AINsight: Flying Free of Federal Excise Taxes

 - May 14, 2021, 12:01 PM

After years of advocacy by the business aviation industry, the U.S. IRS recently shifted its position on federal excise taxes (FET) largely in favor of aircraft owners.

Since around 2012, the imposition of FET on private aircraft owners has cut across virtually all management services, including related flights conducted under FAR Parts 135 and 91. The IRS position contradicted the core purpose of levying FET on taxable transportation services by air.

In this overly broad interpretation, the IRS tried to impose on the amounts paid by the owner for aircraft management activity and related flights on the owner's aircraft.

Final Regs Lift Burden on Aircraft Owners

On Jan. 14, 2021, the IRS issued the final FET regulations. In a pivot away from its previous policies, the IRS provides greater clarity in, and an expansion of the scope of, the exemption under Internal Revenue Code (IRC) Section 4261. In a win by the business aviation industry, the IRS generally realigned the exemption more closely with its purpose of only imposing FET on taxable transportation by air.

However, the IRS also embedded some traps and significant limitations in the final FET regulations that require you—as an aircraft owner, a related party to the owner, or an aircraft manager—to scrutinize these regulations and structure the use of the exemption properly in consultation with your tax advisors and aviation lawyer. Importantly, even if you qualify for the exemption, you must also comply with the FARs lest the FAA demonstrates, at your peril, that safety rules its mission, not the final FET regulations or your desire to use the exemption.

Summary of FET

FET is a percentage “ad valorem” tax on the amounts paid for transporting property or “persons,” generally, an individual or entity. FET consists of a tax on air transportation, a fuel tax, or a combination of both. The exemption applies to private aviation, which includes flights operated under Parts 135 and 91, but excludes scheduled passenger service for which tickets (or the like) are sold on a seat-by-seat basis to the general public.

FET applies regardless of whether the purpose of your transportation is business or pleasure. The domestic FET is 7.5 percent of the “amount paid” (in cash or property) to transport persons plus a domestic segment fee in the U.S. Also, you may pay facility fees for international trips, which differ from the segment fees on domestic flights based on several factors. Neither fee will be charged when the exemption applies.

To substantiate your qualification for the exemption, you should obtain and keep contemporaneous, “adequate records” of your “aircraft management services,” as well as document the operating and leasing structure explained below.

Five Key FET Questions And Answers

The following five questions and high altitude answers should help you navigate the final FET regulations:

What aircraft management services and flights does the exemption cover?

The exemption appears to apply to almost all maintenance and support of, and flights on, your aircraft. The scope includes flight planning, weather forecasting, fueling, insuring, maintaining, and hangaring/storing your aircraft, paying management fees, and performing such other services necessary to support flights operated by an aircraft owner.

Who must pay for management services to qualify for the exemption?

Only an “aircraft owner” qualifies to use the exemption. An “aircraft owner” consists of three narrow classes of interests in aircraft: (1) a holder of legal title to, or holder of “substantial incidents of ownership” in, an aircraft, and (2) a holder of an aircraft lease, namely a lessee, other than a disqualified lease described below.

Although the final FET regulations do not provide a special definition of a “lease,” they explicitly state that an operating agreement with an owner trustee is a lease between the trustee and the “operator” of the aircraft, typically the owner trust beneficiary. The beneficiary can use or lease the aircraft to another person, including a Part 135 management company, the beneficiary, or other person that qualifies to exercise operational control under the FARs.

Otherwise, a lease, which includes a sublease, generally refers to a transfer of the right to possession and use of the aircraft for a term in return for consideration. You might think the IRS should recognize every lease and sublease as a lease under the final FET regulations and classify every lessee and sublessee as “aircraft owner,” but neither is the case.

Instead, the final FET regulations restrict the use of the exemption in at least two significant ways. First, to avoid abuse of the exemption, the IRS excludes any lease between a person, as the lessee, and a management company or related party, as the lessor, with a term of 31 days or less, called a “disqualified lease.” In doing so, the IRS intends to prevent anyone from entering into multiple short-term leases to enable its lessees to use the exemption for daily or occasional flights more akin to chartering an aircraft.

Second, despite advocacy by the business aviation industry, the IRS refused to allow the use of the exemption by “related parties” such as members of an affiliated group, members of an LLC, disregarded entities, and family members just because of their relationship with the aircraft owner. Rather, the related parties must, like any other person, lease the aircraft to qualify as aircraft owners under the final FET regulations though the result seems inconsistent with practical trip planning of the aircraft owners for their related parties.

Can one person pay for management services on behalf of another person?

No person can pay the invoices on behalf of an aircraft owner, other than an agent that pays invoices for the aircraft owner, as the principal. Each aircraft owner must pay the manager directly. Suppose a single-member LLC holds title to the aircraft. A friend cannot pay for the flight of an LLC member even when the member properly leases the aircraft from the LLC in compliance with the final FET regulations.

Will you lose your right to use the exemption if you allow certain others to lease your aircraft?

No. If you lease your aircraft to related parties, you will not lose your qualification to claim the exemption yourself. Each lessee will have to evaluate how to use the exemption, including an analysis of a disqualified lease. Managers must also be aware of their obligation to collect FET to avoid the secondary liability for not collecting the FET from the appropriate person. As a planning point, an aircraft owner may pay for an aircraft flight, but the owner does not have to travel on the flight.

Can you use the exemption on a substitute aircraft?

No. The exemption does not apply to any substitute aircraft you may use. The exemption does not travel with you; you have to travel on your own aircraft. For example, suppose you fly on a third person’s aircraft provided by your management company while your aircraft is being repaired or is otherwise unavailable. In that case, you will be required to pay FET for the flight as a charter.

Conclusion

Although the final FET regulations improve the exemption for travel on your own managed aircraft, the IRS may still impose FET if you travel outside the boundaries of the new regulations. And if you fail to comply with the FARs, you may receive a troubling visit from the FAA. Having greater clarity in the final FET regulations is a welcome change, but you may only be able to use the exemption if you plan well ahead of takeoff.