One of the central promises of the new administration has been long-awaited tax reform. President Trump has promised imminent executive action outlining the tax reform priorities that he will pursue, and with a Republican Congress in place, some version of tax reform is likely either in 2017 or in early 2018. While it is difficult to read the tea leaves, there are some commonalities between the Congressional tax reform agenda and the campaign promises of the president that signal significant relevant changes to corporate and small-business taxation.
Potential Cuts to Business Taxes May Make Deductions More Valuable This Year
One cornerstone of the Trump tax plan is a significant decrease in corporate tax rates, as well as taxes paid by owners of flow-through businesses, including S corporations, partnerships, and Schedule C businesses that flow through to 1040 returns. Current corporate rates at 35% are proposed to be cut to 15% in the Trump plan, and although that may not be politically feasible, the Kiplinger Tax Letter believes that a top rate of 25% is politically likely. Perhaps even more significantly, flow-through profits from S corporations, partnerships, and Schedule C businesses that currently are taxed at the owners’ 1040 rates are also subject to significant cuts, with a proposed rate of 15%. (The House GOP Blueprint calls for 20% corporate rates and 25% flow through rates. The Trump plan calls for both rates to cap at 15%.)
Why does this rate shift make aircraft purchases or purchases of new equipment installed on aircraft in 2016, and likely 2017 (contingent upon the date of reform), a unique opportunity? Deductions taken for expensing property or depreciation are commonly referred to as “timing differences,” given that any deduction taken, to the extent that it exceeds the actual loss in value in the property, is subject to recapture at the time the property is sold or no longer used for business. While there is no reason to believe at this time that recapture would not occur in future tax years, that recapture would be treated as ordinary business income in the year the property is taken out of service. Assuming a significant and potentially lasting change in business tax rates, the deductions taken for the property in years before rate cuts are likely to save significantly more tax dollars than those due at the time the property is sold, given the potentially large reduction in rates. For example, if corporate taxes decrease by 50% as proposed, the tax savings at purchase will double that owed upon disposition. This, combined with 50% bonus depreciation in 2017 and the $500,000 expensing election, may make this the ideal time to add to your fleet or upgrade equipment on your aircraft.
Tax Reform can be messy
Comprehensive tax reform is challenging, and details of the plan are already facing significant adjustment and possible override. Discussions of border adjustment taxes have left Congress and the Administration at odds on the balance of the plan. Accordingly, those businesses currently operating business aircraft need to be agile and informed as reform happens. While LLCs have been a preferred business structuring tool for their flexibility and ease, partial reform that reduces rates for corporations but leaves out pass-through structures may require businesses to re-evaluate whether they are operating the aircraft in the most tax-advantageous manner. Such restructuring requires sensitivity to basis concerns, as well as state and local tax consequences. Elimination of estate taxes, including adjustments to, or the elimination of the “step up in basis” rule, also impact long-term business succession planning.
Bonus Depreciation decreases after 2017
Under the Bonus Depreciation rules, purchases of new aircraft, or new aircraft component parts installed, i.e., a new avionics suite, are eligible for an accelerated bonus-depreciation allowance in the year they are placed in service. Absent a change in this specific code provision, for tax years 2016 and 2017, the bonus-depreciation allowance will be 50% of the cost. This reduces to 40% in 2018, 30% in 2019, and is phased out thereafter (although some 2020 acquisitions may qualify, where a written binding purchase contract was in place before 2020). The additional first-year depreciation deduction is allowable both for regular income-tax purposes and alternative minimum tax.
Aircraft eligible for bonus depreciation must be new, used primarily for qualified business purposes, and meet other tests necessary to qualify for depreciation under the modified accelerated cost recovery system (MACRS). Bonus depreciation excludes property acquired under written binding contracts in effect prior to January 1, 2008. Special rules may apply to agricultural and firefighting aircraft.
Business taxpayers may have a truly unique investment opportunity in 2017, but must exercise extreme care to sustain the deductions under IRS scrutiny. The IRS has a number of tools at its disposal to claw back tax savings so graciously provided by the legal tax incentives. Careful adherence to the myriad use, structuring, and recordkeeping requirements is particularly important where taxpayers expect to receive large tax benefits in a given year.
It is critical to consult with a qualified expert, not only on whether a particular transaction qualifies for the incentives, but also on whether associated tax rules may take away benefits the incentive programs may have made available. This article is merely an overview of the topic, and not necessarily comprehensive. There are clear indications that tax reform is on its way and that the impact on business aviation will be significant. Now is the time to have a knowledgeable aviation tax advisor on your team as you evaluate your aircraft operations for 2017 and years ahead.
Suzanne Meiners-Levy, Esq. is Legal Advisor for Advocate Consulting Legal Group, PLLC, a law firm whose practice is limited to serving the needs of aircraft owners and operators relating to issues of income tax, sales tax, federal aviation regulations, and other related organizational and operational issues. Tax Disclosure: Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under tax laws, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.