When planning an aircraft purchase, one key consideration is always whether you are likely to trigger transfer taxes. Transfer taxes can take many forms, including sales and use taxes, excise taxes, transaction privilege taxes, value-added taxes (VAT, especially in Europe and Asia), and stamp taxes (when your purchase contract is executed in a jurisdiction that applies them), among others. And transfer taxes can be significant and easily reach into the tens of thousands if not millions of dollars, depending on the price of the aircraft. In general, taxes are most likely going to be triggered on your aircraft purchase based on:
- Where is the aircraft physically located when you purchase or sell?
- Where will the aircraft be based and primarily used after you purchase?
- Will your subsequent use of the aircraft involves transferring usage to third parties for compensation (such as under post-closing leases)?
These issues arise on every aircraft, whether commercial passenger aircraft, business jets or general aviation aircraft, and wherever you take delivery in the world, and in every case, you should be analyzing the situation to find and take advantage of appropriate exemptions before you purchase. Surprisingly, however, tax analysis can be particularly complex in the United States where you have 50 different state jurisdictions and potentially hundreds of local jurisdictions within each state, all with their own rules and quirks. While we do recommend working through this analysis wherever you take delivery, this article focuses on the complexities found in the United States.
Typical State Transfer Taxes and Exemptions on Aircraft Purchases
Aircraft are typically subject to sales or use taxes (or other transfer taxes) in most states. The sales tax will generally apply when the aircraft buyer purchases the aircraft in the state; use taxes typically apply when an aircraft is purchased in one state but is based in or used in another. In most states, a seller is generally required to charge the buyer sales tax on the purchase price and then remit it to the state taxing authority unless the buyer provides an appropriate exemption. However, most aircraft purchase agreements will squarely place the responsibility for paying the taxes on the buyer.
When a buyer takes delivery in one state but then moves the aircraft home to another state, the buyer’s home state will often notice the presence of the aircraft and come looking for their use taxes. In those cases, a buyer can usually offset taxes paid in another state, but a sales tax exemption in another state will not affect the right of a home state to collect. The buyer in this situation is generally required to charge itself use tax and remit it to the state where the aircraft is now based.
For all these reasons, a savvy buyer will look for a tax-friendly state, where there are no applicable taxes. Montana and Delaware are common examples. [1] When state taxes do apply, it is important to analyze the state’s rules for potential exemptions, both in the delivery state and in the home jurisdiction of the buyer. Typical exemptions include:
- Fly away exemption. Under this exemption, which many states have, if the sale and purchase of the aircraft is consummated while the aircraft is physically present in the state, and the new owner removes the aircraft from the state within a certain time period, then the transaction is not subject to that state’s sale or use tax. However, while the transaction is not taxable filings may be required with the taxing authority, such as in Florida for example.
- Purchase for resale (often under a dealer’s license, when taking an aircraft into inventory). Because the buyer (dealer) is going to resell the aircraft in a later and presumably taxable transaction, the state will not require the dealer to pay the sales or use tax when it takes it into inventory.
- Purchase for resale when resale includes leasing. This is similar to the exemption just discussed but doesn’t require a dealer’s license and the “reselling” is the leasing of the aircraft to another individual or entity. The owner must charge the lessee sales tax on the rent payments and remit it to the state taxing authority but avoids having to pay sales or use tax on the full purchase price upfront, making this exemption more of an extended sales and use tax payment plan.
- Isolated and occasional sale exemption. Some states, such as Utah, use their isolated and occasional sale exemption as a form of limited fly away exemption. For an aircraft sale and purchase transaction to close while the aircraft is in Utah without triggering a potential Utah sales or use tax liability, the seller cannot be regularly engaged in the sale of aircraft anywhere in the world and the buyer must promptly remove the aircraft from Utah.
The harder analysis has to do with the home-state base of the aircraft, where the buyer’s future conduct needs to align with the exemption, and not just the day after the purchase but possibly during the entire ownership period. Purchase for resale (with lease), in particular, can have many pitfalls for the unwary buyer.
Parsing the Purchase for Resale Exemption – It’s All About the Lease
Under a purchase for lease exemption, a buyer can potentially avoid paying taxes on the original purchase, but each lease transaction itself is a taxable event as to the aircraft. As such, the buyer typically needs a sales tax license and to collect and remit tax payments during the life of their ownership of the aircraft. While many states allow something similar, each state has its own variations. Some of the state requirements include:
- The leasing must be the only use of the aircraft and the lessor must never be the operator. Failure to meet this requirement results in the original purchase being taxable retroactively, with penalties.
- Some states would argue that leasing solely to an affiliate is a sham transaction and therefore will ignore the leasing arrangement.
- Other states say the lease must be exclusive to one entity.
- A few states, like Ohio, require accelerated sales tax payment where the owner must charge the lessee sales tax on all the lease payments over the entire lease term upfront and remit it to the state.
- Some states, such as Indiana, require that the lease revenue must exceed X % of the purchase price in order to qualify so the taxing authority receives the tax revenue within a certain amount of time. In any state, there is also a potential pitfall that a below-market rent might disqualify you from the exemption (as discussed further below).
Buyers also need to be aware that in some states, leasing will be considered a taxable event whether or not you paid sales taxes on the purchase. For instance, Iowa will allow leasing without being subject to tax if the taxes were paid on the original purchase. And some states, such as Wisconsin, require sales taxes on the purchase and subsequent leasing of aircraft.
Avoiding Common Mistakes
Specifics of the exemption aside, there are also some common themes that should be considered for a buyer using a lease structure. They include:
- Follow corporate formalities. This helps ensure the state taxing authority views the entity as a legitimate business.
- Understand the ownership and leasing structure and follow through with it. This makes sure the state taxing authority views the purchase and resale (lease) transaction as legitimate. Have a written lease and ensure it is executed at the time the aircraft is purchased (or shortly thereafter) as the state may have a time limit within which the exemption must be claimed. And follow the terms of the lease. For example, the owner should invoice the lessee and the lessee should timely pay the rent payments due under the lease.
- Lease payments should be arguably market rate. This will prevent a state tax authority from disregarding the lease transaction and imposing their own, and usually much higher, lease rate. A Gulfstream jet owner should not charge the lessee $100 per flight hour, similar to what an aircraft owner in Ohio attempted to do but ended up with a large tax bill. [2] The owner needs to justify that the rate it charges is market rate or at least not unreasonable. Some states require the owner to charge a rate that will result in the sales or use tax that would have been due had the purchase or resale exemption not been used being paid over the course of a certain time period, like Indiana with the lease payment required to be at least 7.5% of the purchase price per year. Charging a lease rate others are charging for the same or comparable aircraft is also another way of determining a market rate.
- Keep records of everything. This will allow the owner to survive a state tax audit. Many states’ laws require taxpayers to keep accurate books and records. Additionally, state tax authorities generally don’t give much weight to self-serving statements unless they are backed up by other records. For example, software such as Quickbooks is great for tracking income and expenses, but a Quickbooks report prepared by the owner isn’t given much weight by auditors unless the owner can produce other records such as bank statements or invoices to back-up the accuracy of each entry. Thus, keeping records from third parties, such as maintenance invoices and bank statements, is extremely important. And make sure these records correctly identify the owner and operator of the aircraft.
Other Considerations
You should also be aware that state transfer taxes are not the only state fees to be aware of. Some states also impose registration taxes and fees and personal property taxes on aircraft. All tax aspects of purchasing and owning an aircraft should be addressed prior to purchasing the aircraft and on an ongoing basis to avoid falling victim to an overzealous or aggressive state taxing authority, many of which view aircraft owners as easy money due to the simple fact that aircraft are expensive and therefore require an owner with deep pockets.
Need help analyzing your tax situation and structuring against potential pitfalls? FMJ assists aircraft buyers from around the world with US tax analysis and we would be glad to assist. Please contact Nathan Haynor at nathan.haynor@fmjlaw.com or Kevin Johnson at kevin.johnson@fmjlaw.com.
[1] Many people also consider whether to take delivery of aircraft over international waters, believing that there are no applicable laws and therefore no taxes. While this is true, be aware that certain aviation authorities (including the FAA) frown on this and would view you as illegally flying (and landing) an unregistered aircraft once title has transferred.
[2] See Pi In The Sky, L.L.C. v. Testa, 155 Ohio St.3d 113, 2018-Ohio-4812. Available at https://www.supremecourt.ohio.gov/rod/docs/pdf/0/2018/2018-Ohio-4812.pdf
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