Jeff Wieand from Business Jet Traveler – Reports
Understanding these IRS rules can make a big difference in your bottom line.
Business jets are expensive to own and operate, but to the extent that they are used in a trade or business, it is possible to write those expenses off for tax purposes—assuming you follow the rules.
Here is a brief rundown of some key business jet federal tax issues. Failure to deal with these issues successfully could cause you to lose tax deductions for expenses of particular flights, including depreciation and other fixed costs. It could also deprive you of the ability to deduct expenses as rapidly as possible—or even to deduct them at all.
Expenses Must Be ‘Ordinary’ and ‘Necessary’
To be deductible for federal tax purposes, expenses must be “ordinary and necessary” for your business. According to the IRS, an ordinary expense is “one that is common and accepted in your industry.” To be “necessary,” says the tax agency, an expense need not be indispensable but only “helpful and appropriate for your trade or business.”
Characterizing business jet expenses as ordinary and necessary can pose challenges. Though courts have recognized that the use of private aircraft in some businesses is common, most businesses don’t operate jets, which gives IRS agents an incentive to argue in many cases that jet-related expenses are neither ordinary nor necessary.
Even the use of a small turboprop can seem excessive, depending on the circumstances. In a case involving an attorney who used his Cessna Skylane to travel for business to nearby destinations, the court pointed out that “the cost of owning and operating a private airplane would not appear to be ‘normal, usual, and customary’ for an attorney in solo practice, especially one who makes 60 to 65 percent of his destinations within 100 miles of his home.” The court was no doubt correct in concluding that the attorney “immensely enjoys flying.”
To meet ordinary and necessary standards, you should emphasize the benefits of private air transportation, such as security and efficiency for busy executives, and keep good contemporaneous records of the business purpose of flights (and why each passenger is on the flight) to help justify tax deductions.
Beware of ‘Hobby Losses’
A related problem to the ordinary and necessary issue arises if your jet expenses are construed as “hobby losses.” Here, the IRS argues that you’re not operating a business jet for valid business purposes; instead, like the Cessna Skylane owner, you simply enjoy flying around in your own jet, and aircraft-related expenses should therefore not be deductible even to the extent they do not exceed gross income from the hobby (as was the case under prior law). The aircraft, in other words, is really a hobby and is not held for productive use in a trade or business, which results in the gross income from the activity being taxable and the expenses being non-deductible.
It helps if the business in which the jet is supposed to be involved actually makes—or is reasonably expected to make—a profit. The profit should also be important to the taxpayer; if you have “sizable income” from another source, this may suggest that you don’t really care whether the activity involving the business jet makes money. The IRS normally presumes that an activity engaged in by an individual, partnership, LLC, or S corporation is “for profit” if gross income exceeds deductions for at least three of the last five years. In addition, though as usual, the tax agency will consider all the facts and circumstances, IRS regulations offer a nine-point test for determining whether an activity is a hobby, including the expertise of the taxpayer in conducting the activity and the taxpayer’s history of income or losses with that activity. The more factors you satisfy, the more likely it is that the IRS will conclude the aircraft is used in a legitimate business instead of a hobby.
Passive Losses Have Less Value
If the IRS deems your aircraft expenses ordinary and necessary, and you’re clearly operating a legitimate business, it nevertheless helps if you are actively engaged (“materially participating”) in the business. Otherwise, the losses can still be deductible, but only against passive income (which generally doesn’t include interest, dividends, or capital gains) in a given tax year. Excess passive losses are disallowed but can be carried forward to subsequent tax years; you can generally deduct any remaining suspended passive losses in the year you sell the aircraft.
This is often a problem for jet owners whose aircraft are put out for charter. Business jet charters are managed and operated by the charter certificate holder, which is usually a management company, not the aircraft owner. Therefore, the owner typically does little with respect to chartering the jet except leasing it to the charter company. This combination of leasing the aircraft and the lack of involvement by the taxpayer in generating the charter income makes the income passive—and the losses passive as well.
One way to try to solve this problem is to “group” the charter business with another business in which you materially participate. If you can group the businesses together as an “appropriate economic unit,” you can use losses from the charter business to offset taxable income from the grouped business as a whole. Grouping can help mitigate the inability to take deductions for a “hobby loss” activity as well.
Personal Use Raises Issues
Personal use of a business jet not only raises an income tax issue for the passengers; it can also affect the deduction of business jet expenses for the personal-use flight, including how fast flight expenses in general can be deducted.
To qualify for accelerated depreciation under the Modified Accelerated Cost Recovery System (MACRS), and thus bonus depreciation as well, the aircraft must be primarily (more than 50 percent) employed in qualified business use by the taxpayer. If at least 25 percent of the aircraft’s use is for qualified business purposes (not counting certain specified personal-use flights, including ones by persons owning at least 5 percent of a taxpaying entity), personal-use flights by employees can generally count as qualified business use for purposes of determining whether the 50 percent test is satisfied because the flights are treated as compensation by the taxpayer to the passengers, and income is imputed to the passengers for tax purposes, ordinarily using the Department of Transportation’s Standard Industry Fare Level (SIFL) rates. As a result, the employees have taxable income to the extent that they are paying less than the SIFL value of the flight. Special rules apply, however, regarding the deductibility of expenses of flights for “entertainment, amusement, or recreation.”
If the 25 percent qualified-business-use test is not satisfied, personal-use flights don’t count as qualified business use, and if the aircraft flunks either the 25 or 50 percent test, it is not eligible for MACRS or bonus depreciation and must use the less rapid alternative depreciation system instead.
Know When Excise Tax Is Due
The transportation excise tax applies to commercial flights—basically charter flights, flights under time-sharing and interchange agreements, and other cases where a passenger is paying for air transportation. For flights within the U.S., the tax is 7.5 percent of the amount paid, plus a small “segment fee.”
The excise tax is not due on most non-charter business jet flights (other than time-sharing and interchange flights), but it is important to understand when it is due to avoid failing to collect or pay the tax when required.
If you think any of these issues apply to you, they are worth discussing with your tax advisers.