NetJets Lawsuit Tackles IRS Excise Tax Problem

 - January 4, 2012, 4:00 AM

The U.S. government claims that NetJets owes the Internal Revenue Service (IRS) nearly $643 million in federal excise taxes, assessed penalties and interest. The amount is just $125 million less than the $768 million in pre-tax earnings that NetJets parent Berkshire Hathaway reported in its last financial report for the “other” category of subsidiaries that includes NetJets, FlightSafety International and other businesses. The amount is also not much less than the $725 million that Berkshire Hathaway paid for NetJets in 1998.

NetJets filed a lawsuit on November 14, accusing the Internal Revenue Service of improperly attempting to collect the $643 million, because the taxes were assessed on “the fees that aircraft owners pay to plaintiffs to manage and maintain the owners’ aircraft.” The fees were paid by customers of NetJets subsidiaries NetJets Aviation, NetJets International, NetJets Large Aircraft and Executive Jet Management.

Business aviation industry experts interviewed by AIN have expressed concern that not only is the IRS attempting to set a precedent by targeting NetJets, the largest fractional share operator, but it also may be planning to require management companies to pay excise taxes on all the fees that they charge aircraft owners. “Unfortunately, the IRS position…is that all fees paid by the owners to the fractional managers are subject to the tax, whether the owners fly on their own airplane or not,” Jonathan Levy, legal director of Naples, Fla.-based aviation tax consulting firm Advocate Consulting, told AIN. “This is a hot legal issue and we will be watching the NetJets case closely.”

The fundamental issue in the NetJets complaint is that, according to the lawsuit, “Plaintiffs do not transport these owners, but instead simply act as the owners’ agent and assist them in transporting themselves on their own planes. As such, the ticket tax has no application to the fees that aircraft owners pay to plaintiffs to manage and maintain their aircraft for them.”

NBAA Requires Rule Clarification

The business aviation industry is hoping to clarify with the IRS whether management and fractional-share companies are “providing aviation expertise and consulting, not a transportation service,” explained Mike Nichols, NBAA vice president of operations, education and economics. “The IRS is focusing on two things,” he explained. “One, how are the agreements written and two, what are the actual practices of the charter/management [firm], of the Part 91 aircraft management [firm], and how are those acted upon? And as a result of one or both of those items, would the IRS be able to make an argument that there is a transportation service provided that would then be a taxable service?”

NBAA sent a letter to the IRS on Jan. 9, 2009, posing questions and comments about the Air Transportation Excise Tax–Audit Technique Guide, which was published in 2008 (and has not been updated).

The letter requests the IRS to clarify in the guide that transportation is defined as the person providing transportation must have possession, command and control of the aircraft. While NBAA is hoping that the IRS will update the guide, the problem now is that the IRS isn’t applying any resources to the issue.

“This is moving at a glacial pace,” Nichols said. At one point, the NBAA had the IRS’s attention, but then the IRS policy person was reassigned to healthcare excise tax issues. “However, frustratingly for the operators and management companies who were affected by this,” he added, “that didn’t affect [the IRS’s] audit pace, which picked up, so more operators were facing audits. And at the same time the guidance that was issued by the IRS with regard to air transportation excise taxes was not helpful and I would go as far as to say in some cases was incorrect.”

What NBAA does know and is trying to explain to owners, operators and management companies is that if they can show the IRS that the owner of the aircraft has possession, command and control of the aircraft, they end up without additional taxes following an audit. Nichols claimed that many audited operators have been able to overturn IRS demands.

“There were no additional taxes paid and it was because those operators were able to point to the management agreements, that the way it was structured in the Part 91 environment, the owner had possession, command and control of the aircraft,” he explained “Not only were the management agreements structured properly but the practices were in support of that as well. And those two things have to happen, in a Part 91 managed situation, in order for there not be a taxable transportation service.”

It is important, Nichols explained, for owners and operators not to assume that just operating under Part 91 means nothing to the IRS. “What they need to do is talk to a legal advisor, a tax lawyer who understands aviation law, review their management agreements to make sure that if they don’t intend to be providing a transporting service that would be taxable, that they’re actually not then providing a transportation service but that what they’re doing is providing aviation expertise and consulting, not a transportation service.”

The NBAA letter to the IRS specifically excludes fractional-share excise tax issues, and it appears that the NetJets case will likely end up in tax court, which could set a precedent for fractional operators. None of the fractional companies AIN contacted, including NetJets, offered a comment on the excise tax issue.

NetJets began fractional flying in 1986, so it is a little surprising that the IRS is only now seeking excise taxes from a fractional share provider. “If the IRS is going to make federal case out of this, it should have done this years ago,” said Jeff Wieand, senior vice president and general counsel at Boston JetSearch and a member of the NBAA Tax Committee.

Pilots Picket NetJets Over 401k and Cost-cutting

In other NetJets news, the company’s headquarters in Columbus, Ohio, was the target of an informational picketing session on December 12 by 75 to 80 members of the NetJets Association of Shared Aircraft Pilots (NJASAP) and other employees, including mechanics, dispatchers and a flight attendant representative. The picketing was designed to bring attention to issues that the union claims the company management is not addressing.

While the issue that prompted the picketing was NetJets’ switch to a new 401(k) provider, union members have a much wider set of concerns. “Since the [David] Sokol, now [Jordan] Hansell management team came in, we’ve been under a deteriorating labor relationship,” said NJASAP president Mark Luthi. “We’ve got grievances all over the place, on training and everything else. The whole focus of NetJets [management] in the last two years has been cost-cutting, and it appears that they want to take cost-cutting into our contract, and what we won’t give them, they’re going to take, including issues that affect the scope agreements, which protects our work. [NetJets management] wants relief from some of our scope provisions that protect some of our flying.”

The NJASAP leader claimed that NetJets is continuing to lose owners “at a good rate,” and that NetJets is trying to dispose of 90 unneeded aircraft. NetJets declined to confirm that number. NetJets does have orders in place for up to 125 Embraer Phenom 300s and 120 Bombardier Globals, but Luthi is concerned that deliveries aren’t taking place soon enough to bring in new customers.

Luthi also said that NetJets is required to obtain mutual consent from NJASAP before making any changes like the switch from Fidelity to Schwab for the company 401(k) plan, but that in this case, NetJets informed only the union’s retirement committee.

“NetJets has fully complied with the terms of all applicable collective bargaining agreements,” said Linda Miller, NetJets v-p of global human resources. “NetJets is, as it always has been, committed to maintaining positive relationships with its team members and believes the pilot union leadership is sponsoring this picket in an attempt to gain leverage in other areas of the labor-management relationship.

“The purpose of the change was to enhance the plan for the benefit of participants by lowering participant fees and adding additional fund choices in a new self-directed brokerage option. NetJets has not reduced the benefits available under the plan and is proud to continue matching an industry-leading 50 percent of all employee contributions, up to IRS maximums. The unions cannot claim that NetJets’ actions will harm plan participants or provide lesser benefits than were previously available.”