If the Tax Cuts and Jobs Act of 2017, H.R.1, aimed to simplify federal taxes in the U.S., it missed the mark for business aviation. However, it did include significant tax benefits and other changes worth considering before a prospective business/taxpayer enters into an aircraft purchase, sale, lease, or management arrangement. Changes include full expensing of aircraft cost until 2023, repeal of like-kind exchanges, an exemption of aircraft management fees from federal excise taxes (FET) and continuing incentives for tax leasing.
H.R.1 should boost new and preowned aircraft acquisitions and sales because it offers buyers immediate cash savings on purchases of aircraft. It does so by increasing “bonus depreciation” on business aircraft purchases from 50 percent to 100 percent starting Sept. 27, 2017, and ending in 2023. After that, it phases down 20 percent per year to zero.
A business can, therefore, “fully expense” the aircraft cost in the year the business places the aircraft in service in its “trade or business,” meaning it must use the aircraft for more than 50 percent business use. Previously, bonus depreciation applied only to new aircraft, but H.R.1 extends bonus depreciation to preowned aircraft. If the business does not use the aircraft in its trade or business, this benefit does not apply.
The cash value of full expensing helps offset the disappointing repeal of IRS section 1031 like-kind exchanges. To illustrate, assume a business purchases a preowned, “replacement aircraft” for $5 million in 2018 and sells its fully depreciated, old, “relinquished aircraft,” for $4 million that same year. The business receives $4 million in ordinary income from the sale of the relinquished aircraft and fully expenses the $5 million purchase price of the replacement aircraft.
At the new corporate tax rate under H.R.1 of 21 percent, down from a previous 35 percent maximum, the business saves $840,000 in taxes on its $4 million sale. Before H.R.1, it would have deferred the taxable income under IRC section 1031 rather than achieve immediate tax savings. Importantly, as bonus depreciation phases down, income taxes will likely increase on proceeds of aircraft sales that a like-kind exchange could otherwise have continued to defer.
In a change that provides some relief for business aviation, H.R.1 seems to protect management companies and their customers from FET on “aircraft management services.” This new term refers to a broad range of flight, administrative, and support services provided by management companies to aircraft owners and lessees.
The key to structuring non-FET management arrangements appears to be simple: only aircraft owners and certain lessees may pay for flights of their managed (owned or leased) aircraft, even if they are not on the flight. This rule should ease the concern about IRS imposition of FET and provide a reliable basis for structuring management and leasing transactions.
One key feature of H.R.1 arises from what it does not include. H.R.1 omits any reference to “possession, command, and control” (PCC) of aircraft, its controversial Chief Counsel opinion in 2012. There, it sanctioned the imposition of FET on management company fees largely because it found that the management companies exercised PCC.
The absence of that factor in H.R.1 should insulate owners and certain lessees from IRS intrusion based on specious PCC arguments. Nevertheless, owners, lessees, and other operators should scrutinize existing and new aircraft lease and management documentation to align the provisions closely to applicable provisions in H.R.1.
Management companies beware: H.R.1 does not change the imposition of FET on parties engaged in “transportation by air” under IRS Section 4261 for commercial operations/charter. Further, H.R.1 does not alleviate the existing ambiguity in categorizing private and commercial operations caused, in part, by the IRS’s persistent disregard of FAR Parts 91 and 135.
Stated differently, the FAR and IRS apply different standards to identify private and commercial flights. Still, this disconnect should not interfere with the practical applications of H.R.1 or the FARs.
Finally, H.R.1 alters the tax dynamics for leasing. Businesses already use leases, as lessees, to shift residual value risk to owner-lessors and achieve favorable pricing. Although higher pre-H.R.1 tax rates encouraged tax leasing, H.R.1 should nonetheless support tax leasing by lessees that lack a sufficient tax liability to use full benefit of 100 percent bonus depreciation, loan interest, and state income tax deductions.
A lessor can help reduce its lessee’s after-tax cost of capital when using the tax benefits available to it on acquiring aircraft. By purchasing an aircraft, a lessor with an adequate tax appetite should use tax benefits efficiently and share its reduced tax burden by lowering rents payable by its lessee.
H.R.1 should help lift the volume of business aviation transactions, but businesses must properly structure deals to make the most of it. As with any tax or legal matter, always consult your own expert to properly address your personal situation.
David G. Mayer is a partner in the global Aviation Practice Group at the Shackelford Law Firm in Dallas, which handles worldwide private aircraft matters, including regulatory compliance, tax planning, purchases, sales, leasing and financing, risk management, insurance, aircraft operations, hangar leasing and aircraft renovations. Mayer frequently represents high-wealth individuals and other aircraft owners, flight departments, lessees, borrowers, operators, sellers, purchasers, and managers, as well as lessors and lenders. He can be contacted at firstname.lastname@example.org, via LinkedIn or by telephone at (214) 780-1306.