While general aviation interests hailed the tax law that extended the deadline for the 50-percent accelerated bonus-depreciation allowance for business aircraft, the law also contains a provision that severely limits expenses that a company may deduct when employees use an employer-provided aircraft for personal travel.
In effect, the law reverses what has become known generically as the “Sutherland Lumber decision.” Sutherland Lumber-Southwest allowed several of its officers to use the corporate jet for nonbusiness purposes such as vacations and charitable activities. The company treated this use as a fringe benefit and included an amount in the employees’ income based on a formula in the Treasury regulations.
Sutherland Lumber company deducted the full cost of maintaining the jet, which exceeded the income the employees reported. When the IRS reduced the deduction, the company appealed and in Sutherland Lumber-Southwest, Inc. v. Commissioner of Internal Revenue, the courts sided with Sutherland.
But Congress this summer signaled that personal use of corporate aircraft was going to be a target, and both chambers of Congress introduced bills to limit the amounts of deductions for expenses relating to personal travel on business aircraft.
Rep. Rahm Emanuel (D-Ill.) and 10 other Democrat cosponsors introduced a bill in the House to amend the IRS code to deny a deduction for the portion of employer-provided vacation flights in excess of the amount of such flights that is treated as employee compensation. He claimed the “loophole” reduced federal tax revenue by $287 million.
Sens. Kay Bailey Hutchison (R-Texas) and Mary Landrieu (D-La.) sponsored an amendment to the Jumpstart Our Business Strength (JOBS) Act that limited such deductions. The extension to the placed-in-service deadline for companies to qualify for the bonus-depreciation allowance eventually became part of the same JOBS bill because it was the first piece of tax legislation that had a chance for passage.
Revisiting Sutherland Lumber
NBAA said the new provision is a reaction to the Sutherland Lumber case, which involved “very substantial personal use” of company aircraft, as well as to the widespread news reports of the details of the executive compensation package provided to former GE CEO Jack Welch, which included substantial personal use of GE aircraft after his retirement.
Richard Belas, chairman of the NBAA government affairs committee, wrote that the new tax law generally denies a business deduction for expenses relating to entertainment, amusement or recreational activities or facilities unless they are directly related to the taxpayer’s trade or business. There is an exception for such expenses “to the extent that” they are treated as compensation or wages for an employee.
In the Sutherland Lumber case, the tax court determined that the language “to the extent” did not mean that the related deduction was limited to the amount taken into income as compensation for the employee. It meant simply that the provision limiting business deduction for entertainment, amusement or recreational activities did not apply at all to personal travel on a company aircraft as long as an appropriate amount was attributed as income to the employee, said Belas, a partner at David & Harman, a Washington, D.C. law firm.
It did not matter that the amount the company treated as compensation for the employee, computed using the special valuation rules for valuing personal travel on business aircraft provided by the Treasury regulations, was substantially less than the cost of providing the travel.
Belas counseled that the new legislation reverses the decision in the Sutherland Lumber case by changing the “to the extent that” language to limit the deduction expressly to the actual amount treated as compensation to the benefited individual.
The legislation applies to officers, directors and 10-percent or greater owners of privately and publicly owned companies. The term “officers” is defined as the president, principal financial officer, principal accounting officer (or, if there is no such accounting officer, the controller), any vice president in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy-making function or any other person who performs similar policy-making functions.
Belas said a number of questions of interpretation are not answered by the statutory language and the legislative history of the JOBS Act, which became law when President Bush signed it on October 22. NBAA and the General Aviation Manufacturers Association have requested immediate guidance from the Treasury Department on the tax law changes that affect business aviation operators.