WELCOME [] IRS ordinary and necessary business expense standard requires that an expense be:...

WELCOMECopyright © 2011 Wolcott AviationSeminars, LLC

2011 NBAAMeeting and Convention

Tax Benefits ofBusiness Aircraft

OwnershipOctober 11, 2011

Topics

Copyright © 2011 Wolcott Aviation Seminars, LLC

Ownership structures

General rules and regulations

Income tax deductions

State and ad valorem taxes

Resource Materials


Copies of today’s materials are available at ourwebsite at www.aviation-cpa.com.

This PowerPoint presentation –

IRS code and regulation references on each slide

Look for green lookup bar on the homepage

50100

Resource Lookup


Topics


Ownership structures

Individual ownership

Corporations and partnerships

Single-member LLC’s

Individual Ownership


Individual’s name appears on the FAA registration Co-individual’s names appear on the FAA registration

as tenant's-in-common Individual(s) using their aircraft in their business report

taxable income or loss from aircraft on Form 1040Schedule C

If aircraft use is purely recreational, no IRS reportingis required

Schedule CReporting


Partnership, Corporations, Trusts


Partnership Aircraft is registered in the name of the partnership All tax consequences pass to the partners

Corporation Aircraft registered in the name of the corporation S Corp - income or losses pass to shareholders C Corp - pays income taxes; shareholders receive after-tax

dividends

Trust Generally a pass-through entity

Best Practice Example Partnership orMM-LLC*


Partnership:Reports on K-1

IndividualOwner - 1040


K-1Reporting for S-Corps & Partnerships


Single-Member LLC*


Single-member LLC’s (SM-LLCs) are entities separate fromthe owner/member

Disregarded by IRS - means does not file a separate taxreturn

All tax elements from the SM-LLC are reported on themember’s return

FAA registration lists the LLC as owner Permits aircraft ownership and registration to be in an entity

separate from the owner for liability purposes No tax benefit or drawback to the owner/member

* currently the preferred method of ownership

Best Practice Example IndividualOwner/Sole Proprietorship


Single-MemberLLC – Reportedon Schedule C


Examples:Flight InstructorCommercial RealEstate Agent

Tax Reporting

FAA Reporting

Best Practice Example Operating Company


Single-MemberLLC – Reported

on CorporateReturn

Corporate TaxReturn

Tax Reporting

FAA Reporting

Ownership Structure: Best Practices


Best practice is to place the aircraft in an operatingcompany and depreciate along with all other companyassets Applies to either sole proprietor business, or

Corporate-structure operating company

Try and place aircraft in an entity that will absorb thedepreciation and not report a taxable loss

Reporting aircraft in structures separate from thecompanies that use the aircraft in their businessbecomes more complex, and may involve additional IRSrules

Topics


General rules and regulations

What is business use?

Documentation and substantiation

Reporting business vs. non-business use

Use of your aircraft by others

What is Business Use?


Aircraft is a business asset just like an automobile

Travel expenses for business trips can be deducted

Only expenses that are ordinary, reasonable andnecessary

Only expenses that are directly attributable tobusiness may be deducted

Travel expenses to and from a destination aredeductible if the trip is primarily related to thetaxpayer’s trade or business

I.R.C. §162 10103



The IRS ordinary and necessary business expensestandard requires that an expense be:

Appropriate

Helpful in carrying on the taxpayer’s business

A common and accepted practice

Reasonable in amount

Incidental to the business

Not “lavish” or “exorbitant”



The questions the IRS auditor will always ask:

Is the aircraft truly incidental to the company business, or

Is the aircraft an expensive perk for the benefit of theowners and company executives…

In general:

Company must have a need for air transportation

Air transportation need can be best met by private airtransportation

Aircraft size must be appropriate for the company’s use

Documentation of Business Use


In general, no deduction allowed for travelunless the taxpayer substantiates thefollowing elements for each expenditure Amount

Time and place of travel

Business purpose

Business relationship to the taxpayer of each personon board the aircraft

I.R.C. §274(d)(4) 10305

Reporting Business vs. Non-Business Use


IRS agent will expect to find non-business use

Three categories of non-business use, threedifferent sets of rules:

Aircraft operated by owner/pilots

Corporate (and partnership) owned aircraft flownby company owner-pilots

Company owned aircraft flown by professionalflight crews

Reporting Business vs. Personal Use for Owner-Pilot Aircraft


Only the business use is deductible

Apply “primary purpose” test to all flights If flight is primarily for business, deduct entire cost of

the flight

If the flight is primarily non-business, do not deduct anyof the cost

Calculate the business use/personal usepercentages based on flight hours

Apply these percentages to all costs

Deduct business use on Schedule C of Form1040

Treasury Reg. § 1.162-2(b) 10200

Total Business Non-Business

Hours 300 160 140

100% 53% 47%

Total Operating Costs (100,561) (53,297) (47,264)

Depreciation (200,000) (106,000) (94,000)

Interest Expense (19,572) (10,373) (9,199)

Licenses & Fees (1,035) (549) (486)

Total $(321,168) (170,219) (150,949)

Reporting Business vs. Personal Use forOwner-Pilot Aircraft

Copyright © 2011 Wolcott & Associates, PA

Reporting Business vs. Personal Use forOwner-Pilot Aircraft

Copyright © 2011 Wolcott & Associates, PA

Total Business Non-Business

Hours 300 160 140

100% 53% 47%

Total Operating Costs (100,561) (53,297) (47,264)

Depreciation (200,000) (106,000) (94,000)

Interest Expense (19,572) (10,373) (9,199)

Licenses & Fees (1,035) (549) (486)

Total $(321,168) (170,219) (150,949)

Reporting Business vs. Personal Use for CorporateOwned Aircraft Flown by Company-Owner Pilot


Corporate and partnership owned and operatedby a pilot-owner: Business flights totally deductible

For non-business flights, owner-pilot may apply primarypurpose rules, same as for individual-owned aircraft

Better alternative – dry lease the aircraft to the ownerpilot for non-business flights;Owner pays company fair market lease rate and pays

flight costs

Company entitled to full deductions, since leasing is abusiness use

Reporting Business vs. Personal Use for CorporateAircraft Flown by Professional Flight Crew


Corporate and partnership owned and operatedby professional flight crew

Entirely different set of rules

Employees report SIFL [Standard Industry Fare Level]taxable income for non-business flights

Company must apply cost limitations for entertainmentflights

Passive Activity Loss Rules (PAL)


Renting or leasing of aircraft IRS “passive activity loss limitations” apply when aircraft is

used (leased) by anyone other than the owner for payment

Passive rules also apply to business activities where theowner does not materially participate

Either condition will render the activity passive

Passive rules limit applying aircraft costs and depreciationto reducing other taxable income

Deduction is not lost, only postponed

I.R.C. §469 10600



Types of use considered to be “passive”

Lease to a 135 charter operator

Lease to a flight school

Lease to another company or individual

Lease to rental company or FBO


Passive loss limitations apply to

Individuals, partnerships, trust, estates, and S-corporations

Passive rules do NOT apply to C-corporations

Advantages to deferring losses

Offset expected income increase in future years

Tax rates likely to rise

There are no restrictions on cash flow, only tax losses inexcess of taxable income


Passive Activity Loss Rules - Exceptions,Grouping, and Reporting

There are 6 exceptions to the PAL leasing rules.Treas. Reg. § 1.469-1T(e)(3)(ii)(A)-(F)

There are 7 “tests” in the PAL materialparticipation rules. Treas. Reg. §1.469-5T(a)(1)-(7)

PAL grouping rules provide a defense to thematerial participation rules. Treas. Reg. § 1.469-4

32

10601

10603

10604

Topics


Income tax deductions – what is deductible?

Types of costs and expenses

Depreciation

Training

Deductions for W-2 employees

Do aircraft cause audits?

Types of Costs and Expenses


DOC’s – direct operating costs Fuel

Oil

Maintenance & supplies

Landing fees

Fixed and ownership Hangar

Insurance

Interest

Pilot salaries

Depreciation

Depreciation Benefits


Depreciation – applies to

Aircraft

Upgrades and overhauls

Capital improvements

Amount of business use determines the amount ofdepreciation deduction

Calculate percent of business use from log books

Apply business use percent to total availabledepreciation to determine amount of annual write off

Depreciation can represent a substantial tax deduction

Depreciation Benefits


Normal depreciation + 50% business use - you can use “accelerated

methods”

- 50%, must use straight-line

Accelerated depreciation just means “faster”, not more

Deprecation rate depends upon use 5-year life for Part 91 aircraft

7-year life for Part 135 aircraftDepreciation recovery period and method can change each

year depending upon use

Bonus Depreciation


Available for purchases in 2011 New property only First owner of record Must qualify for accelerated depreciation (+50% business

use)

First year depreciation For 2011: 100% of the cost of the asset For 2012: 50% of the cost of the asset

Taxpayer deducts business use percent x bonus amountin 1st year of business use

If bonus creates a loss on the tax return, that loss can becarried back to offset past income (2 years) or forwardindefinitely

Sec. 179 Depreciation Benefits


Applies to new and used property

In 2011: expense up to $500,000

Subject to $2,000,000 ceiling

In 2012: expense up to $125,000

Subject to $200,000 ceiling

Depreciate remainder of cost under normal method

NOTE: Section 179 cannot be used to create orincrease a loss. Deduction only offsets taxableincome

Calculation of Acquisition Year Section 179 andMACRS & Bonus, 75% Business Use


Cost of used aircraft, equipment or upgrades $1,000,000

Section 179 (max deduction for 2011) $500,000

MACRS 20% 1st year depreciation (500,000 x .20) 100,000

Total 1st year depreciation 600,000

Business use percentage 75%

Net deduction $450,000

Training Costs for Owner-Pilot


Training costs Primary training costs for either owner-pilot or

professional pilot are not deductible

Additional training = facts and circumstances

Maybe as a personal tax deduction (as opposed to abusiness deduction)

Lifetime Learning Credit Be careful: Are you acquiring or improving job skills?

If you are an airline pilot, possibly

If you are a salesman, probably not

Training Costs as Company Deduction


For owner-pilots: Recurring training – probably not deductible

No restrictions on instructor accompanying owner-piloton business trips; deduct instructor as copilot

For professional flight crew: Familiarity training and recurring training is deductible

Use of Aircraft by W-2 Employee


IRS expects a business aircraft to be an asset of anoperating company, not owned by an employee

Aircraft owned and used by employees are“challenging” to deduct

Rules are different between FAA and IRS

Use of Aircraft by W-2 Employee – IRSRules


Company can reimburse for use of the plane

Similar to car rental reimbursement

Employee can deduct unreimbursed expenses, butthe expense is subject to itemized deductionlimitations for business expenses

See Noyce vs. Commissioner case

W2 employee

Able to deduct operating costs and depreciation asunreimbursed employee business expenses

60100

Use of Aircraft by W-2 Employee –FAA Rules


Certain conditions apply to reimbursements

FAR § 61.113 Private pilot privileges

(a) Cannot be PIC for compensation

(b) Restricts when you can be compensated

(c) Restricts amount of reimbursement

Commercial pilot privileges

FAR § 61.133 Commercial pilot privileges

FAR §119.1(e) Allowed operations

AC 120-12A Private vs. common carriage

FAR § 91.501(d) “Two times fuel” rule (if >12,500lbs)

40102

40103

40104

40105

40100

Tracking and Reporting UnreimbursedAircraft Business Expenses – W2 Employee


For individual 1040:

Deduct total expenses for the flight(s) from the amount ofreimbursement to get net unreimbursed expenses

Add unreimbursed business expenses to Form 2106

Form 2106 carries forward to Schedule A - ItemizedExpenses

Note: such expenses are subject to a 2% AGI limitation

Expenses need to exceed 2% of adjusted gross income in order tobe included in your itemized deductions.

If all of your itemized deductions do not exceed the standarddeduction, you will not be able to deduct these expenses

Schedule A


Do Aircraft Cause Audits?


Aircraft don’t cause audits per se

When auditors find aircraft they tend to examinecarefully

Poorly-planned ownership structure can increase IRSaudit exposure

Best practices: Place aircraft in a profitable company that can absorb the

costs and depreciation

Avoid single-purpose companies that only own and reportthe aircraft

Document all business use

Future Tax Issues Affecting AircraftOwnerships


American Jobs Act of 2011

Depreciation legislation

Bonus Depreciation

Change in aircraft depreciable asset life

Health Care and Education AffordabilityReconciliation Act of 2010

Medicare 3.8% tax in 2013 on passive income

Topics


State and ad valorem taxes

State sales taxes

State use taxes

Local ad valorem taxes

State Sales Taxes


Enforcement is increasing

States need revenue and aircraft are big $$

States have easy access to information

Internet flight tracking software

FAA public-use registration data

FBO rent rolls, hangar-tenant lists

State Sales Taxes


43 states levy aircraft sales and use taxes

Sales Tax – applies to aircraft located in a state atthe time of purchase

Use Tax – applies to purchases made outside of thestate but brought into a state assessing sales tax

If no sales tax has been paid, state where aircraft isbased has use-tax nexus

Sales/Use tax laws change – consult beforepurchase

State Sales Taxes


Typical exemptions Fly-away exemption

Use by air carrier (generally means 135)

Aircraft weight

Commercial use

Leasing deferral Permits deferring sales taxes over the life of a lease

Generally must be set up prior to closing

All rules vary by state; plan in advance NBAA

Conklin and de Decker

State Sales Taxes


Using exemptions

Do your research BEFORE you make a purchase

If you purchase outside of your home state, understand therules in both states

Documentation

You may need to prove that you complied with state rules

Example: Don’t claim you are a “fly away” and have noproof of leaving

Be careful when re-registering your aircraft; FAA couldexpose your aircraft to a sales tax inquiry

Ad Valorem Taxes


25 States levy ad valorem taxes on aircraft

Ad Valorem taxes are administrated by localmunicipality tax appraisers

Tax is calculated on millage basis of cost or value

Rates varies by county and airport

Typical exemptions (where applicable): Commercial use

% of use in the state vs. use outside the state (landings)

Provide proof that aircraft was not in state on valuationdate

Parting Thoughts


If you have a business and you own an aircraft,use your aircraft in your business

Don’t fear deducting your aircraft and aircraftrelated expenses. You are entitled to thedeductions

Keep contemporaneous records

Resources:


www.aviation-cpa.com

Flight Tax Systems, Inc. – Coming Soon


Aviation software created to assist aircraft ownersand operators in properly recording anddocumenting business flight use. Calculates: Primary purpose flights

SIFL employee fringe benefits

Entertainment cost disallowance

And Much More!

Call for more information 954-763-9363

Thank You Very Much!


Jed Wolcott, MBASue Folkringa, MBA

Certified Public Accountants

Wolcott Aviation Seminars, LLC5525 NW 15th Avenue, Suite 203Fort Lauderdale, Florida 33309

954-763-9363

www.aviation-cpa.com

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