A letter from the Internal Revenue Service (IRS) can cause any taxpayer’s heart to skip a beat. For aircraft operators, whose main focus of government compliance is the FAA, it can be easy to overlook the many nuances of the federal and state tax codes to ensure all taxes are being paid.
During the Conklin & de Decker Commercial Operators and Management Tax Course held earlier this year in Florida, representatives from several charter companies and corporate flight departments learned the many ways–over and above the normal corporate and income taxes–the federal and state governments exact their pound of flesh from aircraft operators.
Federal Excise Taxes
One of the most complicated sets of tax rules for corporate aircraft operators to decipher is the federal excise tax (FET), which requires commercial operators to pay one set of fees while noncommercial operators pay another.
The commercial FET consists of a 7.5-percent transportation tax plus a segment fee, currently $3.20 per person per leg. The 7.5-percent tax applies to the entire cost of the flight, including aircraft operating costs, crew expenses during layovers, fuel and any other taxes and fees but does not apply to anything the passengers could do for themselves, such as limousine rental or catering if separately stated on the invoice.
These FET levies apply to domestic commercial flights or flights from the continental U.S. to destinations in Mexico or Canada within a 225-sm zone from the U.S. border. Any flight originating in the U.S. and ending outside that 225-sm zone or in any other foreign country, is subject to an international FET of $14.10 per person for the departure and another $14.10 per person for the return leg into the U.S. Departures from Alaska and Hawaii to anywhere in the U.S. or any foreign country are subject to a $7 per person FET instead of the $14.10 per person FET.
Non-commercial FET consists solely of fuel taxes, currently 21.9 cents per gallon for jet-A and 19.4 cents per gallon for avgas.
Fortunately, the two taxes are nearly mutually exclusive. Although all operators initially pay the fuel taxes, those flights considered commercial by IRS definitions are entitled to a fuel tax credit or refund. For example, a charter operator conducting a flight considered commercial for tax purposes must collect and remit commercial FET to the IRS, and then is entitled to a refund or credit for all but 4.4 cents per gallon of fuel tax paid for that flight. If the aircraft is under management and the charter operator is charging the aircraft owner for all fuel and tax receipts, then the tax credit or refund should be passed on to the owner, who ultimately paid for the fuel.
Whether an operator owes the commercial FET has nothing to do with the FAR part under which the flight was flown because the IRS’s definition of a commercial flight is different from the FAA’s definition, according to tax analyst Nel Sanders-Stubbs of Conklin & de Decker’s Scottsdale, Ariz. office.
“An operation can be flown under FAA Part 91 and still be subject to the commercial FET,” said Sanders-Stubbs, noting that timesharing (the wet lease of an aircraft and crew for a specific dollar amount set by FAA regulation that usually doesn’t even cover direct operating costs) and interchange (an hour-for-hour exchange of flight time on someone else’s aircraft) are both allowed under FAA Part 91.501 Subpart F yet are also subject to commercial FET. On timesharing, the FET applies to all amounts paid, while on interchange, since no money generally changes hands (although it could legally happen), the FET applies to the fair market value of the flight.
Other Part 91 operations that can be subject to FET include chargebacks within corporations or subsidiaries and demonstration flights if a fee is charged for the flight.
“But it plays both ways,” Sanders-Stubbs continued. “There can also be times when an aircraft is operated 100 percent under Part 135 but might not be subject to commercial FET.”
This case applies mostly to managed aircraft placed on a Part 135 certificate for charter. Typically, the management company flies all charter flights under Part 135, while all owner flights are flown under Part 91. The FET applies to the Part 135 charter flights but not to the Part 91 flights. However, there are cases when the owner determines that he wants all flights, including his own, flown under Part 135 for perceived safety or other reasons.
Possession, Commandand Control Test
“If the owner retains possession, command and control of the aircraft, then his flights may not be subject to commercial FET, even if he has hired a management company to operate the aircraft for him under Part 135,” Sanders-Stubbs said. “As long as I [the owner] can get my airplane when I want it, can dictate availability and have the right to cancel third-party charter, then there’s no [commercial] FET on those flights. It’s as if they were still Part 91 flights.”
However, if a management agreement stipulates that the owner must give a certain number of hours’ notice to obtain use of his airplane, or that the owner cannot cancel third-party charter flights, the owner has lost command and control of aircraft in the eyes of the IRS and his flights are then also subject to commercial FET. The IRS’s possession, command and control test is also the reason that all fractional flights are subject to commercial FET.
“In 1992 the IRS came out with a ruling that said fractional owners do not have possession, command and control of their airplane,” Sanders-Stubbs said. “The hourly rate charged under a fractional ownership program is subject to [commercial] FET. The IRS is also going after the management fee that fractional companies are charging because the fee includes transportation items that are not broken out.”
Sanders-Stubbs said that aircraft management companies will likely have to collect commercial FET on their fees in the near future, especially if they assess a flat monthly fee to aircraft owners instead of separating the air transportation costs from administration, catering and other items not subject to FET.
There are some exemptions from commercial FET, including aircraft weighing less than 6,000 pounds and not operating on an established line but, according to Sanders-Stubbs, the IRS’s broad interpretation of an established line includes any aircraft operating “with some degree of regularity between two points” and the two points can actually be the same point in the case of a tour operator. Other commercial FET exemptions include most helicopter flights for oil/gas exploration, forestry operations and emergency medical flights, although there are some caveats for each of these as well.
According to Sanders-Stubbs, the IRS “has felt for a long time that there is a high degree of [commercial FET] noncompliance within the air charter and business aviation community” and is conducting an increasing number of FET audits. “Be prepared that you will get an FET audit,” she said. “It will happen.”
International User Fees
In addition to international FET, commercial aircraft operators that fly into the U.S., whether based in the U.S. or overseas, may owe international user fees to a number of agencies. Customs and Border Protection (CBP), an agency created from the former U.S. Customs and Immigration and Naturalization services, collects two different fees for the arrival of passengers aboard commercial aircraft. Only Part 121 and Part 135 operators must collect and remit these fees; the IRS definition of “commercial operator” doesn’t apply to any of the international user fees.
Congress authorized the $7 per passenger immigration user fee in 1987 to reimburse the Immigration and Naturalization Service for passenger immigration inspections, and the $5 customs user fee in 1995 to cover costs associated with clearance/inspection of international passengers. Both fees are assessed per passenger, regardless of passenger citizenship; American citizens returning to the U.S. are not exempt.
There are some other exemptions to these international user fees, however. Crewmembers and those directly connected with and on official business for the carrier are exempt from both fees, as are foreign diplomats on official government travel. The customs user fee also exempts passengers arriving from Canada, Mexico, U.S. territories and possessions, and several adjacent island nations, including the Bahamas, Bermuda, St. Pierre, Miquelon, the Turks and Caicos Islands, and all islands in the Caribbean.
People traveling under U.S. Department of Defense contract are exempt from the immigration user fee.
A third set of fees can be collected by the Animal and Plant Health Inspection Service (Aphis). Authorized in 1990 to recover agriculture inspection and quarantine costs, these fees were increased to $5 per passenger (previously $4.95) and $70.25 per aircraft (previously $70) as of October 1. Flights of business aircraft with fewer than 64 seats can be exempt from the fee if the flight does not carry certain food and plant items and does not offer meal service other than prepackaged snacks. The prepackaged snacks cannot contain meats derived from cows, swine or poultry, and no fresh fruit or vegetables can be served.
If international customers require food that disqualifies the entire aircraft–including the crew on duty, carrier or charter company employees on official business, foreign diplomats and passengers from Canada–from the exemption, certain people on board the aircraft can be exempt from the per-passenger fee.
Aircraft flying only between the U.S. and Canada are exempt from both the passenger fee and the aircraft fee, as are aircraft flying solely between the U.S. Virgin Islands and Puerto Rico, and any aircraft chartered for official U.S. or foreign government business.
Any applicable international user fees must be imposed at the time a ticket or travel document is issued. For example, on the invoice for a charter flight from Frankfurt, Germany, to New York in which a catered steak dinner is to be served to all five passengers on board, three additional line items would be included: customs user fee–$25; immigration user fee–$35; and Aphis fee–$95.25 (which includes both passenger and aircraft charges). Operators must remit the fees to the individual agencies quarterly.
According to Terri Farish, director of marketing and client services for Virginia-based charter operator Chantilly Air, the agencies are getting tougher about enforcing international user fee payment. “Tons of charter operators are not paying this because they don’t know they are supposed to,” Farish said during the seminar. “These fees are generally not included in flight operations software because the rates keep changing and there are so many exemptions.”
But Farish said these fees are “big business” for the government, with Aphis reportedly expecting to generate $175 million in air transportation user fees annually. Even if one CBP officer performs all three inspection jobs–customs, immigration and agriculture–the operator must pay all three fees, and the fees are not subject to a statute of limitations.
Farish recommended that any charter operator not already collecting and remitting these fees begin doing so immediately and obtain counsel to work out an agreement with the agencies for back payment of fees. More information on international user fees can be found at the National Air Transportation Association (NATA) Web site: www.nata.aero.
Taxes do not end at the federal level. Each state also levies its own aircraft taxes in the form of sales and use taxes, registration fees, personal property taxes and fuel taxes. The regulations governing who owes, what they owe and when they owe it vary from state to state. According to Sanders-Stubbs, some aircraft owners can even incur tax exposure in multiple states.
“We have one client who purchased [a Challenger 604] in Texas, is a Wyoming resident who hangars the aircraft in Utah and spends a significant amount of time in Arizona,” Sanders-Stubbs said. “He had tax exposure in four states…but with tax planning and use of exemptions, he ended up paying taxes only to Arizona.”
Sanders-Stubbs recommends aircraft buyers start tax planning before they purchase the airplane to reduce exposure to sales, use and aircraft registration taxes. Since sales taxes are incurred in the state where the aircraft is delivered, sellers will often want to deliver aircraft in states that either assess no sales tax on aircraft or allow a “flyaway” exemption.
The flyaway exemption waives the sales tax if the buyer removes the aircraft from the state within a specified time period, anywhere from the first flight of the aircraft to 10 days after delivery, depending on the state. Either option relieves the seller of having to collect or remit sales tax.
“If you’re going to use a flyaway exemption, use the proper form and get a signature,” Sanders-Stubbs said. “[The seller] needs something to demonstrate [the buyer] truly intends to remove that aircraft from the state, or else the seller could be left on the hook to pay a sales tax he didn’t collect.”
Although the seller may be exempt from collecting and remitting sales tax in the delivery state, the buyer may still owe a use tax in the state in which the aircraft is ultimately domiciled. Sales and use taxes are essentially the same, with use taxes incurred if an asset is purchased in one state and moved to another. Most states assess a use tax to compensate for the asset’s being purchased in another– lower-tax or sales tax-free–state but ultimately used in the domiciled state.
In some states, including Florida and Arizona, the buyer can defer use taxes by purchasing the aircraft under a resale certificate obtained by a limited liability company (LLC) established for that purpose. The LLC then leases the aircraft to the operating entity and collects the use tax on the lease payments instead of on the aircraft purchase price. According to Sanders-Stubbs, this structure is particularly effective for companies that upgrade their aircraft every few years.
“After five years, the aircraft are depreciated, tax benefits are gone and it’s time to get a new one,” she said. “So at the end of five years, you will not have paid in use taxes [on the lease payments] what you would have if you paid the use tax on the purchase price. Figure 6 percent of 10 million or 6 percent of $2,500 per hour.”
Aircraft owners who lease their aircraft to a Part 135 charter company can, in some states, eliminate sales or use taxes through the “common carrier” exemption. Although many states have a common carrier exemption, not all apply to Part 135 operations and others specify the percentage of time the aircraft operates under Part 135 versus Part 91. In Kentucky and Texas, for example, the aircraft must be used exclusively for Part 135 operations to be exempt from sales and use taxes.
Other exemptions include the occasional/casual sale, which exempts the sales tax on a one-time sale of an asset if the seller is not engaged in the business of selling that asset; and a trade-in credit exemption, which reduces the sales tax due to the difference between the value of the trade-in and the new aircraft.
In addition to sales and use taxes, some states assess an aircraft registration fee. Twenty-five states currently assess this annual fee, ranging from $10 per aircraft in Hawaii to $10,000 in Utah for each jet aircraft with an mtow of 20,000 pounds or more. Other states calculate the fee based on the aircraft’s age, a percentage of the mtow, or a percentage of the fair market value. Arizona, for example, applies both a $5 aircraft registration fee and an annual aircraft license tax of .5 percent of the aircraft’s average fair market value.
Of the states that do not assess an aircraft registration fee, 18 levy personal property taxes (PPT) on aircraft. Only Virginia charges both an aircraft registration fee and PPT, although Indiana, Utah, New Hampshire and Arizona levy PPT-like taxes. Utah’s “uniform fee” adds .4 percent of the aircraft’s fair market value to the $5,000 or $10,000 annual registration fee, while New Hampshire’s “operating fee” levies one cent per pound of the aircraft’s maximum weight plus the number of mills (one tenth of one cent) per dollar of the manufacturer’s list price, minimum $15.
Non-residents may fall victim to aircraft registration fees and/or property taxes if they hangar or operate their aircraft for a certain period of time, ranging from 60 to 90 days nonconsecutive. One state that is reportedly aggressively collecting registration fees from non-resident aircraft is Virginia, which requires any aircraft operating in the state for more than 60 nonconsecutive days within any 12-month period to register. The registration fee is $5, but the operator must also pay Virginia’s 2-percent sales and use tax on the aircraft’s fair market value before registering the aircraft, unless he has already paid a higher sales tax to another state.
Aircraft operators must also watch out for non-aviation fees assessed against aircraft. New Jersey, for example, is reportedly being aggressive about collecting a “franchise tax” for the privilege of doing business in the state. According to Sanders-Stubbs, the franchise tax can be levied against any operator landing an aircraft in the state and discharging or picking up passengers.
“A small operator flew up to New Jersey and got dinged with this tax,” Sanders-Stubbs said. “They fought it and spent more money than the [$500] tax cost…[Recently] a major operator got a letter from the state regarding this tax. So they’re being extremely aggressive.”
Although worker’s compensation is not a tax per se, it is mandatory insurance coverage in all 50 states, with policy coverage and benefits set by state statutes. Because it is not a tax that must be remitted each quarter like other payroll taxes, some employers, including aircraft operators, can unintentionally overlook it. According to Bill Kingsley of Aero Insurance, operators that don’t carry worker’s compensation insurance may be required to pay damages out of their own pocket when an accident occurs.
“If you don’t have [worker’s] comp, and you should have [been covering the employee], the states are going to say that you must pay their compensation as if you had the insurance,” Kingsley said during a presentation at the Conklin & de Decker Corporate Operators Management Tax Course held earlier this year in Florida. “Depending on the circumstances, you could be paying [worker’s compensation benefits] for the next 20 to 40 years.”
Worker’s compensation pays benefits to workers who contract job-related illnesses or are injured or killed on the job. There are usually no dollar amount limits to the medical expenses worker’s comp covers, and compensation for lost wages and vocational rehabilitation is usually set by a state worker’s compensation board that hears the individual cases. Covering an employee under worker’s compensation also statutorily prevents the worker from suing the company for additional damages.
Since state statutes set the death benefits at a specific amount, Kingsley said it’s actually to an aircraft operator’s benefit to ensure all pilots and flight attendants are covered under the operator’s worker’s compensation policy. “There’s a chart of benefits, and in a matter of minutes I was able to tell a client after they had a fatal crash the limits that were going to be paid out,” Kingsley said, “which is different from when a plaintiff’s attorney gets involved and it can drag on for years.”
Some operators might be tempted to skimp on worker’s compensation insurance by hiring pilots and flight attendants as independent contractors. However, if there is an accident involving the independent contractors, this can backfire in two ways. One is the probability that the state worker’s compensation board will still rule the crewmember an employee subject to worker’s compensation benefits, to be paid as if he were covered under insurance.
In most states, if the employer must provide the equipment to do the job, specifies working hours and conditions, and the worker doesn’t take similar assignments from other firms, the worker is usually considered a de facto employee, no matter what the hiring agreement says. But even if the state rules that the crewmember was not an employee, the independent contractor or his estate can sue as a passenger, which means the payout and court costs will likely be several times greater than the payout would have been under worker’s compensation.
Kingsley said the safest and, in the long run, least expensive, route is to state in the hiring agreement that the aircraft operator is providing worker’s compensation and that worker’s compensation is the sole benefit in the case of injury or death.
“If you compare the limits of liability that you carry on your aircraft [to worker’s compensation], the compensation insurance is very cheap and you can get out for a lot less.”