Business and Tax Planning for Aircraft Owners and Operators

Transcription

1 Business and Tax Planning for Aircraft Owners and Operators McGrath North Mullin & Kratz, PC LLO First National Tower, Suite Dodge Street Omaha, Nebraska McGrath North Mullin & Kratz, PC LLO 2009

2 Goals of Today s Discussion Overview of typical Aircraft Operating Structures Highlight Key FAA and Tax Issues to Consider in Aircraft Acquisitions, Ownership and Operations

3 Introductory Why do people buy airplanes? Expensive (Black holes for $$) Subject to limitations of weather High probability of IRS audit Productivity multiplier Limited work hours in a day Face to face meetings are more effective Non-hub to non-hub airline trip may take all day How can you help your company? Adopt a structure that minimizes taxes Be aware of special rules Be careful of Bad Press Keep good records

4 Terminology FAR = Federal Aviation Regulations Wet Lease vs. Dry Lease (FAA definition) Wet Lease is lease of aircraft with pilot Includes charter operations Dry Lease is lease of aircraft without pilot Can include fuel, insurance, hangar, etc. Common assumption = without fuel FBO is Fixed Base Operator Rents aircraft to pilots May fuel, maintain and hangar aircraft Charter Company (Air Taxi) Provides on demand air transportation

5 General FAA Rules FAA rules govern US aircraft operations Primary source of guidance is the FARs Primary objective is safety of flight Aircraft operations classified by FAR Part Part 91 private operations Part 135 charter operations Part 121 airline operations Most owners use Part 91 More liberal rules But responsible for Operational Control i.e. for maintaining and operating aircraft Rationale? Will operate more safely if at risk

6 FAA Limitations and Options Sole Purpose Corporation If plane and pilots in separate corporation Solely provides transportation to others This is a charter operation Even if transport only related companies Using SMLCC does not help To FAA, SMLLC is a separate corporation Can put plane in leasing company Does not protect user from liability User must lease aircraft from company User responsible for operational control Truth in Leasing rules must apply If Large Civil Aircraft (over 12,500 lbs MGTOW) Also be careful of the Same Source Rule

7 Also Allowed Under Part 91 Can hire Management Company Manages aircraft maintenance. Provides pilots to operate aircraft. Operational Control is retained by the owner. Can lease aircraft to Charter Company Puts Aircraft on Operating Certificate. Must maintain aircraft to Part 135 standards. Crew must meet Part 135 standards.

8 Also Allowed Under Part 91 (Cont.) Other arrangements and operations Intercompany flights Co-Ownership and Joint Ownership Timeshare allows limited compensation Interchange hour for hour exchange

9 Other Arrangements and Operations Intercompany Flights FAR (b)(5) (b) Operations that may be conducted under the rules in this subpart instead of those in parts 121, 129, 135, and 137 of this chapter when common carriage is not involved, include- (5) Carriage of officials, employees, guests, and property of a company on an airplane operated by that company, or the parent or a subsidiary of the company or a subsidiary of the parent, when the carriage is within the scope of, and incidental to, the business of the company (other than transportation by air) and no charge, assessment or fee is made for the carriage in excess of the cost of owning, operating, and maintaining the airplane, except that no charge of any kind my be made for the carriage of a guest of a company, when the carriage is not within the scope of, and incidental to, the business of the company;

10 Other Arrangements and Operations Co-Ownership and Joint Ownership Joint Owner Joint Owner FAR (b)(6) and (c)(3) (c)(3) A joint ownership agreement means an arrangement whereby one of the registered joint owners of an airplane employs and furnishes the flight crew for that airplane and each of the registered joint owners pays a share of the charge specified in the agreement.

11 Other Arrangements and Operations Timeshare Owner/Operator Aircraft User Timeshare Agreement FAR (b)(6), (c)(1) and (d) (c)(1) A time sharing agreement means an arrangement whereby a person leases his airplane with flight crew to another person, and no charge is made for the flights conducted under that arrangement other than those specified in paragraph (d) of this section. (d) Reimbursable Expenses (1) Fuel, oil, lubricants, and other additives. (2) Travel expenses of the crew, including food, lodging, and ground transportation. (3) Hangar and tie-down costs away from the aircraft's base of operation. (4) Insurance obtained for the specific flight. (5) Landing fees, airport taxes, and similar assessments. (6) Customs, foreign permit, and similar fees directly related to the flight. (7) In flight food and beverages. (8) Passenger ground transportation. (9) Flight planning and weather contract services. (10) An additional charge equal to 100% of the expenses listed in paragraph (d)(1).

12 Other Arrangements and Operations Interchange Owner/Operator A Lease Interchange Agreement Lease Owner/Operator B FAR (b)(6) and (c)(2) (c)(2) An interchange agreement means an arrangement whereby a person leases his airplane to another person in exchange for equal time, when needed, on the other person's airplane, and no charge, assessment, or fee is made, except that a charge may be made not to exceed the difference between the cost of owning, operating, and maintaining the two airplanes. Hour for Hour Exchange Charge may be made for differences in owning, operating and maintaining the two airplanes.

13 Types of Taxes: Aircraft Taxes Federal Transportation Tax (FET) Federal and State Fuel Taxes State Sales and Use Taxes Federal and State Income Taxes State Property and Registration Taxes May Apply to: Purchase or sale of aircraft Use and operation of aircraft

14 Federal Transportation Tax Applies to Commercial Transportation Charter; Interco flights; Timeshare; Interchange. Rate is 7.5% of Amount Paid Add $3.70 Segment Fee In Lieu of Federal Fuel Tax Fuel Tax paid is refundable Fuel Tax is generally 1/3 of Transportation Tax Exemptions FET does not apply to: Dry Leases Not a transportation service Small Aircraft Not on Established Lines 6,000 lbs MGTOW Certain Related Company Flights Generally same as Income Tax Affiliated Group 80% ownership by Common Parent

15 Federal Transportation Tax Problem Areas Audit Tax Guide & Management Company Suggests that tax applies to owner flights If dry lease to Management Company and/or If Management Company employs pilots Both are contrary to 50 years of precedent Amendment to definition of SMLCC / QSSS Not ignored for transportation tax purposes May affect captive Charter Company

16 Federal and State Fuel Tax Federal Fuel Tax Applies to Noncommerical transportation Generally included in price of fuel Refundable if transportation tax applies State Fuel Tax May be part of sales tax or separate tax Generally included in price of fuel May be refundable under special rules

17 State Sales and Use Tax Applies to sale or use of property in State % of sales price or purchase price Sales Tax on aircraft usually easily avoided Take delivery of aircraft in friendly State e.g. Aircraft Exemption or Flyaway Exemption Avoiding Use Tax is more difficult Applies if Substantial Nexus in State If Aircraft Based in State Otherwise, more than days in State e.g. Irwin Industrial Tool case Can apply in more than one State Generally State will tax entire aircraft Must allow Credit for Taxes Paid to Other State

18 Sales and Use Tax Exemptions Sales Tax Exemptions Flyaway Exemption Occasional Sale Exemption Sales and Use Tax Exemptions Resale Exemption Exclusion Occasional Sale Exemption Aircraft Exemption Common Carrier Exemption But Federal Transportation Tax may cost more Trade-in Exemption Leasing Company Purchase exempt / lease payments taxed

19 Sales Tax Leasing Company Advantages of Aircraft Leasing Company Avoids Up Front Tax Lessor claims Resale Exemption Lessor charges tax on lease payments Greatest flexibility Can lease aircraft to other users Lease not subject to Transportation Tax Only taxed on own use Provides protection from other State Use Tax Limitations Generally, lessor must use only for lease Cannot use aircraft in lessor business Some States allow divergent use

20 Sales Tax Leasing Company (Cont.) Minimize the lease payment If possible, lessee should pay all costs Fuel, hangar, insurance, repair and maintenance May not be practical if multiple lessees Computing the lease payment Essentially includes only Cost of Capital Elements: Interest Obsolescence Tax Benefits Trade-In Exemption May be able to use in conjunction with lease If lessee trades old aircraft to lessor

21 Sales Tax Leasing Company Trap Simplest structure: User creates SMLLC User leases aircraft from SMLLC Benefits: SMLLC ignored for income tax SMLLC respected for sales tax Problem: Some States ignore SMLLC for sales tax AL; MO; SC; TN; WI; Others? Causes leasing company to disappear Possible Solutions: User should not own SMLLC Don t use SMLLC

22 Sales Tax Lease Co Trap (Cont.) Charter company allowed to use aircraft Typical Arrangement Owners pays all aircraft costs, including pilots Charter Company employs pilots Parties share gross charter revenues e.g. 15% to charter company / 85% to owner This may be a joint venture and not a lease Would not qualify for Resale Exclusion Lessor using aircraft in charter business Owner may have to pay tax on entire aircraft Even where used for charter Solution: Lease to Charter Company

23 Federal and State Income Tax Aircraft business costs are deductible Costs must be Ordinary and Necessary Aircraft are Listed Property Greater documentation requirements Subject to reduction of depreciation deduction Subject to Entertainment Facility rules Change effective October 22, Depreciation deduction is huge In 2009, Bonus Depreciation rules applied Allowed deduction of up to 60% of cost of new aircraft in 1 st year 2010: Can still deduct entire cost over 6 years Aircraft tend to retain value Standard depreciation is around 2.5% per year

24 Income Tax Depreciation Items Depreciation deduction varies 5 Year Class Non-transport aircraft 7 Year Class Transport Aircraft Listed Property Rules apply to aircraft Record-keeping requirements ADS applies if business use is 50% or less 25% or less if corporation ADS might not apply to aircraft leasing company Limitations on first year depreciation Short year (can use SMLLC to avoid) Acquisition in last 3 months Like-Kind Exchanges especially helpful

25 Like Kind Exchanges Income Tax Use Like Kind Exchange to Defer Gain Types: Simultaneous exchange Deferred exchange (old aircraft first) Reverse deferred exchange Intermediaries Qualified intermediary Exchange Accommodation Titleholder Sales and Use Tax Generally only simultaneous exchange works

26 Income Tax Business Use IRS tends to question aircraft deductions Generate unreasonably large deductions More expensive than airline Responses: Exclude depreciation deduction Not a true measure of cost Enacted by Congress to encourage purchase Private aircraft saves time Time has value Helpful case: Stanley M. Kurzet, 222 F.3d 830 (CA10, 2000)

27 Income Tax Personal Use If Sole Proprietorship (including SMLLC) Personal use is nondeductible Can deduct only business use Deduction includes: Direct costs Allocable percentage of indirect costs -Percentages = Business Hours / Total Hours If Corporation / Partnership (including LLC) Employee / Partner taxed on imputed value of use Partner reports income as guaranteed payment Employee reports on employee s W-2 at end of year Can use charter value or SIFL method to compute value Corporation / Partnership may lose deductions If Entertainment Use by Specified Individual Complicated rules for computing disallowance

28 Income Tax Personal Use (Cont.) SIFL = special aircraft valuation rule Treasury Department calculates the equivalent of first class airfare cost per mile semiannually. Company calculates SIFL valuation charged to employee based on: Size of the aircraft (Multipliers for size of aircraft and classification of employee larger multiplier for Control Employee ) Number of passengers on board Length of the flight Traditional Benefits: Employee includes SIFL value imputed costs on employee s personal tax return. SIFL value generally is a fraction of the actual cost of the flight. Company may deduct 100% of the aircraft costs. (In Many Cases) American Jobs Creation Act of 2004: Disallowance of Excess Deductions Limits the company s deduction of aircraft costs for Entertainment Use flights to the amount imputed to Specified Individuals. Specified Individuals are officers, directors and owners of 10% of any class of equity security. The Act does not limit deductions for use by Non-Specified Individuals. Allowing the continued use of company aircraft for bonuses, awards or incentives. Different methods to compute deductions. Use leasing company or charter to mitigate?

29 Income Tax PAL Limitations Cannot currently deduct losses where: Rental Activity; or Do not materially participate in the business Might apply to aircraft leasing company Exceptions: Not a rental (e.g. SMLLC leases to owner) Grouping Rules Allows grouping of related activities Exception: Cannot aggregate rental activity Exceptions to that exception: Identical Ownership Exemption Rental activity insubstantial to other activity IRS says cannot group with C-Corp

30 Property and Registration Taxes Aircraft may be subject to annual tax: Property tax (NE, KS, MO, WY) Registration tax (IA, SD) None of the above (CO) Significant difference in rates Property tax generally 1-2% of FMV Registration tax is generally nominal (IA: $5,000 maximum per year Aircraft subject to tax Property tax if have situs in State Registration tax if based in State days

31 Property Tax Computation Compute value Might use Blue Book to compute FMV Some States use table Compute Allocable Value If Domiciliary, then 100%, except: Percentage attributable to out-of-state situs Amount excluded by law If Nondomiciliary, then: Only % attributable to in-state situs; or If better, statutory %

32 Property Tax Computation (Cont.) Compute Assessed Value Some States use classification Determine tax rate Generally varies by county Many airports in separate tax district

33 Property Tax Exemptions Types 100% Exemption Business use aircraft (KS) Personal use aircraft (WY) Apportionment Large aircraft (MO) Business aircraft (TX) Economic development exemption (NE) Claiming: Might claim exemption on return Might have to file special claim

34 Property Tax Aggressive States Why should I care? I m in Iowa. Many States look for untaxed aircraft Some States take aggressive position Especially States with interstate exemption e.g. Texas and Missouri Federal Constitution applies Aircraft must have Situs in State Mere landings are not enough Requires substantial presence (e.g.>30%) Determining situs States tend to look at time on ground; not landings

35 Iowa Taxes: Typical Operator Assume: Acquire Used Lear 45: 7 years old : Purchase Price: $5 million : Leasing Company acquires and leases the Lear to its Operating parent company, which employs the pilots and operates the plane. Taxes: Sales/Use Tax: Resale exempt at time of registration: avoids 6% upfront tax: $300,000. Lease payments: $50,000/mo. Are subject to tax on amount paid. Registration Fees: If based / used in IA 30 days or more: Manufacturer s list price = $10.2 million Years from Manufacture Date Year 1: 1.0% $5,000 maximum Year 2:.75% $5,000 Year 3:.50% $5,000 Year 4+:.25% $5,000 (applies to aircraft mfg. 4 or more years prior) Property Tax: None Registration Fee applies First year Depreciation: 20% or $1,000,000 2 nd 6 th Years Depreciation: 39%;10.2%;11.52%;11.52%;5.76%

36 General Conclusions If acquiring an aircraft, it is important to adopt a structure that will minimize all taxes. Up front tax planning can save tax dollars. Requires attention to FAA rules. Have to consider all taxes. Periodically review aircraft operations. Review usage for tax and FAA problems. Confirm that company kept good records. Aircraft ownership is an opportunity. For your company to increase productivity. For you to save tax dollars for your company.

37 Disclaimer This presentation should not be considered as legal, tax, business or financial advice. This presentation is designed to provide information about the subject matter covered. It is provided with the understanding that while the speaker/author is a practicing attorney, neither the speaker nor the firm has been engaged by the attendee/reader to render legal or other professional services (unless a specific engagement agreement has been executed). If legal advice or other expert assistance is required by the attendee/reader, the services of a competent professional should be sought. Circular 230 Disclosure The following statement is required by the U.S. Treasury Department Regulations: Any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed here.

38 Thank You McGrath North Mullin & Kratz, PC LLO First National Tower, Suite Dodge Street Omaha, Nebraska McGrath North Mullin & Kratz, PC LLO 2009