Buying a Business Aircraft
Aircraft have tremendous potential to be a valuable tool in business. However, aircraft present themselves as a target to various federal and state tax authorities. Perhaps business aircraft got caught in the crosshairs when the CEOs of the “Big Three” flew to Washington D.C. in 2008 to request loan packages from the federal government to keep their manufacturing operations running. It is quite possible that this handful of flights was the genesis of the increased scrutiny on business aircraft; however, many tax practitioners are of the opinion that travel in general is in fact the better historic and more consistent audit flag of the IRS. Anyone that is considering acquiring and operating an aircraft to support a trade or business should carefully consider the unique challenges that aircraft present with respect to legal, tax (both state and federal) and FAA regulatory issues.
When shopping for an aircraft, range, speed, and ramp appeal factor strongly into every buyer’s decision. As enticing as the sleek aerodynamic shapes of a new aircraft are, a buyer should not lose sight of major practical considerations with state sales and use tax planning being at the forefront of the aircraft acquisition process. Many of those contemplating aircraft ownership have probably heard from a friend who owns an aircraft or even a trusted local pilot that all one needs to do to avoid sales tax on purchase is to simply form a corporation or limited liability company in a corporate-friendly state, such as Delaware or Nevada, to own and register the aircraft. The intent behind organizing the aircraft ownership entity in a corporate-friendly state is the fact that the registered agent’s address is then available for use on the FAA Aircraft Registration Application, which will then be used in the FAA’s online, publicly-searchable aircraft registration database. Delaware for instance, does not, as a general rule, disclose the identity or addresses of a company’s principals, as only the registered agent’s information is available for public consumption. While flying under the radar and hiding behind the cloak of a registered agent may have worked for many aircraft owners in the past, many states have become more aggressive in auditing and collecting aircraft sales and use tax. In many cases, it is no longer a matter of whether the state will find the aircraft and formally issue a sales tax notice, but when. Aircraft purchases are the perfect target for a state’s department of revenue auditors because such purchases involve high dollar amounts and only a single item of tangible personal property. These facts make for a fairly straightforward and mechanical audit if the buyer closes on a whim in an unfavorable sales tax jurisdiction or closes prior to obtaining a viable sales/use tax exemption. From an auditor’s perspective, auditing the purchase of a million dollar aircraft purchase is much less tedious than auditing a million dollar inventory composed of hundreds of individual items. Coupling the mobile nature of the aircraft itself with the fact that aircraft are already audit targets means aircraft buyers can face potential sales tax exposure in multiple states without proper planning. By consulting with attorneys and CPAs to do some pre-purchase planning, each buyer will be in a better position to determine its eligibility for the various sales and use tax exemptions that may be available given the facts and circumstances surrounding each particular aircraft closing and delivery.
Just as state tax laws can be rote and unforgiving, so can the internal revenue code. Proper structuring and placement of the aircraft ownership entity within a buyer’s existing business organization is an important step in the acquisition process. A good structure for federal tax purposes can improve a taxpayer’s presentation of his/her aircraft related expenses and deductions and can have the additional benefit of removing some of the IRS’ hypertechnical arguments that have been successfully used in past audits to chip away at legitimate aircraft deductions and expenses. In the last few years accelerated depreciation methods such as bonus depreciation and Section 179 expensing have been the ultimate deciding factor in many buyers’ decisions to purchase. Such front-loaded depreciation methods have the potential to generate the interest of an IRS auditor very much like the single transaction large dollar amounts do with the state taxing authorities. That is, if an auditor can successfully challenge and reclassify even a small number of flights as non-business, the auditor may be able to claw back large deduction and expense amounts with minimal effort. A successful challenge of a large accelerated depreciation or expense amount likely means a large proposed adjustment to the taxpayer’s ordinary income for the year audited. Thus, proper classification and tracking of flights is paramount in order for the taxpayer to maximize the tax savings with respect the aircraft. Characterizing and tracking each flight, as well as each and every passenger on a each flight, has recently become even more vital given the finalization of the “occupied seat rules” in 2012. (Flight and passenger characterization and the “occupied seat rules” are two topics that are beyond the scope of this article but will be addressed in a future article).
The final step in the acquisition process is to ensure that the state sales and federal tax planning and structuring do not interfere with operational limitations provided for in the Federal Aviation Regulations (the “FARs”). After all, no one wants to purchase an aircraft that cannot be legally flown. Unfamiliarity with the FARs (and the corresponding body of administrative decisions and opinions), can create operational illegalities that can potentially compromise the optimized structure the buyer was striving for in the very beginning and leave the buyer stuck on the tarmac. A smooth aircraft acquisition, along with an optimized operating structure, starts well before the first flight is ever taken.
 What many well-intentioned owners and pilots also failed to mention is that Delaware does in fact have a gross-receipts tax on aircraft sales depending on aircraft ‘size’ and that Nevada taxing authorities have the ability to impose a 300% ‘evasion’ penalty on a Nevada resident intentionally trying to avoid Nevada sales/use tax owed under the law!