Company Jet Audit Issues: A Word To The Wise

Once a business attains a certain level of success, an aircraft often becomes a valued asset. Public and closely held private companies alike find that the use of a private aircraft—whether possessed via whole or fractional shares, and whether owned, leased or chartered—fosters secure and efficient transportation for owners and executives. However, this benefit does not come without a price, and it is not unusual for the tax deductions with respect to the typical flight department to run in the $20 to $30 million range. These significant amounts, and the fact that the deduction and other tax rules are so complex and often subjective, have caused company aircraft to catch the attention of the Internal Revenue Service (IRS). A new Information Document Request (IDR), IRS Form 4564, has recently been employed on audits of companies with business aircraft, providing a roadmap for how to prepare for an IRS audit.

Overview

In order for a business to deduct substantial aircraft-related costs, several complicated tax issues must be vetted, including: (1) the proper depreciation schedule for the aircraft and equipment; (2) the new Internal Revenue Code (Code) Section 274 entertainment disallowance rules; and (3) the passive activity rules. Any actual or deemed payments for use of the plane also may be subject to a 7.5 percent excise tax. Finally, the executives flying may have more imputed income for flights not properly documented as being primarily in the interests of the business rather than an individual benefit. The new IDR requests information that would allow the IRS to determine whether these tax requirements are satisfied.

The Business Deduction

In preparing the business tax return, taxpayers historically simply deducted all the expenses of the business aircraft on the basis that the aircraft was used within the scope of the company's business and thus met the deduction rules of Code Section 162. However, since October 22, 2004, there has been a "take away" from that deduction under Code Section 274 for any use that is considered personal "entertainment, amusement, or recreation." Unfortunately, many businesses are unaware of this rule, or if they are aware of it, they do not follow the now-final Treasury Regulations promulgated pursuant to Code Section 274 regarding how to properly calculate the "take away."

In short, under these rules, if a business has $20 million of aircraft expenses, and 25 percent of the aircraft usage was for personal entertainment travel, $5 million of the expenses are not deductible on the business tax return.

The IRS is aware of some easy adjustments vis-à-vis the Code Section 274 deduction disallowance that applies to virtually all companies owning aircraft. The new IDR asks for the Code Section 274 calculation performed by the company. The IDR separately asks for the total expenses of the aircraft, including the following:

Catering fees Depreciation Interest expense Lease payments Charter payments Management fees Other costs Crew and maintenance salaries Crew meal and lodging expenses Takeoff and landing fees Maintenance flights Hanger fees Fuel Tires Insurance Registration The IDR also asks for all information that would be on the flight logs, and requires...

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