In today’s fast-paced business world, air travel has become a vital tool for executives and entrepreneurs seeking efficiency, flexibility, and accessibility. While owning or leasing a business aircraft can undoubtedly provide numerous advantages, it is crucial to understand the tax implications associated with such a significant investment. This article aims to shed light on the complexities of purchasing a business aircraft, focusing on four key aspects: 1) determining whether it is more beneficial to lease or buy 2) understanding how depreciation impacts the decision-making process 3) understanding fractional ownership of an aircraft; and 4) unraveling the intricate relationship between personal use of the plane and the deductibility of expenses. By delving into these essential factors, business owners and aviation enthusiasts can make informed decisions that maximize tax advantages while optimizing their air travel requirements.
When contemplating the acquisition of a business aircraft, one of the initial considerations is whether to lease, buy, or purchase a fractional share. Each option presents distinct advantages and disadvantages, which extend beyond financial aspects. Leasing an aircraft offers flexibility, lower initial costs, and the possibility of upgrading to a newer model in the future. Buying an aircraft outright provides full ownership, potential tax benefits, and the ability to customize the aircraft to suit specific business needs. Alternatively, buying a fractional share allows for cost-sharing and access to a fleet of aircraft, providing a balance between ownership and affordability. Understanding the tax implications associated with each approach is crucial in making an informed decision that aligns with your business goals and financial circumstances.
Purchasing an Airplane:
- Depreciation: If you decide to purchase an airplane, you can depreciate the cost over its useful life.
- Interest Expense: If you finance the purchase with a loan, the interest payments may be tax-deductible, subject to certain limitations.
- Maintenance and Operating Costs: These expenses, such as fuel, insurance, hangar fees, and pilot salaries, can be deductible.
Leasing an Airplane:
- Lease Payments: Lease payments for business purposes are generally deductible as ordinary business expenses.
- No Depreciation: Since you do not own the aircraft, you cannot claim depreciation deductions.
- Flexibility: Leasing provides flexibility, allowing you to upgrade to newer models without the hassle of selling or disposing of the aircraft.
Fractional Ownership of an aircraft can mean two distinctively different things. You may choose to purchase an interest through a fractional provider or you may choose to be responsible for the joint ownership yourself and own the aircraft through a partnership.
A partnership or joint ownership arrangement is an FAA-sanctioned agreement for more than one owner to share the cost of operating a single aircraft. It differs from a fractional ownership arrangement in that it is an agreement between private owners without the assistance or support of a fractional provider, such that the joint owners are directly responsible for all aspects of flight operations and aircraft maintenance. Ownership in an aircraft through a partnership is somewhat a cross between fractional ownership and full ownership. They are far less flexible than a fractional interest in that the partners are utilizing a single aircraft, but generally are more cost effective per hour.
One of the most important questions that must be addressed is when the cost of private aviation is considered an ordinary and necessary business expense. Under IRC Sec. 162, a deduction is allowed for all ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business. The first consideration in this test is the reasonableness of using a personal aircraft versus the use of an alternative means of transportation. If business is typically conducted locally, or business travel is between major cities that are regularly served by the major airlines, it may be difficult to justify the cost of private air travel as an ordinary and necessary expense of the business. A better fact pattern occurs when the business requires flights to out-of-the-way locations without ready commercial air service, the timing and duration of business flights are unpredictable, or personal security is a significant concern.
Once the ordinary and necessary requirement is met, the next issue is to determine which costs are deductible and which are not. Since the aircraft being purchased is owned by an entity, costs need to be apportioned to each passenger on each flight and then allocated between business and personal use. Each individual passenger’s purpose for travel as the primary tax treatment driver. Costs related to business passengers are generally fully deductible. Personal use may also be further allocated between entertainment and non-entertainment.
Personal non-entertainment flights can include commuting, traveling for a funeral, traveling to visit a sick relative, traveling to receive medical treatment, or traveling to see an advisor. As long as the owner, shareholder, officer and/or other employee has compensation imputed to him for the flight for an amount equal to the imputed income required, personal non-entertainment flights are fully deductible by the partnership. The traveler may also reimburse the partnership for the amount of imputed income required which takes away the deduction for the partnership but also doesn’t increase the traveler’s compensation. There may be other opportunities to classify personal flights as non-entertainment and it would be prudent for the partnership to examine its flight logs and passenger travel more closely.
Personal entertainment flight examples could include flying to vacation locations or places specifically to visit friends or relatives. If an owner, shareholder, officer and/or other employee flies for personal entertainment purposes, the cost of the flight is only deductible to the extent compensation has been imputed to the individual for the flight. Like personal non-entertainment flights, the traveler may also reimburse the partnership for the amount of imputed income required which takes away the deduction for the partnership but also doesn’t increase the traveler’s compensation. Personal entertainment is broadly defined and generally includes all personal travel that is not otherwise categorized as personal non-entertainment.
For purposes of determining the expenses allocated to entertainment air travel of a specified individual, the partnership must use either the occupied seat hours or miles, or the flight-by-flight method. The methodology used must be used for all flights for all aircraft owned by the partnership for the taxable year. Like all the aforementioned items, documentation is of paramount importance.
It is also important to ensure that the entity structures and agreements related to the airplane usage are set up and followed correctly. This is especially important in the instance where related parties are involved. We recommend consulting with an attorney or legal team that specializes in aircraft transactions when setting up these agreements.
Purchasing an aircraft is a significant investment that comes with considerable tax implications. Contact our team for help determining the best investment strategy for your business.
The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.