Many lawyers, accountants, and wealth managers have received that call from a client who says, “I plan on buying an aircraft, what should I be thinking about?” Or, worse yet, “I just bought an aircraft, is there something I need to do?” Unless you have been in these situations before, you may be unprepared for the unique challenges that come with a client who wishes to introduce an aircraft into their business or personal life.
Aircraft ownership and use are highly regulated by multiple government entities, and the wrong approach to owning and using the aircraft can have costly consequences. When your client calls, it is good to have at least some idea of these challenges. This article highlights five of the major areas that deserve your attention when you receive that call.
1. Tax Planning Before the Purchase Can be Crucial
If your client buys an aircraft solely for personal use, and with no intention to take tax deductions, then the way your client purchases the aircraft might not be that important for taxation purposes. However, if your client is thinking about optimizing their tax benefits and burdens, then your client should be planning ahead, preferably before the purchase. Multiple tax considerations may actually change how you should purchase or use the aircraft:
- Where you purchase and where you base your aircraft may have sales, use, and other tax consequences, maybe in multiple states. So, advanced planning is crucial.
- If your client has heard there are possible benefits from depreciating an aircraft, either on a bonus basis or otherwise, it is essential to consider how to show qualified business use for your aircraft. Both the ownership structure and the expected use can permit or prevent a client from being successful at this endeavor.
- In addition, poor planning in the aircraft ownership and use structure can expose your client to Federal Excise Taxes (FET), the same taxes you are charged for a passenger ticket on airlines like Delta or United.
Choosing the right structure up front may allow your client to take advantage of potential tax benefits and avoid major pitfalls. If possible, it is best to identify your client’s tax priorities well before they purchase or take delivery of their aircraft.
2. Aircraft Safety, as Regulated by the Federal Aviation Administration (FAA), has Special Rules that are Frequently Misunderstood and Should be Considered in Your Structuring
Advanced planning is every bit as important for FAA regulatory purposes as it is for tax purposes. But there is likely even more misinformation and bad planning with regard to FAA rules and regulations. So, it is important that professional advisors have a general sense of what works and what does not.
In our experience, one of the most frequent pieces of bad advice is that clients should always create a special purpose limited liability company or corporation to own and operate their aircraft. Those who give this advice think that the limited liability shell will protect clients from liability related to aircraft usage. Unfortunately, that advice, by itself, wrong. When a company’s sole purpose is to own and/or operate an aircraft, the FAA views the business of that company as “providing transportation for hire,” no matter how the money flows between the owners and users. As such, that company either needs to have a charter certificate, or the FAA will most likely conclude that the company is illegally operating charter flights. Further, the fact that you have created a company for an illegal purpose may well destroy any limited liability that the limited liability company might have provided.
Another example arises when an aircraft owner or operator wants to share usage of their aircraft with friends and acquaintances. Whether this is acceptable frequently comes down to the question of who has “operational control” over the aircraft. “Operational control” is defined in the Federal Aviation Regulations as “the exercise of authority over initiating, conducting, or terminating a flight.” The FAA’s position is basically this: if one person pays any sort of compensation to another person for use of an aircraft, and the person being paid is in operational control, it is likely an illegal charter. It is possible to structure use of the aircraft to avoid these pitfalls, but it requires a knowledge of the rules and proper planning.
3. Reimbursement of and Deducting the Costs of Business Use of an Aircraft is More Complicated Than You Expect
When a business owner purchases an aircraft, even when she or he does so for mostly personal use, the question frequently arises: to what extent can I run the costs of my flights through my business and make them deductible? Unfortunately, when there is a mix of personal and business use, the ability to deduct costs is also mixed.
The Internal Revenue Service (IRS) will ask whether the aircraft is used in a trade or business of the taxpayer in which the taxpayer materially participates. If the aircraft is operated by an individual (either under ownership or lease), chances are the answer to this will be “no” and the ability to deduct those costs will be highly unlikely. As discussed above, FAA rules generally prohibit individuals that operate an aircraft from receiving reimbursement for flight costs, except in very narrow circumstances.
Assuming that the aircraft is operated by a company whose business is something other than air transportation, the answer to this may well be “yes.” But then you need to ask the second, related question: can the costs of operating the aircraft be claimed as ordinary and necessary business expense deductions? To a great extent, that depends on the nature of the individual trips.
IRS rules separate a company’s aircraft use into three buckets – business use, personal non-entertainment use and personal entertainment use. Businesses need to understand that there can be significant disallowances as to the deductibility of expenses for personal non-entertainment use and personal entertainment use. The nature of the use quickly becomes more complicated depending on who is on board the flight, the reasons for the travel as to each passenger, and whether the predominant purpose of the flight was for business use. Some personal use can be deductible to the company if the usage is correctly documented as an employee benefit using what is frequently referred to as the Standard Industry Fare Level (SIFL) rules.
In order to address these and related issues, it is, once again, best to have done advanced planning. As a part of that planning, it is absolutely essential to set up and maintain contemporaneous record keeping that can track the type of use for each flight, the passengers on board, and the purpose behind each passenger’s travel (among other things).
4. International Transactions Have Their Own Unique Issues that Should not be Ignored
Whether a client is buying an aircraft from an international seller or an aircraft that has been based outside of the United States, there are a variety of issues that may need to be addressed. Major international considerations include the following, to name a few:
- Purchasing an aircraft in an international location has its own sales, use and transfer tax considerations, including value added taxes (VAT) in the EU and other non-EU countries. The tax exposure in some of these jurisdictions can be astronomical and needs to be planned for in advance.
- If an aircraft is entering the United States for the first time or after a period of a year or more outside of the United States, it will need to be Customs imported into the United States on the first flight into the country. Ideally, this should be arranged well in advance of arrival to avoid penalties and seizure by U.S. Customs.
- If your client is negotiating a new aircraft purchase from a foreign manufacturer, it is always smart to have the manufacturer deliver the aircraft FAA registered and properly imported. Buying a used aircraft internationally is often more complicated and these types of closings sometimes involve international wire payments and deregistration of the aircraft from the foreign country where it is registered. Both o these things can take more than a single business day to complete, depending on the country. Both also involve risks where the buyer might make payment but then not timely receive the title or registration to an airworthy aircraft.
- When a buyer first registers an aircraft with the FAA, the temporary registration (a copy of the registration application) is only good for domestic United States operations. This is a problem for the Minnesotan or North Dakotan who wants to hop in their new aircraft and fly to Canada to go fishing. It’s an even bigger problem for the aircraft sitting in Switzerland for which any flight is an international flight.
5. Is Your Client Buying an Airworthy Aircraft?
Last, but by no means least, first-time aircraft buyers need to realize that when they buy an aircraft, they are generally buying a very expensive asset on an “as-is, where-is” basis, unless they have negotiated other rights in their purchase agreement. Typically, this involves the opportunity to have a qualified maintenance shop inspect the aircraft to see if all maintenance has been performed and all records kept in accordance with FAA rules. This can be particularly important when buying an aircraft internationally, where it can be possible to buy an aircraft that does not have the records or approved equipment to register
the aircraft in the United States.
For better or for worse, aircraft use and ownership is often more complicated than clients imagine, but there are usually ways to work through or around the complications. A little advanced planning can go a long way toward making the ownership and the use much smoother in all respects.
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