Aircraft Taxes: Navigating the Shoals of Taxation
With the growing complexity of myriad federal, state and local taxes and fees, and the increasing intensity with which they are enforced, there was plenty to discuss at the Commercial Operators Tax (COT) seminar, held September 7 and 8 in Scottsdale, Ariz. Co-sponsored by Conklin & de Decker and the National Air Transportation Association (NATA), the event attracted business aircraft owners, operators and management companies.
Much of the seminar was directed toward aircraft management companies who are typically also Part 135 certificate holders, FBOs and MRO providers. Thus they benefit from knowledge of FARs, IRS rules, insurance, state and federal tax issues.
The week’s big news–issuance of the IRS final rule on business aircraft “entertainment” flight expense deductions (see article on this page)–turned out to be no big news. The rule, issued August 1 after a nearly five-year gestation period, incorporates language virtually identical to the June 15, 2007, Notice of Proposed Rulemaking (NPRM), which itself drew heavily from IRS Notice 2005-45, Interim Guidance, of June 30, 2005.
The final rule, like the NPRM, limits deductible expenses in a narrow range beyond income imputed to or repaid by an employee for the flight. In calculating hourly and annual expenses, operators must work within IRS expense guidelines. The IRS rule conflicts directly with the FAA, which expressly forbids an employer to accept payment for a non-business flight from an employee. Conklin & de Decker tax expert Nel Stubbs outlined the complex set of calculations required to determine flight costs using IRS procedures. The final rule retains the provision that a percentage of all yearly direct and indirect costs associated with owning and operating a non-commercial business aircraft is disallowed based on the ratio of total hours or miles to “non-business” flight hours or miles.
Federal Excise Taxes
The issue of federal excise taxes (FET) attracted some attention, with the IRS’s recent renewed interest in the subject. To understand federal excise taxes on any aviation activity, one must consider not only the FAA definition of the activity but the IRS view, as it is the latter that claims and collects the FET. Much of the confusion about how the taxes apply, Stubbs observed, stems from the differing ways the FAA and the IRS look at identical situations. First there is the issue of whether an operation is commercial.
The FAA and the IRS often disagree on what constitutes a commercial operator or operation. The FAA defines a commercial operator as a “person who, for compensation or hire, engages in the carriage by aircraft in air commerce of persons or property.” It says an operation is for “compensation or hire” if the carriage by air is a major enterprise for profit, not merely incidental to the person’s other business. The IRS considers a commercial operator “anyone in the business of transporting persons or property for compensation or hire by air.” Profit is not a consideration.
Though these two definitions may appear similar, the FAA is concerned primarily with safety and the IRS is concerned with taxation. An IRS revenue ruling states that the FAA’s definition of commercial aviation is not determinative in deciding which tax applies, Stubbs cautioned.
In determining which tax applies in any particular situation, the FAA uses the phrase “operational control,” defined as the “exercise of authority over initiating, conducting and terminating a flight.” However, the IRS determines who has “possession, command and control” by examining who owns the aircraft, has control over the aircraft’s personnel, pays the operating expenses of the aircraft, and maintains the insurance for the aircraft. It uses these criteria for “possession, command and control” to determine if the transportation is taxable.
“Who has possession, command and control of the aircraft determines who’s liable for the FET,” Stubbs stated. “For example, a company hires an aircraft management company, but the owning company still maintains possession, command and control. Therefore, flights flown for the owner by the management company’s people are not subject to the commercial transportation tax.
“So why such confusion as to which operations are subject to the commercial FET? One reason is the FARs allow certain noncommercial [Part 91] operators to receive some compensation for Part 91 flights as long as the operation is incidental to the business of the company. These operations are considered noncommercial to the FAA, but the IRS does not distinguish between ‘merely incidental’ operations and those that are a ‘major enterprise for profit.’ If an aircraft is provided to any entity and compensation is received, it is considered commercial for FET purposes, unless an exemption applies.
“To what does this tax apply? All amounts paid, including dead head, crew expenses and salaries, layover time, state taxes and so on. In the case of an interchange the tax is due on the fair market value of time exchanged. Mind you, there are two fair market values in life, yours and the IRS’s. So your best bet is to apply the tax to your fair market value and not wait for the IRS to do it for you,” Stubbs cautioned.
Vic D’Avanzo of USAIG discussed how the IRS position on management companies, in particular their obligation to collect federal excise taxes, can affect insurance decisions. He presented two potential pitfalls regarding insurance policy ownership, beginning with a policy in the aircraft owner’s name. He noted that IRS Chief Counsel Advice includes comments regarding “possession, command and control” being, in part, determined by whether the aircraft owner or management company exercises decision-making control over the insurance.
If a management company allows the managed aircraft’s owner to provide the insurance, the FAA may declare that the management company has relinquished operational control, possibly causing the company to lose its air operator certificate. Alternatively, the IRS may take management company control of the insurance as proof of operational control and retroactively demand collection and remittance of FET. If the company was unaware of that obligation it could face problems up to and including bankruptcy, D’Avanzo advised.
A better solution for the management company, he continued, would be to amend management contract language to make it as clear as possible that the aircraft owner in fact “controls” the insurance. He suggested wording such as: “…Aircraft Owner will maintain aviation insurance…” or “…Aircraft Owner directs manager to place insurance…” In that case the aircraft owner should pay the insurance premium directly.
Plan Carefully for State Taxes
Stubbs introduced state tax planning by advising, “There’s no great rush to take delivery of an aircraft. Right now it’s a buyer’s market. Advise your management clients to take the time to plan aircraft delivery in the most advantageous state.” She added, “What they might not tell your client when he takes delivery is that there can be, depending upon the state, up to four different taxes and fees when he buys and operates an aircraft in certain states.”
Stubbs said taxes on aircraft are different in every state. “They’re always changing, usually not a lot but enough that it’s good to stay on top of them. Among the variances she cited is how various state sales and use taxes apply to aircraft placed on a Part 135 certificate. Stubbs also reviewed how aircraft registration fees and personal property taxes are applied to aircraft used in commercial operations. She listed some common exemptions to these taxes and misconceptions regarding them. “States are becoming aggressive in assessing their taxes, so you and your owners need to be prepared in the event of an audit.”
One less than isolated error made by aircraft owners is the belief that as long as they reside in a “low tax” state their aircraft will be safe. No so, cautioned Stubbs. “Tax is levied on where the aircraft lives [hangared], not where the owner lives.” She highlighted some states with relatively greater potential tax liability to aircraft owners, calling them “gotcha” states.
“What is a ‘gotcha’ state? According to Nel Stubbs, a gotcha state is a state that will tax an aircraft even though all appropriate taxes have been paid to the home state.” Stubbs’s examples:
• Arizona, for its aircraft license tax
• California is “extremely aggressive” about property taxes. “There have been some instances where they have sent a letter to a nonresident for payment of property taxes. However, as long as you can show that you pay all your taxes to another state and that the aircraft is clearly domiciled in that state, they are generally happy with that.”
• Iowa requires aircraft registration if operated or based in the state for more than 30 days. “There could be some risk here.”
• Kentucky has shown renewed interest in assessing property taxes on non-resident aircraft
• Minnesota will tax any non-resident aircraft that plies the airspace over the state for more than 60 days in a tax year.
• Missouri defines a commercial aircraft as any aircraft that weighs more than 3,000 pounds and taxes all commercial aircraft the same. “There has been some exposure here for property tax unless you can prove that you do not have sufficient nexus in the state.”
• Texas: “Dallas County has become aggressive in assessing property taxes on aircraft that land at any airport in the county. However, there are guidelines that state unless you have sufficient nexus–50 percent or more of your time in Texas–the property tax does not apply.”
Conklin & de Decker offers a software program containing complete tax information for all 50 states, including exemptions, limitations and rates, compiled and continuously updated by Stubbs.
User Fees? Paid At The Pump
What are the different tax rates between the non-commercial and the commercial federal excise tax? The non-commercial FET is a fuel tax paid at the pump. If you are considered a non-commercial operator for FET purposes, then you have paid your taxes.
“If you are considered commercial for FET purposes you are required to pay:
• transportation of persons tax, currently 7.5 percent on amounts paid
• transportation of property tax, 6.25 percent on amounts paid, whether inside or outside the U.S.
• international departure and arrival fees, for 2012: $16.70 per person departure from the U.S. and $16.10 per person arrival. For departures from Alaska and Hawaii, the tax is $8.40.
• segment fee, for 2012, $3.80 per person, per leg.”