flight operations. In a shock to the corporate aviation community, the IRS has claimed that the aircraft management fees paid by an aircraft owner to its aircraft management company are subject to FET, even when the aircraft is operated by the owner under Federal Aviation Regulation Part 91. Aircraft management is a contractual relationship where the owner/operator of an aircraft entrusts a management company to provide support to aircraft operations, including oversight of maintenance and repair, hangar service, fuel, scheduling, and other services. Management companies are an efficient outsourcing method used by a corporate aircraft operator that do not want to create and staff a flight department for their aircraft usage.
In a Chief Counsel Advice memorandum written in 2012, the IRS examined a case where an aircraft owner hired a management company to oversee aircraft operations, and the owner paid the management company a monthly management fee and reimbursed pilot employment and training costs. The IRS determined that the management company provided taxable transportation to the aircraft’s owner, and that FET was due on the monthly management fees and pilot reimbursements, neither of which (according to the IRS) were non-transportation services. However, this new IRS position was inconsistent with prior guidance and generated surprise and confusion. In response, representatives of the National Business Aviation Association (NBAA) and National Air Transportation Association (NATA) met with IRS officials to request clear guidance on FET as applied to aircraft operated privately by owners that use aircraft management company services.
In consideration for the concerns of NBAA and NATA, the IRS will develop formal guidance and audit standards for both future FET liability and past activity. However, until formal guidance is provided, private aircraft owners using aircraft management company services should review their arrangements to clearly establish that, for FET purposes, the aircraft owner has possession, command, and control over its aircraft and the management company is merely acting as an agent of the owner in order to reduce the risk that the IRS claims that FET is due on such aircraft management fees.
Qualified Business Use of an Aircraft by Certain Lessees
Business aircraft are commonly depreciated for tax purposes under the general depreciation system (GDS) over a five or seven year recovery period based on the “primary” use of the aircraft. However, under IRC § 280F, if an aircraft is not predominantly used for “qualified business use” (i.e., used more than 50% in the trade or business of the taxpayer) for any taxable year, a longer depreciation deduction period is imposed under the alternate depreciation system (ADS) and any first-year bonus depreciation taken must be recaptured as ordinary income in the tax year that the aircraft is not predominantly used for “qualified business use.”
Determining whether a taxpayer predominantly uses the aircraft for “qualified business use” is a two-step process. First, at least 25% of the total use of an aircraft during the taxable year must consist of qualified business use that does not involve leasing the aircraft to any 5% owners or related persons (the 25% Threshold). If this first requirement is met, then the aircraft business use of such persons may count toward meeting the requirement that the aircraft be used predominantly (more that 50%) for qualified business use.
However, for the last few years, the IRS has interpreted the 25% Threshold narrowly. Even if a 5% owner or related person is leasing and using the aircraft for business purposes, the IRS will not treat such business use as “qualified business use” of the aircraft for purposes of determining whether the aircraft’s owner has satisfied the 25% Threshold, but will instead treat all such passengers’ flights on leased aircraft as non-business flights. Taxpayers argue that the IRS’s interpretation of the law that treats all such flights on an aircraft leased to a 5% owner or related party as personal flights for purposes of the predominant business use test in IRC § 280F fails to accomplish Congress’ purpose of making accelerated depreciation available to purchasers of assets when there is no excessive personal use of the asset. However, until further guidance is issued, taxpayers with leased aircraft should track whether a passenger is a 5% owner or related person for each flight.
The sooner Treasury and IRS can provide guidance on these issues, the better. However, with 396 items on their 2013-2014 Priority Guidance Plan, help with these issues may not be coming soon, and taxpayers must continue to plan their aircraft operations under uncertain circumstances.