IRS

  • Tracey Cheek posted an article
    IRS Record Keeping Requirements - Best Practices for Business Aircraft Owners see more

    NAFA member, Chris Younger, with GKG Law, shares timely tax tips for business aviation owners.

    As the April 15 individual income tax return filing deadline approaches, it is important to think of ongoing requirements regarding recordkeeping to support any business related deductions claimed on your tax return including those relating to aircraft ownership and operations.  As is the case with the governance of any operating business, owners of business aircraft must maintain adequate records to support the deductions claimed with respect to such aircraft. Furthermore, the records must be retained for a sufficient amount of time in the event they are needed in connection with an income tax audit.

    As a general rule, business aircraft owners should retain tax records for a minimum of six years following the date that the owner files the income tax return to which those records relate. Normally, the typical limitations period prohibits the IRS from challenging the contents of a tax return more than three years after it is filed.  However, in certain instances, such as where income is understated by a substantial amount, this time period can be expanded to six years.  There are exceptions to these general rules, such as where a taxpayer engages in fraud or fails to file a tax return. In those situations, there is no applicable statute of limitations. Assuming that those exceptions do not apply, following the general six-year rule should be adequate.

    Additional Rules of Thumb

    In addition to these “rule of thumb” recommendations, business aircraft owners should keep all records relating to an aircraft, including those pertaining to the purchase and sale of the aircraft, until six years after the owner sells or otherwise disposes of the property. The purpose for such retention is to ensure that the owner can support the amount of any gain or loss reported as a result of the sale of its aircraft and any concomitant tax basis adjustments to the aircraft that affect the amount of such gain or loss.

    Business aircraft owners also face certain unique tax record keeping requirements. For example, they must create and retain records relating to SIFL (Standard Industry Fare Level) income inclusion amounts and personal loss deduction limitations. (SIFL is an amount specified by the federal government to determine the value of personal travel on the company aircraft.)

    These records include items that must be created contemporaneously with the flights to which they relate. If a business aircraft owner fails to create such records contemporaneously with the relevant flight, the IRS may have a basis to question or challenge the veracity of the information contained in those records during an audit by, for example, arguing that a business aircraft owner created records merely to support its tax position in an audit.

    Records and Management Companies

    A business aircraft owner should be able to access flight, financial and tax records relating to ownership and operation of its aircraft. If a business aircraft owner hires a management company to maintain certain records (e.g., flight logs, passenger manifests, flight-related activity and maintenance costs), the owner should ensure that its agreement with the management company gives it the right to access these records as necessary even after the termination of the agreement between the owner and management company. Among the recommended provisions to guarantee access to such records would be a covenant by the management company that it will retain those records for an adequate period of time after their creation.

    A business aircraft owner should also ensure that certain records are created in a manner that will enable the owner to effectively utilize them in the event of a tax audit. This is especially true for records that are used as back-up to support SIFL income inclusion amounts and deduction limitations resulting from use of the aircraft for personal purposes and/or entertainment purposes.

    Since the process can be complex, a business aircraft owner should consider retaining a qualified aviation tax consultant who has expertise in collecting and organizing the information needed to correctly calculate these items. Seeking legal counsel regarding record keeping will ensure that an owner of business aircraft is well prepared in the event of an IRS audit of the owner’s tax return.  

    For more information on this topic or other business aviation related tax needs, please contact Chris Younger at cyounger@gkglaw.com.

    This article was originally published by Christopher B. Younger with GKG Law on April 9, 2019.

  • Tracey Cheek posted an article
    AINsight: Maximize Aircraft Bonus Depreciation in 2019 see more

    NAFA member, David G. Mayer, partner with Shackelford, Bowen, McKinley & Norton, discusses how bonus depreciation has its appeal, but it might not be best for a taxpayer's particular set of circumstances.

    If you plan to purchase a private aircraft in the U.S. this year, developing and executing an appropriate tax strategy before you enter into a letter of intent or contract to purchase the aircraft enhances the likelihood that you will be able to take 100 percent depreciation (bonus depreciation). This strategy should incorporate your projected business revenues, intended aircraft use, and unique attributes as a business taxpayer relative to taking depreciation deductions.

    Depreciation is an allowance Congress enacted to encourage businesses to purchase capital equipment and other tangible personal property such as private aircraft. Depreciation allows business taxpayers to claim an annual tax deduction to recover the aircraft cost or other basis (adjusted cost) of the property for its wear and tear, deterioration, or obsolescence. A taxpayer usually deducts depreciation over a certain number of years called the “recovery period.”

    STRAIGHT-LINE, MACRS, AND BONUS DEPRECIATION

    Perhaps the best-known depreciation method is straight-line under the Alternative Depreciation System (ADS). This method allows the taxpayer to deduct roughly equal parts of the aircraft cost or other basis over the applicable recovery period. The recovery period depends on the predominant use of the aircraft. As a rule of thumb, the recovery period is six years for FAR Part 91 aircraft (private use) and 12 years for FAR Part 135 aircraft (commercial use such as chartering or carrying freight).

    The Modified Accelerated Cost Recovery System (MACRS) is another way to depreciate aircraft. The Internal Revenue Code (IRC) sets forth specific requirements that a taxpayer must meet to qualify to use this accelerated depreciation method. MACRS allows a taxpayer to write-off its aircraft in five years for FAR Part 91 (private use) aircraft and seven years for FAR Part 135 aircraft (commercial use). A taxpayer takes depreciation in the early years of the recovery period relative to approximately equal parts under the straight-line method.

    Although the total depreciation taken under the straight-line and MACRS depreciation methods is the same, acceleration of depreciation under MACRS increases the time value of the tax benefits of MACRS compared to the slower straight-line method. Consequently, a tax advisor can help evaluate system and method that maximizes depreciation arising out of a taxpayer’s unique circumstances.

    Taxpayers must comply with the MACRS requirements for an aircraft to be eligible for bonus depreciation. Under the Tax Cuts and Jobs Act of 2017, bonus depreciation applies to new and, for the first time, preowned aircraft acquired and placed into service after Sept. 27, 2017, and before Jan. 1, 2023, with a phasedown of 100 percent depreciation starting in 2027. Importantly, to depreciate a preowned aircraft, the taxpayer must not have used the aircraft before purchasing it.

    QUALIFIED BUSINESS USE

    The IRC establishes qualifications for, and limitations on, deducting depreciation under MACRS and, by extension, bonus depreciation. MACRS requires that an aircraft must be used in a trade or business or for the production of income. A taxpayer must also “predominantly” operate the aircraft for “qualified business use” (QBU). In other words, QBU generally means the aircraft operates in connection with the taxpayer’s business enterprise conducted regularly and continuously for income or profit. Predominant use generally refers to 50 percent or more of total aircraft use per tax year.

    In part to guard against taxpayer abuse of depreciation deductions, the IRC has placed aircraft in a special category called “listed property” under IRC Section 280F. In general, listed property that a taxpayer does not use more than 50 percent for business will not qualify for MACRS or bonus depreciation. Instead, such property must be depreciated under the slower ADS using the straight-line method. In relation to depreciation, the failure to comply with MACRS may arise out of excessive personal use under the listed property rules and MACRS requirements discussed above.

    However, in certain circumstances, an aircraft may be eligible for bonus depreciation if the taxpayer can demonstrate 25 percent business use. Once the 25 percent threshold is met, this special rule in IRC section 280F allows a taxpayer to add in other activity that the rule initially excludes from the QBU test. The effect of the add back is to boost the business use above the basic 50 percent requirement. It is important to prepare contemporaneous and detailed records that support all aspects of QBU on the assumption that the IRS will ask for the records.

    IRC Section 274 describes various types of personal use of aircraft. Often, personal use refers to the use of the aircraft for entertainment, amusement, or recreation such as parties, golf outings, family vacations, and sporting events. But it can also mean personal use of an aircraft for another reason: non-entertainment such as travel of an aircraft passenger for business unrelated to the business activities of the taxpaying entity that owns the aircraft.

    If an aircraft is used for entertainment use, the IRC has a special provision that minimizes the impact of personal use on bonus depreciation. For purposes of depreciation, the provision allows a taxpayer to elect the straight-line calculation of the disallowed deductions attributable to entertainment use. The provision permits a taxpayer to claim bonus depreciation in the acquisition year and, concurrently, elect separately to calculate an IRC Section 274 “entertainment disallowance” using the straight-line method.

    This election allows the taxpayer to deduct more depreciation in the year of acquisition than it otherwise would without the special IRC section 274 rule. This area deserves planning attention as it might, if structured correctly, provide a taxpayer with an increase in after-tax value and spur the taxpayer to establish an entertainment travel policy that applies this provision.

    COMPLIANCE: RECAPTURE INCOME

    My clients often ask whether they can claim bonus depreciation in the acquisition year by satisfying the QBU and other MACRS eligibility requirements in that year and keep bonus depreciation if they do not satisfy the QBU and other MACRS eligibility requirements after the acquisition year. In this scenario, the answer is no. And the consequence might be very expensive for the taxpayer because the Internal Revenue Service (IRS) can use a “recapture” provision.

    By doing so, the IRS causes the taxpayer to recognize income for the excess depreciation taken over the allowable straight-line method as calculated through the year of recapture. After that, the aircraft remains on straight-line and cannot return to MACRS. At a minimum, the taxpayer should track and record the QBU and other MACRS eligibility requirements throughout the ADS recovery period and, to be on the safe side, as long as the taxpayer owns the aircraft.

    Once a taxpayer qualifies for MACRS and bonus depreciation, the taxpayer will still encounter such other limitations as the passive activity loss limitations, the excess business loss limitations, and the hobby-loss rules.

    Prospective purchasers of aircraft seem universally interested in 100 percent bonus depreciation, but, as a taxpayer, the purchaser should not assume either that the aircraft will be eligible for bonus depreciation or that bonus depreciation will offer the optimal tax and economic solution. Still, by planning ahead of a purchase and involving specialized aircraft tax advisors, a purchaser should be able to identify the appropriate type of depreciation to maximize the reduction in its taxable income and lower its after-tax cost of capital. It certainly seems worth looking closely at bonus depreciation as it is easy to appreciate the significant value it might provide in an overall tax strategy.

    This article was originally published by Shackelford, Bowen, McKinley & Norton on AINonline on March 8, 2019.

     

  • Tracey Cheek posted an article
    Taxing Leases - When the FAA and IRS do not agree see more

    NAFA member, Nel Stubbs, Vice President of Conklin & de Decker, writes about when the FAA and IRS do not agree about taxing leases.

    The recent spotlight on illegal charter and who has operational control of an aircraft is generating new interest in leases: not finance leases, but “wet” and “dry” aircraft operating leases.

    The FAA defines a “wet” lease as “any leasing arrangement whereby a person agrees to provide an entire aircraft and at least one crewmember.” Leasing an aircraft without the crew normally is a “dry” lease, and the lessee has operational control of the aircraft. With a “wet” lease, the lessor retains operational control.

    The IRS imposes the commercial Federal Excise Tax (FET) on wet leases, and the noncommercial Federal fuel tax on dry leases. But the distinction is not simple. While passing the test for FAR Part 91 (owner use only), a wet lease operation might be considered a commercial activity (Part 135) for FET purposes.

    The most common non-financial leasing arrangements and their tax ramifications are:

    Wet Leases

    CHARTER – Conducted under FAR Part 135, the operator must hold a commercial operating certificate. Charter is always considered a wet lease, as the aircraft is provided with crew. “Commercial” for both FAA and IRS purposes, the FET is due, less catering, flight phones, ground transportation, etc., listed separately on the invoice. A credit or refund is allowed for tax paid on the fuel for that flight.

    TIMESHARING – FAR Part 91.501 permits timesharing, a form of wet lease, which allows the owner to provide the aircraft and crew to a lessee, and charge up to twice the direct operating costs for any flights. The IRS considers this a commercial activity, and the FET is due on the amounts paid and a credit or refund is allowed for the tax paid on the fuel consumed during the trip(s).

    INTERCHANGE – When “… a person leases his airplane to another person in exchange for equal time, when needed, on the other person’s airplane and no charge, assessment or fee is made, except that a charge may be made not to exceed the difference between the cost of owning, operating and maintaining the two airplanes,” it also is a wet lease, as the aircraft and crew of one company is exchanged for another’s aircraft and crew. So for FET purposes, it’s a commercial operation, and tax is due on the fair market value of any difference between the operating costs of the two aircraft. Again, a credit or refund is allowed for the tax paid on fuel. Two fair market values must be considered: the IRS’ and yours.

    Dry Leases

    A “True” Dry Lease offers the aircraft without crew. Typically, the lessee hires the crew and has operational control of the aircraft. The lease is considered noncommercial, and neither lessee nor lessor are required to hold an FAA-issued charter operator’s certificate, as long as the lessee does not carry persons or property for compensation or hire. The IRS and FAA agree that no FET is due on dry lease payments.

    A “Sham” Dry Lease (or “Damp” Lease) may be a purposeful attempt to confuse the issue of who has control of the aircraft. Typically, the lessor provides the aircraft under a dry lease and also provides the crew under a separate agreement. Or, the lessor leases the aircraft, but you as lessee must get your crew from the lessor or a lessor-specified source. In each case, the aircraft and the crew are too closely connected, and the FAA may determine that the lessor should hold a commercial operating certificate. The IRS likely would consider the lessor to have “possession, command and control,” and the lessee would owe FET on the lease and pilot service payments.

    It’s in everyone’s best interest to understand what type of lease arrangement you are entering. Don’t be caught unaware by either the FAA or the IRS. 

    The original article was published in Business Aviation Advisor on August 31, 2018.