IRS Now Auditing Aircraft Management Firms

 - July 3, 2012, 5:35 AM

The U.S government’s Internal Revenue Service (IRS) is auditing aircraft management firms and trying to impose the federal excise tax (FET) on fees charged by the firms to aircraft owners. According to industry sources, IRS agents are targeting major charter/management firms, although the firms allegedly being audited didn’t wish to speak to AIN about their experience with the IRS.

The FET, also known as the ticket tax, was designed by legislators to provide a taxing mechanism for people flying commercially on airline and charter aircraft. The tax is applied as a segment fee, usually 7.5 percent of the amount charged to the passenger for a flight. Perhaps because airlines have unbundled their services and now charge separately for the flight and untaxable baggage, meals and other services such as a few more inches of legroom, FET collections from airlines may have dropped. Couple that with the government’s ongoing budget shortfalls and it appears that IRS auditors are on the lookout for more ways to extract money from business jet operators.

A clear signal that the IRS means business came in a Chief Counsel Advice (CCA) memo released on March 9, outlining the IRS’s viewpoint that there is no difference between commercial flights under FAA Part 121 regulations or Part 135 charter flights, which are clearly subject to FET, and Part 91 flights facilitated by management companies. The memo responded to three scenarios in which the IRS employee who requested the memo questioned the applicability of the FET.

It has become abundantly clear that the IRS not only wants to apply the FET to non-commercial Part 91 flights that are facilitated by aircraft management companies but that its auditors are now doing so, bolstered by the CCA. And the auditors are not only trying to apply the FET to flights, at an hourly rate comparable to charter rates, but also to the amounts that aircraft owners pay to management companies for the services provided. That means an aircraft owner who pays a management firm to cover the expenses of operating the aircraft could be assessed 7.5 percent FET on the cost of fuel, insurance, hangar, flight crew salaries, maintenance and so on. The prospect of aircraft owners having to pay 7.5 more for all of the services provided by management companies and the possibility of an audit forcing an owner to pay three years or possibly more in back taxes is a serious concern to the charter/management industry.

According to Pentastar Aviation senior vice president and CFO Greg Schmidt, “Pentastar is monitoring the situation regarding the IRS’s application of FET on management companies and shares the concerns of many in our line of business that this will have a significant impact on our industry if it continues to be enforced by the IRS.”

“If we start seeing the IRS starting to move forward with this, people are going start fighting for their lives,” said Matthew Winer, president of Florida-based Executive Air Services. “If it becomes retroactive, the penalties are severe, and can also become [a personal liability] for [management company] principals. The ticket tax wasn’t meant for private owners; they’re operating their own aircraft.”

The IRS claims that the FET is applicable because aircraft owners are giving up possession, command and control of their aircraft to management companies. And thus companies like Executive Air Services are clarifying in management agreements that the owner retains possession, command and control of all non-charter flights. To satisfy the IRS, it may become necessary to have aircraft owners take on more expenses, including hiring pilots, instead of paying a fee and having the management company pay all expenses and employ pilots and flight attendants.

“We have a fiduciary duty to our owners to inform them of the best way to structure their aviation operations, manage those operations and to operate safely,” Winer said. “We look at it as being a self-imposed requirement to notify our owners of changing legislation.” Another concern is that owners might decide aircraft ownership is not worth the expense or the headache. Or they might try to set up their own flight departments and not take advantage of the efficiencies and safety offered by well structured management firms.

After an IRS Audit

ACP Jets of West Palm Beach, Fla., has been audited by the IRS. ACP president Suran Wijayawardana recommends that management firms that are audited and assessed unjustifiable FET “take it to appeals.” Wijayawardana said he is aware of one management firm that appealed its case and won. “Every attorney is comfortable that once the case goes to appeals it can be won. It costs money to go to appeals and it’s burdensome. That’s why the industry wants to take a more robust stance and wipe this off [the books].”

Wijayawardana doesn’t want the charter/management industry to change the way it does business. “It’s not in their best interest to drastically change their relationship with owners,” he asserted. “But it’s prudent to look at ways to restructure the agreement to mitigate their exposures.” Management agreements should be structured to satisfy the IRS but without going so far as having owners employ pilots directly, he added. “I don’t think companies and owners want to employ crew.” But the agreement should clarify that the aircraft owner has the right to be part of the process of hiring flight crew and even, if necessary, choosing crew for a particular flight.

As more management firms fight the IRS through the appeals process, Wijayawardana believes that this will quell the IRS’s attempts to collect FET for non-commercial (Part 91) operations. Each appeal gives ammunition to the next appellant, he said, and management companies should also contact their legislators. “This is clearly a case of double taxation,” he said.

The National Air Transportation Association is working on the FET situation, which was a key subject at the recent NATA Charter Summit. In an Action Call about the FET, NATA wrote: “Applying the commercial excise taxes to fees paid by an owner to have an aircraft managed by a third party is contrary to the intent of Congress when it established separate excise taxes for commercial and noncommercial operations.” (Part 91 operators currently pay excise taxes on fuel.) NATA recommends contacting members of Congress to express opposition to the IRS’s attempts to impose the FET on management-related Part 91 operations.

NBAA’s tax committee has met with the IRS, and the association is preparing a submission to the IRS that a spokesman said “details the industry’s concerns with the CCA the IRS published and requests further guidance from the IRS [regarding] excise tax applicability for much more common scenarios than the three that the IRS included in its CCA.”