BUSINESS FLYING AND TAXES Back to Basics – Aircraft Tax Planning 101

Business aviation has been in a frenzy since the early stages of the pandemic. Health concerns, commercial airline difficulties with customer experience, and favorable tax benefits have all contributed to activity levels not predicted when the economy was on lockdown in 2020. There have been many new entrants into private aviation, and this article will address some of the basic tax issues that should be considered, or should have been considered, when acquiring a business aircraft.

“Just because you have a lot of income, it does not mean you can write off an aircraft.”

If you realize a significant gain when you sold your business, you may not be able to buy a business aircraft and capture the depreciation benefits. If you sold your business and retire you no longer have a business justification to write off the aircraft. Continuing business activities are needed to treat the aircraft as a business asset and capture the depreciation deductions.

For instance, a car dealer with multiple locations in the metropolitan area, while extremely profitable, may have difficulty to justify the need for a business aircraft, if the business travels consist of a few trips to dealer’s meeting or the national convention once a year.

“All incomes are not created equal.”

A banner year in the stock market with sizable capital gains and dividends or selling a property at a significant profit are examples of incomes that do not justify the need for a business aircraft. A business aircraft is best utilized by a business owner in a profitable business operation. Visiting multiple office locations; clients and vendors; and attending trade shows and conventions are prime examples of good justification for a business aircraft. The ability to be more efficient in running a business operation and therefore become more productive, and possibly more profitable, are a great explanation of why the aircraft is ordinary and necessary for your business.

“All business uses are not created equal.”

Using the aircraft for your business travels and flying employees to meetings are a good active use of a business aircraft. Deductions from the active use of a business aircraft can be used to offset any business income of a taxpayer.

Leasing the aircraft to a management company to generate revenue from charter or other leasing activities, while it is considered business use, may be classified as passive business use. The trouble with passive business use is that passive deductions can only offset passive business income. Passive incomes are generally income from rental real estate and business income from a business that you do not actively manage and participate (rare occurrence). Stock market capital gains and interest income and dividends are not examples of passive income.

“You will be audited by the IRS if you write off a business aircraft.”

I would modify the above statement by saying, “certain ownership structures will very likely invite an IRS audit.” The art of aviation tax planning is to avoid the mistake of utilizing an ownership structure that will heighten the IRS audit risk. For example, reporting an aircraft on a Schedule C (sole proprietorship) with little or no income, and a significant loss from bonus depreciation will likely result in an IRS audit.

The trouble with an IRS audit is not so much about winning, it’s the drain of resources to deal with an overzealous IRS auditor and the long-drawn-out process that may take months to resolve and win. Avoiding being picked for an audit should be the top priority when designing an aircraft ownership structure.

“We will set up a Montana LLC to buy the plane and we will get out of paying sales tax.”

This continues to pop up in conversations with clients and prospects. Where the aircraft LLC is set up is irrelevant to sales/use tax assessment. Sales tax can generally be avoided by closing in a tax-friendly state that allows a non-resident to fly away post-closing. Beware that not all fly-away exemptions are created equal. Some states have strings attached to the exemption and the exemption typically applies only to a non-resident of the state.

Use tax cannot be easily avoided. Use tax is assessed based on where the aircraft is primarily hangered. It is not uncommon to have multiple states attempt to assess use tax on one aircraft, as many taxpayers have multiple homes and offices and use tax liability can be created by the frequency an aircraft visits a state. The closing location is step one of many when it comes to sales and use tax planning.

Daniel Cheung, CPA, is the principal of Aviation Tax Consultants, which is celebrating its twentieth anniversary in 2023. Daniel recently joined the Board of Directors of Angel Flight West. ATC assists taxpayers in acquiring aircraft in a tax efficient manner. Their consulting services include the elimination or reduction of sales and use tax, maximizing income tax savings, controlling the cost of personal use of the aircraft, and complying with Federal Aviation Regulations. Cooperation with client’s current tax and legal advisors is welcome and encouraged.