Twin Commander flown by Erick Teeters & John Kelley. A Closer Look at the Impact of the Tax Cuts and Jobs Act
The 2017 Tax Cuts and Jobs Act (TCJA) provides a unique opportunity for business aircraft purchasers of both new and pre-owned aircraft to take 100% bonus deprecation on the aircraft purchase price.
The bonus depreciation can be taken in the year of acquisition pursuant to Section 168(k), provided that the aircraft is placed in service for business use in that year. This purchase incentive can serve as a valuable tool to free up capital, encourage business investment and activity, and facilitate the purchase of a more capable aircraft by significantly lowering business tax liability at the time of purchase.
Pursuant to I.R.C Section 280(f), to qualify for bonus depreciation an aircraft must be used predominately for business use, with at least 25% of the business use meeting a specific definition of “qualified business use.” That is a term of art that excludes most compensatory use and use by related party lessees. After the 25% qualified business use requirement is fulfilled, some compensatory use and related party leasing can be used to meet the predominant (50%) business use test to qualify for accelerated depreciation and bonus.
While all personal use of company aircraft impacts the deductibility of both depreciation and aircraft operating expenses, a properly filed straight-line election pursuant to 274-10 can preserve close to full depreciation deductibility for almost all business aircraft with a mixed-use profile, provided that the aircraft is predominately a business tool and detailed flight logs are maintained to support the deductions. This allows a business to preserve almost full purchase price depreciation deductibility even in cases where personal use is significant.
Simple, right? Not so fast. For the unwary, what the Congress giveth, the IRS taketh away. New aircraft limitations on the definition of business flights, coupled with structuring hurdles or desires may jeopardize the ability for your company to take advantage of this incentive. This article examines a couple of ways that the TCJA interacts with existing law in creating potential tax traps for the unwary owner or operator.
Narrowing the Definition of Qualified Business Use
First, the TCJA narrowed the category of flights that will be considered qualified business use for the purpose of determining business eligibility. It did this by declaring travel associated with business entertainment nondeductible pursuant to Section 274, the section of the Code that details both the recordkeeping requirements for business deductions and the impact of personal use on deductibility. Business entertainment flights, whether taking a client to a sporting event or to a ranch, have previously been considered business flights, provided that proper documentation was kept to establish an affiliated business meeting and a reasonable purpose for the entertainment. Effective in 2018, most trips focused on or associated with entertaining clients will no longer be considered business use of the aircraft. This change, coupled with the fact that business entertainment trips often include a high passenger count, can dramatically alter the qualified business use percentage of a business aircraft.
Additionally, Section 274 was amended to make employee commuting travel non-deductible. While commuting trips have never been treated as the first category of qualified business use, generally they have been treated as deductible employment compensation when reasonable and properly taxed. This altered treatment may significantly shift the business use percentage of many business aircraft that were commonly used for commuting travel. The reach of this provision remains somewhat unclear and requires careful analysis in applying it to individual travel arrangements.
Incentivizing New Ownership Structures
The cornerstone of the TCJA was the cut in the corporate tax rate, which was paired with an income-deduction provision for pass-through entities. The corporate rate cut is significant, from 35% to 21% in the top bracket, incentivizing the operation of business through a corporate structure for many taxpayers, especially those located in high-tax states that also favor corporate structuring (i.e. California.) The corporate alternative minimum tax also was repealed. For pass-through entities (partnerships, S-corporations, Schedule C business and other LLCs), the law provides for a new deduction of up to 20% of qualified business income subject to significant limitations, especially for most highly profitable professional services companies, which likely will not qualify for any income deduction. Accordingly, determining the proper business entity structure with tax considerations is now a much more individualized inquiry, requiring an examination of business type, basis in qualified property, W-2 wages paid, and a variety of other factors.
How does this impact aircraft? In determining whether a business aircraft is ordinary or necessary, the Service has been charged by the Courts to look across entities to the trade or business or business activity of the taxpayer at issue. When the aircraft is owned by a pass-through entity and used in the business of another pass-through entity, the Courts have generally been open to “grouping” the entities to determine both profit motive and whether an activity is passive or active. However, because corporate taxpayers are not pass-throughs, both the IRS and the Courts have been wary to impute the intent of the Taxpayer across corporate entities, even when the ultimate owner remains the same. This can put business tax concerns at odds, creating a tension between the desire for a rate reduction and the potential for negative treatment of the aircraft losses.
Thinking Ahead
The Tax Reform and Jobs Act provides an economic opportunity for businesses to become more productive and efficient through the use of general aviation business aircraft, perhaps more affordably than ever before. The next couple of years may provide a once-in-a-lifetime opportunity to begin, expand, or upgrade your general aviation fleet. Through thoughtful planning beforehand, coupled with assisted contemporaneous monitoring of use, your company can avoid falling into an unforeseeable tax trap. The issuance of regulations in the future may better clarify the scope of both the new limitation under Section 274 and the application of the corporate rate cuts and pass-through income deductions. However, regulatory clarification is notoriously slow and employing knowable tax counsel now is critical to avoid making a structuring mistake that converts deductible business use into lost or delayed deductions.
Suzanne Meiners-Levy, Esq. is a Shareholder in Advocate Consulting Legal Group, PLLC, which serves the needs of general aviation clients throughout the country. For more information see www.advocatetax.com.
